Welcome to TMA’s 94

th

Annual Meeting & Conference

May 18, 2009

Williamsburg, Virginia

Farrell Delman

President Tobacco Merchants Association TMA’s 94 th Annual Meeting & Conference May 18, 2009 Williamsburg, Virginia

SCHIP FCTC FDA RECESSION

Conference Overview

• • • •

Some Key Trends The WHO’s Framework Convention

SCHIP FDA

Conference Overview

• • • •

Some Key Trends The WHO’s Framework Convention

SCHIP FDA

World Cigarette Production & Consumption

(Billions of Pieces) 6,500 6,000 5,500 5,000 4,693 5,230 5,170 5,341 5,110 6,025 5,695 5,585 5,296 5,469 5,745 5,590 5,818 4,500 4,658 4,000 1984 1988 1992 1996 2000 2004 2008 Production Consumption Source: USDA-FAS, TMA Estimates

World (excluding China) Cigarette Prod. vs. Cons.

(Billions of Pieces) 4,500 4,000 3,630 3,685 3,500 3,595 3,613 3,697 3,488 3,994 3,907 3,636 3,798 3,871 3,731 3,819 3,623 3,000 1984 1988 1992 1996 2000 2004 2008 World Production World Consumption Source: USDA-FAS, TMA Estimates

TAXES

…

SMOKING BANS

…

NO ADVERTISING

POINT-OF-SALE AD BANS … IN CARS … KIDS OUTDOOR SMOKING

Sales Trends: Shorter Cigarettes

Marlboro 72’s (Philip Morris USA and PMI)

Sales Trends: Smokeless Products Around the World

Sweden United States India

Ruyun

The E-Cigarette

e-Cigarette-USA Freedom Equazcion

China

’

s Cigarette Market

(Billions of Pieces)

2,300 2,200 2,100 2,000 1,900 1,800 1,666 1,600 1998 1,677 1,671 2000 1,722 1,708 2002 1,874 1,859 2,022 2,008 2004 2006 2,206 2,196 2008 Production Consumption The China National Tobacco Corp. (CNTC) is the largest cigarette producer in the world and China is nearing 40% of the world’s consumption Source: CNTC

4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0

China vs. World Cigarette Consumption Forecasts

(Billions of Pieces)

3,545 2,218 3,497 2,219 3,449 2,221 3,401 2,223 3,353 2,224 2009 2010 2011 2012 2013 China Cig. Consumption World minus China Cig. Consumption Source: TMA Estimates

A Chinese Wall Against Cigarette Imports

(% of Total)

1988 15.99 bn (1.02%) 1,557.08 bn (98.98%) CNTC Sales Imports 1998 1,655.3 bn (99.79%) 3.42 bn (0.21%) CNTC Sales Imports 2008 2,195.74 bn (99.84%) 3.50 bn (0.16%) CNTC Sales Imports

Since Joining the WTO in 1997, China’s Market is as Closed as Ever

Source: TMA.org, CNTC

Sales Trends: Cigars

(Billions of Pieces) 15.750

16.186

17.017

18.728

19.451

21.404

22.067

23.203

2001 2002 2003 2004 2005 2006 2007 2008 Source: TMA International Issues Monitor

Sales Trends: Roll-Your-Own

(Billions of Pieces) 87.18

92.93

94.36

68.27

69.89

71.86

$6.60

$6.04

$6.93

$11.47

$13.80

$15.17

1998 2000 2002 Volume (Th. of MT) 2004 2006 Value (Bn of US$) 2008 Source: TMA International Issues Monitor

Sales Trends: Slim/Super Slim Cigarettes

Virginia Slims (PM USA & PM Int’l) Sobranie (JT/Gallaher) Vogue (JT) ESSE (KT & G) Led by Esse, Slims had 37.6% of the Korean market in 2007 and are projected to hit 59.2% by 2012; Korean slim exports grew from 6 mn pieces in 2001 to 10 bn in 2007

Next Stops for Public Health?

