Retailors’ demand for cigarette decreased in the past three years as a direct result of increasing cigar’s price of manufacturers and exercise tax and an indirect result of long term declining of general consumption of cigarette. Due to profit pressure resulted from declining consumption of cigarette, the activities of restructure and re-consolidation among cigar manufacturers have been frequent, which eventually resulted in less competition and allowed the increase in cigar’s price. Food wholesale seems to be able to provide higher margin and driver of growth as demand from stores for food increases.

Sector’s current, trend, causes behind trend, and future

Current and Trend

• General consumption of cigarette has been decreasing for years.
• Demand from retailors for cigarettes has decreased since 2015 as indicated by the decrease in distributors’ sales volume to existing stores of major cigarette wholesalers.
• Manufacturers’ real cigar price continued to inflate.
• Profits in this cigarette value chain are shifting to more consolidated cigar manufacturers from distributors and force the later to acquire more market shares by consolidation to keep profitability.
• Demand from stores for food wholesale increased 7-18% annually in the past three years.

 

Causes behind the trend

• With the long term declining of consumption of cigarette, the increased pressure of profit speeds consolidation activities among cigarette manufacturers, which in turn allow them to raise cigar’s price to keep profitability.
• Increased price and exercise tax of cigarette in some of regions working with the pressure from the decrease in consumption resulted in the decrease in demand from stores.
• Increasing acquisition activities among cigarette wholesalers are because some of wholesalers of cigarette failed to pass on increased supply price of cigarette to their customers/stores or failed to offset the decreased profit, resulted from shrinking sales volume, by reducing their other expenses while they are able to successfully keep their margin uncontaminated.

 

Industry Future

• More consolidation activities mean more increase in price from manufacturer side and as well larger pressure on margins on distributor side. Considering the current small profit margin of distributors, it may be very difficult for some of wholesale distributors in this sector to find more rooms for further decrease in their margin. The result will be that if the raised price cannot be passed on to consumers/stores a portion of the current profits generated among distributors in the whole cigar value chain will have to shift to manufacturers until the same restructure and consolidation happen among wholesalers as they did among manufacturers.
• Those wholesalers, who are having strong relationship with food stores or able to provide value-added management service for stores, may become the winners eventually.

General Financial Performance of Companies In the Sector

While it has been the truth that consumption of cigarette has been declining for years, our company’ sales volume data indicate that demand from existing stores for cigarettes did not decrease until 2016 as manufacturers continued to raise their products’ price (reduce the promotion of their price) and/or increasing exercise tax in some of regions. Demand for food distribution seems to have been strong and help offset the decline in cigar sales in the past several years.

While companies usually are able to pass on the increased price from supply side to customer side so that they can maintain the fixed profit per sales unit, the increase in cigarette’s price from manufacturer side has been giving huge pressure on cigar wholesalers’ gross margins, which have usually been very small due to the nature of intensive competition in this sector. And the decrease in sales volumes and downward pressure on gross margins inevitably resulted in significant shrinks in those companies’ profits (operating income decreased by 22% - 36% in fiscal 2017 compared with 2016 so far) and may push profits of some of wholesalers into negative range (operating margin 5% currently) if they were not able to pass the increased price to stores or save costs by other ways. The recently rising demands for food distribution, with higher margin, seem to be offsetting the lost profits of companies in this sector resulted from declining cigar sales/volume.

In this situation, lifting sales of cigarettes by grabbing more market shares from other competitors and pursuing growth from business with higher margin such as grocery food and fresh food distribution ( around 13% gross margin for food distribution compared with 5% for cigarette) have become the only ways for current wholesalers to keep growth of their profits.

A typical gross margin for companies in this sector is around 5-6% with around 5% SG&A spending as percentage of sales. Therefore, their operating margins usually have been very close to fall below zero.

According our analysis, there is a large span between companies’ enterprise price/adjusted EBI from 19-39 with interest/EBI ratio of 20-30%. 

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