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Fitch Sees Drastic Decline Altria Group Inc Price increases driven by higher federal taxes, coming on top of secular declines in consumption, are likely to lead to US cigarette sales volume declines in the high single digits to low double digits, according to Fitch Ratings. Cigarette manufacturers raised their prices significantly in the first quarter in anticipation of the increase of the federal excise tax which went into effect April 1, 2009. While tobacco products are relatively inelastic, they are not perfectly inelastic, which means volumes will decline given price increases albeit at a rate less than the price increase, Fitch says. Based on Fitch Ratings estimate of an average retail price of $4.45 per pack of cigarettes at the end of 2008, the cigarette manufacturers pricing actions will result in volume declines of 5% to 7%. Given secular volume declines in the low to mid-single digit range, Fitch anticipates 2009 volume declines in the high single digits to low double digits. It may take several months for tobacco consumers to adjust to the new pricing, and volume declines are likely to be greatest in the reporting periods following the price increase, Fitch says. In the face of the recession, consumers may make a more concerted effort to cutback their tobacco purchases. Price-sensitive consumers are also likely to switch to value or discount brands from higher-priced premium brands, which would impact the tobacco manufacturers with significant premium skews in their product portfolios such as Altria Group, Inc. (NYSE:MO) Philip Morris USA and Lorillard, Inc. (NYSE: LO). Reynolds American Inc. (NYSE: RAI) R. J. Reynolds Tobacco Co. may benefit from trading down considering the value brands in their product portfolio, Fitch says. As consumers adjust to tobacco product pricing and the temporary effects of the floor tax work their way through tobacco manufacturers results, credit metrics are likely to weaken. However, Fitch expects volume declines to moderate after the pricing actions have taken place, and large tobacco manufacturers are expected to continue to generate significant cash from operations despite the volume pressure. Current Fitch ratings for tobacco companies cand be found here. Additional information can be found in Fitch recent special report, 2009 Tobacco Outlook: Higher Taxes to Further Pressure Cigarette Volumes

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