Exclusive interview of Philip Morris Ukraine Managing Director Maksym Barabash with Interfax-Ukraine News Agency

 

- In mid-June, Philip Morris International (PMI) announced the investment of more than $30 million in a new production facility in the Lviv region. The plant was to launch the new facility in the first quarter of 2024 – how is the project progressing now?

– Everything is going according  to plan. One key goal of the new facility is to provide workplaces for our staff who used to be employed at our Kharkiv factory. We received consent from 250 people. The first group will relocate in October 2023 and will participate in the installation of equipment. More employees will be relocated once the facility is operational.  

We are currently finalizing plans for the reconstruction of the existing building to meet the technical requirements for production and hope to have everything in place by the beginning of February 2024. By this time, the first production lines will have already been installed, which we expect to be delivered in September-October 2023.

We expect to launch commercial production in late March or early April 2024, before gradually increasing output toward maximum capacity during the year. Our objective is to meet domestic demand almost entirely.

- Does this include both volumes and product line?

- Indeed. There may be some specific products that it does not make sense to produce in Ukraine, but we would like 80% to 90% of the products (this is subject to the format, assortment and volume) to be produced at the new plant in Lviv.

- People are increasingly discussing the prospect of a long war. Have you factored this into your business plans? Will you expand production in Lviv in order to resume export operations? Do you have any vision for the resumption of operations at your Kharkiv plant?

- Due to the difficult situation, it is now impossible to make any plans for the resumption of production in the Kharkiv region, so our priority now is the opening of the new plant. At the same time, we are guided by the long-term PMI strategy of developing and producing the latest tobacco products. This may open up opportunities to attract major investments to reequip our Kharkiv production facilities. However, this will require favorable conditions including fiscal and regulatory policy along with support for innovations from the state. At present, the existing business conditions are significantly less advantageous than in neighboring EU countries, but we hope the situation will improve.

- Do you have plans in place to address negative developments in the overall situation in Ukraine?

- Yes, we have backup plans in place to address every eventuality. We build our business plans with all of the potential risks in mind and guard against potential future challenges. For example, if interruptions to electricity supply temporarily prevent us from meeting our production targets at the new Lviv region facility, we will balance out any shortages via imports. Several PMI plants in the European Union have already confirmed their readiness to provide us with the necessary products within one month. We are also in the process of diversifying our warehouse storage. We previously stored most of our produce at a single warehouse close to Boryspil in the Kyiv region, which created major issues during the early weeks of Russia’s full-scale invasion.

- There is an understandable shortage of new investment projects in Ukraine at present. Did you have any problems with stability of the currency and ability to import equipment? Beyond the obvious security concerns, is it feasible to invest in today’s Ukraine?

- Absolutely. We aim to demonstrate by example that investing in Ukraine is entirely realistic. Our business model is economically sound – we are investing in Ukraine because it makes good economic sense to do so.

Firstly, we are able to offer employment to staff from our Kharkiv plant. Rather than being forced to dismiss them, we provide them with the opportunity to work, earn, and feed their families. According to our calculations, one workplace at the new plant creates 10 work places in related industries such as logistics and security.

Secondly, in our industry it is crucial to have control over product quality, production speed, and the full logistical chain. This means that there are a number of clear advantages to local production over imports. It is worth noting that when you rely on imports, operations are extended by a month, while funding must be provided in advance for logistical and production expenditures. 

We have fulfilled all the regulatory requires for our investment in Lviv region and have encountered strong assistance from the authorities. I think at both the national and regional levels, Ukraine is interested in the success of this investment.

-  Are you facing any personnel challenges to find the specialized staff for your new facility? Even before the onset of Russia’s full-scale invasion, there were reports of staff shortages in western Ukraine with companies seeking to recruit further east in the Vinnytsia and Zhytomyr regions.

- As I mentioned, 250 workers from the Kharkiv region have agreed to relocate. To make the relocation process as comfortable as possible, we are providing housing for all employees and their families. At the same time, local residents will also be involved in related areas, with local companies recruited for the installation of equipment and reconstruction work. Some of these workers are more likely internally displaced persons.

