OVERVIEW (July 04 2009): The country's cigarette market is the 18th largest in the world. There are 57 tobacco manufacturers currently operating and around 78% of the market share belongs to two corporate giants: Pakistan Tobacco Company, a subsidiary of British American Tobacco, and Phillip Morris International (PMI), which acquired Lakson Tobacco Pakistan, in February 2007. Pakistan Tobacco Company Limited (PTC) is part of British American Tobacco; the world's most international tobacco group, with brands sold in 180 markets around the world.
The company produces high quality tobacco products to meet the diverse preferences of millions of consumers, and it works in all areas of the business - from seed to smoke. Pakistan Tobacco's operations in Pakistan began in 1947, making it one of Pakistan's first foreign investments. Pakistan Tobacco provides a number of reputed brands of cigarettes to consumers in Pakistan, including Benson and Hedges, Embassy, Gold Flake, Capstan and Gold Leaf. Over the years, Pakistan Tobacco has shown a rising trend as evident from the impressive growth in gross, net and operating profits, with the operating profits growing by 28% and net profit growing by 44% in 2006 compared to the previous year.
The strong financial performance is attributable to significantly higher sales volume, improved margins across all brands, and continued control over cost through focus on operational efficiencies and other initiatives. The company maintained double-digit volume growth in 2006 with a record sales volume of 34.5 billion sticks - 13% higher compared to the same period last year (SPLY). This is a remarkable performance keeping in view the overall industry growth which is estimated at 3%. Gold Flake remained the volume leader in the portfolio and grew at a phenomenal rate of 27% vs. SPLY, whereas Gold Leaf maintained its volume base.
RECENT RESULTS 1Q09
The company achieved a sales volume of 11.1 billion sticks during the period. The growth is driven mainly by Gold Flake, while Gold Leaf led the way in driving value.
PTC's gross turnover and gross profit are higher vs. SPLY by 18.7% and 9% respectively. The gross profit margin was, however, lower by 3.96ppt mainly due to high material costs on account of inflation and sharp devaluation of the rupee during the second half of 2008. The power shortage in the country has also resulted in an increased use of generators adding further to the cost base during 1Q09. The net turnover however was higher by 20% to Rs 5.4 billion, while the cost of sales were up by 28.5% due to inflationary pressures as well as above mentioned factors. Marketing expenses swelled by 35% in order to maintain and increase market share. The bottom line showed slight improvements, with PAT up by 3% to Rs 854 million with an EPS of Rs 3.34.
FINANCIAL PERFORMANCE FY08 In terms of volume alone, PTC managed to sell 41.5 billion cigarette sticks, an increase of 12%. Compared to sales volume of the tobacco industry, which increased by only 2.4%, sales volume growth of PTC was remarkable. Due to this, the company increased its market share by 1.3% to a new level of 46.4%. This is thanks to two of the company's high performing brands, Gold Leaf and Gold Flake. Gold Leaf is the company's main value generator, growing at a healthy 10%. On the other hand, Gold Flake is the fastest growing brand in the market with a growth rate of 19%.
PTC managed to post a strong performance in FY08 in spite of the adverse economic situation prevalent in the country during the time. Factors such as inflation, rupee devaluation, high fuel costs, damage to company property and operations due to terrorism, and an overall recessionary trend did not dampen the sales of PTC. In fact, the Sales Turnover reached a new high of Rs 49 billion in FY08, up from Rs 41 billion in FY07. The gross profit was Rs 7.28 billion, an upsurge of 11.8% from previous year's Rs 6.52 billion. The profit for the year increased by 4.9% to Rs 2.53 billion from Rs 2.42 billion a year earlier.
Profitability of Pakistan Tobacco Company has witnessed a decline, but only to a nominal extent. Gross profit margin has come down to just below 15%, a change of nearly one percentage point from its last year's figure. This trend was seen as sales turnover of the company grew by a robust 20% but the growth in gross profit was only 12%. Many factors have led to this trend. One of them is the increased government levies for all tobacco product and producers in the form of custom duties, government sales tax and especially Federal Excise Duty (FED). In fact, the government had announced a further increase on FED on tobacco products in February 2009. Therefore, the effect would also be seen in the company's performance of the next year.
Secondly, the cost of sales rose by over 21% in FY08. Primarily, this was due to the inflationary pressures in the country, along with the high international and local oil prices. Understandably, the purchase costs of raw material and fuel and power costs contributed a hefty portion of the increased cost of sales. The profit margin of the company was down to 5.16% from FY07's 5.90%. Mainly, this can be attributed to a great increase in the administration expenses which rose by 26%. Within administration expenses, there were prominent increases seen in the Salaries and Wages as well as in the fuel and power categories.
These are quite obvious due to the prevalence of high inflation in the economy. Aside from these, administration expenses included great upward movement in repair and maintenance and travelling, accounted for by the relocation and repair costs borne by the PTC since it lost its head office in the Marriott bombings. Secondly, a lower profit margin for FY08 was also due to a surge of other expenses by a whopping 89%. Again, these were the result of costs that were a result of head office relocation. Furthermore, nearly half of other expenses are made up of costs of business restructuring, which the company is going through at the moment. The net Income grew by 4.63%, which was slower than the growth seen in total assets of the company.
