Gallaher set to trump rivals with signs of a China breakthrough

Gallaher moved closer to becoming one of the first Western tobacco groups to break into the world's biggest cigarette market yesterday after signing an agreement with the Chinese tobacco monopoly to operate in China.

The company, which makes Benson & Hedges and Silk Cut brands, said it had signed a letter of intent with the state-run China National Tobacco Corporation to manufacture and distribute its cigarettes.

"It's a big step forward, but we need to develop [the agreement] into firm contracts," Nigel Northridge, Gallaher's chief executive, said. The major tobacco companies have been jostling to get a foothold in China, which smokes 1.7 trillion cigarettes a year, or 40 per cent of world annual consumption.

A deal would work on a reciprocal basis, with CNTC making and distributing one of Gallaher's brands in China, while Gallaher follows suit with one of CNTC's brands in Russia, where it owns Liggett-Ducat. Gallaher has yet to decide on which brand to launch in China.

While the move is not expected to result in significant additional volumes for Gallaher until 2004 at the earliest, analysts said it sealed the group's status as a global tobacco player. "It's interesting in terms of Gallaher's credibility," Andrew Darke, at Williams de Broe, said.

Gallaher also raised its full-year earnings expectations, to "high, high single digits" according to Mr Northridge, on the back of strong first-half figures that beat market forecasts. Its shares climbed 6 per cent to 670p – their highest level since the group was demerged from Fortune Brands in 1997 – topping the risers in the FTSE 100 index.

The group, which bought Austria Tabak last year and Ligget-Ducat in 2000, reported a 23 per cent rise in pre-tax profits before amortisation for the six months to 30 June to £223m. Turnover rose by 84 per cent to £4.2bn.

Analysts said the strong results laid to rest criticisms that the group had overextended itself by overspending on Austria Tabak, which it bought for €2.2bn (£1.3bn). Cigarette sales in continental Europe rose by 12 per cent to 23.6 billion sticks.

"We are beginning to join up all those dots," Mr Northridge said, referring to the group's ambition to be a leading player across Eurasia. He said there would continue to be scope for further acquisitions but that the rate was likely to slow from the heady levels of the past five years. Most expansion opportunities were likely to take the form of niche acquisitions, strategic alliances and joint ventures, especially in the Far East, he added.

In the UK, Gallaher's earnings fell by 4 per cent as it increased its marketing spend ahead of an imminent ban on tobacco advertising. The company said the UK market had stabilised, after years of declines of up to 12 per cent, as the government crackdown on smuggling paid off. Its market share slipped to 37.6 per cent from more than 40 per cent last year, hit by the success of new, extra long cigarettes sold by its arch rival Imperial.