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One Reason Why I Wouldn’t Buy British American Tobacco plc Today

Today I am looking at why illegal cigarette smuggling continues to crimp British American Tobacco’s (LSE: BATS) (NYSE: BTI.US) revenues outlook.

Illegal producers thwack sales performance

The issue of illegal cigarette production continues to hamper the performance of the likes of British American Tobacco. Indeed, figures recently released by financial services powerhouse KPMG revealed that more than one in every ten cigarettes purchased in the European Union last year were either counterfeit or contraband, i.e. those illegally moved from countries with low tax bands to those with higher tariffs.

The number of prohibited cigarettes consumed last year clocked in at a mind-boggling 58.6 billion sticks, even though this was down from 65.7 billion units in 2012 as increased legislation from member states kicked in.

But although a figure of 10.5% for 2013 was an improvement from a record high of 11.1% in the prior 12-month period, the high levels of british american tobacco / imperial tobaccoillegal tobacco sales remain a major headache for the world’s biggest manufacturers — indeed British American Tobacco generates more than a fifth of total profits from Western Europe alone.

Indeed, customs officers in Ireland seized €14m — or 32 million cigarettes and 4,500 kilograms of water pipe tobacco — worth of illegal material at the port of Drogheda this week. The operation was the largest such seizure in Europe this year, and illustrates the complexity of the industrial-scale smuggling network — the goods arrived in Ireland via Portugal from suppliers in Slovenia.

The KPMG report also delivered a double whammy to the cigarette industry by revealing that consumption of legal product slumped 7.5% last year. Analysts pointed to rising unemployment in 21 of the EU’s 28 member states, allied to price increases north of 5% in half of the region’s countries, as contributory factors.

Cigarette companies are caught in a vicious cycle of lifting prices as falling tobacco demand bites the bottom line, which in turn pushes consumers towards illegal alternatives which the likes of British American Tobacco attempts to combat through further price hikes.

The problem is a global one and particularly prevalent in emerging markets, home to the vast majority of the world’s smokers. And with production and the transportation of these products becoming more and more sophisticated the tobacco industry faces an uphill battle in overcoming these cartels.

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> Royston does not own shares in British American Tobacco.