This is what pulled the return on assets down marginally to 24.36%, a 0.2% decrease in one year. The company's assets grew by an overall 5.79%. This was the average of the growth rates seen by fixed assets, showing a greater growth of around 8.6%, and of current assets, which grew by 2.1% only. The return on equity, however escaped this downtrend seen in profitability ratios. ROE went up to 70.2% in FY08 compared to 65.1% last year. The reason why ROE witnessed an upsurge, in contrast to other related ratios, was that the total equity of PTC has seen a decline of 2.6%, mainly on account of decreased levels of Revenue reserves which declined by 8.4% from their figure in FY07. There was no change in the share capital of PTC in the year under scrutiny.
The liquidity position of PTC worsened in the financial year 2008. Following a declining trend since 2006, the current ratio reached a level of 0.90 in 2008, down from 0.96 a year earlier. Basically, this happened because much more growth was seen in the firm's current liabilities compared to its current assets. In the year 2008, current liabilities grew at almost 8% while current assets' pace of growth was little over 2%. In fact, due to the slow growth Current now constitute 45.6% of all assets, while previously they formed 47.23%. The main head making over 85% of current assets is that of stocks-in-trade, which only grew at 1.5%, bringing down the growth rate of current assets.
Similarly, the main growth driver of current liabilities was trade and other payables, which grew at a rate of 21.9%. Trade and other payables form about 83% of all current assets. If we analyze further, we find that payables as FED to the government form nearly half of trade and other payables, and they grew by 30%. Something similar was witnessed in the sub heading of sales tax payable to the government. Thus, we find that a large part of the current liabilities grew because of the presence of payables to the government in the form of tax.
PTC's asset management has been very commendable in the recent past, and the same can be said about the year 2008. Inventory Turnover Ratio was 36.4 days in 2007, which improved to 31.2 days in FY08. Virtually, PTC's entire inventory is in the form of Stock-in-Trade, which has only grown by 1.5% in 2008. Comparing this with the 11% growth seen in Sales Turnover, the result is a faster inventory turnover. Thus, PTC was able to grow its sales by 11% by not even increasing its inventory by 2%, which is quite a feat.
One of the most striking features of PTC's asset management is its day sales outstanding ratio, which is at an astoundingly low level of 0.02 days. The ability to convert its credit sales into cash so quickly is a great achievement of the company. As a result, the company boasts an operating cycle of 31.21 days, down from 36.46 days in FY07. In FY08, the total assets turnover ratio has improved to 4.72, an increase of 0.56 compared to the previous year. Growth in sales turnover has outpaced that of total assets by almost two times which led to a better TATO.
As we have discussed before, Total Assets had grown at 5.8%, out of which Current Assets grew at a slower rate of 2.1%, while Fixed Assets grew by 8.64%. The major growth driver of fixed assets was the head of property, plant and equipment, which makes up 54% of all assets of PTC, and which grew by 8.4% on account of additions to plant and machinery. Despite this, the growth shown by either fixed or current assets was no match for that of the sales turnover. Deterioration was witnessed in PTC debt management ratios. The debt-to-asset ratio increased to 0.65 in FY08, up from 0.62 in FY07. A similar increase was seen in the debt-to-equity ratio which was previously on the level of 1.65, but grew to 1.88.
The reason for both these trends is the high growth rate of liabilities, both current and long-term, compared to the slow growing assets, and the declining equity. The effect is even more pronounced in long-term debt-to-equity, which was 0.44 in FY08, a long way from its previous figure of 0.35. Long-term liabilities of PTC grew by 21%, mostly due to the 51% increase in the retirement benefits which were a result of the changes made in actuarial projections.
The Times Interest Earned ratio was at 74.02 in FY08 as compared to 74.80 a year earlier. The EBIT of the company was up by 4.6% but the Finance Costs of PTC had seen a greater increase of about 6%. Thus an increase in Finance Cost of 6%, considering the high interest rates prevalent in the economy, was not able to bring about an equal rate of increase in EBIT. This deteriorated the TIE ratio to its current level.
PTC has been lukewarm when it comes to its market value. It must be mentioned that its dividend payout ratio has been high, although its dividend for FY08 of Rs 9.65 is lower than that of 2007 by Rs 0.25. The earnings per share was up by 4.65% from Rs 9.47 in 2007 to Rs 9.91 in 2008. The price-to-earnings ratio tumbled to Rs 10.73 from Rs 16.42, mainly on account of a lower market price in 2008. This was due to the ill performing stock exchanges of the country after the economic shocks it sustained in the year, a contrast to the high flying year of 2007. The book value per share has decreased slightly as the equity of the company saw a small decline while the number of outstanding shares remained constant.
