Corporate Finance Report: Lakson Tobacco Company
Corporate Finance Report: Lakson Tobacco Company
TABLE OF CONTENTS
Our group would like to thank the management of the Lakson Company who helped us in the completion of this report. We would also like to complement each other on great teamwork and group effort without which this report would not have been possible.
This report deals with the Tobacco Industry in General. The company that I have chosen for analysis is Lakson Tobacco Company. The competition that it faces is from Pakistan Tobacco Company and Khyber Company.
The first section deals with the brief profile of the company and gives the Industry background. The company profile and an extensive background analysis has also been provided.
The second part deals with the economic environment faced by the company. The factors affecting the Government regulation and competition faced by the company from within and outside are analyzed.
The Core Part of the report focuses on the Dividend Policy of the company. The key ratios related to the company are highlighted in this part. These are:
- Dividend Yield
- Earnings Per Share
- Price Earnings Ratio
- Retention Ratio
The last part deals with the Financial Leverage of the company and examines the debt and the equity structure in great detail. The Authorized share Capital and the Capital Structure of the company is analyzed and explained in great detail.
The tobacco crop is of great economic significance for Pakistan although it occupies a relatively small area of 0.27% of the total irrigated land in the country, and about 3% in the NWFP. With suitable crop treatment, it is capable of yielding very high income to the growers as compared to any other cash crop. Its greatest attribute is its link with the viable and efficient cigarette industry. It is a highly labor intensive crop and provides employment both in the fields and in the factories.
The tobacco industry contributes over Rs. 14 billion annually through Central Excise Duty and sales tax to the Federal Exchequer. Apart from this a formidable foreign exchange is earned from the export of tobacco and its products. Almost all tobacco produced in the country except for nominal quantity, which is imported for superior brands of cigarettes. If the per annum demand had to be met only by exports it would cost imports of Rs. 3.7 billion per year.
Primarily their proper marketing and disposal, ensuring a fair return to the tiller, regulate production and quality of tobacco. The most sensitive aspect of the tobacco crop apart from its production is the marketing process, which is based on plant position grading.
In 1947 after the independence of Pakistan there was no tobacco industry in existence. The first setup came in the 1950s in the form of Pakistan Tobacco Company (PTC). Since the tobacco industry is the highest taxpayer, it has encouraged the unorganized sector to flourish by producing low quality brands. The formation of PTC was followed by another giant entry called Lakson Tobacco Company (LTC). Both PTC and LTC control 90% of the market share while the other 10% shared between small-scale local manufacturers.
After the merger of Lakson Tobacco Company and Premier Tobacco in 1997 the Lakson Tobacco Company has taken over the market leadership from Pakistan Tobacco Company. Now PTC holds 45% of the market share as compared to 55% of LTC. However LTC believes that it holds 42% of the market share and PTC holds 40.8% while the rest 17% belongs to the emerging unorganized sector.
The following are the major constituents of the tobacco industry of Pakistan
- Khyber Tobacco Company Ltd. (Year of Listing: 1988)
Khyber Tobacco Company manufactures and sells cigarettes. Its brands include Players, Red Lamp, Richmond and Sports.
- Lakson Tobacco Company Ltd. (Year of Listing: 1979)
The company manufactures and markets cigarettes under the brand names Buckingham, Morven Gold, Panama, Princeton and Royals.
- Pakistan Tobacco Company Ltd. (Year of Listing: 1956)
The company manufactures and markets cigarettes. Brands include Gold Leaf King Size, Capstan Filter and Wills King. As of December 1997, B.A.T Industries (UK) owned 63% of Pakistan Tobacco.
- Sarhad Cigarette Industries Ltd. (Year of Listing:
Sarhad manufactures and sells cigarettes, mostly local brands.
- Souvenir Tobacco Company Ltd. (Year of Listing:
The company manufactures and sells cigarettes, its brand includes Allwin, Mayor and Melburn.
- Tobacco International Ltd. (Year of Listing:
Tobacco International manufactures and sells cigarettes. It is recently under suspension from 27-01-2000.
The following are the Stock Quotations of the tobacco companies as on March 11, 2000:
|Company||Last Rate||Ch. From Prev.||Hi||Lo||Turnover|
According to a report in the newspaper the Pakistani people are smoking away Rs. 24 billion annually with the number of cigarette smokers increasing at an alarming rate. Most of the cigarette smokers are people of young age that have just converted into teens.
