Under increasing international pressure, four leading international tobacco manufacturers have joined the US and European companies behind the Russia-Ukraine conflict.
In early March, all the major cigarette manufacturers announced they would suspend operations or pull out of Russia altogether, although some were less enthusiastic than others, after the United States, the European Union and Britain imposed economic sanctions.
After initially announcing that it would suspend its planned capital investments in Russia, BAT quickly reversed course: on March 11 it announced that its ownership of its Russian operations was no longer sustainable in the current international environment, which it described as a "highly complex and exceptionally volatile" issue.
At the same time, BAT is in advanced negotiations to transfer its Russian operations to the SNS Group of companies, which has been a distributor in the country since 1993. According to SNS, production levels and supply and distribution chains will be maintained through transfers. BAT cut its annual revenue growth outlook to 2-4 per cent from the 3 per cent it announced in February because of BAT's exit.
Bat took action after a Russian government committee approved the nationalization of the assets of departing foreign companies. On March 10th Russia's ministry of Economic Development published a draft bill that would give Vnesheconombank, a state-owned firm, and the State Export Guarantee Agency the right to seize the property of foreign companies that leave the Russian market on their own.
KIngsley Wheaton, BAT's chief marketing officer, told Reuters in an interview that the proposed law would treat a company's decision to exit a business as a criminal bankruptcy and authorize authorities to initiate criminal justice proceedings against local management.
After announcing plans to scale back its Russian operations on March 9, Philip Morris International in late March specified specific steps it would take, saying it was studying an "orderly" exit from the Russian market. The company said it had stopped offering some cigarette brands on the market and suspended marketing activities. In addition, it has cancelled all product launches planned for Russia this year, including the launch of its new tobacco heating product (THP), IQOS Iluma, and plans to produce over 20 billion Terea sticks, which are consumables for IQOS Iluma. Production of the latter would have involved an ongoing investment of $150 million, which the company also canceled.
Meanwhile, JTI initially limited its withdrawal from Russia to suspending all new investments and marketing activities and launching its latest THP Ploom X. However, on March 9, the company announced that it would also cease operations in the country and halt all sales and marketing activities.
Imperial Brands, which has a relatively small footprint in Russia, announced on March 15 that it had begun talks with a local third party about the transfer of its Russian business assets. "We believe that under the current circumstances it will be in the best interests of our Russian colleagues to proceed with an orderly transfer of our operations as a going concern," Imperial Brands wrote in a statement.
In addition to the Actions in Russia, all four cigarette manufacturers have temporarily closed their production bases in Ukraine to protect their jobs and promised to continue paying employees in the affected countries.
"The decision to leave Russia not only has financial consequences, but also practical challenges."
(Photo: Tobacco Reporter file)
The horns of a dilemma
In deciding on a course of action, cigarette makers face a dilemma: leave and protect their reputation, or stay and continue to benefit from the world's fourth largest tobacco market.
The decision to leave has not only financial consequences but also practical challenges, says Jon Fell, a partner at Ash Park Capital. "Said 'we no longer send our luxury handbags or fashionable trainers to Russia' is one thing, but if in addition to the factory or distribution center, do you have hundreds or thousands of workers in the country - so far, they have long been regarded as an integral part of your international company - then you must make a difficult and complicated decisions, and have no obvious simple, "The right answer," he said.
"It takes time to sort out the mess, and you can't just abandon people," Fell added. "I don't think the overall approach of the tobacco industry is very different from that of other consumer packaged goods companies, quite a few of which now continue to do business in Russia -- and have been criticized for it.
Russian cigarette makers sold 206bn cigarettes in 2020 with an estimated value of $717bn, according to Euromonitor International. The market has been declining at a compound annual growth rate of 6 per cent over the past decade and nearly 7 per cent over the past five years.
Meanwhile, the country has developed into a promising market for THPs, which will account for 11% of the total tobacco market by 2021, according to Moningstar, making the country one of the largest markets for these products outside Asia.