FY03-FY07 In 2007, the company posted a record level of sales and profitability. Operating profit grew by 29% to Rs 3,973 million and profit after tax grew by 27% to Rs 2,413 million. Contribution to the government's revenue amounted to Rs 26 billion, an increase of approximately 15% over the last year. Underpinning this exceptional financial performance were factors such as strong organic volume growth, efficient cost management, continued investment in our brands and people, and most of all the consumers who continue to support our brands.
Sales volume, at 37.2 billion sticks, grew by 8% during the year ahead of the industry growth that was estimated at 2%. Market share also grew by 1.7 percentage points, further strengthening our position as the market leader in the domestic tobacco industry. PTC further strengthened its brand portfolio with the launch of new variants, limited edition products and packaging, consumer promotions, and effective presence across key market segments. Cost of sales increased by 14% in 2007 over last year and this was mainly due to higher production volumes and inflation.
However, the Company was able to derive benefit from economies of scale (highest ever production) and various cost control initiatives in its supply chain. As a result, increase in cost per unit was contained at 6% over last year, which is well below inflation. Improved financial performance of the Company translated into a significant increase in its operating cash flows. Though they were partially offset by higher dividend payments and investment in plant and equipment during the same period, yet it resulted in a net increase in cash amounting to Rs 358 million in comparison to a net decrease of Rs 887 million in 2006.
In line with its drive to invest in latest machinery and facilitate up-gradation in its technology footprint to meet the industry's increased demand, the Company invested Rs 1.2 billion in tangible fixed assets in 2007. Moreover, various process optimization initiatives were undertaken at both the factories to further strengthen supply chain's competitive advantage. The liquidity of Pakistan Tobacco has remained barely above 1 for the past couple of years, and actually fell in 2006 compared to 2005. This is because despite improved profitability on account of strong financial performance the company's cash outflow remained higher than inflow mainly due to higher income tax, dividend payment and capital expenditure. Consequently, there was not a significant increase in the current assets as opposed to the current liabilities.
Pakistan Tobacco's asset management ratios depict a healthy trend of improving inventory management and improved credit policies. Both the inventory turnover (days) and the days sales outstanding have decreased, indicating that the company has been able to utilize its inventory at an optimally better level each year, and has been able to receive cash from its debtors over shorter periods of time subsequently over the lapse of time. Even though the inventory turnover has increased in 2007 the overall operating cycle has improved tremendously, falling from around 57 days in 2003 to around 36 days in 2007. As far as the fixed assets are concerned, recently the Company spent Rs 1.2 billion (Rs 0.5 billion more than the previous year) for acquiring latest machinery to cater for increased demand and to facilitate up gradation in the technology footprint.
With the phenomenal growth in sales over the past couple of years and efficient utilization of property plant and assets, the overall total asset turnover ratio has also shown a rising trend over the years. The total asset turnover ratio exceeded 3 in all the five years, hence bearing substance to the efficient asset management practices of the company. The Interest Coverage Ratio of Pakistan Tobacco has improved phenomenally over the past couple of years.
It has increased from 7.68 in 2003 to 74.8 in 2007, showing that over the years, the company, with improved operating margins, has improved on its ability to pay its financial costs pertaining to interest payments. However, the long term debt to equity ratio of the company increased over the years as well, primarily due to an increase in the deferred taxation of the company. However, the reliance of the company on long term debt is negligible, the only long term debt arising through taxation. Total dependency on debt financing is on average 50%, the main component of debt being the short term loans and payables.
FUTURE OUTLOOK The ratification of Framework Convention for Tobacco Control (FCTC) by Pakistan, coupled with marketing restrictions of various kinds has not bid well for tobacco manufacturers. Furthermore, there have been increased taxes and duties levied by the government on tobacco products and producers. In fact, in February 2009, the government increased the Federal Excise Duty on tobacco products. Considering that the cost of doing business will not subside in the near future for manufacturers due to prevalence of high inflation and fuel costs, these factors would hurt the future earnings of PTC.
The Federal Board of Revenue (FBR) has proposed levying of Rs 4.75 per ten cigarettes as federal excise duty on the retail price of a packet selling for up to Rs 10; Rs 4.75 per 10 cigarettes plus 70 percent over every incremental rupee on retail price of a packet of Rs 10-19; and 64 percent federal excise duty on retail price of over Rs 19 per pack. The above measures are due to discourage the customers from consuming high cost brands and switch over to illegal sector, thus adding to the woes of tobacco industry.
COURTESY: Economics and Finance Department, Institute of Business Administration, Karachi, prepared this analytical report for
Business Recorder.
DISCLAIMER: No reliance should be placed on the [above information] by any one for making any financial, investment and business decision. The [above information] is general in nature and has not been prepared for any specific decision making process. [The newspaper] has not independently verified all of the [above information] and has relied on sources that have been deemed reliable in the past. Accordingly, the newspaper or any its staff or sources of information do not bear any liability or responsibility of any consequences for decisions or actions based on the [above information].
Copyright Business Recorder, 2009 
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