Being a highly labor-intensive crop, tobacco provides ample job opportunities for (1) employment in the fields at the time of production, priming and curing and (2) in the tobacco factories where the tobacco is processed for the manufacture of cigarettes. About eighty thousand people are engaged in the crop production and marketing and another about 34,000 to 40,000 workers are employed in the tobacco industry for the manufacture and handling of end products. Also a vast number of people are involved in retail marketing of cigarettes and other tobacco related products. In all the tobacco industry provides gainful employment to about one lakh people, both directly and indirectly, including the vast majority of farming community of NWFP and Punjab.
Tobacco is one of the major crops of Pakistan along with wheat, cotton, rice, sugarcane, gram, rapeseed and Mustard.
LAKSON TOBACCO COMPANY LIMITED
After the Economic Coordination Committee increased the support price for tobacco to give benefit to the growers there has been an increasing challenge to the socio-economic environment of the business. The foreign Exchange situation of the company has been continuously deteriorating which has inevitably caused the cost of inputs to increase. Production and Sales are expected to vary because of expected delays in the establishment of LCs with the banking sector.
The company has taken the Year 2000 issue very seriously and has pursued the Year 2000 program since 1996. The company has attributed high priority to rendering of social services to the community. It has continuously held free eye camps particularly in the tobacco grown areas. An under-age smoking prevention program has been initiated in association with other participants in the cigarette industry. Through this the company wishes to transmit to the public that smoking is an adult-oriented choice.
The future strategy for the company has been identified and documented by the leadership in the company. These are consolidation of position, improving quality volume, profitability, effective cost control, increasing emphasis on expansion of distribution coverage and to continue investment.
Lakson Tobacco holds 100% shares of Premier Tobacco Company (Pvt.) Limited, which is an unquoted subsidiary. The company accounts were officially merged on January 1, 1997.
In the 30th AGM the company has declared very lucrative profit payoff, at Rs. 4.20 per 10 Rupee share as cash dividend and Re. 1.00 as bonus stock dividend.
BOARD OF DIRECTORS
Iqbalali Lakhani (CEO & Chairman)
Amin Mohammad Lakhani
Robert Gordon Barrie
Robin Nicholas Wood
Hasaali H. Merchant
Tasleemuddin Ahmed Batlay
Lakson Square, Building No. 2
Sarwar Shaheed Road
- SITE Kotri
- Koragi Industrial Area
- Qadirabad (Sahiwal)
- Mandra Village (Gujar Khan, Rawalpindi)
- Ismaili (SWABI)
|1. Individuals||2, 221||5, 008, 975||25.51|
|2. Investment Companies||2||742||–|
|3. Insurance Companies||6||521, 087||2.65|
|4. Joint Stock Companies||11||5, 567, 475||28.36|
|5. Financial Institutions||3||587, 994||3.00|
|6. Charitable Institution||1||24, 927||0.13|
|7. Govt. Organization||2||18, 457||0.09|
|8. Foreign Companies||4||7, 901, 834||40.24|
|9. Banks||2||3, 095||0.02|
|2, 252||19, 634, 586||100.00|
Lakson Tobacco Company was incorporated in 1969 and was listed in 1979. The company since its inception has enjoyed very prosperous growth even in times of recession. The company has merged with Premier Tobacco on January 1, 1997. According to the chairman of Lakson this amalgamation has lead to considerable savings through streamlined distribution, elimination of duplication of services and operations and a reduction in overhead expenses. The amalgamation has opened doors for reinvestment in manufacturing, marketing and geographic expansion of distribution. This has lead to increase in sales, lowering of costs and efficiency in unified operations.
Lakson Tobacco has demonstrated excellent results for the last year 1999. The share price of Lakson is Rs. 53.00, which has shown an increase of 4.14 points and is approximately 460% of its par value. The company has shown record high figures of Profit After Taxation (PAT) of Rs. 180.39 million for the year ended June 1999. The company has enjoyed a 415% growth with respect to its turnover as compared to that of June 95.
|(in Millions Cigarettes)||1999||1998|
|Capacity||26, 096||24, 218|
|Production||28, 477||26, 376|
The legal import of foreign cigarettes has posed a threat to the tobacco industry. The high rate of taxes imposed on the local manufacturers has made the locals vulnerable to loose out the market share competition with the foreign varieties. If the foreign brands are successful in penetrating the market then the whole market would be filled with foreign brands. Thus it would be difficult for the local brands to survive because of the difference in the tax structure of the two.
