Price increases and stronger product mixes will help European tobacco companies stub out the negative effects of new plain packaging regulations and declining volumes, according to new research from Moody's.
European tobacco giants Imperial Brands, Philip Morris International (PMI), British American Tobacco (BAT) and Swedish Match will stay resilient and experience steady operating profit growth of around four to five per cent in the next 12-18 months, excluding foreign exchange rate effects.
Although cigarette sales have diverged in developing markets in recent years, Moody's forecasts tobacco companies will make up for volume losses with price hikes.
"While smoking continues to increase in the Middle East, Africa and Indonesia, cigarette consumption is declining in Russia, most Eastern European countries and South America as a result of very large excise increases, anti-smoking legislation and consumers' lower disposable income," said Ernesto Bisagno, Moody's vice president and senior analyst.
"However, we expect that tobacco companies will more than offset the impact of declining volumes with price increases."
In addition, more stable oil prices and an easing up of foreign exchange volatility should support emerging market currencies and moderate FX impacts on operating profit in the next 12 to 18 months, Moody's said.
Western Europe: Plain packaging and lower volumes
In Western Europe, cigarette volumes are projected to fall by around one to two per cent over the next year and a half - slightly higher than a drop of 0.7 per cent registered in 2015.
These declines will nonetheless be more than offset by higher prices and improved product mixes, Moody's said, as the firms expand into growing areas such as e-cigarettes and heated tobacco, as well as further benefiting from cost efficiency and streamlining programmes.
The main downside risks for the sector are the new European Union Tobacco Product Directive legislation, which came into force in May 2016, and the introduction in the same month of plain packaging in France, the UK and Ireland.
BAT and Japan Tobacco International have publicly said they will launch an appeal against the High Court ruling that paved the way for the new plain packaging law, under which all cigarette packets manufactured for the UK now share the same dark green base colour, as well as the same font, size, case and alignment of text.
While it is difficult to estimate the impact of plain packaging, it could reduce volumes and brand value over time, potentially nudging consumers to trade down to cheaper brands.
However, looking at the experience of other developed countries that have introduced similar measures (such as Australia) the impact on consumption has been relatively modest and particularly concentrated in the first year after implementation.