Where there's smoke there are profits: Cigarette smoking may be declining in the US, but not in Brazil, where market leader Souza Cruz and its smoking CEO Flavio de Andrade are taking on all corners in the multi billion-dollar market

Latin CEO: Executive Strategies for the Americas, Dec, 2001 by Larry Luxner

FLARIO DE ANDRADE BEGINS OUR long anticipated interview not with a "Bom dia, how are you?" or a "Please sit down," but with a cheery "Mind if I smoke?"

If he were anyone--or anywhere--else, the request might seem politically incorrect. But this is Brazil, and Andrade is president and CEO of Souza Cruz SA, Latin America's largest cigarette manufacturer and one of the world's top exporters of tobacco leaf.

"I was very young when I started, and I never quit," explains Andrade, 53, as he lights up his fourth Lucky Strike (a licensed Souza Cruz brand) of the morning. "I like smoking."

So, apparently, do 35 million other Brazilians--nearly one-third of the adult population of this vast country. Unlike the United States, where cigarette sales have been declining steadily for years, Brazil is a growth market for tobacco companies, with consumption expected to rise 4 percent this year and another 3.6 percent in 2002.

While the anti-smoking lobby would be appalled by such statistics, they're music to the ears of Andrade, whose 98-year-old company enjoys a whopping 80 percent share of the nation's legal cigarette market. Seven of its brands--including Derby Free, Hollywood and Carlton--are among Brazil's 10 top-selling brands. Derby alone accounts for more than 41 percent of all Brazilian cigarette sales.

To get an idea of the sheer size of this giant, consider the following numbers: Souza Cruz expects 2001 revenues of around US$2.4 billion, with net earnings of US$290 million, making it one of Brazil's five largest private-sector companies. Production of cigarettes at the company's two factories in Uberlandia (Minas Gerais) and Porto Alegre (Rio Grande do Sul) is expected to reach 85.2 billion units this year, up from 82.6 billion in 2000.

And there's more to come: On April 25, 2003, the company's 100-year anniversary, Souza Cruz will inaugurate a third factory in Cachoeirinha (Parana) that cost US$500 million.

Meanwhile, exports of tobacco leaf should hit a record 92,807 tons in 2001, up from 79,000 tons last year. Continuing political turmoil in Zimbabwe, the world's No. 2 exporter of tobacco leaf after Brazil, almost guarantees that Brazilian exports of tobacco leaf--a field in which Souza Cruz clearly dominates--will keep climbing at an annual rate of 10 percent or more for several years to come.

In a Nov. 1 report to investors tided "It Can't Get Any Better Than This," the Sao Paulo office of Banco Santander Central Hispano said Souza Cruz remains its top pick in the Brazilian consumer sector. To support its "strong buy" recommendation, Santander noted that the company's third-quarter 2001 consolidated net revenues jumped 27 percent to 657.1 million reais (US$258.4 million) compared to the same period a year earlier, and that during the first nine months of 2001, consolidated adjusted earnings soared 50 percent to 508.9 million reais (US$220 million) compared to a year earlier.

"Souza Cruz is expected to register solid results both this year and in 2002," says Santander analyst Daniela M. Bretthauer, "with an extremely healthy cash flow for three main reasons: its pricing strategy, the impact of the exchange depreciation on its tobacco exports, and the effect of the exchange depreciation on its dollar investments. Added to these factors are the company's aggressive dividend policy and its healthy balance sheet."

Rich History, Counterfeit Challenges

FOUNDED IN 1903, RIO DE JANEIRO-BASED Souza has been a British American Tobacco (BAT) affiliate since 1917. It is today 75.3-percent owned by London-based BAT, with the remaining 24.7 percent of its shares publicly traded. Of those, 8.5 percent are owned by individual Brazilian investors; 7.2 percent by foreign investors; 7 percent by Brazilian pension funds; and 2 percent by local Brazilian asset management companies.

Despite a nationwide ban on cigarette advertising that went into effect last January, the company logo--a stylized gold and blue tobacco leaf--seems to be everywhere in Brazil. It's also cropping up in communist Cuba, where Souza Cruz launched a joint-venture cigarette factory with the Castro regime six years ago (see sidebar).

Robert Blocker, an investment analyst at Blocker Assessoria de Investimentos e Participacoes Ltda. in Sao Paulo, says that from the beginning, no other company has even come close to Souza Cruz in conquering Brazil's cigarette market.

"Basically they were very agile and reacted very fast. They had a wonderful distribution system and used it to their advantage," he says. "All of the big cigarette manufacturers have tried to get in here, but nobody's been very successful because Souza Cruz was always so fast and good at marketing their brands."

So good, in fact, that last year the Brazilian anti-monopoly agency Conselho Administrative de Defesa Economia (CADE) ruled to abolish exclusive cigarette contracts at points of sale throughout Brazil. Says Santander's Bretthauer: "This represents a major victory for Philip Morris, which had argued that the reason it was unable to compete directly with Souza Cruz was partly due to the latter's exclusive contracts with most of the points of sale for cigarette distribution."