The reported increase in various taxes has been there since 1993 when the government increased the excise duty on cigarettes, which in turn had an increasing, effect on the end-user prices. Similarly if the legal foreign imports were allowed to shoot up it would further aggravate the country’s balance of trade causing a draining effect on the country’s foreign reserves. It is also predicted that if foreign brands were allowed to flourish the local manufacturers with foreign principals, like Phillip Morris and BAT, would shut down their local operations and start importing themselves. But according to some analysts there will be no impact of foreign brands import because they regard them as two different segments.
- J. Reynolds Private Limited has opened its offices in Pakistan to market five of its international brands. PTC on the other hand has started marketing the legally imported Benson and Hedges Brand. It is reported that soon the 555, Marlboro and Dunhill brands will soon come in through the main door to pitch themselves against the same brands that come in from the backdoor. The most popular brands that are smoked in the market are Benson & Hedges, Marlboro, Dunhill, Dunhill Lights, More, Mild Seven, Silk Cut and 555
The tobacco industry of Pakistan has been constantly under the hitting of various organizations. Strong lobbying against tobacco smoking and production has made it difficult for the tobacco industry to flourish easily. Tobacco is fast becoming a greater cause of death and disability than any single disease as it kills over three million people all over the world every year. Unless the smoking behavior is changed, premature death caused by tobacco in the developing world will exceed the expected death from AIDS, Tuberculosis, and complications of childbirth combined. These effects of smoking have been the major targets for various anti smoking organizations. NGOs are continuously pressurizing the government to take anti-smoking steps in public transport.
The WHO has launched an unprecedented global initiative to counter what it calls “The Tobacco Industry’s Campaign of Deception and lies around the world. Similarly the world’s beleaguered cigarette makers face the prospect of fighting on a new front as UN launches the first international treaty to curb tobacco and its advertising. The treaty focuses a global ban on cigarette advertising, an increase in taxes on tobacco products and a right to smoke-free environment. If the Pakistani government endorses the treaty, it would directly threaten the growth market of tobacco in Pakistan.
According to many analysts ban on tobacco advertising would cause many retailers to go underground. It would hardly stop the people from smoking. Lack of advertising and direct mail initiatives will lead to a loss of brand image. This would then increase the flow of cheap brands causing the profit levels to go down hence encouraging retailers to buy leading brands through smuggling. It is said that a ban on cigarette advertisements would cost PTV a revenue shortfall of Rs. 80 million per year which might not be adjustable as PTV itself is undergoing severe financial crunch.
The Lahore High Court (LHC) while accepting a written petition moved by the Pakistan Chest Foundation has banned the tobacco ads on the PTV and Radio Pakistan. But the court has allowed telecasting the ads only if the cigarettes are shown instead of live smoking.
Smuggled cigarettes are continuously flooding the markets in major cities of the country, thus causing an annual revenue loss of Rs. 3 billion to the national exchequer. A large amount of smuggled cigarettes are brought in the country through the Afghan Transit Trade (ATT) that has grown at a faster rate during the last few years. Besides ATT, cigarettes were also smuggled from free port of Dubai by boats and convenience of the flight crew. Although the ATT route was then officially monitored the smuggling continued on through Iran to Quetta and then to Karachi. Selected outlets and every cigarette-selling kiosk have got the supply of smuggled cigarettes. As these items are not legalized no import tax is paid on them as well as the CE duty and the sales tax hence giving handsome profits to the sellers.
Smuggling has been the cause of low revenue generation in the country and availability of smuggled items has severely affected the local industry. The local manufacturers are already facing stiff competition because of lower duty tariffs and are facing losses due to competition from the smuggled brands and those cigarettes on which the duty is not paid.
