Interview with MD and CEO of Eastern Company

However, in the age of COVID, increasing production and operating costs, currency devaluation, the government’s efforts to raise tax revenue, and increasing general health awareness, Eastern Company is now entering a new era with a new set of challenges and obstacles to overcome.

Arab Finance sat down with Hany Aman, the CEO and Managing Director of Eastern Company, to discuss some of these obstacles.

As the sole local cigarette producer, how has the company performed during and following the COVID pandemic?

We were only impacted negatively during the last fiscal quarter of last year, which was the beginning of the corona pandemic during April (Eastern Company’s fiscal year runs from July 1st to June 30th). Our issue was not even sales, honestly, it was only production when our team was concerned about coming in to work, resulting in a shortage of production, not in sales. And this was normal, and it was not only Eastern, but also everyone else.

During this year, where despite the production decline during the last quarter, the company managed to deliver a higher net profit than the year before. This means our performance during three other quarters was enough to support the production drop during quarter four (Q4). By the end of June and coming into July when things became more relaxed, the company started to see a great year. (Eastern Company’s net profit increased 24% year on year to EGP3,889mn during the first nine months of 2020/2021). Q1 was the best ever, and Q2 was even more exceptional, Q3 was the best of all, and we just closed the year now – a few days ago we had announced a 16% growth on production and 12% growth on sales volumes, something which had never happened before.

It looks like our market share has increased, and it looks like our profit is taking an upward trend. So things are in great shape. The year of the start of the pandemic ended in a great way for us, and this year looks like it’s even better. I would say Eastern Company has been taking the right steps on enhancing efficiency, enhancing productivity, looking into costs, and making sure we are delivering our numbers at the end of the year – not just achieving our targets, but also exceeding them.

Eastern Company recorded record local sales volumes of 67 billion cigarettes and local production volumes of 70 billion cigarettes during FY 2020/2021. How was the company able to achieve this?

We achieved a record production volume of 70 billion cigarettes with the same machine that had previously never reached more than 60 billion. The company before used to buy new machines and new production lines, but, starting with the new management team, we decided not to do that and instead look into the capacity and utilization of our machines and to make sure we are delivering the right number out of those machines.

We have been conducting lots of meetings with the our production team. We have looked into the gaps: Where are the issues? What are the obstacles? What can we do better? What can we do to enhance? We held lots of meetings even with the suppliers of the machines to make sure that we are conducting the right maintenance and have the right spare parts to make sure we are outputting our target numbers. Things have been gradually picking up. We started with an average daily production of 200–210 million cigarettes, while today we are talking about 250-260 million cigarettes, and we are aiming to enhance this even further to 270–280 million in the next six months or so. The utilization, the efficiency, the enhancement in capacity, in coordination with solving various issues with the relevant teams, closing gaps here and there, this is all leading to results.

Eastern Company has not really raised ex-factory prices since 2018, with most of the price increases since then either tax or insurance based. Many financial analysts would say a catalyst to the stock would be price increases. Is Eastern Company considering raising prices in the near future? If so, by how much?

When I joined the company two and a half years ago, the main question asked by analysts was when we would increase ex-factory prices. I told them that before raising prices, I would like to enhance efficiency, and I promised them that day that Eastern Company would be able to deliver the impact of price increases without actual price increases, and this became a kind of slogan. Nobody believed this would be possible in the beginning, claiming price increases would be the only way to register growth, but I believed otherwise, seeing we could deliver this impact from volume growth, cutting costs, and enhancing our efficiency. This wasn’t clear in the beginning.

During the past three-year period, the cost of production had increased on multiple facets like customs duties, utilities, salaries and wages, and we calculate that at around EGP 1 billion more or less. That said, we were able to deliver in just nine months this year the same profit that we had delivered the year before over a 12-month period. This shows that something is different. We have increased our volumes for the first time, and analysts now are starting to see that something different is happening at Eastern. We have been registering 12% sales volume growth, and our market share increased by taking some sales from competitors. We have also been absorbing the cost increases into our numbers by enhancing efficiency. Today we are recording net profit growth that is not only just greater than that of last year, but we hope to register record growth. When we announced our record production and sales volume divs a few days ago, we also anticipate our net profit growth will be on the same level.

Earlier in March, the Egyptian government announced it would tender a new license that would allow for the local production of cigarettes, e-cigarettes, and heated tobacco products, effectively ending Eastern Company’s monopoly on local tobacco production. Can you please provide insight on how this will impact the business?

I would like to say something here because honestly the word “monopoly” does not apply in our case. We do not have a monopoly because I believe monopolies occur in sales, not in production. Monopoly means a single company is controlling sales of particular items, with this company enjoying the “bad habits” of a monopoly, and this of course is not happening at Eastern. All the cigarette companies and brands are fairly competing in the market. Yes, they are producing their products at our facilities, but they are selling their products in the market. And guess what? If we were controlling and held a monopoly, then we would have gained out of that by increasing our prices, putting our products across different levels, denying consumers choice outside of our own products at whatever price points we set, all of which never happened.

For three years, we have not increased prices by even a penny, while other companies have raised their prices to cover their costs. At the moment, yes we are the only company with a local production license in the country. We operate with love, and all our toll-manufacturing partners enjoy working with us. They are enjoying this relationship with us, and we have been enhancing this relationship to a level where they have the ability to import their products from abroad if they are not happy to produce their products at Eastern, but instead they have chosen to look only into enhancing their production in Egypt and enhancing their relation in the country with us. I just wanted to clarify why the use of the word “monopoly” is not applicable here. Yes, we have continued to be the only company with a local production license, but this has never prevented anyone from producing or selling their products in the local market. We might even have some good news in the future about newcomers to the country.