- The insurance issue is worth clarifying. Ukraine’s First Deputy Prime Minister and Minister of Economy Yuliya Svyridenko recently announced that by the beginning of November 2023 the government and the EBRD will launch military insurance as a working tool for new investment projects. Have you attempted to insure your new project against war risks?

- Unfortunately, this approach will not be effective for our industry, because the necessary amount of insurance coverage for the end product alone, where taxes play a large part, is measured in the billions of hryvnias. The state currently cannot offer the kind of coverage we would require.  For companies such as Philip Morris, these funds will only be sufficient to cover the risks of destruction due to the military actions of a small regional storage.

- Let's talk about the budget process. The government’s 2024 budget plan is in line with the excise plan agreed several years ago. It is stated that price indexation is not foreseen, but only a 20% increase in the specific rate and the minimum tax liability. Does this meet your expectations?

- The excise plan, which is in effect now, was adopted in 2017. Twenty percent growth is not enough: cigarettes, which now cost 70 hryvnias, will cost 85 hryvnias in a year. This increase is greater than anticipated inflation. However, we believe that sticking with the plan is the right thing to do.

Currently, we are more focused on the medium-term perspective, since this excise plan was approved for eight years. It was good for the industry at the time, but this period will end soon: the tax plan will be in place for another two years, so we understand that discussions will begin next year on a new long-term excise plan covering the period 2026-2030. It is important for us that during the discussion of this project, there is no repetition of previous mistakes regarding the equal taxation of cigarettes and other tobacco products. It is necessary to consider the European experience, where cigarettes are taxed at a minimum excise rate of 90 euros (or at the minimum rate that will be established by the European Union at that time), and other tobacco products have differentiated rates of taxation.

– This year, the Ukrainian parliament reintroduced three-year medium-term planning by law. Will this issue be resolved next year?

- In large companies like Philip Morris, planning is generally for three-year periods. We need to understand what expect, especially an area as important as taxation. Today, more than two-thirds of the value of the product is excise duty, which is why tax policy is so important to us. And of course, we hope for harmonization with the European approach.

War adds unpredictability, therefore predictability on the part of the state, understanding the need to apply transitional periods for the introduction of new restrictions, is particularly important. This year, we learned about new restrictions from the "Voice of Ukraine" newspaper: these restrictions affected our activities the very next day after publication, while it takes months to rearrange processes.

On the positive side, I will say that we were listened to on the issue of introducing electronic excise stamps from 2026. It remains very important to apply a European approach to software development and control over the volume of excise goods.

- Regarding the idea of introducing holograms on excise stamps from September 1 this year, it seems that the authorities did not listen to you?

- We have always advocated that the state does not spend money on ineffective measures. We consider this decision to be completely ineffective, but the government adopted it, so we are implementing it: we have already received new excise tax stamps and they are used in production.

Our experience demonstrates that this hologram does not add much protection against counterfeiting, because the majority of cigarettes that are on the illegal market are sold without excise stamps at all. If this hologram is designed to reduce illegal trade, the impact is likely to be very insignificant.

- You mentioned that the average price of a pack of cigarettes is currently UAH 75, but recently on social networks I saw a photo of a shop window somewhere in the Odesa region where the price was UAH 47. Another study shows that from the beginning of the year to June inclusive, the share of illicit products decreased from 20.2% to 19.5%. How do you currently assess the dynamics of the fight against the illegal market of counterfeit tobacco products?

- We are hoping to see more optimistic results than the situation at present, because 20.2% and 19.5% are numbers of the same order. This estimated 6 billion illegal cigarettes and more than UAH 20 billion in unpaid excise and other taxes. Sometimes this struggle resembles a kind of dance involving one step forward and two steps back: the authorities close a large production facility and we note a decrease in counterfeit produce, but other illegal producers quickly fill this space, so the share increases again.

It is important for us, because we are building a new plant but the market is moving into the shadows year after year and we cannot compete with this segment. You mentioned cigarettes for 47 hryvnias; taxation on a single pack today is 59 hryvnias.

We are very concerned that while illegal products were earlier sold under the counter, illegal cigarettes for UAH 47 are now openly being offered in kiosks alongside legal cigarettes for UAH 70, 75, 80.

