Expansion abroad has U.S. downside

IN CIGARETTE INDUSTRY, BURNING ISSUE IS SURVIVAL

May 30, 1994|By Ian Johnson | Ian Johnson,Sun Staff Writer

When food and tobacco giant Philip Morris gave Wall Street investors a recent update on its financial health, it released a little-noticed but startling fact: For the first time in the company's 75-year history, it made more money selling cigarettes to foreigners than to Americans.

Given tobacco's uncertain future in this country, that news looked like a example of smart corporate diversification. Americans may be avoiding cigarettes in droves and the federal government threatening to regulate tobacco like a drug, but at least foreigners are coming to Marlboro Country.

But like so much in the tobacco business, even this silver lining is clouded by unexpected problems.

International operations have indeed bolstered profits, but by focusing operations overseas and importing tobacco, the tobacco companies have contributed to layoffs at home and a steady squeeze of U.S. tobacco farmers.

The result: once-loyal supporters of the big tobacco companies have disappeared, leaving the companies vulnerable as they face an implacably hostile Congress.

These endless problems with tobacco are forcing the nation's two cigarette-making and food-processing giants -- Philip Morris Cos. and RJR Nabisco Holdings Corp. -- to ask a question that would have been unthinkable a few years ago: Is lucrative tobacco worth all the hassle?

The answer may be no. Both companies are weighing radical plans to dump their tobacco divisions, a move that would strip them of tobacco's fat profits but also free them from its endless series of lawsuits, taxes and restrictions. And just last month , the nation's fourth-largest tobacco manufacturer, American Brands Inc., announced that it was selling its tobacco division to a British company.

"It's crunch time for the tobacco companies. Diversification has not been working as well as they thought, and even overseas expansion has its drawbacks. There's no clear way out for them," said David Tice, a tobacco industry analyst based in Dallas.

Only a few years ago, making cigarettes was anything but the problem child of U.S. industry.

As the 1980s drew to a close, corporate raiders fought for the right to own RJR Nabisco and its Camel, Winston and Salem cigarette brands. When the buyout of RJR was completed in 1989, new owners Kohlberg Kravis Roberts & Co. had spent $29.6 billion in a leveraged buyout of the company, going massively into debt on the premise that tobacco could easily pay it all off in short order.

"I'll tell you why I like the cigarette business," billionaire investor Warren Buffett is reported to have said when asked why so much was being bid for RJR Nabisco. "It costs a penny to make. Sell it for a dollar. It's addictive. And there's fantastic brand loyalty."

Today, cigarettes still cost just pennies to make, but that dollar sale price is increasingly made up of taxes. Meanwhile, the addiction is spurring damaging government inquiries and the brand loyalty is dependent on lower prices and dangerously bloated marketing budgets.

Another vanishing advantage allowed RJR Nabisco and Philip Morris to increase prices virtually at will. Between 1984 and 1993, prices for tobacco products shot up at nearly twice the rate of inflation, according to the U.S. Department of Agriculture. The reason was not prices for tobacco, which declined during that time, but because profit margins zoomed upward.

Those salad days ended just after the RJR Nabisco buyout. As the economy slowed and cigarette prices continued to rocket upward by 10 percent a year, low-cost "generic" cigarettes became a serious force in the market. Between 1988 and 1993, the number of generic cigarettes rose threefold, from 62 billion cigarettes to 180 billion, making up 40 percent of the U.S. cigarette market.

Meanwhile, sales of premium cigarettes, such as Marlboro, declined from 501 billion cigarettes to 295 billion.

The companies responded a year ago by cutting the price of a pack of premium cigarettes by 40 cents -- a move that cost Philip Morris $2 billion in 1993. They are regaining market share from the generics, but have had to sacrifice tobacco's legendary profit margins.

Last year, for example, Philip Morris' profits fell 37.4 percent to $3.09 billion, while RJR Nabisco's profits dropped 43 percent last year to $464 million.

Now, Mr. Buffett tells another story when asked about tobacco: "I would not like to have a significant percentage of my net worth invested in tobacco businesses."

As smoking became a riskier business over the past decade, the tobacco companies started diversifying. R. J. Reynolds Industries Inc. merged with Nabisco Brands Inc. in 1985, while Philip Morris snatched up Kraft foods in 1988. That gave RJR Nabisco household products, such as Oreo cookies, Planters peanuts and Ritz crackers, while Philip Morris rounded out its cigarettes with Kraft cheeses, Breyers and Sealtest ice cream, Oscar Mayer meats and Kool-Aid drinks.

Baltimore Sun Articles
|
|
|
Please note the green-lined linked article text has been applied commercially without any involvement from our newsroom editors, reporters or any other editorial staff.