1999 final results presentation
1 March 2000
Nigel Northridge and Philip Burchell
Slide 1 |
(Gallaher) |
Slide 2 |
(Nigel Northridge) Good morning everybody. I feel very privileged to be standing here today - my first presentation as chief exec - to discuss these record results - EPS up over 14%. Gallaher's operating and financial performance last year stands us in good stead for the future. However, although I look forward to running through our recent achievements, I suspect that you are more interested in my views on Gallaher's outlook. |
Slide 3 |
As I see it - there are four key issues. First: what potential is there for us to improve our - already excellent - UK performance? Bearing in mind the state of the UK legitimate market - how secure is our UK business? Secondly: are there any further cost-cutting opportunities available to us - when we have already placed ourselves at the forefront of operating efficiency? Thirdly: internationally, what are our organic growth prospects? And fourthly: how should we use the cash we generate, and our potential debt facilities, to best serve the needs of our business and our shareholders? Before I answer these questions, I should like to hand you over to Phil, who will take you through our results. |
Slide 4 |
(Philip Burchell) Thank you Nigel, and good morning ladies and gentlemen. As this is the last time I will be presenting to you, I am pleased to be able to do so with a strong set of financial results. We increased turnover by more than 2%, and achieved record operating profits, up nearly 7% on 1998 - despite having charged £3.7mn of costs, in relation to our abortive bid for R.J. Reynold's European tobacco business. Without these costs, operating profit would have been ahead by close to 8%. We also continued to increase our operating margin, up to a record 43.4% in the year. Interest charges were higher in 1999, as we financed a higher level of duty-paid stock before the UK duty increase in December 1998, and carried out further share repurchases during 1999. Costs did benefit, however, from the absence of a stock financing programme at the end of 1999, now that the timing of the duty increase has moved to March. Average borrowing rates have also fallen, from an average of 7.2% in 1998, to 6.8% in 1999. The tax charge, and effective tax rate, are both lower in 1999 - mainly one-off effects from changes to deferred tax in relation to overseas earnings. We expect rates in the future to normalise at around 1% above the UK statutory rate. |
Slide 5 |
Results from our UK business were strongly ahead. We increased duty-exclusive turnover by more than 3%, largely from price increases, including the impact from duty-paid stock. Although volume sales benefited from our acquisition of the Dorchester and Dickens & Grant brands during the year, overall unit sales were down. This related largely to the increased penetration of non-UK duty-paid products in the market, coupled with the absence of a duty increase in December 1999. This meant that the pull forward of sales by the trade, that normally precedes an increase, did not occur in 1999. Operating profits were ahead by over 7%. In addition to the gains from our price increases, further profit was made from the duty-paid stock we held at the start of the year. Benefits arose not only from the higher levels than at the start of '98, but also following the imposition of an immediate duty increase in March. Production cost savings, and profits on the sale of fixed assets relating to the closure of our Hyde factory, also benefited operating income. However, the effect of these benefits was reduced by the lower sales volumes - and, in particular, the loss of sales pull-forward - downtrading, higher marketing expenditure, legal charges and pension costs. |
Slide 6 |
Despite some localised setbacks, our international business also recorded another good year. We held turnover excluding duty at 1998 levels, despite the adverse impact of the strong pound, and a reduction in unit sales of 14.8%, largely as a result of difficult trading conditions in the CIS. However, outside the CIS, and, excluding the contract manufacture we carry out for BAT, volumes performed well - up 12.7% on 1998. These gains in higher-margin volumes, together with production cost savings, helped to drive operating profit up by 10.6% to £73mn, despite increased marketing expenditure, mainly relating to the launch of Benson & Hedges Lights in Germany. Operating margin improved to 30.8% in the year, up from 27.9% in 1998. |
Slide 7 |
Turning to cash flow. In addition to the gain in operating profit in '99, operating cash flow has been significantly enhanced by favourable movements in working capital during the year. This largely reflects the impact of unwinding, in 1999, the financing of duty payments prior to the UK duty increase in December 1998. This did not apply in '99, now that the timing of the duty increase has moved to March. Our balance sheet now reflects a much lower level of capital employed than in December 1998. As a result, the operating cash flow of £1.2bn - £1.5bn ahead of 1998 - amounted to nearly three times operating profit in the year. |
Slide 8 |
The increase in operating cash flow has been further assisted by lower tax payments, despite moving to a payment-on-account regime in 1999, mainly as a result of higher tax deductions for interest costs and provisions. Capital investment was some £7mn higher. Expenditure on fixed assets was lower in 1999, following the completion of investment in our factories in Lisnafillan and Kazakhstan, and a new warehouse at Crewe. This reduction was offset, however, by expenditure on trademarks, mainly the Reynolds Dorchester and Dickens & Grants brands in the UK, and the rights for Benson & Hedges in Spain. We received the final deferred consideration proceeds from the sale of our former optics and housewares' businesses. Increased dividend payments reflect changes to both the level, and timing, of payments since our demerger. This cash flow generation has meant that we have been able to significantly reduce net debt at the end of 1999, down to below £900mn. |
Slide 9 |
We have committed facilities of some £1.8bn, comprising £1.3bn of bank facilities, and nearly £500mn of eurobonds, with maturities up to 2009. We have fixed the interest rate on a substantial proportion of these borrowings. We have also continued to carry out share repurchases during the year, buying back some 19.7 million - or roughly 3% - of the Company's shares, at a cost of about £70mn. This has reduced our cost of capital while also enhancing earnings per share. We continuously aim to achieve the best balance between reducing our cost of capital, while retaining the flexibility to respond to potential future investment opportunities. The on-market share purchases we carried out in 1999 held interest cover to 5.5 times. Looking forward, we now see scope to accelerate the buyback programme. More on that later. |
