LAST year was a “very intense year” for the tobacco industry as the full effects of a tobacco tax increase imposed in November 2015 hit home, according to Guilherme Silva, managing director at JT International Bhd (JTI Malaysia).

“This past year has been very intense because it was the first full year we had to face the consequences of the big tax increase. The overall legal tobacco market saw a massive 25.5% decline in cigarette volume,” he tells The Edge.

“Out of the countries where [parent company] Japan Tobacco International (JTI) has operations, this is by far the largest market fall we have seen,” says Silva.

In November 2015, Malaysia raised cigarette taxes by more than 40%, compounding the decline in tobacco volume already created by a 12% increase in cigarette excise barely a year before and the implementation of the Goods and Services Tax at 6% on April 1, 2015.

Tobacco companies have offset volume falls in the past two years by increasing prices on the back of tax hikes.

However, the strategy has been undermined by consumers trading down to illicit products. Silva points out that the circulation of illicit cigarettes has increased from 36.9% in 2015 to 51.2% last year.

He says the number of consumers who have traded down from expensive cigarette brands to cheaper legal alternatives has been limited.

“When consumers decide to change brands, they go all the way down [to illicit products]. We saw a number of people who used to smoke legal cigarettes turn to illegal cigarettes because illegal products are four times cheaper than a legal product. For example, you pay either RM15.50 or RM17 to buy a legal pack of 20 sticks while an illegal cigarette pack goes for RM3.50 and RM4,” says Silva.

“This was the main challenge that we had last year and it will remain the biggest challenge in 2017,” he adds.

Tobacco companies such as JTI Malaysia are of the view that the government has failed to curb the growing illegal trade in tobacco products.

“The main objective of the Ministry of Health is to reduce the consumption of tobacco, but last year, that [did not happen]. If you put together [the volume for] legal and illegal products, we actually have not seen a reduction in the consumption of cigarettes. That strategy is not working.

“However, [recent] talks with various government entities such as the Ministry of Finance and the Royal Malaysian Customs Department show indications of more political will to address this problem. We now need to see those actions,” says Silva.

In the meantime, JTI Malaysia is taking a wait-and-see approach.

“We feel that the government is committed to address this problem. This is a national problem because it affects government revenues and public health,” he adds.

Meanwhile, with a weaker ringgit against the US dollar resulting in higher import prices and costs of products, there seems to be no reprieve on the horizon for tobacco companies.

For JTI Malaysia, while Silva expects the company to remain profitable this year, the year-on-year fall in profit and revenue will go on in a market that continues to be clouded by illegal cigarette trade. “We are probably going to make less profit this year than what we made last year.”

JTI Malaysia, whose brands are Winston and Mevius, has not publicly disclosed its financial results since the company reverted from public to private ownership in 2014. Silva, however, reveals that it witnessed a sharp drop in net profit and revenue for the financial year ended Dec 31, 2016 (FY2016), alongside the large fall in volume.

Its performance is in line with its peers. British American Tobacco (M) Bhd (BAT), the country’s largest tobacco company by market share, reported a 39.6% decline in net profit to RM432.95 million in the first nine months ended Sept 30 last year, while revenue dropped 17.2% to RM2.92 billion. It is due to release its fourth quarter and full year 2016 results this month.

Last year, the pressure on volume and prices saw BAT closing its plant in Petaling Jaya, Selangor. The counter has taken a beating over the past year, falling 20.7% from RM56.06 on Feb 10, 2016, to close at RM44.44 last Wednesday.

Silva says JTI Malaysia has managed to grow its share in a difficult market from 21% in January 2016 to 23% at year end.

“While we lost a lot of volume, we did better within the industry than our competitors,” he adds.

Silva says two immediate challenges await the tobacco industry this year, the first of which is controlling the illegal trade of tobacco products.

The industry also faces uncertainty as the Ministry of Health pursues a new Tobacco Act.

‘Hear us out’

As new tobacco laws are being put in place, Silva hopes the ministry will refrain from taking any precipitating decision before “hearing us out”.

“We were informed that the government is going to pursue a new Tobacco Act to basically address areas in the industry that are not fully regulated yet. We welcome that. We are not against regulations. On the contrary, we think that regulations that are well thought out and address the key objectives are good,” he says.

“But our major concern or anxiety is, will the government be able to come up with regulations that will effectively deal with the problems in Malaysia? Because the key challenge that we see in other markets is that you have international bodies like the World Health Organization and non-governmental organisations that operate on a global level and a lot of times, they come with solutions that were implemented in different countries and they try to push these to be implemented elsewhere just so that globally, they have an alignment. If Malaysia tries to adopt these measures that are done in other places, it can make the current situation worse.”

Silva contends that Malaysia is in a unique situation where more than half of the tobacco products sold here are illegal.

“One of every two cigarettes sold in the country is illegal. So, when the government is crafting the regulations, it needs to keep in mind that it also needs to be able to curb the illegal sale of tobacco products.

“I believe that the government’s main objective is to lower the consumption of cigarettes by Malaysians. We welcome that but as a company, we hope the government has also the humbleness to listen to industry concerns,” says Silva.

“All we want from the government is to be able to listen to what it is thinking and give it our view. It does not need to follow or agree with our views, just listen because we operate in over 120 countries and we have a lot of experiences from different countries on how things are done. There is no harm in listening.

“I believe the industry needs more time to recover. If possible, we would recommend not having another tax increase this year to give time to the industry to recover,” says Silva, who last year said Malaysia has reached a “tipping point” in terms of the amount of tax that the industry can absorb.

The 36-year-old Brazilian, who assumed his current role on Jan 1 last year after holding various senior roles in markets such as Switzerland, South Africa, Mexico, the Philippines and Cambodia, says Malaysia has the “most challenging work environment” that he has encountered in his career.

“My biggest competitor here in Malaysia is not BAT or Philip Morris International, but illegal products,” Silva laments.

“As a legal tobacco company, our only defence is to continue to invest in improving the quality of our products and developing new products. We will also continue to innovate and answer to consumer preferences,” he says.

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