(CNSNews.com) - Times are tough for Big Tobacco. As America's top two cigarette manufacturers were announcing grim financial forecasts this week, they also faced new taxes on cigarettes, increased competition and consumers who were opting for discount brands.
Cigarette sales were the biggest drag for Altria Group (formerly Philip Morris Cos.) and R.J. Reynolds Tobacco Holdings in 2002 and they could continue to hurt profits in 2003. It might take tobacco companies several years to recover from these tough economic times, according to industry analysts.
A number of factors, including a weak economy, contributed to Big Tobacco's troubles last year. The 21 states that hiked their cigarette excise taxes, for instance, forced many smokers to abandon their favorite brands for discount cigarettes.
Large tobacco companies responded by offering major discounts on their top-selling premium brands to remain competitive. And while the companies took a financial hit for these promotions, they defended the strategies as an effective way to slow the growth of their discount competitors.
The challenges facing Big Tobacco are much broader than increased competition, but Philip Morris USA and R.J. Reynolds Tobacco Co. have made it clear they do not intended to back down to the obstacles ahead of them in 2003.
Several Hurdles to Overcome
Tobacco industry analysts said they view the weak economy as the primary source of concern in the short term, but there was no consensus among them as to how long it might take the industry to bounce back to profitable levels.
When Altria and R.J. Reynolds released their 2002 results this week, domestic tobacco weighed down both companies.
Altria, the parent of Philip Morris USA, managed to post a profit, but it came from strong showings by Kraft Foods and its international tobacco operation. Those companies carried Altria throughout 2002 as domestic tobacco struggled, chief financial officer Dinyar S. Devitre said.
"Philip Morris USA's shipment volume and shipment share decline were due to a number of factors, including a weak economic environment, sharp increases in state excise taxes and resulting consumer frugality, exacerbated by heightened competition," Devitre said Wednesday.
Those same factors hurt R.J. Reynolds as well. But the nation's second largest cigarette manufacturer posted a large loss due to an expensive restructuring charge and increased promotional spending.
Several uncertainties await Big Tobacco in 2003, but companies are closely watching state lawmakers to see if they opt for more cigarette taxes. "Sin taxes," as they are often called, have become a popular source of revenue in many states with large budget deficits.
"We're already working in 16 states, fighting aggressively to defeat or minimize a potential increase," said Richard H. Bogan, chief operating officer of R.J. Reynolds Tobacco Holdings. "Historically, excise taxes have run in cycles. If most states address their budget deficits in 2003, we could have reduced activity in 2004."
Tobacco litigation and policy analyst Mary Aronson of Aronson Washington Research said Big Tobacco is no longer able to fight these legislative efforts like it did in the past. Part of the reason, she said, has to do with a changed culture that remains skeptical of the tobacco industry.
"It was hard for the public to avoid hearing about all the bad things that the industry had done over the past 20 to 30 years," Aronson said. "Every time you picked up the newspaper or turned on the evening news, you were assaulted by the evil tobacco empire. That significantly changed the attitude of the public -- the same public that sits on juries and elects state and federal representatives."
The result: Big Tobacco has lost some of its influence in Washington, D.C., and state capitals across the country, Aronson said.
Big Tobacco's Positive Outlook
Besides excise taxes, tobacco companies remain concerned about the emergence of a black market, counterfeit products and competitors that are not complying with the 1998 Master Settlement Agreement.
Bogan said that while R.J. Reynolds was fighting future tax increases it was also lobbying states to strengthen or enforce laws related to the tobacco settlement. Some smaller companies do not pay the huge sums mandated by the agreement, and since 1998 they have infiltrated Big Tobacco's share of the market.
By the end of 2002, 18 states had passed laws that put a greater burden on these smaller tobacco producers to comply with settlement payments. Bogan said another 25 states could take similar steps this year. In addition, more than 340 lawsuits have been filed by state attorneys general seeking compliance by the smaller firms.
Meanwhile, Philip Morris has called for increased enforcement to deal with the rise in counterfeit cigarettes, particularly knock-offs of the popular Marlboro brand.
In November, Philip Morris USA chairman and chief executive officer Michael E. Szymanczyk said progress was being made. At the time, the U.S. Customs Service had made 250 seizures of counterfeit cigarettes in 2002, up from 24 in 2001. Philip Morris is also suing 56 retailers and one distributor for engaging in counterfeit sales.
"There are several reasons we expect to see progress this year," Devitre said Wednesday, citing these initiatives as well as a stronger showing by premium cigarettes in the last quarter of 2002.
But that optimism has not persuaded some industry analysts. Sandy Sanders of Evergreen Investments said domestic tobacco was likely to weigh heavily on companies like Altria for years to come.
"I don't think Philip Morris USA has a positive future in terms of growth," Sanders said. "They can sustain themselves for a long time with [about $4 billion in] cash flow, but it's going to be a slow, painful mature ride down. I think the company is in serious trouble."
Sanders said Big Tobacco has to worry about excise taxes and no-smoking ordinances in the short term, but its biggest challenge could come with the thousands of lawsuits that were brought against companies several years ago and remain on appeal.
"They'll get in trouble if the 4,000 outstanding lawsuit all eventually get pushed through and people get awarded $20 million here or $30 million there," Sanders said. "They've been able to continue to appeal and they haven't had any major class-action lawsuits that have awarded billions."
Part Two: States Accused of Hypocrisy in Spending Big Tobacco Bucks
Part One: Hostility from States, Smokers Clouds Big Tobacco's Future
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