Bloomberg News

Brazil’s Souza Cruz Set for Biggest Tobacco Stock Drop

August 03, 2012

Souza Cruz SA (CRUZ3)’s 64 percent surge in the past year has made the Brazilian cigarette maker the global industry’s second-most expensive stock even as it loses market share to illegal sellers.

The local maker of the Lucky Strike and Dunhill brands, based in Rio de Janeiro, has a price-to-estimated earnings ratio of 24.3, second only to India’s ITC Ltd. (ITC) The stock is expected to fall 12 percent, the most of any tobacco producer worldwide, according to median 12-month target-price estimates tracked by Bloomberg.

Souza Cruz is losing sales to black-market cigarette sellers amid lax government control and a growing tax burden. Illegal cigarettes accounted for about 20 percent of Brazilian sales last year, driving down Souza Cruz’s share to 61 percent from 62 percent a year earlier, the company said in a presentation on its website.

“Brazil is a huge market, but at the same time it has a huge problem with illegal trade,” Owen Bennett, an analyst at Nomura Holdings Inc., said in a telephone interview from London. “It’s probably one of the highest illegal trades in terms of percentages across the world.”

Souza Cruz rose 2.4 percent to 29.80 reais at 11:43 a.m. in Sao Paulo trading, bringing its year-to-date gain to 30 percent. The stock boasts the second-highest total return in the past five years among companies on the Bovespa index. Cia. Hering had the highest total return in the period.

Smoking Bans

Brazil has been taking steps to curb smoking through bans in restaurants and office buildings, advertisements on the Internet and graphic warnings on the back of cigarette packs featuring patients with cancer and other diseases. The government also increased the industrialized products tax, known as the IPI, on cigarettes twice since 2009. The tax will climb to 60 percent in 2015, from about 40 percent now, according to information on Brazil’s revenue service website.

Of the 10 analysts that rate Souza Cruz and are tracked by Bloomberg, five recommend holding it, two rate it a sell and three advise clients to buy the stock.

Above-inflation price increases and a growing population of new smokers in Brazil will propel earnings growth past peers, said Barclays Plc. analyst Gabriel Vaz de Lima, who has an equivalent of a buy recommendation on the stock.

‘Premium’ Stock

“Margins have been improving on the back of their pricing power and growing sales of premium cigarettes,” Lima said in a telephone interview from Sao Paulo. “The company is trading at a premium because of high dividends and low debt.”

A company official for Souza Cruz, who asked not to be identified because of internal policy, declined to comment when contacted by Bloomberg News.

Souza Cruz on July 27 said second-quarter profit rose 8.3 percent to 398.9 million reais from 368.2 million a year earlier. Revenue climbed 18 percent in the period, even as sales volumes slumped, after the company boosted prices by 21 percent.

“Souza Cruz still has room to keep raising prices, if you consider that a pack of cigarettes costs four times more in the U.K. than in Brazil,” Nick Robinson, who helps manage $15 billion in Latin American shares at Aberdeen Asset Management, said in a July 19 telephone interview. “Still, it looks expensive and may be a case of taking a bit of profit.”

To contact the reporters on this story: Lucia Kassai in Sao Paulo at; Rodrigo Orihuela in Rio de Janeiro at

To contact the editors responsible for this story: James Attwood at; Jessica Brice at

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