tma annual meeting and conference global leaf trends changing dynamics / future trends presentation...

TMA Annual Meeting and Conference

Global Leaf Trends Changing Dynamics / Future Trends

Presentation By:

Jim Starkey

Williamsburg, VirginiaMay18, 2009

• Some Significant Changes• Market Implications• Current Supply and Demand Situation• Future Trends / Potential Beneficiaries• Final Observations

2008 Estimated World Leaf Production

Significant Changes

• Sources of leaf have shifted dramatically

Flue-Cured Tobacco Production

1960 2008

Burley Tobacco Production

1960 2008

A Dynamic Industry

• Sources of leaf have shifted dramatically• Consolidation has reduced the number of

industry players– Leaf dealers– Manufacturers

Leaf Industry Consolidation

Past

Universal LeafSocotab (49%)Thorpe & RicksGKCasalee

DibrellIntabexA.G. MonkAustin

TranscontinentalAdamsMeridional

Present

Universal Leaf

Alliance OneMonk Austin

DIMON

Standard Commercial

Manufacturer Consolidation

JT RJI/Gallaher

Imperial Altadis / Commonwealth

BAT ETI / RJ(42%) / Tekel / Scantoco

PM USA John Middleton / UST

PMI Lakson / Sampoerna / Rothmans, Canada

RJ Conwood

The Current SituationA Dynamic Industry

• Cigarette manufacturers expand portfolio– New products/smoking devices– New categories

• Cigars• Smokeless• Snus• Other

Market Implications

• New origins entail greater production risk– Less irrigation– Shift from large commercial farms to small scale– Shift from auction to contracting

• Result is greater downside production risk

Market Implications

• Increased production risk• Buyer/user consolidation

– Smaller numbers– No unplanned inventory– Shorter durations

• Higher market volatility

Market Implications

• Increased production risk• Market volatility• Higher production costs

– Fertilizers– Pesticides and herbicides– Fuel– Labor

• Plus alternative crops– Tobacco growers have alternatives– Crop prices have risen dramatically

Market Implications

• Cost of buyer-mandated programs– Improve leaf quality– Eliminate foreign matter– GAP– Social responsibility

Market Implications

Attractive Alternatives

Buyer Mandates

Higher Leaf

Prices

Increased: Production Risk Market Volatility Production Costs

The Current SituationSlow Growth in Leaf Markets

Cigarette Production Trend

The Current SituationSlow Growth in Leaf Markets

• Growth mainly in:– Asia– Eastern Europe– Middle East

• Declines in developed countries– Characterized by:

• Increasing taxation• Increasing regulation• Production shifts

Population growth

Rising income levels

The Current SituationSlow Growth in Leaf Markets

• Less clear how much leaf utilization has increased, if at all outside PRC– New manufacturing technology uses less leaf/stick– Impact of industry consolidation

• Supply chain efficiency• Waste reduction/increased utilization

– American blend growth has stalled – affects burley demand

The Current Situation

FC Leaf Production 2003-2008 (Million Green Kgs)

3,3153,513

3,792 3,702 3,6563,969

PRC Other Exporters

The Current SituationFlue-Cured Leaf Production

• Two very different stories– PRC

• Dramatic growth• 500 mKgs or 28%• Only slightly greater than cigarette production growth (24%)

The Current SituationFlue-Cured Leaf Production

• Exporters down 2%

World Flue-Cured Exporters’ Leaf Production (x-PRC)

The Current SituationFlue-Cured Leaf Production

• 2008 declines in Brazil, Zimbabwe, other Africa and Canada

• More than offset increases in US, EU and India

The Current SituationBurley Leaf Production

• Production recovered in 2008 from weather-reduced 2007 crops

685

806704

664563

Primarily Flavor Primarily Filler

+ 39%

+ 0%

688

The Current SituationBurley Leaf Production

• However– Filler primary beneficiary– Flavor styles flat– Burley supplies, particularly flavor remain tight

The Current SituationBurley Production - Flavor

Selected Countries

2000Million

Green Kgs

2007Million

Green Kgs

2008Million

Green Kgs

2007-08%

2000-08%

US 143 102 102 - -29

Brazil 95 105 100 -5 +5

Argentina 39 37 42 +14 +8

The Current SituationBurley Production - Filler

*EU exporters include Poland for all years

Selected Countries

2000Million

Green Kgs

2007Million

Green Kgs

2008Million

Green Kgs

2007-08%

2000-08%

Malawi 142 87 170 +95 +20

Mozambique 6 28 44 +57 +633

Zambia 3 5 12 +140 +300

India 9 15 23 +53 +185

Thailand 28 43 36 -16 +29

EU Exporters*

87 53 56 -3 -36

PRC 62 25 38 +52 -39

Philippines 27 8 9 +13 -67

Mexico 23 10 10 - -57

S. Korea 22 9 9 - -59

The Current SituationUnsold Stocks

• Last piece of market puzzle– Flue-cured unsold stocks

• At lowest level since 1991• Reflects lower 2008 production x-PRC

The Current SituationUnsold Stocks

85

128

151

187

98

72

U.S. Pool Others

World Uncommitted Flue-Cured Stocks as of June 30

The Current SituationUnsold Stocks

• Flue-cured markets balanced heading into 2009

The Current SituationUnsold Stocks

• Burley unsold stocks– Essentially gone

49

86 8572

29

U.S. Pool Others

9

World Uncommitted Burley Stocks as of June 30

The Current SituationUnsold Stocks

• Burley markets remain– Extremely tight for flavor– Still tight for filler

Future Trends/Potential Beneficiaries

• Cigarette Production– China will be main growth engine– Growth outside China will be slow (0-0.3%)