Fast Food Obesity Big Pharma Alcohol

Conference Overview

• • • •

Some Key Trends The WHO’s Framework Convention

SCHIP FDA

U.S. Ratification of the FCTC As of today, while

164 168

nations or parties have signed the FCTC, have ratified it.

The United States signed the FCTC on May 10, 2004 , but has not yet ratified it.

FCTC - Timeline

May 1999:

resolution which calls for the development of a

October 1999:

Framework Convention on Tobacco Control.

1 st session of FCTC Technical Working Group

October 2000:

Public hearings on FCTC held 1 st session of Intergovernmental Negotiating Body held

March 2003: May 2003: October 2004: April 2005:

The 52 nd World Health Assembly backs a WHO members draft FCTC text 192 nations adopt FCTC text at WHO’s 56 th Assembly 1 st TobReg Meeting 1 st TobLabNet Meeting

Feb. 2006: Feb. 2008:

1 st Conference of the Parties [COP] 1 st session of INB to negotiate protocol on illicit trade

March 2009: June 2009: 4Q10:

4 th TobLabNet meeting held in Rio, Brazil 3 rd session of INB to be held in Geneva 4 th session of the COP to be held in Uruguay

FCTC: Articles 9 and 10



Article 9: Tobacco Product Content COP 3 recommended to submit a report at COP 4 which:

 

Identifies best practices in reporting to regulators regarding content, emissions and product characteristics Validate, within 5 years, the analytical chemical methods for testing and measuring cigarette content and emissions



Article 10: Tobacco Product Disclosure COP 3 recommended to submit a report at COP 4 which:



Collects and analyzes information on legal cases related to tobacco product disclosures

FCTC: Article 11



Tobacco Product Packaging and Labeling The COP 3 recommends:

  

Well-designed health warnings and messages Large picture warnings located on principal display areas The use of color rather than just black & white along with relevant qualitative statements to be displayed on each pack (or package) about the emissions of the tobacco Nations should also consider adopting measures to restrict or prohibit the use of logos , colors , brand images or promotional information on packaging other than brand names and product names displayed in a standard color and font style (plain packaging).

FCTC: Article 15 - Illicit Trade



INB -3 Protocol Now Being Developed



Defines “Illicit” as



Smuggling

 

Illicit Manufacturing Counterfeiting



Create Practical T&T System (s)



Cases / Pallets vs. Cartons vs. Packs

 

“Sales only allowed in X Country/Province” To Determine Point of Diversion

 

Monitoring & Reporting System (s) to Track the Product Movement through Distribution Authorized Enforcement Access to commercial shipment data bases

FCTC: Article 15 - Illicit Trade



Mandates Cooperation & Data Sharing National & International Agencies (AP) Among

  

Monitor & Collect Data on Cross-border trade (not national data alone) As well as all product “moving under suspension of taxes or duties within its jurisdiction” Provide COP Reports



Requires destroying counterfeit & contraband product and machinery used to produce it and the confiscation of ill-gotten gains



Encourages Nations to Enact Penalties and Remedies, including contraband” (AP) licensing , to prevent illicit trade “including counterfeit and

U.S. Ratification of the FCTC

     

(Article 5) (Article 6) (Article 8) (Article 9) (Article 10) (Article 11) (Article 12) (Article 13)



(Article 15)



(Article 19) FCTC Checklist: General Obligations Price and Tax Measures Protection from ETS Contents of Tobacco Products [FDA] Tobacco Product Disclosure [FDA] Packaging & Labeling of Tobacco Products [FDA] Education, Communication, Training & Public Awareness Tobacco Advertising, Promotion & Sponsorship [FDA] Illicit Trade in Tobacco Products [FDA] Liability

Conference Overview

• • • •

Some Key Trends The WHO’s Framework Convention

SCHIP FDA

US Federal Excise Taxes on Tobacco Products First Implemented

1862: 1865: 1897: 1917: 1965: 1989: 2000:

