BAT is the second largest tobacco producer in the world, with a market share of 22.1% and more than 300 brands in its portfolio. BAT holds robust market positions in each of its regions and has leadership in more than 50 of the 180 markets where it does business. The company processes some 660 million kilos of tobacco leaf and producing some 853 billion cigarettes in 2004. Due to the addictive nature of tobacco products, BAT's products enjoy a built in high level of demand, and the company's vast array of popular brands mean that it is in a position to consistently take advantage of this demand. The strong market position of the company is a key strength for BAT.
Geographically diversified
BAT is very well diversified geographically. The company operates through 81 factories in 64 countries. However, the company's largest market, Europe accounts for only 41.4% of its net revenues. Geographically balanced in its operations, BAT is not overly dependent on any of its operating regions. The America-Pacific region accounted for 21.3% of the company's net revenues in 2004; while the Asia-pacific region accounted for 13.1%. In 2004, Africa and the Middle East contributed 12.4% of BAT's net revenues and Latin America contributed another 11.8%. The company has strong market position in North America, Western Europe and Eastern Europe, three of the strongest markets for tobacco products in the world. However, this has not stopped BAT from expanding into emerging markets like China where the sheer size of the smoking population presents a significant opportunity for the company. The company's wide geographical spread has provided it growth opportunities in diversified markets.
Control over tobacco leaf
BAT's tobacco leaf business is large, with the group purchasing about 517,000 tons of leaf tobacco annually. Subsidiary companies operate leaf growing programs through which they provide direct agronomy support to farmers if it is not otherwise available.
BAT purchases on average about 65% of its leaf through these programs, mainly through directly contracted farmers. In 2004, BAT's subsidiary companies operated 22 leaf programs in 22 countries, covering about 254,400 hectares under cultivation. This gives the company an assured supply of tobacco leaf and insulates it from demand and price fluctuations for tobacco leaf.
Weaknesses
Declining operating profitability
Despite a 31.7% increase in total revenues during 2004, the operating profit of the company increased a mere 1.0% over fiscal 2003. As result, the company's operating margins decreased from 7.4% to 5.6%. Profit from the America-Pacific region was £795 million, a decrease of £200 million from the same period last year. This was the result of lower profits in Canada and Japan. In Latin America, profits from Brazil were slightly down from 2003 due to lower volumes requiring higher marketing expenses.
Profits in Chile also declined. These declines in profitability were further accentuated by the translation of US, Canadian and Latin American results into pounds sterling. The decline in profit in these two operating regions caused the overall profitability of the company to decline and this reflects poorly on the company.
Falling revenues from major operating segments
Three of the company's five operating regions witnessed declining revenues during 2004. Net revenues from the America-Pacific region reached £2294 million in 2004, a decrease of 35.6% from fiscal 2003. At the same time, the Asia-Pacific region's net revenues declined by 4.6%. Latin America, which accounts for 11.8% of the total revenues, witnessed a 2.5% decline in revenues during 2004. In the Asia Pacific region, the company witnessed a decline in Indonesia and Malaysia while in the America-Pacific region, Imperial Tobacco Canada witnessed declining volumes and deteriorating sales mix. In Latin America, regional sales volume at 148 billion was down by 2 billion mainly as a result of increased pressure from growing illicit trade. Falling revenues from major operating segments could lead to a loss of market share for BAT.
Decreasing operating cash flows
For fiscal year 2004, BAT's cash flow from operations was £2677 million, a decrease of 14.0% from 2003. The free cash flow for the company was £2412 million, 10.4% less than the free cash flow in 2003. The decline in the company's operating cash flow and free cash flow is largely attributable to an increase in working capital requirements. Declining cash flows from operations are indicative of the company's poor cash management.
Opportunities
Light cigarettes
The demand for tobacco products with lower nicotine content has been rising in the past few years due to increasing health concerns. As a result, most tobacco companies have shifted focus from manufacturing strong cigarettes to manufacturing 'lighter' ones, with low nicotine content. Considering the fact that adult women smoking population presents opportunities for growth, most tobacco companies have introduced light cigarettes for the market. BAT has a strong position in the market for light cigarettes and these are marketed under some of the company's strongest brands. The company can thus leverage the growing popularity of light cigarettes to increase its sales volumes.
Market potential in China
China is potentially a huge market for BAT. While the majority of the market remains under the control of China National Tobacco (CNTC), a state tobacco monopoly, there is a growing demand for international brands in China in all product categories. With 2003 volumes of 1.75 trillion cigarette sticks (one-third of the total global market), China is the large volume prize for all the international majors, who currently have barely a foothold in the market. However, of all major international players, BAT is the best-placed as far as taking advantage of this is concerned since, the Central Government of China and the relevant government departments approved the Group's strategic investment in China in the year 2004. The new factory is being established by BAT in a joint venture with China Eastern Investments Corporation, and will reach a manufacturing capacity of 100 billion cigarettes (State Express 555 and other brands) per year. The venture will also allow BAT to distribute and sell its brands all over China.
Rising popularity of smokeless tobacco
The world market for smokeless tobacco is worth an estimated $2 billion of which the US accounts for approximately 65%, followed by Sweden with sales of $480 million in 2003. Other markets with a strong smokeless tobacco tradition include India, Algeria, Pakistan, South Africa and Norway. The European market for snus has been witnessing increasing sales. Norway and Sweden especially enjoy a lively snus market, with sales increasing rapidly over the past few years as consumers turn to reduced-risk nicotine consumption. During the five years ended 2004, Sweden's market for snuff increased by 30%. In May 2005, BAT started test-marketing smokeless snus for the first time and the company has put two of its best-known brands (Lucky Strike and Peter Stuyvesant) behind it. With the market for snus increasing in Europe, the company's largest market, BAT could have found a new area for growth.
Threats
Increasing health concerns
Due to increasing health concerns worldwide, there has been a general decline in the consumer preference for tobacco products. While active smoking leads to a number of respiratory and heart ailments, even passive smoking has been proven to cause certain diseases. The frequency of consumers who have suffered irreparable damage to their health is slowly increasing as also the incidence of such people taking cigarette companies to court for punitive damages. BAT is no exception to this, and should this trend continue, it may be the single largest factor leading to a decline in the company's revenues.
Competitor strategies
Major cigarette manufacturers like BAT, which are subject to pending lawsuits worth billions of dollars, are facing competition from smaller manufacturers who are not subject to litigation. The bigger companies are being forced to set aside substantial amounts of their profits to pay for damages they might have to pay in future. Smaller companies are trying to take advantage of this by tying up with each other and offering very-low priced but quality tobacco products. As a result, they are gaining market share from established players who cannot afford to price their products below a certain level, in order to maintain the premium image of their products.
Contraband and counterfeit cigarettes
BAT is also threatened by the increased availability of contraband and counterfeit cigarettes. The company plans to tackle this by working in partnership with governments. It is playing a major role in The Global Business Leaders Alliance Against Counterfeiting, a group whose aim is to increase political awareness of the risks and impact of counterfeit. The company has also been experiencing falling growth volumes because of the planned action taken to restrict the supply of duty-free products. Approximately 15% of all cigarettes sold in the UK are expected to be contraband / counterfeit. In 2002-03, the company's Benson and Hedges brand accounted for 19% of all seizures of illicit cigarettes made by the UK customs. Of these, 90% were counterfeit. The company has also witnessed counterfeit products in East European and Asian markets. Since these cigarettes are cheaper (due to not being taxed), an increase in the availability of such illicit cigarettes could deprive BAT of potential customers.
