Philip Morris discount stuns tobacco industry Price war seems likely, analysts say

April 03, 1993|By Ian Johnson | Ian Johnson,New York Bureau The New York Times News Service contributed to this article.

NEW YORK -- In a move that blindsided Wall Street and could signify a fundamental shift in the way cigarettes are marketed, Philip Morris Cos. announced yesterday that it would fight discount cigarette companies head to head by offering huge discounts to protect its faltering line of Marlboro cigarettes.

Industry analysts said the decision meant a price war -- a radical shift for an industry in which most companies had combatted declining levels of smoking by raising prices.

More discount pricing is also likely to raise health concerns, coming as it does amid signs that the growing popularity of cheaper, generic cigarettes has helped attract new smokers and temporarily slowed the 30-year decline in smokers.

Philip Morris, the nation's largest cigarette manufacturer, said the decision would slash this year's profits by 40 percent -- or as much as $2 billion. This helped send its blue-chip stock tumbling $14.75, to $49.375, a 23 percent drop that wiped out $13.5 billion in market value and helped drive the Dow Jones industrial average down by nearly 69 points, its second-largest drop of the year.

Philip Morris said the measures would include lower prices, which still have to be negotiated with stores, and more sales promotions. The reduced prices would also include Parliament, Benson & Hedges and Virginia Slims and will show up in stores during the next few weeks.

The goal is to fight the steady rise of discount cigarettes, which cost on average $1 per pack less than premium cigarettes.

"They felt they had to do something. Their main products had been eroding steadily and they wanted to be one of the survivors," said Edward A. Froelich of Pershing & Co. Inc.

Marlboro and other premium brands have seen discount brands, such as Raleigh Extra and GPC Approved, increase their market share from 1 percent in 1983 to 36 percent last year. Although Marlboro is the country's top-selling cigarette -- as well as the world's best-selling consumer product -- its share dropped to 22 percent last month from 24.5 percent last year, industry reports show.

Discount cigarettes have become popular as consumers have become more price conscious, a trend likely to become even more pronounced given proposals by the Clinton administration for new, steep increases in federal cigarette taxes.

The cheaper cigarettes, which sell at retail for about $1.20 a pack vs. $2.15 a pack for premium cigarettes, have helped reverse a 25-year trend toward fewer smokers.

Other tobacco companies did not announce moves to counter Philip Morris' cuts, but analysts said a price war seems inevitable.

"They will have to cut their price. The move now is toward pricing," said David Adelman of Dean Witter Reynolds Inc.

The second-biggest tobacco company, RJR Nabisco Holdings Corp., hinted that it would follow suit soon. At its annual meeting yesterday in Wilmington, RJR said it would "remain competitive" and not allow its brands, such as Winston and Camel, to lose market share.

The threat of a price war helped drop all major tobacco companies' stocks yesterday, with RJR sliding $1.25, to $6.75, and American Brands Inc. falling $3.75, to $30.

Analysts said Philip Morris' decision ends the comfortable price structure that had supported the industry despite declining numbers of smokers.

"Until now, cigarettes had not been a commodity. Most big brands hadn't been sold on price," said Terry Bivens of Argus Research.

Instead, manufacturers had relied on prestige and marketing to fight off the challenge of discount cigarettes, Mr. Bivens said.

Now, however, Philip Morris is gambling that it can cut prices and still win enough smokers to make the cuts worthwhile.

Unlike other markets, where new consumers can be won, the circle of smokers is in a long-term decline, although the number of smokers did not decrease last year. This means that Philip Morris will be able to make the discounts pay only if it takes customers away from other brands, said Guy Chance of Scott & Stringfellow Investment Corp. of Richmond.

"They say they can do it, and I've got to give them the benefit of the doubt," Mr. Chance said. "It's been a well-run company for a long time."

Philip Morris has been one of the stronger performers of the recent three-year bull run. The stock has doubled since 1990.

The company, based in New York City, last year sold about $59 billion worth of Cheez Whiz, Miller beer, Maxwell House coffee, Kraft foods and dozens of other immediately recognized products -- a volume far greater than any competing maker of consumer goods.

Until yesterday, the big brokerages had continued to be bullish on the company.

But when Philip Morris made the announcement, brokers raced to sell as quickly as possible.

STOCKS PLUMMET

Philip Morris' bombshell wasn't the only bad news on Wall Street yesterday, as stocks suffered broad losses in response to a weak U.S. employment report and surging bond yields. The Dow Jones industrial average fell 68.63 points, to close at 3,370.81.

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