Large Cigars Cigarettes Little Cigars (Under 3 pounds per 1,000) Pipe, Snuff and Chewing Tobacco Pipe, Snuff and Chewing tax eliminated Pipe, Snuff and Chewing Tobacco Roll-Your-Own Tobacco

1865: c.1880: c.1890: 1920: 1941: 1943: 1952: 1983: 1991: 1993: 2000: 2002: 2009:

The US Federal Cigarette Excise Tax Timeline

(US$ per 1,000 pieces) $1.20 - to pay costs from the Civil War $1.75

$0.50

$3.00 - to pay costs from World War I $3.25 - to pay costs from World War II $3.50 - to pay costs from World War II $4.00 - to pay costs from the Korean War $8.00 - “Tax Equity & Fiscal Resp. Act of 1982” $10.00 - “Omnibus Budget Recon. Act of 1990” $12.00 - “Omnibus Budget Recon. Act of 1990” $17.00 - for uninsured children’s health care $19.50 - for uninsured children’s health care $50.33 – State Children’s Health Insurance (SCHIP)

Product Cigarettes Little Cigars Large Cigars Large Cigar Tax Cap Chewing Tob.

Snuff Pipe Tobacco RYO Tobacco

“SCHIP” Excise Tax Rate Hikes

Old Rate 39¢/pack 3.76¢/pack 20.719% 4.875¢/piece Current Rate % Increase $1.0066/pack 158.1% $1.0066/pack 2,577.1% 52.75% 40.26¢/piece 154.6% 725.8% 19.5¢/lb.

58.5¢/lb.

109.69¢/lb.

109.69¢/lb.

50.33¢/lb.

$1.51/lb.

283.11¢/lb.

$24.78/lb.

158.1% 158.1% 158.1% 2,159.1%

State Tobacco Product Excise Taxes

Cigarettes Large Cigars Little Cigars Smoking Tob.

Chewing Tob.

Snuff

- All 50 States and D.C.

- 47 States and D.C.

(excl. FL , NH , PA ) - 49 States and D.C. (excl. PA ) - 49 States and D.C. (excl. PA ) - 49 States and D.C. (excl. PA ) - 49 States and D.C. (excl. PA ) NOTE : Florida Senate Bill 1840 would impose an OTP tax rate of $1 per ounce on cigars.

Cigarette Cigar OTP

Local Tobacco Product Excise Taxes

- 8 States ( AK , AL , HI , IL , MO , NY , OH , VA ) Major cities include among others: Anchorage, AK Honolulu, HI Cleveland, OH Chicago, IL New York City, NY Alabama (269 cities, 53 counties); Missouri - 129 - 4 States ( AK , AL , HI , MD ) - 4 States ( AK , AL , HI , MD ) Source: TMA’s Tobacco Tax Guide (May 2009)

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 State Cigarette Excise Tax Increases (1999 – 2009) # of Bills # of States # of Approvals 57 24 51 116 175 139 114 57 105 57 89 21 7 26 34 37 33 30 25 24 20 32 3 (MD, NH, NY) 1 (LA) 5 (ME (2), RI, WA, WI) 21 (AZ, CT, DC, HI, IN, IL, KS, LA, MA, MD, MI, NE, NJ, NY, OH, OR, PA, RI, TN, UT, VT) 15 (AR, CT, DE, DC, GA, ID, MT, NJ, NM, NV, PA, RI, SD, WV, WY) 8 (AL, AK, CO, MI, MT, NJ, RI, VA) 9 (KY, ME, MN(2), NC, NH, NM, OH, RI, WA) 6 (AZ, HI, NJ, SD, TX, VT) 8 (CT, DE, IN, IA, MD, NH, TN, WI) 4 (DC, MA, NH, NY) 4 (AR, KY, MS, RI… HI )