Of course the new production license could impact the company. If one of our bigger toll manufacturing players left our company, this could impact revenue, but we had already been deliberating this subject some time ago. When our new management team joined the company a few years back, with a new board and new people with different skillsets running the company, we immediately formed a risk committee, which highlighted major risks such as the potential issuance of a new production license and bigger players leaving the company, and we have been prepared for that since that day. So what is happening now is not really outside of the scope of our strategy that we implemented a few years earlier when we set up several what-if scenarios. With our operational efficiency, higher utilization rates, sales growth, cost cuts, and higher profits, we have been preparing ourselves for the future. The license talks are now back at the forefront again, and we are discussing how to make our operations even better.

Thank you for the clarification on the use of the word “monopoly” here and for your elaboration. Are we correct in understanding you would also own a 24% stake in the new company that wins the new local production license?

The new license terms stipulate that the newcomer provide Eastern Company with a 24% stake, and we would then have the right to chose if we want to take it or not. We would have to wait to see the exact terms of the new license, who is going to win it, what the impact of this would have on Eastern, and then we will take a decision. So yes, we have the option to be part of the new company with a 24% stake.

Does Eastern Company plan to produce e-cigarettes and alternative products?

The alternative products are happening now, and we have seen a lot of smuggled products coming from outside. We have also seen BAT introducing their plans into the country starting January. Honestly, we have not yet seen significant enough volumes, but yes Eastern Company is considering playing a good part in this product category. We plan to be testing the market with a new product that will be imported. If we find that it is economically viable with enough demand volume, then of course the second step would be to immediately invest in production. We found that the approximate investment for a new e-cigarette production line from A-Z would be EGP 300–500 million. We would like to put in this investment if we see a market that can absorb these costs.

Even before COVID-19, there has been generally a rising trend toward a more health conscious consumer. How do you see this possible shift in consumer mindset affecting revenue?

Of course the health concern awareness is happening. I would say it is happening day-by-day, every single day, but honestly from the day that I joined the company I have not seen any decline in our numbers. On the contrary, our numbers are rising. Eastern Company has not participated in any activity - direct or indirect - to enhance or encourage smoking. We are not even giving a penny as a discount, we are not engaged in any marketing activity at all, zero, but at the same time we have been seeing Eastern Company’s numbers growing, coming from either existing or new smokers. Our market share is growing, meaning we are taking a bigger portion of the pie from another player, and we expect to see a continued growth trend over the coming 3 years.

Eastern Company has quite a lot of unutilized assets, including land in Giza and Alexandria, as well as warehouses found in Al-Monasterly and Al-Zumar in the Al-Omraniya area. These assets’ total market value range EGP 3–4 billion, Al Mal had previously reported. What are your plans for these assets?

Our plan is to utilize these unutilized assets. The issue with these unutilized assets is that they are like a Rolls-Royce on the car market. They are big, they are valuable, and are very expensive. As is the case when you are selling a Rolls-Royce, you need someone qualified with the right expertise to evaluate its value.

Likewise, we need good developers to evaluate these properties and to come with the right valuation. We have been putting all options on the table. We would prefer to sell the plots and receive the cash to distribute to shareholders, but if not then we are considering a joint venture, if not then maybe leasing, if not then maybe another alternative. Before the pandemic, we had seen some good interest for the land, which lead to visits and good discussions with developers, but following the pandemic this was all put on hold. Today, things are coming back and we have seen people knocking on our doors to discuss these properties. We hope something will happen in the near future, at least for one of them. We have a great investment committee that is willing to discuss all options, and we believe one day soon things will be helped by one of the big developers.

Eastern Company’s board decided to write off 20 million treasury shares, reducing its issued and paid-in capital to EGP 2.23 billion from EGP 2.25 billion. Why did Eastern Company decide to do this rather than sell as initially intended?

The initial question to ask is why did we even participate with our treasury stocks. We did this when we found that our stock price had dropped dramatically during the pandemic, so we decided to send positive signals to reinforce trust in our company and communicate to investors that we are optimistic about the future. We are willing to do that; we are buying because we do not believe this is the right share price. The law now provides companies with a 12-month window, either to sell treasury shares or to cancel them. We believed that during the right time we would be able to show some interest and then sell these shares at a good price and make some good money after delivering our message on the company’s future. We found there was a good price for some time, then we sold these treasury stocks and we generated some profit. When the window came to an end and we had to take a decision, suddenly the price dropped back to the price at which we were initially buying the stock. We decided based on input from shareholders and sound financial advisory to cancel the remaining treasury shares and give shareholders the opportunities get better numbers, and this is exactly what we did.

Finally, can you please provide our readers with a general outlook on how you see Egypt’s tobacco industry a few years from now?

I believe demand for traditional cigarettes will continue for some good time, at least 2–3 years, with the new trends to start to appear by the end of this year. The market will start to test these new trends and new categories. We will be competing on this with the others. I believe it will not be before 2–3 years that we will see a shift to the new trends or new categories. During this time, we expect to see continued growth, with the size of the pie growing a little bit between the different companies, but Eastern Company will continue to have a bigger slice of that pie.