The president of the Small Cigarettes Manufacturers Association (CGMA) has stated that CBR and other departments concerned in collusion with the multinational companies are busy in hatching conspiracies against the local cigarette manufacturers. And due to the harassment and corrupt practices rampant in the excise department the government is not realizing full amount of revenue. Local manufacturers need to be protected and saved from unfounded propaganda launched by the multinational companies that are striving hard to cause damage to the local industry. Government functionaries are on the payroll of these MNCs, which get 20% of their materials through import and the rest 80% from smuggling. The MNCs are also accused of exercising complete control on the purchase of tobacco hence exploiting the poor cultivators.
TRADE OF FAKE CIGARETTES THRIVING
Manufacturing of counterfeit cigarettes, modeled on foreign as well as largely consumed local brands is causing millions of rupees losses to the public purse. Best selling cigarettes like Dunhill, 555, Benson & Hedges, Marlboro, Gold Leaf, Capstan, Red & White are being pumped into the market in such a large quantity that the companies concerned or their agents are unable to cope with the situation. All of the cigarettes’ vendors are making huge profits by selling fake cigarettes.
PTC is the worst sufferer. Its best selling brand Gold Leaf is being manufactured illegally by Mardan based companies and are marketed all over the country
The tobacco industry of Pakistan is faced with many economic environmental constraints. First of all since the tobacco business is unethical, excessive promotion by the government does not allow the tobacco companies. The government has been heavily taxing the Tobacco Industry from 1993 onwards and according to the latest tax figures the tobacco industry has paid around 14 billion in taxes. This is a very huge amount for the government and the government is continuously trying to find ways to increase the taxes. To start with it is better to first mention the details about Pakistan Tobacco Board (PTB) and its functions.
PAKISTAN TOBACCO BOARD (PTB)
In the late sixties the Federal Government felt the need for a proper agency to promote the cultivation, manufacture and export of tobacco and tobacco products. Hence the Pakistan Tobacco Board (PTB) was formed in February 1968 which had the responsibility of the following functions:
- To regulate, control and promote export of tobacco and to fix grading standards.
- To promote the undertaking of research in the tobacco industry.
- To provide assistance for the development of the existing tobacco growing areas and finding new ones
- To collect any information pertaining to the tobacco industry.
- To perform various functions under the directive of the Federal Government.
There are 21 members in the Board and their breakup is as follows:
4 Federal Govt. Representatives
4 Provincial Govt. Reps.
2 CMA and PCCI members
7 Tobacco Growers of NWFP & Punjab
4 Tobacco Dealers from NWFP & Punjab
The PTB has its headquarters located in Peshawar and its zonal office in Lahore. Apart from this PTB has four research stations in Mardan, Mansehra, Okara and Gujrat. It has five other special committees assisting it in performing its functions that are:
- Tobacco Development Committee
- Finance Committee
- Research Committee
- Price and Grade Division Committee
- Selection Committee
In addition to the above the network under operation consists of 21 field officers present in the operating areas. The PTB tries to bring about a harmony between the production and demand of tobacco companies. The PTB ascertains requirements of tobacco companies for various types of tobacco from ensuing crop. The tobacco companies are required to execute agreements with the growers in the prescribed format for the Virginia and Burley crop. The Federal Ministry for Commerce fixes minimum prices for cigarette-type tobacco. The weighted average prices of Virginia and White Patta are protected under the provincial laws while those of dark aired cured tobacco are fixed by the discretion of PTB. The marketing of tobacco is based on plant position grading. Tobacco marketing has been streamlined through the formation of provincial laws and administrative decisions taken by the PTB from time to time. The PTB promotes the exports of tobacco and its manufacturers by keeping a liaison with the embassies of Pakistan abroad in tobacco producing \ exporting countries. The PTB issues a general called Pakistan Tobacco, which is also available to these embassies for information. In conclusion PTB has brought revolutionary changes in tobacco cultivation, yield, quality and thereby making the tobacco crop secure a prominent position in economic / financial stability of the company.
Tobacco marketing in the Frontier Province is regulated through provincial laws. Under these laws tobacco companies indicate their requirements to the Pakistan Tobacco Board (PTB) well before the sowing of the tobacco seeds. The tobacco companies have procured higher than their actual requirement and are holding tobacco stock inventories at very high levels.