The Shrinking U.S. Cigarette Market

700 650 600 Peak: 1981 – 641 bn. pieces 550 500 450 400 FET Doubled (1983) Marlboro Friday (April 1993) MSA (November 1998) 350 300 Bottom: 2008 – 345.1 bn. pieces 19 75 19 77 19 79 19 81 19 83 19 85 19 87 19 89 19 91 19 93 19 95 19 97 19 99 20 01 20 03 20 05 20 07 Cigarette Consumption Source: USDA-Economic Research Service TMA’s Tobacco USA

(Bn. of Pcs.) Cigarette Domestic Taxable Removals (First Quarter 2009) 30 25 20 15 10 5 0 25.469

25.368

25.967

January February March Domestic Taxable Removals Source: TTB

U.S. Cigarette Sales by Quarter

(Billions of Pieces)

100 90 80 70 60 50 2002 2003 2004 1Q 2005 2006 2Q 3Q 2007 4Q 2008 2009

-10.45%

vs. 1Q08 Source: Maxwell Consumer Report

Taxable Removals by Product (February 2009 vs. March 2009) (Mn. of Pcs.) 600 548.5

500 455.0

400 300 200 100 0 Large Cigars 498.2

February March 323.3

Little Cigars (Mn. of Lbs.) 8 7 7.60

7.00

6 5 4 3 2 1 0 2.60

2.50

Chew.

Tob.

0.19

0.27

Snuff Pipe Tob.

1.87

1.30

RYO Tob.

February March Source: TTB

U.S. Cigarette Price Elasticity

e = Δ Quantity/ Δ Price 2008 Est. price: 2008 consumption: $4.58 345.1 billion pieces 2009 Est. price: 2009e consumption: $5.50

327.8

billion pieces $5.50

324.3

billion pieces $5.50

$5.50

320.8

billion pieces 317.4

billion pieces Elasticity: -0.250

-0.300

-0.350

-0.400

U.S. Cigarette Forecast

(Billions of Pieces) 388 376 372 364 345 324 319 314 2004 2005 2006 2007 2008 2009e 2010e 2011e Cigarettes (Bn. Pcs) Source: TMA Estimate

Cigarette Tax Revenue Forecast (Millions of US$) 2008 FET $0.39/pk 2008 Consumption 345.15 bn. pc 2008 Fed. Tax. Rev.

$6,730.4 mn 2009 FET $0.39/pk $1.0066/pk TOTAL 2009 Consumption 80.11 bn. pc. (Jan-Mar) 244.19 bn. pc. (Apr-Dec) 324.30 bn. pc.

2009 Fed. Tax. Rev.

$1,562.1 mn $12,290.1 mn $13,852.2 mn The Federal government is expected to collect an additional $7.12 billion in 2009.

Source: TMA Estimate

Cigarette Tax Revenue Forecast (Millions of US$) 2008 SET $1.08/pk 2008 Consumption 345.15 bn. pc 2008 State. Tax. Rev.

$18,638.1 mn 2009 SET $1.12/pk 2009 Consumption 324.30 bn. pc 2009 State. Tax. Rev.

$18,160.8 mn State governments will collect $477.3 mn

less

in tax revenues even as some States raise their excise tax rates in 2009.

Source: TMA Estimate

State MSA Revenue Forecast (Millions of US$) 2008 Consumption 345.15 bn. pc 2009 Consumption 324.30 bn. pc 2008 MSA Payment (in 2009) $6,769.1 mn 2009 Est. MSA Payment (in 2010) $6,630.8 mn State governments will collect $138.3 mn

less

in MSA payments as the cigarette market continues to decline.

Source: TMA Estimate

Cigarette Tax Incidence - 2007 (tax share of retail price) State South Carolina Avg. Price per pack $3.658

FET $0.39

SET $0.07

Sales Tax $0.196

Tax Inc. 17.9% US (Average) $4.678

Rhode Island $6.590

$0.39

$1.0725

$0.239

36.4% $0.39

$2.46

$0.405

49.4% NOTE: The price figures include sales taxes.

