Tobacco companies feel the heat as emerging markets burn out Emerging markets have long provided a breath of fresh air for tobacco companies. As the industry struggles with declining smoking rates, higher sales taxes and strict regulations in mature markets, developing economies have offered better prospects. British American Tobacco, the world's second largest tobacco company by market share, returned to Myanmar last year, a decade after public pressure forced it to leave in 2003. Other tobacco companies followed suit, seeking new customers in a country where 45 per cent of men smoke or chew tobacco but only a small fraction smoke filtered cigarettes, according to the World Health Organisation. But after a tough two years in which cigarette volumes for the world's largest tobacco companies have fallen more quickly than usual, there are doubts about whether growth in developing markets can continue to be a panacea for the tobacco industry. "Emerging markets are never again going to represent for the industry an uncomplicated source of growth," says Shane MacGuill, analyst at Euromonitor. Some markets that were once drivers of growth are faltering, says Mr MacGuill. For example, sales in Russia - the second largest market after China in terms of volumes but one that until recently was continuing to grow - has been hit by tax increases combined with new bans on smoking in public places. Other countries have taken similar steps to clamp down on smoking. In 2013 the Philippines and Turkey put through tax increases on cigarettes, while Brazil introduced minimum pricing on top of a tax hike, which analysts say led to an increase in illicit trade. Despite strong volume growth in some southeast Asian countries, including Indonesia where smoking is deeply ingrained in society, the global trend is towards higher taxes and regulation, say analysts. The tougher environment in emerging markets has resulted in faster than usual falls in volumes for the four largest tobacco companies since 2013, though rates have stabilised in 2014. "Volumes are still going down but not at such alarming rates," says Chris Wickham, analyst at Oriel Securities. He points out that tobacco companies have offset volume falls in the past two years by increasing prices on the back of tax hikes. However, that strategy is being undermined as consumers trade down to cheaper brands of cigarettes, hand-rolled tobacco and illicit products. "The big preoccupation at the moment is how much down trading will hit the industry's pricing model," says Martin Deboo, analyst at Jefferies. To grab market share, some companies have lowered prices of certain brands, or decided against price rises, say analysts. Japan Tobacco International lowered prices of its Camel cigarettes in Turkey, gaining market share as a result. Imperial Tobacco, the Bristol-based maker of Gauloises, has seen more resilient sales of its cheaper brands than its premium brands in the past five years, according to Moody's, the rating agency. "You have to recognise in a number of markets affordability has been a key issue for consumers over the past couple of years," Alison Cooper, chief executive of Imperial Tobacco, recently told analysts. The pressure on volumes and prices means cost cutting has been high on the boardroom agenda. Imperial is closing plants in the UK and in France as part of a cost-reduction programme that will see the company save £300m per year by the end of 2018. Other tobacco companies have instigated similar policies: BAT has closed 67 factories since 2000 and Japan Tobacco International recently announced the closure of its factory in Northern Ireland. Companies have also turned to acquisitions for growth. Earlier this year Imperial Tobacco agreed a £4.2bn deal to buy several US cigarette brands, including Winston, Kool and Salem, from Lorillard, the US tobacco company. But in a consolidated market dominated by four large international tobacco companies, opportunities for big mergers and acquisitions are limited. Are there many more out there like it that would be sensible from a strategic and financial perspective? I can't think of many," Alison Cooper, Imperial chief executive, said at the start of November as the company reported its full-year results. Smaller bolt-on acquisitions are more common. Tobacco companies have been buying small ecigarette companies in an attempt to tap into the growing "vaping" and cigarette alternatives market, which is worth around $3.5bn but is expected to grow to $51bn by 2030, according to Euromonitor. Philip Morris International bought British ecigarette manufacturer Nicocigs in June for an undisclosed amount, while BAT launched the UK's first ecigarette brand Vype last year after its acquisition of ecigarette start-up CN Creative in 2012. But the ecigarette market remains a small fraction of the overall tobacco market and is yet to achieve meaningful profitability, according to Moody's. Despite the challenges, analysts point to the industry's ability to produce profit and dividend increases year-on-year. And although cigarette smoking is in long-term decline, ecigarettes and cigarette alternatives could one day provide a sustainable future for the industry, said Shane MacGuill, analyst at Euromonitor. "That's the one that could see genuine growth," he said.