• July 15, 2024

Shifting Sands

 Shifting Sands

Image: Givaga

Image: Givaga

Under pressure from the IMF, Egypt’s government reduces its share in Eastern Co.

By Stefanie Rossel

On Oct. 29, 2023, Egypt’s House of Representatives approved a long-expected tax hike on tobacco products. The amendment to the 2016 VAT law will expand the price ranges of taxed cigarettes by raising the minimum and maximum limits of each segment by 12 percent annually for five years. In addition, the draft law will increase the fixed tax by EGP0.50 ($0.02) on the three segments of cigarette prices, resulting in EGP4.5 for cigarettes retailing at less than EGP31, EGP7 for the mid-price cigarette range (those costing between GDP31 and GBP45) and EGP7.5 for cigarettes priced above EGP45.

The bill also increases the tax on tobacco products by 75 percent, raising the minimum from the present EGP30 to EGP60 per kilogram. Imported and local molasses products will see a 25 percent tax hike whereas the tax on heated-tobacco products will rise from EGP1,400 per kilogram to EGP1,800 per kilogram. Under the new law, e-liquids will be taxed at EGP4 per milliliter instead of the current EGP2 per milliliter.

The amendment will allow cigarette manufacturers, who have been facing increasing production costs and a plummeting Egyptian pound, to adjust prices without moving into higher tax brackets. The tax hike is expected to generate up to EGP8 billion annually in additional revenues for the state budget.

According to the head of the House’s Planning and Budget Committee, the move is also designed to encourage tobacco companies to increase production in a way that will stem the rise in cigarette prices, thus putting an end to the country’s cigarette crisis. Since May, the Egyptian cigarette market has been in turmoil. According to observers, the problem emerged after the minister of finance called for an amendment to the 2023–2024 budget to increase its tax revenue from EGP81 billion to EGP87 billion. The government, however, was slow to implement the tax hike. What followed was a shortage of tobacco products, particularly cigarettes, and the rise of an informal, parallel market in which a pack of the country’s most popular brand, Cleopatra, sold at EGP50 instead of EGP24.

As soon as they got wind of the tax increase, tobacco traders seized the opportunity to make additional profits by hoarding cigarettes. The artificial scarcity caused cigarette prices to soar, forcing smokers to buy unknown, adulterated or smuggled cigarettes, which in turn reduced tax revenues. After Egypt’s tobacco monopoly, Eastern Company, increased production by 40 percent and stepped up vigilance against illicit sales, cigarette prices decreased to EGP40 in September.

In the short term, [the deal] is clearly positive,” says Vorster, “but the potential for more adverse excise and regulatory regimes could detract from that significantly.” 

Pieter Vorster, managing director, Idwala Research

Foreign Currency Crisis

“Other than for the traders exploiting the situation, it is clearly an unfavorable environment, albeit one caused by tax increases telegraphed well ahead of their implementation, exacerbated by weak enforcement and currency shortages,” says Pieter Vorster, managing director of Idwala Research. “The tax hike helps to reduce margins in the parallel market, but stockpiling will likely continue if potential disruptions to production owing to currency shortages are viewed as possible.”

Egypt was hit hard by Russia’s invasion of Ukraine in February 2022, which caused many foreign investors to abandon emerging markets. Consequently, the country has been struggling with rising global wheat and energy prices. According to a report by the U.S. Department of State, Egypt’s external debt reached $164.7 billion in June 2023.

In December 2022, the International Monetary Fund (IMF) approved a 46-month $3 billion loan for Egypt to overcome its economic crisis under the condition that the government undertake several structural reforms. It insisted that Egypt adopt a flexible exchange rate, lift of import restrictions and privatize state-owned companies.

Despite the government’s efforts to create a more favorable business environment, foreign investors continue to face challenges such as bureaucracy, lack of transparency, uneven enforcement, corruption, intellectual property issues and a shortage of skilled labor.

Egypt’s sale of a major stake of Eastern Co. on Sept. 3, 2023, was part of its commitment to sell shares in 35 state-owned firms. Global Investment Holding (GIH) of the United Arab Emirates paid EGP19.3 billion for a 30 percent stake of the 50.9 percent stake that the state-owned firm Chemical Industries Holding Co. had previously held—a price that Vorster deems steep. “It seems a high multiple for a noncontrolling stake without the synergies that a tobacco company might have been able to extract,” he says. According to Daily News Egypt, both Japan Tobacco International and United Tobacco Co., in which Philip Morris International controls most shares, also submitted offers for a stake in Eastern Co.