Source: TMA, Orzechowski & Walker

Cigarette Tax Incidence - 2009 (% of tax share of retail price) State Avg. Price per pack South $4.574

Carolina +25% FET $1.01

SET $0.07

Sales Tax $0.259

Tax Inc. 29.3% US (Average) $5.743

$1.01

$1.12

$0.247

41.4% Rhode Island $8.584

+30.26% $1.01

$3.46

$0.562

NOTE: The price figures contain sales taxes.

Source: TMA estimates 58.6%

Retail Price and Tax Incidence Figures f0r 2008

Norway UK Australia Singapore Canada France Germany Italy Retail Price Tax Incidence $11.72

71.20% $9.16

$8.46

$7.95

$7.50

$7.24

$6.82

$5.80

76.49% 65.65% 70.54% 70.73% 80.39% 76.45% 75.17% Retail Price Tax Incidence United States $4.68

36.97% Spain Portugal Poland $4.09

$3.86

$3.14

77.35% 50.25% 74.15% Japan China South Korea Indonesia $3.21

$2.20

$1.88

$0.90

63.06% 60.73% 62.61% 49.09%

All Prices are in US Dollars per pack of 20.

Estimated Price Structure of a Premium Pack of Cigarettes (2009) (% of total price) 100 80 32.5

Operating Expenses ($1.79) State Excise Tax ($1.12) 60 20.4

Federal Excise Tax ($1.01) MSA Payment ($0.45) 40 20 18.4

8.2

9.7

10.9

Trade (Wholesale and Retail ($0.53) Profit ($0.60) 0 Assuming an average retail price of a pack of premium cigarettes in 2009 at $5.50 (not including sales tax).

Source: TMA Estimate

Estimated Price Structure of a 4th Tier Pack of Cigarettes (2009) (Percentage of total price) 100 80 10.9

33.9

Operating Expenses ($0.36) State Excise Tax ($1.12) 60 40 20 30.6

10.3

9.7

4.5

Federal Excise Tax ($1.01) MSA Payment (SPM) /Escrow (NPM) ($0.34) Trade (Wholesale and Retail ($0.32) Profit ($0.15) 0 Assuming a 4 th tier average national retail price in 2009 of $3.30.

Source: TMA Estimate

Product Cigarettes Little Cigars Large Cigars Large Cigar Tax Cap Chewing Tob.

Snuff Pipe Tobacco RYO Tobacco

“SCHIP” Excise Tax Rate Hikes

Old Rate 39¢/pack 3.76¢/pack 20.719% 4.875¢/piece Current Rate % Increase $1.0066/pack 158.1% $1.0066/pack 2,577.1% 52.75% 40.26¢/piece 154.6% 725.8% 19.5¢/lb.

58.5¢/lb.

109.69¢/lb.

109.69¢/lb.

50.33¢/lb.

$1.51/lb.

283.11¢/lb.

$24.78/lb.

158.1% 158.1% 158.1% 2,159.1%

U.S. Little Cigars

(Billions of pieces) 7 6 5 4 3 2 1 1.64

0 1998 2.20 2.24

2000 2.17 2.25 2.30

2.70

2002 Production 2004 Sales 3.77

4.16

4.77

2006 5.45

2008 Source: US-TTB

8 7 6 5 4 3 2 1 0 3.16

1998

U.S. Roll-Your-Own Tobacco

(Billions of pieces [converted]) 3.81

4.16

2000 4.97

5.54

2002 6.21

5.75

2004 6.34 6.06

2006 5.97

6.76

2008 Production Sales 1 cigarette = 0.0325 ounces of RYO Source: USDA-AMS

Projected Declines in Consumption (Billions of Pieces) Little Cigars (bn. pc.) 2008 Cons. Proj. 2009 Cons.

