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A multinational almost as old as Pakistan, the Pakistan Tobacco Company (PSX: PAKT) is the leading cigarette maker in Pakistan. An affiliate of the British American Tobacco Company, PAKT is a successor to the Imperial Tobacco Company of British India, which had been operating in South Asia since 1905. British American Tobacco Company - the world's second-largest tobacco group by global market share - is PAKT's ultimate parent company.

Latest publicly-available information shows that over 94 percent of PAKT's shareholding is owned by British American Tobacco (Investments) Limited. The remaining shareholding is held by a variety of investors, including investment companies, banks, insurance companies, mutual funds and individuals.

PAKT makes and markets a selected few brands of its parent company locally in Pakistan. Some of the top brands include Gold Leaf, Capstan, Dunhill, Benson & Hedges, Gold Flake and Embassy. Previously, PAKT used to command over 50 percent of the cigarette sales volume, followed by Philip Morris Pakistan Limited (PSX: PMPKL) with 15-20 percent market share. However, in recent years, sales of illicit cigarette - counterfeit, smuggled, and duty-evasive products - have apparently mushroomed, shrinking the share of the formal sector. As per PAKT management, illicit sector's share in cigarette sales volume has grown to 40.8 percent as of June 30, 2017.

The firm is ranked among the major taxpaying companies in Pakistan. During CY16, the firm collected on behalf of the federal government Rs 84.4 billion in excise duties and sales tax on tobacco sales. On top of that, it also paid Rs 5 billion under the head of corporate income tax on a pre-tax profit of Rs 15.38 billion in CY16. In total, between CY11 and CY16, PAKT has paid the government Rs 404.17 billion in excise duties, sales tax, and corporate income tax. However, thanks to sagging cigarette volumes, this calendar year, the firm's contribution to the national exchequer has drastically declined. In 1HCY17, PAKT paid the government Rs 34.3 billion under the head of duties, sales tax, and corporate income tax - a figure that is Rs 23 billion lower compared to same period last year.

Recent financial performance Before PAKT hit a massive speed bump in CY17 (more on that later), it had performed spectacularly well in this decade. Between CY11 and CY16, the firm had almost doubled its top-line, with an exponential growth in net profits. The firm consistently returned growth in gross profits, operating profits, and net profits. As can be seen in the table, the magnitude of margin expansion has been wider than the top-line growth over the years. That shows a high degree of operational efficiency at work. For instance, cost of sales - as a percentage of gross turnovers - declined from 24.8 percent in CY11 to 17.1 percent in CY16.

But the initial warning signs had started emerging by 2015. That year, PAKT's cigarette volumes declined for the first time in recent years. Still, upward price adjustments, which were warranted by budgetary increase in tobacco taxes by the federal government, helped the firm eke out a top-line gain. The following year was the first year in some time when PAKT didn't register a double-digit top-line growth. Finally, the decline in cigarette volumes had set in for sure in CY16. The firm's brands in the value-for-money (VFM) segment were being out-priced by cheaper alternatives offered by duty-evasive local cigarette manufacturers.

Yet, despite the top-line disappointment, CY16 was a record-breaking year for the firm. PAKT, expanding its bottom-line by a huge 47 percent, crossed the Rs 10 billion net-profit milestone. The management drove hard cost-saving measures, which were possible thanks to using modern techniques at its tobacco-processing facilities. Besides, a consolidation of distribution channels over the years also bore fruit.

Latest financials PAKT's fairytale wasn't meant to last. Fears of an impending reversal in the firm's fortunes, highlighted by BR Research in its earlier columns, started ringing true this year. The firm's half-yearly financials, announced in late July, screamed red all over, as PAKT continued to battle with its sneaky competitors in the informal sector. The massive top-line drop cascaded into a bigger drop in net profits as cost of sales and operating expenses didn't fall by as much.

Outlook PAKT isn't the only one under the weather - the whole formal tobacco sector seems to be under a recession of sorts. But going by the way 1HCY17 has turned out for the tobacco major, the suffering may get worse by the time this calendar year closes. And that will put question marks over the viability of this top taxpaying sector.

Some respite may be in the offing, as the federal government seems to have realised that the strategy of merely taxing the formal sector higher is proving counter-productive. In the FY18 budget, some measures were announced that may help the formal tobacco players get their footing back. On the fiscal side, the tobacco FED regime has been returned to three tiers, with almost no FED increase on the hitherto two-tier system. The introduction of a bottom slab, in which cigarettes selling below Rs 58.5 a pack would have FED of Rs 16, will help the likes of PAKT better compete with the duty-non-paid brands in VFM segment.

Going forward, the third quarter results will tell if the government remedies, which also include some administrative measures to check the informal sector, have helped or not. Meanwhile, over at the stock market, the PAKT scrip has been up over 40 percent in the year-to-date period. But the stock's low level of free float and thin trading volume - averaging just over 800 shares traded per day in the period - suggest there is little to read in the recent share price surge.





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PAKT: Pattern of shareholding (as at Dec. 31, 2016)

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No. of Shares held % of total

shareholders shares

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Directors, CEO and their spouse and minor children 9 12,274 0.00%

Executives 3 34 0.00%

Associated Companies, Undertakings and Related Parties 2 241,843,423 94.66%

British American Tobacco (Investments) Limited 1 241,045,141 94.34%

Rothmans International 1 798,282 0.31%

Investment Companies 1 515 0.00%

Modarabas & Mutual Funds 5 1,897,213 0.80%

Insurance Companies 3 394,259 0.20%

Banks, Development and other Financial Institutions 9 3,282 0.00%

Individuals 3,193 2,575,043 1.00%

Others 52 8,767,749 3.40%

Total 3,277 255,493,792 100%

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Source: Company accounts





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PAKT: Financial snapshot

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Rs (mn) CY11 CY12 CY13 CY14 CY15 CY16

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Financial position

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Paid-up capital 2,555 2,555 2,555 2,555 2,555 2,555

Reserves 779 1,552 2,857 5,456 7,811 10,422

Property, plant & equipment 6,100 5,695 7,085 8,713 9,185 8,629

Capital expenditure in the year 1,167 421 1,887 2,249 1,491 579

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Operating results

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Gross turnover 67,492 75,531 89,929 107,218 125,013 129,278

Net turnover 22,950 25,880 30,623 36,619 42,907 44,867

Gross profit 6,241 8,446 10,610 13,847 18,555 22,774

Operating profit 661 2,729 4,602 7,087 10,335 15,000

Profit after tax 364 1,728 3,124 4,850 7,046 10,361

Earnings per share (Rs) 1.42 6.77 12.23 18.98 27.58 40.55

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Financial ratios (based on gross turnover)

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Gross margin 9% 11% 12% 13% 15% 18%

Operating margin 1% 4% 5% 7% 8% 12%

Net margin 1% 2% 3% 5% 6% 8%

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Source: Company accounts





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PAKT: latest financials

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Rs (mn) 1HCY17 1HCY16 Chg

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Gross turnover 50,475 82,209 -39%

Net turnover 18,214 28,848 -37%

Cost of sales 9,882 14,150 -30%

Gross profit 8,333 14,698 -43%

Selling & dist. expenses 2,028 2,387 -15%

Administrative expenses 1,111 1,115 0%

Operating profit 4,774 10,403 -54%

Profit for the period 2,976 7,071 -58%

EPS (Rs) 11.65 27.68 -58%

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