Will Japan Tobacco Profits Go Up in Smoke?

Investors are worried that a new government in Tokyo could have Japan Tobacco’s profits go up in smoke.

They needn’t worry so much.

The Democratic Party of Japan wants to slash smoking rates and may hike cigarette taxes to do it.

On the face of it, this certainly isn’t good news — and it explains the sudden reversal in JT’s share price. Down about 18% from a mid-June high of $345.74, the shares are now in the red for the year. Global tobacco stocks, meanwhile, are steadily rising.

But the DPJ has also indicated that they may lift JT’s mandate to buy all tobacco leaf grown in Japan, and allow it to set prices for its products without first seeking government approval — both legacies of the company’s former status as a government-run monopoly.

The purchasing mandate cost the company nearly $640 million in year ending March, because the Japanese leaf is up to four times as expensive as foreign tobacco, says Nikko Citigroup’s Nobuyoshi Miura.

And JT’s used tax hikes to its advantage in the past. In 2006, the last time the government raised cigarette taxes, the company simultaneously won approval to raise its prices — by 11% on its top Japanese brand, Mild Seven, for example.

That helped compensate for revenue lost from discouraged smokers.

Anyway, JT’s growth has been coming from overseas as awareness of the dangers of smoking and a declining population overall have the Japanese market shrinking.

Thanks to acquisitions such as a nearly $15 billion purchase of U.K. tobacco company Gallaher in 2007, nearly 62% of JT’s $19 billion in tobacco revenue was from overseas markets last year. A quarter of JT’s revenue comes from other sources, like food and drugs.

Of course, there is room for some volatility in the stock price. Competing interests in the newly elected party — which is made up of everything from laissez faire to socialist interests — mean surprises could lurk. The DPJ hasn’t said yet how high cigarette taxes could go, but the new administration could find itself desperate for tax revenue.

Still, investors ought to take a long, slow drag on their Mild Seven and consider that they’re overdoing the worry.

© Copyright: Wsj

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