February 20, 2013 / 1:50 PM / in 5 years

TEXT-Fitch: Plain packaging biggest regulatory risk for tobacco cos

Feb 20 - Plain cigarette packaging of the type proposed this week by New Zealand could be particularly damaging to manufacturers’ pricing power if replicated in other countries, Fitch Ratings says. While plain packaging legislation is the biggest regulatory risk facing the tobacco industry, it is still unclear how many other countries may follow suit.

We believe the biggest impact if bigger tobacco markets were to successfully introduce similar rules would be on manufacturers that sell premium and above-premium cigarette brands. As all tobacco packages would look the same, their added appeal would fade, potentially reducing the price difference between brands. Loss of pricing power would be particularly concerning for tobacco companies as it is the ability to increase prices that has allowed them to maintain growth despite falling volumes. Another effect that is difficult to predict is the risk of a widespread pickup in illicit trade, as packages become more vulnerable to being forged.

Any similar rules in major European markets would be likely to have the biggest impact on Philip Morris International, because its portfolio is skewed towards premium brands, and Imperial Tobacco, which has lower-priced brands but relies on Europe for a bigger overall proportion of sales.

We believe politicians in many European countries could be in favour of introducing plain packaging. But any attempt to do this would be met with multiple legal challenges similar to those being brought against Australia - the first country to implement rules of this type, in December 2012. The extent and speed with which other countries might follow is therefore unclear and would depend on the extent to which the courts or arbitration panels could see plain packaging as an infringement of companies’ intellectual property or a breach of trade agreements.

Plain packaging rules are unlikely in the US in the short to medium term, after the success tobacco companies had in fighting a less severe challenge to intellectual property such as graphic warning labels.

Any change is likely to be very slow and our ratings therefore only factor in expectations of falling pricing power for the relatively small Australian market. However, they do factor in other regulatory pressures that are more certain. These include the gradual extension of smoking and advertising restrictions and higher excise regimes in the developing markets of eastern Europe, Asia and Latin America. These pressures in emerging markets will be more than offset in the short term by the trend for consumers in these countries to move on to more expensive products and brands.

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