China’s Killer Profits

12/14/14
 
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By Andrew Martin,

from Bloomberg Businessweek,
12/11/14:

The paradox of China National Tobacco Corp.

The China National Tobacco Corp., which serves China’s 300 million smokers, is by far the largest cigarette maker in the world. In 2013 it manufactured about 2.5 trillion cigarettes. Its next largest competitor, Philip Morris International (PM), produced 880 billion.

In terms of market share, China National is bigger than its next five competitors combined; its growing sales have accounted for a net increase in global production, even as volume at its competitors has fallen. While Marlboro remains the most popular cigarette in the world, China National boasts 7 of the top 10 brands, including Red Pagoda Mountain and Double Happiness. In all, the company made 43 out of every 100 cigarettes in the world last year, according to Euromonitor International. Despite its size, China National is little known outside of China: Almost all its cigarettes are sold in the country, where it has no real competition.

A conglomerate on the order of the old Gulf + Western, China National runs more than 160 cigarette brands, manufactured in about 100 factories across the country, and uses its earnings to invest in banks, luxury hotels, a hydroelectric plant, a golf course, and even drugmakers. Most of its money goes to its owner, the Chinese government; the tobacco industry accounts for about 7 percent of the state’s revenue each year, and China National controls as much as 98 percent of the market. All told, the industry in China employs more than 500,000 Chinese. They are among roughly 20 million people who get some income from tobacco, including members of 1.3 million farming households and workers at 5 million retailers, according to government figures. The extent to which the government is interlocked with the fortunes of China National might best be described by the company’s presence in schools. Slogans over the entrances to sponsored elementary schools read, “Genius comes from hard work. Tobacco helps you become talented.”

The government runs China National as a largely opaque monopoly. The company has successfully blocked competition from Western tobacco makers by limiting imports or domestic production by foreign companies. In the past decade, as smoking has ebbed in other parts of the world, China National has been on a remarkable tear, gobbling up market share and building blockbuster brands. It generated about $170 billion in revenue in 2012, more than Apple (AAPL).

While the growth of its cigarette production has slowed, the company is making more money than ever in the same ways its Western competitors do: by pushing premium brands. Some are low-tar, some are organic, and some feature tobacco from American farmers, whose fortunes have risen along with the demand from China. But China National is being challenged as never before. Faced with a mounting death toll from smoking-related diseases, the Chinese government in the last year has issued a flurry of anti-tobacco edicts and proposed reforms.

China National doesn’t seem too concerned. The general manager of the company is Ling Chengxing, 57, the onetime mayor of Fengcheng in southeast China. He began his tobacco career in 1992, running China National’s branch in Jiangxi province. At a January meeting of cigarette brand managers and tobacco regulators, Ling announced his projections for the industry’s contribution to the government: an increase of 8 percent in 2014. But, he said, “strive for 10 percent.” He’s a nonsmoker himself.

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