5.448

3.269 (-40%) Difference -2.179

RYO Tobacco (bn. pc.) 6.762

4.057 (-40%) -2.705

Combined, the disproportionate excise tax increases for little cigars and RYO tobacco could boost cigarette consumption by an additional 4.884

billion pieces.

Source: TMA Estimate

U.S. Large Cigars

(Billions of pieces) 6 5 4 3 3.66 3.85 3.85

2 1 0 1998 2000 4.11

4.21 4.53

4.94

4.88

5.30 5.55

2002 Production 2004 Sales 2006 5.76

2008 Source: USDA-ERS, US-TTB

U.S. Moist Snuff

(Millions of pounds) 95 90 85 80 75 70 65 60 55 50

59.9 61.6

1998

64.8

2000

66.3

68.6 71.0

2002

74.7

2004

76.7

81.5

2006

86.2

91.3

2008 Production Sales Source: USDA-AMS

U.S. Dark Fire-Cured and Dark Air-Cured Production (Metric Tons) 50 40 34.5

30 37.1

37.6

39.4

41.7

24.4

20 10 11.8

0 2004 11.5

13.2

13.5

2005 2006 2007 2008 Source: USDA-NASS Dark Fire-Cured Dark Air-Cured (One Sucker + Green River)

U.S. Tobacco Consumption by Leaf Equivalents – 2007

(Millions of Pounds) 16.3

34.4

88.3

105.5

634.9

Cigarettes (360 bn pc) Cigars (1 cigar = 10g) Smoking Tobacco Chewing Tobacco Snuff Source: US-TTB, USDA-AMS, TMA

U.S. Tobacco Production by Leaf Equivalents – 1880

(Millions of Pounds) 1.1

4.0

107.2

32.9

35.3

Cigarettes Cigars (1 cigar = 10g) Smoking Tobacco Chewing Tobacco Snuff Source: US Department of Agriculture – ERS, TMA

Conference Overview

• • • •

Some Key Trends The WHO’s Framework Convention

SCHIP FDA

Issue

Tobacco Regulatory Bill Comparison

Waxman/ Kennedy

H.1256/S.982

Buyer

H.1261

Burr/Hagan

S.579

Bill No.

Agency Ingredient Disclosure ‘Tar’ Limits Flavor Ban Fire-Safe “Center for Tobacco Products” within FDA  “Tobacco Harm Regulation Center” within HHS        “Tobacco Regulatory Agency” within HHS    

Issue

Advertising Ban Graphic Warnings Retail Licensing Descriptors Illicit trade

Tobacco Regulatory Bill Comparison

Waxman/ Kennedy

  Waxman: May Kennedy: Shall 

Buyer

  

Burr/Hagan

 (restrictions)        

Creating a Centralized License Data Base of Publicly Available Information to Facilitate Public-Private Communication Manufacturers Wholesalers/ Distributors Retailers Tobacco Product Compliance Center (TPCC) State Tax Administrators Local Tax Administrators One-Stop Updating with License Suspension Reports Provided One important condition: Data integrity and audit trail documenting company usage

Issue

Tobacco Regulatory Bill Comparison

Waxman/ Kennedy Buyer Burr/Hagan

Sales Restrictions Sampling Seizure Small Man. Exemption User Fees  

Smokeless in adult

  From $85mn in FY09 to $712mn in FY19 and thereafter.

    Civil money penalties & license fees.

 

Any TP in adult

  $100mn/yr starting in FY10 with inflationary factor thereafter.

Tobacco Regulatory Bill Comparison

Modified Risk Waxman/ Kennedy Buyer Burr/ Hagan Sets a very high bar to making reduced risk claims. Requires pre-market approval whereby manufacturer files an application detailing elements including product description, formulation, and research. Multi-year research likely.

Creates a “reasonably likely” test for reduced risk claims based on measurable and substantial reductions in morbidity and mortality among users; Smokeless tobacco product can not be sold as a MR product; Requires MR product to be labeled such that the consumer can easily comprehend the risk.

