Will Russia's Monkey Wrench Cripple the Tobacco Industry?


Chalk up another strike against Big Tobacco. For a change, however, it isn't domestic tobacco producers that are on the defensive but global companies that could be facing a whirlwind of change if Russia, the world's third-largest tobacco market, is successful in implementing stringent anti-smoking laws.

Passed by Russian President Vladimir Putin in February and going into effect yesterday, new regulations ban smoking at schools and universities, in hospitals, sports facilities, and museums, and on public transportation. Smoking is predominantly banned in these areas already, but this is more of a uniform countrywide ban, as Reuters notes.

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The real challenge is coming up next year, when the smoking contingencies widen to include a ban in cafes, restaurants, hotels, and street kiosks and will set a minimum countrywide price on a pack of cigarettes. Outside of mandating a new minimum price that would certainly be much higher than the current price, this is sounding awfully familiar to some of the policies enacted by California and the city of New York.

The purpose behind President Putin's actions is to reverse a precipitous downtrend in life expectancy rates for Russia compared with other developed countries that have significantly lower smoking rates. In Russia, about 40% of the population smokes, and if we learned anything from the Tackling Cancer series I just wrapped up, the chances of getting nearly any of the most commonly diagnosed cancer types, as well as a plethora of other common diseases like diabetes, can be exacerbated by smoking.

Russia's move could pose a threat to global cigarette producers such as Philip Morris International and British American Tobacco. Although both tobacco producers operate around the globe, a dramatic shift in curbing smoking from the world's third-largest tobacco consumer is bound to sting. In Philip Morris' case, according to Trefis, Russia accounted for approximately 6% of its total revenue last year, and the Eastern Europe, Middle East and Africa region accounted for roughly one-quarter of sales.

Luckily for Philip Morris and British American, burgeoning middle-class growth in China and India could prove to be more than enough to curb any sales weakness in Russia, but the potential for a "monkey-see, monkey-do" effect could be an even more worrisome signal that the glory days for Big Tobacco are in the rearview mirror.

Things aren't much better here, either
Domestically, Altria and Reynolds American have performed well, all things considered, with both stocks near an all-time high (adjusting for Altria's spinoff of Philip Morris International). However, the underlying fundamentals of the U.S. tobacco business aren't nearly as good as their stock prices would indicate. Altria laid off 15% of its workforce and Reynolds American 10% in response to falling cigarette volume. Furthermore, in President Obama's budget proposal, the federal cigarette tax would be raised 93% to $1.94 per pack, making it even more burdensome on American consumers to purchase a pack of cigarettes.

Few domestic tobacco producers are prospering, with the exception of Lorillard , which has seen a decade's worth of market share gains thanks in large part to the success of its premium Newport brands and its discount brands such as Maverick. Unfortunately for much of Big Tobacco, what gains these companies do see in the volume of discount cigarette sales, they are losing in their margins, which are often much lower than premium brands, making it much tougher for tobacco companies to simply maintain their profits as the number of smokers slowly dwindles.

So much for safety
I think it's fairly safe to say that the tobacco industry is no longer the safe bet it once was. I've been harping for two years now about the dangers of the domestic tobacco industry, with U.S. laws becoming more smoking-repressive. I've certainly been wrong, with Altria and Reynolds advancing higher in spite of weak volume growth. However, the long-term trend bodes poorly for each company, with U.S. lawmakers progressively angling toward more restrictive smoking measures.

The real about-face could come from the international market, but we're probably still a few years away, if not longer, from seeing that happen. I feel the chances of seeing India or China adopt stringent anti-smoking laws is pretty slim. We could, though, see more developed countries follow the example of the U.S., and Russia and take a hard-line approach to smoking in public places. I don't see how this will have any positive impact whatsoever on the sector as a whole and would, yet again -- outside of Philip Morris, which has the most globally diverse product portfolio of any publicly traded tobacco company -- suggest keeping your distance.

Is this your best bet in the tobacco industry?
Tobacco companies have been under siege in the U.S. for decades, as waves of litigation, regulation, and anti-smoking campaigns have given the industry a black eye. Yet Philip Morris International focuses on overseas markets, where business prospects generally look brighter. Investors have been happy with its stock's performance, but is Philip Morris still a buy? Find out in The Motley Fool's premium research report on the company, which includes in-depth analysis of its opportunities and challenges ahead. To claim your report just click here now.

The article Will Russia's Monkey Wrench Cripple the Tobacco Industry? originally appeared on Fool.com.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.The Motley Fool owns shares of Philip Morris International. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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