Introduction
1.1 Background of Study
The Tobacco or Cigarette industry is often an interesting subject matter to study. Over the years its product has little change and is fairly understood by all. One important matter to note is that, whenever people start to talk about cigarette the next thing that comes into discussion is the taxes that it associate with. Tax and duties charged upon productions has become the main concern for all cigarette or tobacco. Basically tobacco industry is well-known to be taxed more than any other industry, especially to countries that have strict regulations of cigarette consumption as efforts to maintain public health, reducing cigarettes consumption and also to raise government's state revenue. (Bernama, 2008)
Cigarettes manufactured in Malaysia are levied at Malaysian excise duty of 18 sen per stick; making duty for 20-stick pack of cigarettes is now increased by 60 sen on budget 2009. (The Star Online, 2008) According to OSK research, year 2009 will be a challenging year for tobacco industry due to the higher excise duty, proliferation of illicit cigarettes, health pictorial warnings and a slowing economy.
In year 2004 and 2005, the Malaysian government increases Ad Valorem duty for the cigarette products by 40% and 13%, respectively, leading to 30%-38% increase in the selling prices. After the sharp excise tax increase of 40% in 2004, the duty-paid industry volume in 2005 declined by 9%. Based on our projections for 2006, the declining trend is expected to continue," said by Tcheng. (Ang,E., 2006) According to Anwar Suprijadi, Director General for Customs & Excise Affairs of Indonesia, in 2009 state budget, the government was set target to collect state revenue amounting to Rp48.24 trillion from tobacco tax duties (RM1=Rp3.10), making government's revenue increased Rp3 trillion to Rp49.49 trillion from Rp45.72 trillion in 2008. (Bernama, 2008)
Up to date, British American Tobacco Malaysia Berhad (BATMB) and Philip Morris Malaysia Berhad (PMMB) are the two Malaysian major tobacco manufacturers. These two companies have captured approximately 84% of the market share in the country.
By the way British American Tobacco Malaysia Berhad is the pick of study in this research. (National Poison Centre, University of Science Malaysia & (SEATCA), 2008)
Cigarette producers may seem clueless about the impact of tax hike. This is said so because, whenever the government proposes an increase in duties, tobacco companies begin to panic. Then naturally they will start blaming on tax hike for the decline of its profit. This, in some sense is quite understandable because reasonably, the increase of duties would affect tobacco company's sales, and pull down its profit. But one should understand that blame should not be put entirely on the rise of duties. Since duties and taxes are apart of tobacco industry major 'cost' concern, it is important for tobacco companies to know the extend rise of tax and duties could harm on its business. v
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1.2 Objective of Study
The purpose of this research is to analyze and evaluate the impact of rising duties on British American Tobacco Bhd (BATB). This study is to determine the extent to which the profitability of British American Tobacco Bhd is affected by the rise duties. It will also consider other exterior factors that play a part to influence the company in times of duty hike. In short the objective of this research is:
to analyse the impact of increase duties towards the profitability of BATB.
1.3 Significance of study
This research is seen as vital because it helps to broaden the view of cigarette companies in the event of rising duties. Although it is obvious that hike of duties will pull down profits and sales, this study will analyze the degree to which the companies are affected. This will help to clearer the misunderstanding that the cigarette companies might have about tax hike, whether how much or how little harm of the rise of tax can do to cigarette companies
Further more these will going to provide an insight for the cigarette companies on some exterior factors that could have a further influence the impact of the company performance. With that, cigarette companies will then be able to foresee clearly and have a better understanding of the situation in consequence to the tax hike. Thus attention could be focused on the situation that is unfavorable and that they are prepared before hand so that necessary action could be taken to reduce the risk of lost of sales or prevent profit being reduced too much and the dropped in the share price. Besides, it would help the cigarette manufacturer to shakes off unnecessary worries over the hike of duties in future.
Literature Review
2.1 Introduction
Looking at it as a whole, rise of duties at times may have impact little on tobacco industry and at times may impact severely. According to World Health Organization (WHO) framework on convention on tobacco control 2003, it is recognized that price and tax measures are an effective and important means of reducing tobacco consumption. (World Health Organization, 2003)
When government impose a tax hike, the tobacco companies have two options, that is, either they absorb the cost by themselves or transfer the increase to its customers by marking-up the price of the beer to recover the cost. (Southeast Asia Tobacco Control Alliance (SEATCA), 2008) Either way would result some shrink in the profit and sales but in most cases the extra cost is pass on to customers.