Creates a “totality of scientific knowledge” test based on a number of joint conditions for reduced risk claims based on available scientific evidence demonstrating that a given product "yields a reduced amount of 1 or more toxicants when compared to an appropriate reference tobacco product or products“.

Uses of the Tobacco Plant (Nicotina Tabacum/Rustica)

Proteins Nicotine Food Cereal Vaccines Enzyme Generation Traditional Medicines Non Traditional Other

HIV, Malaria, Hepatitis B, Insulin, Auto-Immune Deficiencies Depression, Cancer, Parkinson’s, Alzheimer’s Human Growth Hormone

Nicotine Delivery

Traditional Non-Traditional Smoking Tobacco Pipe Tobacco Smokeless Tobacco E-Cigarette Patches Nasal Spray Orbs/Strips/ Sticks Water Gum/ Lozenges Snus Cigarettes Snuff Chewing Tobacco

Plug Firm Moist

Cigars

Machine Made Moist Dry Loose Leaf Twist/Roll Large Little Hand Made (RYO)

U.S. Cigarette Nicotine Consumption

(Metric Tons) 500 450 458.0

451.8

420.4

400 395.0

378.1

350 354.8

340.2

315.5

300 250 200 1994 1996 1998 2000 2002 2004 2006 2008 Source: TMA Estimates

U.S. Cigarette Nicotine Consumption Forecasts (Metric Tons) 300 250 296.3

287.1

291.7

280.7

287.1

274.3

281.6

267.9

276.2

261.5

271.0

255.1

265.2

248.7

US - Optimistic US - Pessimistic 200 150 2009 2010 2011 2012 2013 2014 2015 Source: 2009 TMA Estimates

India: Multi-Ethnic, Multi-Lingual, Multi-Tobacco

THANK YOU!

And now to the World Leaf Situation & Outlook with Jim Starkey

(TMA Chairman and former SVP Universal Leaf Tobacco)

TMA Annual Meeting and Conference Global Leaf Trends Changing Dynamics / Future Trends

Presentation By:

Jim Starkey

Williamsburg, Virginia May18, 2009

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

2008 Estimated World Leaf Production FC 4 186 Oth 458 DAC 134 SC 183 DF 51 OR 259 BU 743

Oth DAC SC DF OR BU FC

Significant Changes

• Sources of leaf have shifted dramatically

Flue-Cured Tobacco Production 43% 6% 3% 6% 5%

1960

37% USA India Zimbabwe Brazil Canada PRC Other 17% 6% 6% 1% 15% 0% 55%

2008

Burley Tobacco Production 1% 1% 5% 1% 10% 82%

1960

4% USA Malawi Italy Mexico 21% Brazil Other Mozambique 2% 6% 9%

2008

22% 36%

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 Leaf Socotab (49%) Thorpe & Ricks GK Casalee Dibrell Intabex A.G. Monk Austin Transcontinental Adams Meridional Monk Austin DIMON Standard Commercial

Present Universal Leaf Alliance One

Manufacturer Consolidation JT Imperial BAT PM USA PMI RJ

RJI/Gallaher Altadis / Commonwealth ETI / RJ(42%) / Tekel / Scantoco John Middleton / UST Lakson / Sampoerna / Rothmans, Canada Conwood

The Current Situation

A 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

Increased: Production Risk Market Volatility Production Costs Attractive Alternatives Buyer Mandates Higher Leaf Prices

The Current Situation

Slow Growth in Leaf Markets

Cigarette Production Trend

PRC World Total x-PRC

6 500 6 000 5 500 5 000 4 500 4 000 3 500 3 000 2 500 2 000 1 500 2002 2003 2004 2005 Calendar Year 2006 2007

