The Marlboro Man diversifies

Declining smoking rates will have tobacco companies jonesing for a new fix.

Tobacco companies are among the most consistently profitable firms around. Philip Morris International, the world’s largest, churns out close to US$2 billion in profit every quarter. The industry has also been kind to investors over the years. The financial performance of big tobacco in the face of increasingly tough government regulations should give investors confidence — and anti-smoking advocates dismay — about the resiliency of the sector. But these gains could be masking long-term problems.

The number of smokers has been falling in developed countries for decades in light of health concerns and government crackdowns with bans and taxes. The industry is coping thus far because of savvy marketing in emerging nations, but some analysts contend this strategy will work for only so long. At some point, tobacco companies may have to enter other industries to maintain profit growth.

Analysts at Citigroup recently published a report predicting that, based on the current rate of decline, smoking could be non-existent in many countries, including the U.K., by 2050. But Euromonitor International tobacco analyst Don Hedley argues the idea that the number of smokers will reach absolute zero is unrealistic since consumer behaviour is tricky to forecast. Tobacco volumes are a more useful indicator of the industry’s future. These, too, are falling.

By 2040, Hedley calculates, Japan’s tobacco market will be 80% smaller than it is today. Markets in the U.S., U.K. and Brazil will be 30% smaller. “The big question is, what do the companies do in the face of all of this?” he says. The opportunities to expand into emerging markets and snap up formerly state-run cigarette companies are increasingly limited. A further tactic has been to introduce flagship brands in these countries to compete with domestic varieties, and charge a premium. But the losses in developed markets, among the world’s largest, could be steep enough that emerging countries are unlikely to have much of an effect. The possible exception is China, which consumes an astounding 40% of world tobacco volumes. The problem is, the state tobacco company enjoys a substantial monopoly, and foreign brands have virtually no presence.

That means the industry could be forced to look beyond tobacco for growth, Hedley speculates. It wouldn’t be the first time. In the 1970s, fears about the future of smoking prompted tobacco companies to branch out. British American Tobacco dabbled in everything from cosmetics to life insurance. R.J. Reynolds Tobacco Co. teamed up with Nabisco Brands. The conglomerates eventually broke up, in part because of fears about liabilities in tobacco-related lawsuits.

If companies are forced to do it over again, the acquisitions may not go so easily this time around. The stigma associated with tobacco products means takeover targets might not be willing to acquiesce.

But those battles are a long way off. In the meantime, tobacco companies are trying yet another strategy to maintain healthy profits: searching for a new product as popular as the cigarette but subject to less regulation. Philip Morris introduced Marlboro Snus in the U.S. a few years ago, a pouch of tobacco placed behind the lip to exude nicotine. It has yet to take off. There are other options, such as electronic cigarettes, smokeless battery-powered devices that produce puffs of nicotine. But if nothing works and acquisitions are necessary, don’t be surprised if the Marlboro Man starts shilling life insurance.