With a 38 per cent share of sales in 2021, according to Euromonitor, JTI has the largest exposure to Russia among tobacco multinationals. The company, which acquired Donskoy Tabak in 2018, has four factories and 4,000 employees in the country. It has invested more than $4.6 billion in the past 20 years. In 2020, it accounted for 1.4% of Russia's state budget. According to Morningstar, Russia will account for nearly 16% of group sales in 2021.
It's one thing to say, "We no longer send our luxury handbags or stylish training shoes to Russia," but if you have hundreds or thousands of employees in the country in addition to factories or distribution centres, then there is no obvious simple, right answer.
Jon Fell, Partner, Ash Park Capital
A high price
For PMI, Russia accounted for nearly 10 percent of cigarette and THP unit shipments and approximately 6 percent of its total net revenue in 2021. The company, which has a 26 percent market share, has three factories, more than 100 sales outlets and about 4,100 employees in the country. PMI Ukraine operates a factory in Kharkiv with about 1,300 employees, which accounts for about 13% of PMI's regional sales and nearly 2% of PMI's total net revenue in 2021.
Morningstar expects PMI tobacco volumes in Eastern Europe to fall 45 percent in 2022 and recover slowly thereafter, as the collapse of the ruble is likely to cause translational currency pressures.
Russia and Ukraine are both important markets for IQOS, accounting for about 23% of PMITHP sales. PMI's shipments of THP consumables in Russia increased from 13.6 billion to 16.3 billion in 2021, while cigarette shipments continued to decline. However, given Russia's deteriorating economic outlook following international sanctions, analysts at JPMORGAN questioned whether PMI could still meet its next generation product growth targets. Morningstar assumes the PMI writedown could be about $7bn, or 5 per cent of the company's market capitalisation, if markets exit.
Ukraine and Russia together account for 3 percent of BAT Group revenue in 2021 and a slightly lower percentage of adjusted profit, the company said on its website. Morningstar estimates that the majority of net revenue (2.5 per cent) in both countries comes from Russia, and BAT has a 25 per cent market share in 2021, according to Euromonitor. Bat employs about 2,500 people in Russia, with a factory in St Petersburg and 75 regional offices. Since entering the market in 1991, it has invested more than $1 billion in Russia. Morningstar estimates that bat's business will lose about $2.2 billion in value, or 2.4 percent of its market capitalization, as a result of the Russian withdrawal.
Imperial Brands is a distant fourth, with 8 per cent of the Russian cigarette market. It operates a production base in Volgograd and employs 1,000 people. Ukraine and Russia together account for about 2 percent of net revenue and 0.5 percent of adjusted profit by 2021, the company said. Because of the limited profit contribution from those markets, Imperial Brands explained that it expected the impact on its fixed-currency adjusted earnings to be "relatively small".
Find another way out
How the retreat of multinationals will affect Russia's illicit cigarette market is anyone's guess. "It is difficult to know how demand and supply of tobacco products in Russia will evolve, given all the circumstances of sanctions, tobacco industry ownership and local purchasing power," Fell said. "I would certainly see an increase in the size of the illegal market as a risk, and it will depend on how long it continues. Illegal cigarette sales accounted for 10.7% of Russia's total tobacco market in 2021, up from 4.6% in 2017, according to Statista.
Much will depend on how long the conflict lasts. Given the heavy investment in Russia over the past 20 years, it is safe to assume that cigarette makers will do their best to minimise losses. These companies have established a strong position in the Russian market and there is demand for their products.
"I would be surprised if any company that exits Russia now -- not just tobacco manufacturers -- does so to prevent them from going back in the future, assuming that at some point the war stops, relations normalize and a return to Russia becomes conceivable," Fair said. "However, arranging this in a way that allows you to say that you have temporarily left the country is undoubtedly very tricky and can lead to decisions that take some time to be reached and implemented.