The Current Situation

Slow 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 Situation

Slow 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) 3,969

4 000

3,792 3,702 3,656 3,513

3 500

3,315

3 000

2,000 2,300

2 500 2 000 1 500 1 000

1,800 1,515 1,700 1,813 1,792 2,050 1,652 1,950 1,706 1,669

500 0 2003 2004 2005 2006 2007 2008

PRC Other Exporters

The Current Situation

Flue-Cured Leaf Production • Two very different stories – PRC • Dramatic growth • 500 mKgs or 28% • Only slightly greater than cigarette production growth (24%)

The Current Situation

Flue-Cured Leaf Production • Exporters down 2% World Flue Cured Exporters’ Leaf Production (x-PRC)

2 000 1 750 1 500 1 250 1 000 750 500 250 0

1,515 1,813 1,792 1,652 1,706 1,669

2003 2004 2005 2006 2007 2008E

The Current Situation

Flue-Cured Leaf Production • 2008 declines in Brazil, Zimbabwe, other Africa and Canada • More than offset increases in US, EU and India

The Current Situation

Burley Leaf Production • Production recovered in 2008 from weather reduced 2007 crops Primarily Flavor Primarily Filler 806 685 704 664 688 563 + 39% + 0%

The Current Situation

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

The Current Situation

Burley Production - Flavor

Selected Countries

US Brazil Argentina

2000 Million Green Kgs

143 95 39

2007 Million Green Kgs

102 105 37

2008 Million Green Kgs

102 100 42

2007-08 %

-5 +14

2000-08 %

-29 +5 +8

The Current Situation

Burley Production - Filler

Selected Countries

Malawi Mozambique Zambia India Thailand EU Exporters* PRC Philippines Mexico

2000 Million Green Kgs

142 6 3 9 28 87 62 27 23

2007 Million Green Kgs

87 28 5 15 43 53 25 8 10 S. Korea 22 *EU exporters include Poland for all years 9

2008 Million Green Kgs

170 44 12 23 36 56 38 9 10 9

2007-08 %

+95 +57 +140 +53 -16 -3 +52 +13 -

2000-08 %

+20 +633 +300 +185 +29 -36 -39 -67 -57 -59

The Current Situation

Unsold Stocks • Last piece of market puzzle – Flue-cured unsold stocks • At lowest level since 1991 • Reflects lower 2008 production x-PRC

The Current Situation

Unsold Stocks World Uncommitted Flue-Cured Stocks as of June 30 U.S. Pool Others 187 151 128 98 85 72

The Current Situation

Unsold Stocks • Flue-cured markets balanced heading into 2009

The Current Situation

Unsold Stocks • Burley unsold stocks – Essentially gone World Uncommitted Burley Stocks as of June 30 86 U.S. Pool 85 Others 72 49 29 9

The Current Situation

Unsold 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 Brazil India US

Estimated Flue-Cured Production in Million Green Kgs 2007

643 260 220

2008E

608 270 231

2009P

595 280 227

Change over 08

-13 10 -4 All x-PRC PRC Others World Total

1,706

1,950 216

3,873 1,669

2,150 217

4,028 1,750

2,200 210

4,160 81

50 -7

132

Future Trends/Potential Beneficiaries

– 2009 Burley • Production increase forecast Malawi US Brazil Argentina Mozambique Exporters Others Total

Estimated Burley Production in Million Green Kgs 2007

87 102 105 37 28

563

57

621 2008E

170 102 100 42 44

688

56

743 2009P

250 98 109 49 53

803

54

857 Change over 08

80 -4 9 7 9

115

-2

114

Future Trends/Potential Beneficiaries

• Will not materially change tight supply situation, particularly flavor • Significant downside risk

Future Trends/Potential Beneficiaries

Slow 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 Beneficiaries

Slow 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 Trends

Winners 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 Trends

Winners 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 Trends

Winners 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 Trends

Winners 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 Trends

Winners 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 Observations

Manufacturers 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 Observations

Production 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 Observations

Continued • 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 Observations

Continued • 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, Virginia May18, 2009