Illegal tobacco is big business, and retail giants are counting the cost

Australia’s tobacco industry has now reached a tipping point with illegal cigarette sales by the criminal underworld on the cusp of exceeding legal sales from our major supermarkets for the first time.

Illicit sales accounted for 39 per cent of the Australian tobacco market for the 2024 calendar year, according to a study by FTI Consulting, but this has accelerated as the vicious gang war for control of the market has consolidated control and distribution efficiency.

We know this from recent retailer updates that revealed sales are diving as a near-tripling in the excise on tobacco over the past decade means you are paying $28 more for a pack of 20 cigarettes.

Australian Association of Convenience Stores (AACS) chief executive Theo Foukkare said that while the recently completed FTI report put the black market at just under 40 per cent last year, “the latest read, as they track it throughout the year, is at nearly 50 per cent”.

If you look at the overall market for nicotine products, including vapes that continue to be a black market staple, we are way past this point of market dominance. But now, organised crime groups are about to succeed with a very hostile takeover of a sector that has been a staple of government coffers and retailers for decades.

It is not hard to find the culprit.

Excise duties on cigarettes have risen from 47¢ per cigarette in 2015 to $1.40 in March this year. Another 5 per cent rise is due to hit next month on top of routine indexation rises, according to Morgan Stanley.

At the start of last month, legally sold packet sizes were restricted to 20 cigarettes and flavours such as menthol were banned.

Foukkare says the initial excise increases between 2010 and 2019 led to a clear reduction in smoking rates, but from 2019 it has had the reverse effect, with smokers trading the legal market for the far cheaper black market.

This has been confirmed by Roy Morgan, which says smoking and vaping rates have remained unchanged over the past decade, with “both vaping and illicit tobacco more widespread” now.

And what a windfall it is for organised crime.

With an estimated annual value of around $5 billion, illegal tobacco far exceeds their combined take from traditional illicit goods such as cocaine, MDMA, heroin and cannabis.

A report from the Australian Institute of Criminology estimated that the street value of consumption for these four illicit drugs was just over $2 billion in 2022/23.

Nothing illustrates the point more clearly than the Viva Energy share price which dived last week after the operator of fuel stations such as Shell and Reddy Express reported a plunge in earnings and revenue from its petrol station convenience stores as the exodus of smokers to illegal tobacco accelerated this year.

Tobacco sales, which dropped 17 per cent in calendar 2024, plunged 27 per cent in the June half year with most of this attributed to new government taxes and regulations driving more smokers to the far cheaper black market products.

Last month, it was Metcash, the retailer behind the IGA supermarket business, which revealed the damage with a massive 20 per cent slump in tobacco sales for the year ending April 30. Sales have now dropped more than 40 per cent since 2021.

“To put that in dollars, we now sell approximately $1.3 billion less tobacco,” Metcash boss Doug Jones told analysts and investors at its full-year results.

To get an idea of the impact, tobacco currently accounts for 17 per cent of Metcash food sales.

Jones was very open about the conundrum facing retailers who need the government to address what many describe as a horrendous policy failure by the federal government.

“It’s a political issue that’s easy to ignore because it’s smoking, it’s bad for you ... but the reality is that there’s data out there showing that the actual incidence of smoking is on the rise because there’s just such a prevalence of very cheap tobacco,” he told the AFR.

And it is going to get far worse. AACS analysis conducted by economic consulting group Tulipwood forecasts that the value of the illegal tobacco business will exceed the legal market by 2026/27.

This forecast is as astounding as it is alarming.

The excise that the black market avoids - $1.40 per cigarette - and the vastly lower prices which result - mean the illegal tobacco market is reckoned to produce sales of around $5 billion, compared to $15 billion for the legal market right now.

The organised crime takeover has been just as dramatic for government coffers.

The tax take has gone from $16.3 billion in 2020 to a projected $7.4 billion in 2025 despite annual excise increases. This means the government is estimated to have lost out on $6.4 billion last year alone.

Even professional investors are having to take notice.

Tyndall Asset Management’s Michael Ward noted in December that retailers have been left vulnerable by the slow progress to beef up legislative and enforcement efforts.

“Major retailers like Woolworths, Coles, and Metcash, which generate $6.5 billion to $7 billion annually from tobacco sales, and fuel retailers like Ampol and Viva Energy, with $800 million to $900 million in annual exposure, face ongoing revenue pressures,” he said.

And the impact goes beyond the loss of relatively low-margin cigarette sales. The dirty little secret for the supermarket giants and the rest of the sector is that cigarette sales are not the only dollars walking out the door.

The truth is, smokers are very good shoppers.

Financial market analysts won’t include this in their commentary, but they recognise that for every dollar spent on tobacco, smokers spend disproportionately more on actual grocery products.

“If you sell tobacco - like a convenience store, an IGA supermarket, Coles, Woolworths or a petrol station - you’re losing additional sales,” Foukkare says.

It is especially impactful for the petrol stations AACS represents.

“The tobacco consumer generally in our retail outlets normally comes in three times a week, and they also have two or three times the number of items in their basket with their tobacco that they purchase. So a drink, a sandwich, a chocolate, a coffee, some milk or bread, if they’re on their way home,” Foukkare says.

“Because they’re not coming to us for tobacco, we’re losing the associated purchases.”

Coles and Woolworths declined to comment, but this would certainly explain why Coles, in particular, aggressively pursued the tobacco dollar a decade ago when the tobacco sales were worth $8.5 billion for Coles, Woolies, IGA and Foodworks - out of a grocery market in 2013/14 that was worth $85 billion.

In 2016, Coles, IGA and Foodworks were slammed by anti-smoking advocates for selling cut-price premium brand cigarettes that were imported from Ukraine.

In 2020, Coles faced Federal Court action from an independent tobacco retailer alleging misuse of market power for predatory pricing on its cigarettes.

That action was discontinued.

The federal government has, so far, declined to consider an excise cut to levels that would remove the massive incentive to pay $14 for a pack of cigarettes that would cost more than $40 at a legal outlet.

Health Minister Mark Butler has offered a further $156.7 million to tackle the tobacco black market to add to the $188.5 million promised early last year on a Border Force crackdown. State governments are threatening steep fines and significant jail time.

Some believe that it won’t be enough to stem the tide on what many describe as a massive policy failure. This includes the AACS, which the legal tobacco giants heavily back.

“We need another approach. Otherwise, the illegal operators will take over the complete supply and consumption of tobacco in Australia,” Foukarre warns.

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