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Philip Morris to Buy Russian Stake

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Tobacco companies are trying hard to get hold of the $20 billion Russian cigarette market to boost volumes. As part of this strategy, two cigarette makers — Philip Morris International (PM - Free Report) and Japan Tobacco International — have announced that they have agreed to acquire minority stakes in their Russian distributor Megapolis.

A major distributor of cigarettes in Russia, Megapolis has almost 70% share in the Russian tobacco market. It has distribution agreements with international tobacco makers like PMI, Japan Tobacco International and Imperial Tobacco Group.

Last week, Philip Morris entered an agreement to take over 20% stake in Megapolis for $750 million. An additional $100 million will also be paid by Phillip Morris based on Megapolis’ performance over the four years following the closing of the transaction.

The deal by Philip Morris comes simultaneously with Japan Tobacco International’s similar agreement with Megapolis. Both the deals are expected to close before 2014.

While Philip Morris expects the acquisition to be accretive to its earnings in the first quarter of 2014, Japan Tobacco expects the takeover to have a minor effect during fiscal 2013.

According to market research firm Euromonitor International, the Russian tobacco market is the most lucrative, as it has a large population and 40% of its adults smoke. Moreover, Russian leaders have decided to significantly reduce import duties on cigars and cigarillos through 2017.

Philip Morris’ cigarettes sold in Russia are locally produced at two state-of-the-art facilities in Krasnodar, in the South, and St. Petersburg, in the North. As per market research firm Nielsen, the company occupies 26.1% of market share in Russia.

The deal is expected to reduce Philip Morris and Japan Tobacco’s distribution costs and raise their profile compared with U.K based Imperial Tobacco. Megapolis also distributes Imperial Tobacco’s brands — Davidoff and Gauloises.

The war for market share between Philip Morris and Japan Tobacco is also significant as the former is facing severe competition in Japan from the latter’s competitively priced local brands — Mighty and Marvel. Moreover, Philip Morris experienced volume decline in the region following the launch of Japan Tobacco’s Melvis Cut in 2013. Marlboro is finding it difficult to compete with the cheaper alternative.

Philip Morris currently holds a Zacks Rank #3 (Hold). Some better-ranked stocks in the consumer staples sector worth considering are Constellation Brand (STZ - Free Report) , Con Agra Foods Inc. (CAG - Free Report) and Green Mountain Coffee Roasters Inc. . All these stocks carry a Zacks Rank # 2 (Buy).

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