Business Page – September 14, 2003

Demerara Tobacco Company Limited and ethical investing

Introduction  

The gross profit margin earned by Demerara Tobacco Company Limited for the first half of 2003 is a whopping 53% up from 46.7% earned in the same period lastyear. This is according to the half-year report published by the company under the Securities Industry Act which came into effect in October 2002. The following table highlights the Company’s performance for the half year and compares it with the unaudited and audited figures for the half-year and full year 2002 respectively.
While the figures for the half-year are unaudited, it is worth noting that the second half of last year was significantly better than the first half, and if the current trend continues the company is heading for another year of bumper profits.

Sales for the period were up by $133.4M or 9.7% when compared with the same period last year, and on an annualised basis would represent 51.3% of sales for 2002. Gross profit for the period was $794.9M or 24.3% up on the same period last year and on an annualised basis would represent 55% of gross profit for 2002. Profit before taxation for the period was $583.9M, an increase of 29% when compared with the same period last year, and on an annualised basis would represent 58.8% of gross profit for 2002.

Super profits and price increase

Given the super-profits being earned by the company it is hard to see the justification for the price increase in July 2002 - a case of exploitation of a market in which the company boasts a 98% market share. Despite the enviable performance of the company in 2002, its Chairman/Managing Director (MD) predicted that “2003 is expected to be a challenging year,” leaving one to wonder what the MD would consider a good year.
The Net Profit Margin - the relationship between net income to sales - for the six months ended June 30, 2003, rose from 46.7% to 52.9% compared with the same period last year. If we go back a little further and compare with its 1998 performance, we see that while the company’s net investment in fixed assets has declined by more than 75 per cent, profits have increased by more than 400 per cent. In 1998 Earnings per Share were $3.68 compared with full-year 2002 of $21.69!

From manufacturing to trading

Having transformed itself from a manufacturing to a trading company Demtoco is flush with cash despite being owed some $300M by its ‘related parties.’ Because the company no longer needs to invest in capital expenditure (its capital commitment at December 31,2002 was nil) it can now pay an increasing share of its profits in dividends which strangely are not reflected in its share price. In both 2001 and 2002 the company paid $17.84 per share which is 42% of the current trading price of the share on the Stock Exchange. In other words any investor buying shares at the current price will recover their cash investment in less than thirty months! Using a price-earnings ratio of eight, the price of a share in this company would be worth approximately $168, meaning that the shares are trading at less than 25% of ‘normal’ value.

Ethical investing

It is possible that there is some reluctance by Guyanese to invest in an industry which is notorious for the harm it does to both its active as well as passive consumers and the extent to which the international industry goes to defend its products. In Guyana the packet needs merely to make a sterile statement that ‘The Minister of Health advises that SMOKING IS DANGEROUS TO HEALTH,’ a note that is not only inconspicuous but has proved to have had little or no impact.
On the other hand, Canada which leads the way with tobacco regulations, in 2000 enacted stringent tobacco product labelling and reporting regulations into law requiring every manufacturer of tobacco and similar products to cover 50% of the exterior packaging of all such products sold in Canada with new health warning messages. These new warning messages include graphic images, such as pictures of mouth cancer, the brain of someone who suffered a stroke, and a bedridden patient dying of lung cancer. Colourful images are accompanied by strong textual warnings, such as “Cigarettes Hurt Babies,” “Tobacco Use Can Make You Impotent,” and “Don’t Poison Us” (accompanying image shows two little children). The regulations are aimed at ensuring that Canadians are better informed about the many serious health hazards associated with tobacco products. A group of tobacco manufacturers including Benson & Hedges filed a lawsuit in Canada’s constitutional court against the regulations. The manufacturers have appealed the decision by the court upholding the Act which remains in force.
The Demerara Tobacco Company’s 2002 Annual Report, while recognising the risks of smoking, also spoke of its pleasures and a lifestyle choice. Would it not be interesting to enquire how many of the company’s directors and senior managers indulge in that pleasure?

Regulatory framework

The report does not even refer to the Securities Industry Act under which it is mandatory for public companies to publish half-year financial reports. Indeed the report generally exceeds the basic requirements of the SIA which is commendable, given that the provisions of the SIA with respect to half-yearly reports are neither demanding of the companies nor helpful to their shareholders. What is not commendable is the fact that the report states that the statements have been prepared in accordance with International Accounting Standard - Interim Financial Reporting. IAS 34 specifically requires ‘selected explanatory notes’ which are absent from the report and which therefore restrict a meaningful analysis of it.
Perhaps the company is merely following the one-sheet rule of the other companies to have published interim financial statements, but to have excluded basic information on accounting policies, currency, share capital, related parties transactions which are substantial, etc.

Smuggling

The huge profits earned by the company on cigarettes raises questions about the competition from smuggling. Cigarettes are one of the most heavily taxed commodities in Guyana, but the market share and profits the company enjoys suggest that it may not be suffering significantly from smuggling. Surely cigarettes are as susceptible if not more to smuggling as say fuel, yet we appear unable to control smuggling of fuel while doing so successfully with cigarettes.

Conclusion

The results since the company closed its manufacturing operations in Guyana have been an astounding success for its shareholders, among which British American Tobacco holds a controlling interest. This story is not unique, and the whole future of manufacturing in Guyana needs to be addressed in an informed, objective manner.
For those who want to see an active stock market in Guyana and who believe in ethical investing there is a real dilemma. The country’s top two companies are deeply involved in that other social evil - alcohol - and the most profitable one is in cigarettes. Their options therefore are extremely limited, and with no signs of any other business going public the level of activity on the fledgling Stock Exchange is hardly likely to rise soon.
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