2.2 Studies on the Impact
In one viewpoint, the tobacco industry is believed to be unaffected by tax hike or any slump in the economy. In India, although high taxation on cigarettes has been decline the cigarette demand in the country in the period 1997-98 to 2001-02 about 19%, but the heavy excise duty did not bring any harm to the tobacco industry and tobacco consumption in that country. (The Financial Express, 2003) A new Fitch report in 2002 about "U.S Tobacco industry-litigation, excise taxes and lower profitability cloud future", shows that, the cigarettes prices increases resulted from the hike in excise tax has decrease the profitability of the major tobacco firms in short-term and drive weaker players to lose a material amount of market share that negatively affect their cash flow and operating earnings. (Business Wire, 2002)
In cigarette business major buyers are the heavy addicted smokers. Due to the addictive quality of tobacco, the increase in excise duty on cigarette could force smokers to reduce consumption of other goods to keep spending or maintain the same level of cigarette consumption and it could also be that smokers are rational in their decision to smoke. (Sylvain, S., 2007) Having said so, the increase of duties will not make a big impact to the producer's profitability.
Besides, The Czech Republic's English-language newspaper (2009) states that, the Czech Republic's largest tobacco company, Philip Morris saw 2008 unconsolidated net profit drop 36.7% year on year to 1.5 billion KÄ, and the company has seen two consecutive years of declining profits, after a loss of 14% in 2007 due to the dual blows from tobacco taxes, which have doubled since 2004. This had persuades many smokers switch to buy cheaper brands and illegal tobacco due to the rise in cigarettes price in Czech Republic. Rising tobacco taxes will decline the profits for legal tobacco company, but increase trading or benefits to the profits of those counterfeit and illegal tobacco companies. (The Prague Post, 2009)
On one occasion, Jack Bowles, Managing Director of BAT Malaysia, (a tobacco company in the Malaysia that produces nearly half of the Malaysia tobacco market), claims that "legal tobacco industry volumes continue to be depressed, since the large tobacco tax-led price increases in July 2007 as higher cigarette prices further encourage consumers to down-trade to illegal cigarettes thereby drive BAT Malaysia's profit before tax for the first nine months of 2007 decline about 4.4% compared to the same period in 2008. (British American Tobacco Malaysia (BATM), 2007) Evident that shows tobacco' profitability is independent of the cigarette price.
Higher taxes discourage cigarette sales, a Nobel economist, Gary Becker pegs the long-run price elasticity of demand for cigarette at 0.8 - i.e., a 10% increase in price causes and 8% decline in unit sales. For example, the Obama tax hike translates into 13.3% increase in the average pack price, which implies a 10.6% decline in unit sales-which the National Tax foundation of U.S. has calculated adds up to a $1 billion overall revenue loss for hard-pressed states. (Schiller, B., 2009) This shows rising excise tax on cigarettes sales will minimizing the profit of tobacco manufacturer.
Still, another score of studies have shown that, the increases of cigarette taxes reduce the numbers of smokers and smoking related deaths. This is because the price increases induce some smokers to quit and prevent others from becoming regular or persistent smokers and also reduce the number of ex-smokers returning to cigarettes and this had reduce the consumption among continuing smokers. Models developed for this report show that increases that would raise the real price of cigarettes by 10% worldwide would cause 40 million smokers alive in 1995 o quit and prevent minimum of 10 million tobacco-related deaths.(The World Bank Group, 2001) Hence, reduce in cigarette consumption will reduce the sales volume which could moderately influences the profitability of tobaccos' producer.
JT international Malaysia Berhad, one of the 3 major Tobacco manufacturers in Malaysia, was also having a little impact from the hike of cigarette excise duty. Based on the quarterly report of the company on 30Th September 2007, for the quarter under review, the Group registered revenue of RM 234.6 million as compared with RM 22.40 million in the same period a year before this. Profit before tax in the quarter under review was lower at RM 37.7 million as compared with RM 43.8 million in the same period a year before. (Yiew. W. C, 2007) Increase in revenues was significantly driven by higher cigarette prices which cause by hike in excise duty and offset partially by lower sales volume. (Yiew. W. C, 2007) Profit before tax was lower mainly attributable to higher marketing and operating expenditure. (Yiew. W. C, 2007) Another prove, that shown hike in tobacco excise duty, would affected the profitability of Tobacco Company.