Unfortunately, we do not currently feel that the state is sufficiently determined to counter the distribution of illegal products. Therefore, we independently focus on the protection of our own trademarks. Our goal is to ensure that counterfeit products using our trademarks are not produced or sold on the market. For example, we recently won our first court case. The court ordered illegal producers to destroy all equipment and pay compensation of UAH 1.4 million. There are currently five more such cases in progress. I should note that we plan to to send the UAH 1.4 million compensation payment to charity for the needs of the Lviv region.

- I read details of the court case and was surprised at how easy it is to find equipment for the production of cigarettes in Ukraine, as well as raw materials. I thought that this market was quite limited.

- There are cases when the equipment found during raids was not destroyed as required. It was confiscated but then simply disappeared. It is transferred to responsible storage, but then something happens to this "responsible storage".

The Ukrtyutyun Association, of which Philip Morris Ukraine is a member, offers all law enforcement agencies the opportunity to store equipment and counterfeit goods free of charge for a certain period of time. However, this can create new problems as sentencing can be a rather long process, while the warehouses that the Association rents for these needs are typically at or close to capacity.

In light of these practical issues, we are calling on the law enforcement agencies to provide all the evidence in court in a timely fashion in order to speed up the consideration of cases. To prevent the equipment and illegal cigarettes being stored in warehouses for years. We pay for this storage, but things do not move on and there are no solutions.

- After a 26.7% year-on-year decline in the first quarter of 2023, the second quarter saw an immediate 53% increase in your business. At the same time, overall market growth is 13.4%. Given these dynamics, are you regaining your market share?

- According to our data, our share of the prewar Ukrainian market was approximately 28.5%. After the beginning of the war, we sold off the stock balance and could no longer produce in Kharkiv. For about two months, we were virtually out of the market while we adjusted to a new import model. During that period, according to our calculations, our share decreased to almost 14%.

We initially established import supply, then we started cooperation with an international company in Kyiv which produced our brands. This made it possible to return to most earlier positions in the portfolio by the end of the year. However, our market share is still significantly less than it was before the war.

Now we are trying to get back what we had before the war. During the past two months, we have recorded an increase of about 24%. We still have a lot of work to do, but the dynamics are positive and that's the most important thing.

In terms of heated tobacco products, these have always been imported. So when the full-scale invasion began, this segment was not seriously affected. We have moved existing products away from active combat zones.

In wartime, it is critical to retain consumers. If a consumer has stayed with the brand during difficult times, you can continue to earn and talk about profitability and profits by providing his needs. But if you lose a customer, it will be much more difficult to get them back after a few years.

- Is the market growing little by little?

- If we take the legal market before the war, then, according to our data, it fell by 10-12% every year due to a number of factors including the growth of illegal products and the rapid increase in excise rates. In 2023, the legal market continued to shrink, but at a significantly slower pace than the previous year, due to the partial return of refugees from abroad. The fight against illegal products also had a small positive effect, with the volume of illegal products no longer growing.

- Your quarterly reports do not indicate distribution by product type. Do you notice any changes in the market? Usually, when people's incomes fall, the share of cheap products increases.

- If we analyze different price segments, then the dynamics are stable. We also expected that there might be an increase in cheaper segments because the economic situation is difficult, but this did not happen.

Significant changes may take place from July next year, when it will no longer be possible to sell cigarettes with flavored capsules. We estimate that the current share of these products is 10-15%. When the sale of these products is discontinued, the consumer will start looking for alternative products. Also, this ban can increase the share of the illegal market, which will attract people not only with low prices but also with flavors prohibited in legal products.

- Your parent company and Japan Tobacco International have been included in the list of international war sponsors by the National Agency for the Prevention of Corruption (NACP) due to the continuation of activities in Russia. How has this affected your business?

- We were of course upset when our parent company was added to this list. The question of exiting the Russian market is not about the company's desire, but more about practical possibilities: today, the regulatory restrictions adopted by the Russian Federation have effectively made it impossible for companies like Philip Morris International to exit.

We received several letters both from the company's trade union and from some partners regarding our further work in Ukraine, as well as investments in a new plant. The company continues to operate in the usual way, and we are building a new plant and fulfilling all our obligations to employees, consumers, and contractors.