The challenge facing the nicotine bandwagon

British American Tobacco has been warding off the anti-smoking pressure groups and fighting tobacco lawsuits for years, but can things get worse for the troubled yet hugely profitable company? Jon Ashworth reports

A couple of years ago, Martin Broughton, chairman of British American Tobacco, was a little too candid with a newspaper interviewer. He admitted that he would advise his children not to smoke, because 'it is not good for you: you are better off not smoking'.

His remarks were immediately seized on by the anti-smoking lobby as an admission of guilt, even though Broughton was simply expressing a common-sense view. It foreshadowed comments made some months later by Matt Barrett, chief executive of Barclays, when he told MPs that he would advise his children against borrowing long-term on credit cards.

Even boardroom veterans get caught out from time to time. But for Broughton, who has just left BAT after 33 years to become chairman of British Airways, the resulting furore was just part of the job. Running a tobacco company hardly makes you 'Mr Popularity'.

When Broughton made his final presentation to BAT shareholders at the annual general meeting in April, he was characteristically upbeat. Yet not even he could fully disguise the raft or problems stacked up against the company.

Broughton launched a scathing attack on anti-smoking pressure groups whom he accused of nobbling standard setters. He told the AGM: 'Some health policy makers show signs of being 'captured' by narrowly-based, vociferous anti-tobacco activists, who are sometimes even funded by the regulators they are lobbying.'

He went on: 'If regulators are 'captured' by lobbies driven by narrow and unrepresentative interests, consumers who choose to smoke - and pay ever increasing taxes to do so - will have every right to ask if their governments have let them down.'

Christian Aid, Friends of the Earth and Action on Smoking Health (ASH) had just published a report criticising BAT for its record on health and the environment.

Broughton's words may have won nods of agreement from BAT's oppressed, over-charged smokers. But for the rest, it sounded like defending the indefensible. Smoking is bad for you; no-one denies it. The challenge for BAT and its competitors is how to keep the nicotine bandwagon rolling for as long as humanly possible.

That could be a very long time. BAT is an enormous enterprise, generating profits, before exceptional items, of £2.8bn last year on sales of nearly £26bn. The company sold 800bn cigarettes, or 'sticks', driven by its four main global brands: Kent, Dunhill, Lucky Strike and Pall Mall.

The company generated net cash of £1.5bn with which to fund acquisitions and pay for the legions of lawyers retained to fight tobacco lawsuits. As the anti-smoking noose tightens in America, the UK and other Western markets, the company is seeking to tap new Asian markets such as Korea and China.

Pension funds are under pressure to boycott 'unethical' sectors. Consumers are being bombarded with graphic images of the health-consequences of smoking. But there will be 18% more adults in the world a decade from now, and BAT reckons the market will remain buoyant.

BAT's origins date to 1902, when Imperial Tobacco of the UK and American Tobacco set up a joint venture company to target international sales. In return, they agreed to avoid competing against one another in their home markets.

By the 1980s, BAT Industries, as it became known, had evolved into a conglomerate, with cigarette brands sitting alongside insurers like Eagle Star and Allied Dunbar. The financial services business was demerged in 1998, and the renamed British American Tobacco returned to the FTSE100 index as a standalone tobacco company. It merged with Rothmans in 1999, adding Dunhill to the family.

In some respects, BAT is no different to any other British-based company with operations around the world. Exchange rate fluctuations are beyond its control. City analysts caution that the weak US dollar could shave 1%-3% points off earnings growth in 2004.

In common with companies such as Unilever or Procter & Gamble, BAT faces aggressive local competition from cheap rivals. In America, discount cigarette brands have grabbed 15% of the local market.

But this aside, BAT is in a league of its own. As of December 2003, the company was facing more than 4,200 individual health-related lawsuits, most of them aimed at its US subsidiary, Brown & Williamson. BAT separately faced 36 class action lawsuits from victims of smoking-related diseases. Claims included a large number of 'passive smoking' cases brought by airline attendants.

In a bid to cap exposure to such claims, BAT announced a $6bn merger of Brown & Williamson with RJ Reynolds, the second biggest US tobacco group. The new company will be called Reynolds American. RJ Reynolds has agreed to indemnify Brown & Williamson against existing and future lawsuits, cauterising BAT's exposure to US litigation.

Reynolds American will take over payments due under the so-called Master Settlement Agreement, in which the big US tobacco companies will pay 46 US states more than $200bn over 25 years to settle smoking-related claims.

Investors have expressed concern that the merger could yet unravel. Also, tobacco companies' success in having smoking claims struck out has suffered a reversal. Tobacco shares fell sharply in May after the Florida Supreme Court said it would review the earlier dismissal of the landmark Engle class action suit, potentially exposing cigarette manufacturers to a $145bn claim.

The same month, a federal judge cleared the way for a $280bn claim against tobacco companies by the US Department of Justice. Tobacco stocks had rallied in recent months in the hope that the threat of litigation against the industry had receded.

Lawsuits aside, cigarette companies are caught in a vice when it comes to advertising their products. Cigarette packets now routinely carry graphic health warnings. Photographs depicting smoking-related diseases could be introduced from the autumn. Members of the European Union have until July 2005 to comply with a EU directive calling for a ban on tobacco advertising. Measures have already been enacted in the UK, with a temporary exemption for 'exceptional global events'.

Outcasts

Meanwhile, smokers are being portrayed as social outcasts. Ireland has banned smoking in all public outlets, and there are calls for a similar ban in the UK. In a recent Mintel poll, of 1,500 adults surveyed, 52% were in favour of moves to outlaw smoking in pubs, bars and restaurants.

Officials in New York estimate that about 100,000 people have quit smoking since March 2003, when smoking was banned in most public places.

In the UK, BAT continues to lose millions of pounds to packs smuggled from abroad. High tax rates mean that up to a third of cigarettes smoked in Britain are not duty paid.

The problems keep rolling in. Earlier in the summer, anti-tobacco campaigners accused BAT of frustrating access to embarrassing documents flushed out as part of the US litigation. One document discusses the company's alleged marketing to 'illiterate low-income 16-year-olds'.

Broughton's successor as chairman, Jan du Plessis, a South African former Rembrandt executive, has all this to look forward to in the months ahead. With cigarette companies, there is always something new round the corner.

Jon Ashworth is business features editor at The Times.