CY19: strong close for PAKT

While cigarette production is on a decline in Pakistan, a surprisingly strong fourth quarter has helped the tobacco giant Pakistan Tobacco Company (PSX: PAKT) produce healthy calendar year-end results. It is quite some feat that despite a decline in net revenues, company’s bottomline saw a double-digit expansion during the period under review.

Formal tobacco industry has been under a cloud since PTI’s mini-budget (March 2019) and the last federal budget (June 2019). Fiscal measures in the two money bills impacted the industry as the effective FED rate on cigarette sales in the formal sector was enhanced. This measure, ‘effective FED’ rate, is the share of federal excise duties (FED) in gross turnover.

The result of higher FED in the last year was lower amount of gross revenues being retained by firms such as PAKT for their P&L. For PAKT, the effective FED had risen to 50 percent of gross turnover in CY19, compared with 46 percent effective FED rate in CY18. This brought down company’s net turnover to 35 percent of gross turnover in CY19, from almost 39 percent in the year before.

However, the topline decline was mitigated by favorable movements among a mix of operating and non-operating factors. The double-digit decline in cost of sales, amid rising input costs, is perhaps explained by lower production volumes, which reduce the dominant head under cost of goods manufactured. The selling & distribution expenses declined, and administrative expenses posted a rather controlled growth.

Massive growth in ‘other income’ – thanks mainly to a large reversal/writing-back of liabilities – helped offset the spike in company’s forex-related losses parked under ‘other expenses’. The aforementioned factors, in the end, helped PAKT achieve a sizable and disproportionate expansion in net profits.

From the government’s perspective, 2019 turned out alright for its tobacco taxes. Latest financials show that PAKT’s tax contribution to the federal kitty during CY19 is over Rs102 billion, a growth rate of 15 percent over CY18. The belief that ‘higher FED works’, would get strengthened by the fact that about 86 percent of the Rs13.5 billion in additional taxes for the year have come from growth in FED rate. However, 4QCY19 FED collection was almost flat at Rs20 billion compared to same period previous year.

Given the limits to further increase FED amid declining production in the formal sector, it remains to be seen if the federal government will go for another round of FED hike in next budget. Tobacco industry is complaining about FED hikes distorting the market, but prospects for lowering the FED are moot. The government seems to have very limited political capital in the current economic situation. It is likely to avoid a situation where it is seen to be pandering to any industry’s demand for relief.