Following the deal, 20.9 percent of Eastern Co. remains with Chemical Industries Holding Co., 35 percent is freely traded on the Egyptian Stock Exchange, and the remaining 15 percent is owned by various private stakeholders. GIH announced that it would invest $150 million to rejuvenate Eastern Co.’s raw material supplies. Whether it will be allowed to use its funds to import tobacco, however, remains unclear. Egypt prohibits tobacco cultivation and taxes leaf imports at 75 percent. According to Mada, an Egyptian media organization, the Emirati firm will work with banks to facilitate Eastern Co.’s access to foreign currency for imports. “In the short term, [the deal] is clearly positive,” says Vorster, “but the potential for more adverse excise and regulatory regimes could detract from that significantly.” 

A Growing Market

The deal might still prove to be a win-win for both parties. Egypt is in dire need of U.S. dollars to pay for imports. Eastern Co. accounts for 70 percent of tobacco sales in Egypt, which is one of the world’s few remaining growth markets for cigarettes. Statista anticipates the market to generate $6.3 billion in 2023 and projects it to enjoy an annual growth rate of 9.65 percent by 2028. According to Alternative Policy Solutions, a public policy research project at the American University in Cairo, around 18 million Egyptians over the age of 15 are smokers. Overall cigarette consumption increased 7 percent in 2022. Smoking is a male habit: The World Health Organization projects that by 2025, 63 percent of the country’s male population will be smokers, up from presently 41.8 percent. Only 0.3 percent of women currently smoke.

According to Forbes Middle East, Eastern Co. is worth $1.2 billion. The company reported a net profit of EGP5.29 billion in the first nine months of fiscal year 2022–2023– 24 percent higher than in the comparable prior-year period. Its revenues rose to EGP14.6 billion from July 2022 to March 2023 compared to EGP12.78 billion in the comparative period of the previous fiscal year. The company supplied 88 billion cigarettes to the Egyptian market in 2022–2023.

With the acquisition of its stake in Eastern Co., GIH will have effectively established control over 40 percent of the Egyptian tobacco market as the investment firm’s founders also hold shares in UTC, according to Mada. How their acquisition will impact on the overall market remains to be seen. Citing Turkiye as an example, Vorster points out that there are several examples where the excise tax and regulatory environments became significantly less favorable when the state exited former monopolies. “It also seems plausible that the market could become significantly more competitive with PMI now manufacturing themselves, and others potentially following in future,” he says.

PMI Starts Local Production

In its domestic market, Eastern Co. is rivaled by only JTI and UTC. BAT exited the Egyptian market last year, claiming a lack of economic viability. Its withdrawal came shortly after PMI in April 2022 had reached a licensing agreement with Eastern Co. to manufacture cigarettes in Egypt. More than a year earlier, Egypt’s Industrial Development Authority had invited companies to bid to become the country’s second tobacco company. However, the agency was forced to relaunch the tender after bidders complained that its conditions gave unjust advantages to Eastern Co. In the renewed tender, UTC was the only company to bid. Under the agreement, Eastern Co. acquired a 24 percent stake in UTC.

Although meant as a first step toward privatization of the tobacco monopoly, the agreement stipulates that UTC manufactures only products owned by PMI, thus protecting Eastern Co.’s market share by preventing the newcomer from producing cigarettes in the same price category as Eastern Co.’s bestseller, Cleopatra.

In September 2022, UTC started producing cigarettes at the manufacturing site of its predecessor Philip Morris Misr, the licensee for PMI products in Egypt established in 2013. PMI’s flagship brand Marlboro has been manufactured by Eastern Co. since 1985. Following the agreement, PMI products in Egypt are marketed under the label “Made by UTC.”

UTC also has permission to manufacture e-cigarettes. In April 2022, Egypt legalized the import and commercialization of vape products. Statista estimates that the revenue generated in the country’s e-cigarette market will reach $400 million in 2023.

The recent sale of the stake in Eastern Co. could also pave the way for more ambitious tobacco harm reduction in Egypt. To date, Eastern Co.’s portfolio has offered only high-risk products, such as cigarettes, shisha and cigars. Vorster is less optimistic. “In theory, it is slightly positive, but with cigarette prices below $2 per pack, it is hard to see reduced-risk products gaining significant traction,” he says.