The tobacco industry is the largest tax-paying sector with figures of Rs. 14 billion per annum. It had been anticipated that the NWFP cigarette industry may be brought under a stop-gap CE Duty formula from March 1, onwards. Under the new arrangement the industry would pay a fixed CE Duty of Rs. 45 million per month. This formula has been devised by the Ministry of Finance and according to CBR the rate is fixed flexibly. The frontier cigarette manufacturers have been offered this formula after a total suspension of CED payment by this industry. The frontier cigarette manufacturers were paying a fixed CED before but the government has abolished this system because of its inability to generate high CED collection from the industry.
The Small Cigarette Manufacturers Association (SCMA) has urged the government to restore the agreement of CED and tax between SCMA and the government for the better collection of revenue and development of industry.
The PTB has setup two committees to work out the cost of production of tobacco in the country for the fixation of maximum prices of the commodity. One committee would visit the tobacco growing areas in Punjab and the other in NWFP, to work out the cost of production. These two committees would then submit a report to the Price and grading Committee, which would in turn submit a report to the Ministry of Commerce for final decision. The massive devaluation of the rupee has increased the price of imports and smuggled items in the local market. The Tobacco Growers Association in Mardan has asked an increase in the tobacco procurement prices reduction in prices of pesticides and adoption of open auction system for the tobacco procurement.
The Federal Government fixes and notifies the minimum prices for various types or grades of tobacco. For the fixation of minimum price of tobacco following factors are taken into account:
- Increase in the cost of production of tobacco
- Minimum prices and weighted average prices of tobacco.
- World Tobacco trends.
- Rate of inflation in the country.
- Increase allowed in prices of other agricultural commodities.
- Wholesale Price index for the industry.
The Ministry of Commerce has proposed an increase of 8 percent in the prices of all kinds of tobacco varieties for the fresh crop. This price increase is to be applied to the following:
- 12 varieties of Flue-Cured Virginia
- 5 varieties of Nicotiana Rustica
- 7 varieties of Dark-Air Cured
- 6 varieties of burley
CENTRAL EXCISE DUTY ON FILTER RODS
Recently in the past the government has imposed 50% tax on the manufacture of filter rods. The argument in this case is that the import of filter rods and rods from Azad Kashmir and other non-tariff areas are not subjected to any CE Duty. Due to this the indigenously produced filter rods are said to attract 33% more incidence of taxes and duties as compared to imported equivalents
The Company faces intense competition from many Industries. The Major competitors are Khyber Tobacco Company and Pakistan Tobacco Company. The company profile is given below:
BROAD OBJECTIVES AND STRATEGIES
The financial position of the company remains the same as it was last year. The company has not received any financial assistance either from the government or from the financial institutions. At this stage to achieve the desired level of profitability, efforts at a very large scale are being made by the management to procure the desired target figures of production and sales of their own brands. The management has placed a lot of emphasis on heavy promotional activities that can act as a solution to strengthen the consumer loyalty in the tough competitive cigarette market, which depends upon the availability of adequate working capital.
However despite sever competition in the market the management has decided to commence manufacturing of cigarettes of their own brands. Strenuous efforts are to be made for marketing these brands on countrywide basis. Although the advertisement and media expenses to be incurred involve very high costs, still the management has felt to go along with this strategy in the best interest of the company. The management wishes to achieve higher returns in the coming year.
Mohammad Nazir Khan (Managing Director/Chief Executive)
The following is the break up in categories of the shareholders of the company.
|Category of Share Holders|
|1. Individuals||709||1, 125, 636||93.66|
|2. Investment Company||1||2, 348||0.19|
|3. Insurance Companies||3||70, 805||5.89|
|4. Joint Stock Companies||2||2, 986||0.25|
|5. Govt. Organizations||3||66||0.01|
|718||1, 201, 841||100.00|
Khyber Tobacco was listed in 1968. It is incorporated in Pakistan as a Public Limited Company and its shares are quoted on the KSE and LSE. Khyber Tobacco is a very small company as compared to Lakson Tobacco in every respect. It has only one production facility located in Mardan. It sells mainly local brands. There has been some controversy regarding the company for the year 1998. According to the company management Khyber Tobacco was documented to be shut down for a whole year. While non-official sources claim that the company was still in operation. The sales of the company are not so substantial in amount. For the year ended 1999 the sales were only Rs. 143,748 while there are no recorded sales for the year 1998 officially.
