Tobacco Facts.

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Imperial Tobacco has issued a profit warning stemming from a price war in Spain.

The company, which owns the Davidoff and Gauloises brands, said on Monday that adjusted operating profits in the region could be as much as £110m ($180m) lower than previously forecast.

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Spain has not been the favourite territory of any tobacco company lately.

The woeful economy means smokers have less money to spend, while a ban on smoking in public places instituted in January means they have fewer places to light up. The market has dropped precipitously as a result.

However, two of the four global tobacco companies have borne the brunt of the pain in Spain. They are Imperial, whose Fortunas is the number two brand by volume in the country, and Philip Morris International, which makes the market leader Marlboro.

Both groups have lost market share recently to British American Tobacco, primarily as it pushed its Pall Mall value brand through price and marketing. BAT boasted last month it aimed to “never miss a good crisis”, in reference to Spain.

At first, Imperial gritted its teeth and held prices, in part because it was still paying down debt from its 2008 acquisition of Madrid-based Altadis.

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But Philip Morris took a different tack. Starting in May this year, it began a series of steep price cuts, and reasserted the role of its value L&M brand as the cheapest on the market.

The ensuing price war eventually drew in Imperial, too, leading to Monday’s profit warning.

But the war is attracting attention disproportionate to what it is costing Imperial, in part because it breaks with an industry-wide pattern that developed early in the recession and has been little questioned since.

Despite volumes ebbing, revenues rose on higher prices. Even if smoking was not recession-proof, tobacco stocks seemed to be. Now some investors worry that Spain could be a harbinger of a new era of tougher pricing pressures for the industry.

Imperial – and many analysts – argue the situation in Spain is unique.

Its recession, after all, was deeper than elsewhere, and exacerbated by a tobacco tax increase late last year and the smoking ban this year. The structure of Spain’s tobacco duty means price wars hit government coffers, too, making price cuts attractive to companies wanting to influence government policy.

Some observers believe Philip Morris is tilting for regulatory change. But one City analyst doubted that. “Price wars happen,” he said. “This is just getting attention because Spain is a big market and it’s in Europe.”

He thinks Philip Morris is taking advantage of the weak dollar to stem market share declines, rather than fundamentally reassessing the trade-off between smoker retention and price.

However, Martin Deboo at Investec Securities is more anxious. “With FY10 an annus horribilis for industry volumes, perhaps Philip Morris might be worried about consumption trends generally, a stance consistent with their FY11 guidance that pricing will be more ‘conservative’,” he wrote on Monday.

“We sense they have a very keen awareness of when pricing is drifting too far away from what customers are willing to pay.”

If this were the case, he said, “we see mature markets where Imperial is number two to Philip Morris – for example Germany, France and Poland – as concerns.”

Imperial’s shares fell on Monday by 29p, or 1.4 per cent, to £20.56. Its difficulties play into market speculation that the number four tobacco group worldwide, by market capitalisation, could eventually be a take-over target. However, many sector watchers argue consolidation would be stymied by competition authorities.

M&A would become more appealing for the industry if organic growth and pricing stuttered. But it is far from clear that it has reached that point. “You can’t really extrapolate from Spain,” said an analyst.

Nor would weakening Imperial ahead of a take-over be one of Philip Morris’s aims. Competition concerns would keep the global market leader from picking off the number four.

The Financial Times