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View from City Road: US smoke clouds dilute BAT's gain

BAT Industries yesterday offered conflicting evidence to the protagonists in the debate about the value of brands. On the one hand, it achieved a good price for offloading European rights to Benson & Hedges as part of a brands swap with one of its main US rivals. On the other, it announced a dollars 75m hit from the US price war started by Philip Morris, the owner of Marlboro.

The brands swap seems to make perfect sense. BAT is acquiring the French business in Lucky Strike and Pall Mall cigarettes, giving it ownership of these brands across Europe. In exchange, BAT is handing over Benson & Hedges, which sells three billion cigarettes a year in Europe, to American Brands.

BAT also receives pounds 135m or more - pounds 70m now and the rest over the next 10 years depending on future sales. BAT is giving up net profits of only pounds 8m, yet claims Lucky Strike cigarettes are much more to the taste of Continental smokers than Benson & Hedges.

BAT will take a capital profit of pounds 135m. However, this will be offset by the emerging damage from America. US wholesalers, used to two or three price rises a year, have run their stocks down in the expectation of being able to buy cheaper later.

Sales of Kool, BAT's menthol cigarettes, have dropped by about 35 per cent. The destocking will cause a dollars 75m reduction in trading profits in first-half profits.

BAT says the impact of stock adjustments is a one-off hit. Even if this is so destocking accounts for only about 15 of the 35 per cent drop in Kool sales, with stronger competition accounting for the rest. This suggests the total impact of the price war could easily be dollars 150m this year.

BAT, which had recently increased its US market share after some years of decline, believes it has so far lost about 1 per cent of its 10-11 per cent share. However, it says there has been little impact on the value- for-money market, the growth of which sparked the retaliation from Marlboro.

It is anyone's guess how long Philip Morris will be prepared to extend its price cuts. The likes of BAT and RJR Nabisco have very deep pockets and seem unlikely to capitulate in the short term. At some point, however, the price of Marlboro will return to 'sensible' levels and it may find it hard to hang on to its market share gains. On this basis there could be long-term damage from the brands war, at least in cigarettes.