|(in Millions Cigarettes)||1999||1998|
|Capacity||4, 422||4, 422|
|Production||1, 220||2, 828|
LAKSON TOBACCO COMPANY
|Acid Test Ratio||0.278||0.318||0.386||0.364||0.436|
|A/C R/A Turnover Ratio||281||241||184||190||145|
|A/C R/A Turnover In Days||1.299||1.515||1.984||1.921||2.517|
|Inventory Turnover in Days||43.170||29.151||27.820||29.464||40.250|
|Sales to Working Capital||34.847||99.489||92.950||(736.996)||(109.389)|
|Net Profit Margin||1.34%||1.23%||1.28%||1.15%||2.36%|
|Gross Profit Margin||9.54%||9.22%||10.80%||11.00%||13.00%|
|Total Asset Turnover||4.59||6.19||6.20||5.50||3.96|
|Return on Assets||6.15%||7.63%||7.95%||6.31%||9.36%|
|DuPont Return on Assets||6.1506%||7.6137%||7.9360%||6.3250%||9.3456%|
|Operating Income Margin||2.52%||2.65%||3.97%||3.99%||5.57%|
|Sales to Fixed Assets||18.82%||26.64%||19.65%||16.67%||16.30%|
|Return on Investment||12.24%||17.65%||19.83%||17.21%||35.63%|
|Return on Total Equity||16.27%||23.96%||25.16%||20.84%||42.03%|
|Earnings Per Common Share||4.156||6.960||8.350||8.644||20.490|
|Price Per Earnings Ratio||6.629||5.699||5.988||6.25%||3.02586|
|Percentage of Earnings Retained||23.44%||50.37%||49.71%||53.08%||25.14%|
|Book Value Per Share||25.544||29.049||33.201||41.389||48.804|
The company has been consistently dividends for the last 8 years. The relevant ratios are as follows:
Lakson Tobacco- The dividend yield for Lakson has shown a steady decline for the first four years after which it has shot upwards to 25%.. This shows that the firm has successfully invested the money not distributed as dividends. Hence the yield is greater.
Lakson Tobacco-. The number of shares outstanding has remained the same but the main factor is the huge increase in the net profit of the company. Also it has been noticed that the tax rate applicable would be low because the government has decided to impose more tax on finished goods, which is included in the cost of sales.
Lakson Tobacco- The company has given a high return to its common shareholders for the forecasted years. The reason being that there had been an increase in the profit such that the management’s decision to declare dividends was necessary. There are no preferred shareholders hence all the net income was distributed among the common equity. We see a large leap for the last two years because in that period net income rose by greater percentage as compared to the growth of the equity
Lakson Tobacco- The P/E ratio has wandered around the 6 mark except for the year 2001 where it has dropped significantly. The market price of the share at that point in time is assumed to be Rs. 62/-. Hence the high EPS value because of the high profit rate has decreased the P/E ratio. Thus we see that in ear 2001 we are able to pay less for a dollar of recurrent earnings. Generally the increase in EPS values has been offset by a greater increase in the market price of the share for the three-year period from 1998-2000. Thus this increase will help to gauge the future earning power of the firm positively.
Lakson Tobacco- We can see that the debt ratio for Lakson has almost remained constant except for the year 2001 where it has risen by just a nominal amount. This shows a stable picture of the company with respect to its long-term debt paying ability. The lower the ratio the better the debt position of the company. In this respect Lakson has been showing a lot of consistency in its debt position. A very low percentage of assets are financed by creditors, which are well protected against insolvency. The company is in a position to issue long-term debt, if necessary
Lakson Tobacco- The book value per share has shown a constant increase. Thus we can say that each year a greater amount of stockholders’ equity is allocated with each share of common stock. Thus the increasing book value can be seen as a potential by the investor. Since the market value of the share is greater than the book value the investors can view Lakson as having enough potential to be worth more than the unrecovered cost
The authorized share capital of the company amounted to Rs. 300,000 in 1999.In 1998, the authorized share Capital of the company was the same. There were fully paid up shares of Rs. 10 each.
The Revenue Reserves in General were Rs. 359,993 thousand Rupees. The balance as a transfer amounted to 68,000 Rs. The transfer from P/L account amounted to Rs. 427,943. The total Stockholders equity amounted to Rs. 499,591 Rs. In 1999. The amount was Rs. 376,627 for the subsequent year ended, 1998.