That compares with management expectations in July of a 3.1 per cent decline. The suggestion of a slight improvement in volumes in the fourth quarter provides some succour to shareholders.
In March, Imperial’s stock tumbled after UBS said earnings growth was set to slow and warned that consensus forecasts for next year looked too high. UBS argued that Imperial was running out of cost savings from its purchase in 2008 of Altadis and remained hamstrung by debt.
Shares in Imperial rose 32p on Wednesday to close at £19.25.
Chas Manso, analyst at Evolution Securities, said the statement was welcome after a string of negative news: “It is saying full-year revenues are up in spite of a fall in cigarette volumes.”
Dynamic pricing has been a saving grace for other big tobacco groups, including BAT and Imperial, following a tough year of trading in 2009 that showed cigarettes were not recession-proof. Eastern Europe was a particular trouble spot, as governments raised taxes, pushing prices up and customers away.
One City analyst remained bearish on the company, arguing that Imperial still needed to persuade the market “that it has got an organic growth story”. An investor day is planned for next week.
Rumours that Imperial might buy of the US are undermined by the American group’s exposure to menthol cigarettes – a product that US authorities are considering banning.
There is also speculation that Imperial could be a takeover target.
Commentary Number 2
Intro:
The Imperial Tobacco Group said that “full-year volumes would be 3 per cent lower than last year’. Contrary to popular belief, “cigarettes [are] not recession-proof”. Even though full-year volumes decreased, the Imperial Tobacco Group still expects that “net revenues from tobacco [will] rise by 3 per cent this year”.
Analysis:
The Price Elasticity of Demand for cigarettes is very inelastic, because tobacco is an addictive drug. People are unlikely to quit smoking just because the price increases a little bit. Loose tobacco, however, acts as a substitute good for “white sticks”, and therefore people have turned to self rolled cigarettes, which offer a cheaper alternative while still satisfying the smokers needs. Demand for cigarettes decreased for several reasons. One reason is the on going recession, which has caused consumers’ incomes, one of the determinants of demand, to decrease.
All economies undergo the so-called business cycle, which is an on going up and down in the economy. During a recession, incomes are fairly low, and therefore buyers will be more likely to buy inferior goods. In this case, the loose-cut tobacco can be considered an inferior good, because its demand increases when money is scarce and it will decrease again once people have enough money to afford pre-rolled cigarettes.
The smoker’s choice to buy either fine-cut tobacco and rolling paper or pre-rolled cigarettes is based on a basic cost benefit analysis he makes without even knowing he is doing it.
This is a simple diagram comparing marginal cost and marginal benefit of another cigarette. The marginal benefit is the same for both the pre-rolled and the self-rolled cigarette, because the products are essentially the same. The self-rolled cigarettes are cheaper, so their financial cost is lower. The personal factor in this equation is how much the personal discomfort of rolling cigarettes is valued with money. As income decreases, people value the money they have more, so the ‘price’ of the discomfort of rolling will be less, making self-rolled cigarettes the better choice for many smokers.
Another factor affecting cigarette sales are taxes. The article mentions, “Eastern Europe was a particular trouble spot, as governments raised taxes”. Taxing of cigarettes is common to counter market failure, which is caused by the negative externalities smoking has. Smoking burdens the health system with enormous costs for lung cancer treatments and passive smoking induces non-smokers with health problems.
When governments raise taxes on cigarettes, they are very well aware that they will also increase the tax revenue, because demand for cigarettes is fairly inelastic.
For unitary elastic demand and supply the tax burden is split equally between producer and consumer, as illustrated in the diagram. But as cigarettes are pretty inelastic, this is not the case for the cigarette market. Demand for cigarettes is a lot more inelastic than its supply, so consumers will carry most of the burden, but producers will still suffer from it.
Evaluation:
In spite of the recession, however, Imperial’s shares are rising. While the recession and increased taxes have caused a decrease in cigarette sales, the sales of loose-cut tobacco have increased by a lot more. The predicted increase in revenue of 3% is still pretty optimistic for the fact that we are in a recession. Volumes of cigarettes are expected to fall even more, and people will smoke less due to the recession. Cigarettes are not recession-proof as tobacco producers wish.
Price Elasticity of Demand (PES) measures the responsiveness of demand to changes in price in the good. It is calculated using the following formula:
A substitute good is a good with a positive cross elasticity of demand, which means that when the price of a good rises, the demand of its substitute will increase.
A recession is defined as two consecutive quarters of negative GDP (Gross Domestic Product, a measurement of an economy’s output) growth
The Determinants of Demand are the 5 factors that affect demand for a product, namely income, tastes, relative prices, number of consumers and expectations
Inferior goods are goods with a negative income elasticity, which means that the more people earn, the less of this good they will buy and vice versa.
Market failure exists because individuals fail to account for society’s benefits and costs when making transactions. There so called externalities cause misallocation of resources, preventing allocative efficiency.