• Growth in Asia, Middle East, and Eastern Europe• Offset by continued declines in developed countries• Leaf markets will be at best flat

Future Trends/Potential Beneficiaries

• Leaf production – short term– 2009 Flue-cured

• Total production forecast to increase due to mainly PRC• Production by exporters x-PRC projected to rise

Estimated Flue-Cured Production in Million Green Kgs

2007 2008E 2009P Change over 08

Brazil 643 608 595 -13

India 260 270 280 10

US 220 231 227 -4

All x-PRC 1,706 1,669 1,750 81

PRC 1,950 2,150 2,200 50

Others 216 217 210 -7

World Total 3,873 4,028 4,160 132

Future Trends/Potential Beneficiaries

– 2009 Burley• Production increase forecast

Estimated Burley Production in Million Green Kgs

2007 2008E 2009P Change over 08

Malawi 87 170 250 80

US 102 102 98 -4

Brazil 105 100 109 9

Argentina 37 42 49 7

Mozambique 28 44 53 9

Exporters 563 688 803 115

Others 57 56 54 -2

Total 621 743 857 114

Future Trends/Potential Beneficiaries

• Will not materially change tight supply situation, particularly flavor

• Significant downside risk

Future Trends/Potential BeneficiariesSlow Growth – What Could Change Trend?

• Higher production and leaf use– Development and consumer acceptance of reduced

risk products that look and act like traditional products– Increased consumption of OTP and snus could create

increased demand for dark air-cured leaf at expense of flue-cured and burley

Future Trends/Potential BeneficiariesSlow Growth – What Could Change Trend?

• Lower production and leaf use– Serious government effort to reduce PRC cigarette

consumption– Development and consumer acceptance of reduced

risk products using heating rather than burning technology

– These products require less leaf

Future Trends/Potential Beneficiaries

• Not much change from current situation• Flue-cured – Flavor

– Brazil• Will continue to dominate • Not immune to weather risk• Strong real raises dollar costs and prices

– U.S.• Termination of program improved leaf competitiveness• Quality remains best• Highest priced but dollar weakness reduces gap

Future Trends

• Flue-Cured - Flavor– U.S.

• Termination of program improved leaf competitiveness• Quality remains best• Highest priced but dollar weakness reduces gap• Probably will remain mainly domestic supplier

– Zimbabwe• Future depends on political/economic change• Would be strong demand, particularly from Europe and as

alternative to Brazil• Production will not recover quickly• Unlikely to reach past levels

Future Trends

• Flue-Cured – Filler

Future Trends

• Flue-Cured – Filler– PRC

• Will grow to meet domestic demand• Exports face increasing competition from India• Reliable supplier concerns make PRC alternate choice

• Questions:– Will PRC continue domestic focus or seek to expand

exports– Can PRC produce significant quantities of an

“acceptable” flavor style

Future TrendsWinners and Losers

• Flue-Cured – Filler– Other Africa

• Zambia, Malawi, Tanzania and Uganda have potential• Excellent conditions including land, labor and climate• Lack of infrastructure/high cost of expansion• Affects competitiveness in market• Absence of land tenure systems is a major problem in some

African countries

– India, Pakistan, Bangladesh• Very competitive in price/quality• Production increasing• Could benefit from European decline• However all have growing domestic markets

Future TrendsWinners and Losers

• Flue-Cured – Filler– Europe

• Full decoupling in 2011 could result in significant decline in production

• Some member states have talked about national subsidies to maintain industry/employment

– Canada• Is essentially a domestic crop now

Future TrendsWinners and Losers

• Burley situation is very tight and demand remains strong

• Uncommitted stocks likely continuing at very low levels

• Burley flavor– Brazil

• Only Brazil has potential for significant increases in short term

• Costs/prices will go up– Strength of real– Prices of other crops – maize, soybeans

Future TrendsWinners and Losers

• Burley flavor– U.S.

• Little interest in producing more even at higher prices in traditional areas

• Further U.S. increases will depend on developing non-traditional areas

Future TrendsWinners and Losers

• Burley – Filler– Malawi

• May be reaching practical limits• Weather risk, particularly drought may be increasing• Prices likely to increase

– Mozambique• Could double production with existing infrastructure• Additional increases possible with additional infrastructure

investment• Dollar prices will have to double to offset impact of strong

currency on local costs and grower incomes

Some Final ObservationsManufacturers Will Determine Where Leaf is Produced

• Price/quality• Risk diversification

– Weather– Political/economic– Reliability of supply

• Scale is important• Other factors

– Social responsibility– Sustainable production practices– Environmental stewardship

Some Final ObservationsProduction Will Likely Remain in Traditional Origins

• New origins are expensive to develop• Dealers can’t afford w/o manufacturer support• More than enough capacity in traditional areas

Some Final Observations

• Production volatility will increase– Shift to non-irrigated production– Little irrigation in new origins– Long term (20-50 year) forecast is:

• Drier weather patterns in Southern Hemisphere• Periods of much wetter and much drier weather

• Shift from auction to direct contracting shifts risk from growers to dealers

Some Final ObservationsContinued

• Leaf prices will rise– Offset dollar decline on local currency costs and

incomes outside U.S.– Rising prices of alternative crops– Cover costs of programs promoted by manufacturers

to:• Improve quality• GAP• Social responsibility

Some Final ObservationsContinued

• Reduced risk products could revolutionize and revitalize industry– Impact level of cigarette and other product

manufacture– Leaf requirements– Future origins

TMA Annual Meeting and Conference

Global Leaf Trends Changing Dynamics / Future Trends

Presentation By:

Jim Starkey

Williamsburg, VirginiaMay18, 2009