Imperial, Britain's second-largest cigarette group after Gallaher, said the legitimate UK market for cigarettes is declining by 8 per cent and that the fall could increase to 10 per cent because of the 39p increase in tax in the past six months. The traditional decline in the UK cigarette market has been 2.5 per cent a year.
Imperial said more smokers are trading down to cheaper brands such as supermarket labels and its own Lambert & Butler brand. Conversely, said Imperial, the non-duty paid market - both legal and illegal - now accounts for more than 15 per cent of the market and rising.
"We want the Government to abandon the policy of increasing tobacco duty by 5 percentage points ahead of inflation," said Imperial chief executive Gareth Davis. He said Sweden had cut its tobacco duty by 27 per cent last year and "stopped smuggling dead".
However, Imperial did not support Gallaher's stance several months ago that the incidence of smoking was now on the rise for the first time in a generation due to the flood of cheap imports. "We were surprised when we saw that. Our understanding has been that the proportion of British people smoking is still in decline."
The comments came as Imperial reported a 25 per cent rise in half-year profits to pounds 183m, helped by last year's acquisitions of Rizla and Van Nelle Tabak.
Imperial, demerged from Hanson three years ago, has been gradually trying to expand beyond the mature UK market, where it has increased its share from 38 to 38.4 per cent in the past year. The Rizla and Van Nelle deals mean overseas operations now account for 39 per cent of Imperial's profits, and the group wants to push this to 50 per cent.
Imperial is looking at deals and could benefit from the fallout from the BAT-Rothmans merger, as the enlarged group will be forced to dispose of some brands to satisfy the regulatory authorities. The contract to distribute the Marlboro brand for Phillip Morris in the UK could also be up for grabs. Marlboro is currently distributed here by Rothmans, and if the BAT merger is regarded as a change of control for Rothmans it could put the contract up for review.
City analysts have been warming to Imperial because of its solid UK business, coupled with good growth prospects abroad. It is also free of the litigation worries that haunt BAT in the United States, where Imperial does not trade.
Simon Willis at CCF Charterhouse points to good margin improvements abroad and impressive cost control at home as reasons to buy the stock. He reckons the shares - up 32p to 687.5p yesterday - have 20 per cent upside, while Credit Suisse First Boston has a target price of pounds 10. On a forward p/e of 13 the stock should puff up higher.