2.3.0 Other Exterior Factors
For accuracy of judgment on the impact, some related exterior factors that influence the impact such as counterfeit or illicit cigarette, graphic health warnings on all cigarette packs by government and all must not be ignored.
2.3.1 Percentage Rise of Excise Duty
According to ECM Libra investment research (2008) and BAT Malaysia (2008) annual report, when cigarette excise duty was RM 81 per 1000 sticks in year 2004, BAT Malaysia achieved both revenue and net profit at RM 3,263,725 and RM 782,084. When excise duty hike 35.8% from previous year in 2005, the revenue was increase 9.2% to RM 3,564,215, but the net profit was dropped 24.3% from 2004 to RM 592,802. The drop in net profit was mainly causes by the 35.8% higher increase in excise duty. But, from year 2006 to 2008 the company net profit does not drop, although the excise duty on cigarette continues to hike year by year, but this making BAT Malaysia net profit increase in a slower rate, whereby the improve of net profit from 2005- 2006 was increase 21.4%, 2006-2007 increase 1.7% and 2007-2008 increase 10.9%, when excise duty hike 63.6% from RM110/ 1000 sticks in 2006 to RM180/ 1000 sticks in 2008. Statistic showed that the rising in excise duty would have impact on the profitability of tobacco manufacturer, whether the impact is making the profitability drop or growth slower.
Diagram 1:
Excise duty on cigarettes with BAT Malaysia Net Profit & Revenue of 2004-2008
Year
Excise duty
BAT Malaysia
Net Profit
BAT Malaysia
Revenue
2004
RM81 per 1000 sticks
RM782,084
RM3,263,725
2005
RM110 per 1000 sticks
RM592,802
RM3,564,215
2006
RM120 per 1000 sticks
RM719,678
RM3,612,482
2007
RM 150 per 1000 sticks
RM731,931
RM3,830,869
2008
RM180 per 1000 sticks
RM811,683
RM4,135,220
Source: ECM Libra investment research 2008
British American Tobacco Bhd 2008
3.0 Research Methodology
3.1 Theoretical Framework
Theoretical framework simply means unified data and information gathered to guide research being conducted to make sure it is in the right direction. The independent variable for this research would be the rise of tobacco tax while the dependent variable is the impact on tobacco's profitability as shown in Figure 1. Basically this is aiming to prove the significance of influence that the rise of tobacco tax would have on tobacco's profitability.
Figure 1
Independent variable Dependent variable
3.2 Data collection
The objectives of the study suggest the use of secondary data. Data will be obtained from British American Tobacco Bhd's annual report and the company's website for analysis of its profitability. Particularly, profit figures for the past five years will be taken from its income statement from financial year 2004 until 2008 for intense analysis. Besides, compilation of tax rate changes in Malaysia over the past five years, from year 2004 to 2008 will also be collected to complement the analysis. The advantage here for using secondary data is that it is cheap and is usually readily available in the internet. The only lack of it is that it is that it may not be much updated. However, this is not the case in this research.
3.3 Data Analysis
After collecting the data through internet, newspaper and journal, the findings will be measured using comparison technique. Year to year comparison of profit and sales revenue will be made to see British American Tobacco Malaysia Bhd financial performance. Financial report of BATMB will be studied. Each year net profits will be traced and match to the increase of duty. Heavy analysis will be made upon financial report of year 2004 - 2008 due to its availability and sufficiency of data.
3.3.1 Regression Test
Based on the nature of this research, linear regression will be used to test the relationship between the two variables that was mentioned above. Linear regression is a test in which used to analyze the relationship between two variables, X and Y. X and Y linear regression will show the best straight line through the data. Linear regressions aim is to allocate the most accurate predicts for Y from X. This regression assumes that the data is linear and finds the slope and intercept to make a straight line which best fits the data and it does not test whether the data is linear (Graph Pad Software 1999)
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