Slide 10 |
We achieved growth in net income in 1999 of over 10%. Assisted by the effects of our share repurchase programme, basic earnings per share rose over 14%, to 36.1p, from 31.6p in 1998. We are proposing a final dividend of 15p per share, amounting to a total dividend of 22.25p for the year, an increase of 8.5% over the total dividend for 1998. These are record results. Since 1992, our like-for-like operating profit has grown by a compound annual rate of 4.6%, and operating margin has increased by over seven percentage points. Our business remains a challenging one, but with this track record and our development plans, we remain confident about the future. And for more of that, back to Nigel. |
Slide 11 |
(Nigel Northridge) Thank you Phil. Before I set about discussing the business of today, I should like to introduce a couple of new faces to you all. Shortly after my own appointment was announced, I announced that I was changing the management structure from the beginning of this year. I have formed a management committee that includes several senior - but non-board - members, to run the day-to-day operations of the Company. This committee includes Mark Rolfe - who many of you already know - who will become finance director in the summer. Two additional key members, who were appointed to their new posts on 1 January, are Barry Jenner - managing director of the UK division - and Yann Tardif - managing director of the continental European division. |
Slide 12 |
The UK legitimate market has declined again this year - by some 10% - as a result of bootlegging - although the signs are that the incidence of adult cigarette smoking has probably risen again. Non-UK duty-paid sourced cigarettes now account for between 20 and 25% of consumption. During the last three years, we have successfully managed our business against a hostile market - and grown our underlying profits. Taking price increases well-above inflation, holding our share of the premium sector, tremendous growth in the low-price sector, and our drive to reduce costs, have enabled us to weather the market dynamics. Looking forward, we support the implementation of any measure that will crack down on the level of smuggled product coming in. And, as the UK market develops more order, I believe that our leading position gives us cause to be optimistic. |
Slide 13 |
We await the Lords' hearing on the ad ban - but, even if we win, I have no doubt that regulations will tighten in the UK at some point. We anticipated this. Our pre-eminence at point-of-sale, and our sophisticated sales force - with our leading brand portfolio - puts us at the forefront. And, anticipating the changing environment, we have focused our marketing activities on these areas. In the meantime - of course - we are continuing to invest in those avenues that are - after all - still open to us this year. We also anticipated that - at some point - measures would be introduced regarding forestalling. Until they were, however, we needed to meet our customers' needs - and to match the competition - when forming our duty pre-payment strategy. We are assuming that the chancellor will impose a 5% real increase on the 21st, effective immediately, and will pre-pay accordingly. From 2001 onward, even though we believe that the draft regulations - as they were announced - are almost unworkable, we are planning on the assumption that forestalling will cease. If forestalling does disappear in its entirety in one go, there will be some effect - initially. However, in the medium- to long-term, I look forward to a narrowing in price differentials between the cheap end of the market and our brand portfolio. |
Slide 14 |
A key plank of our future UK business is our rapid growth in the low-price sector. We have succeeded in balancing our mix of volumes to more closely reflect the market - thereby strengthening our competitive position when considering price increases. We have achieved this by launching new low-price brands, and growing our share of the sector, while successfully maintaining our leading position in the premium sector. We lifted our volume sales by nearly 40% last year, when the sector's volume sales rose by just 3%. With Dorchester, we now have the opportunity to increase margins - in the last twelve months alone, we have lifted Mayfair's manufacturer take by over 37% - while increasing our ability to cap the own label sector, or even replace some of them. |
Slide 15 |
Our strength in the high-margin premium sector continues - providing the best possible base from which to enter an ad ban environment. The resilience of B & H shone through this year - following the extended period of downtrading caused by two duty increases in quick succession, Bensons' share had fallen from 11.4% in January to 10.7% in May. Its share remained 10.7% in December. |
Slide 16 |
Although it is true that our core focus is on factory-made cigarettes, I sometimes feel that our successes in the other tobacco markets are not as well known. We have stabilised UK cigar volumes, and reinforced Hamlet's leading position in '99. Toward the end of the year, we undertook a tactical salesforce coverage of the licensed sector, in the M62 corridor, and the results were pretty convincing - Hamlet distribution up from 79% to 96%, and the installation of cigar bars and trays (on which we earn significant margin immediately) up from 10% to 40%. This focused activity will be rolled out nationally this year. |
Slide 17 |
Handrolling tobacco volumes continue to grow, spearheaded by the tremendous performance of Amber Leaf. And, we widened Condor's leadership of the pipe tobacco market. |
Slide 18 |
I hope you now have a better understanding of why I am confident of Gallaher's future success in the UK. The leading base we have built - founded on our key strengths - position us well for the future. I've illustrated the first three strengths - and our record on the fourth is second to none. More on that later. |
Slide 19 |
By popular demand - our international pillars are back. 1999's international volumes - excluding the CIS and BAT contract manufacture - rose by over 12%. More importantly, we consolidated our positions in key markets, and lifted margins - with our focus on building domestic business underlined. These volumes accounted for around 66% of the total. |
Slide 20 |
Ireland - what a great market for Bensons and Silk Cut. But, we are not resting on our laurels. We are looking at further opportunities - and believe that Berkeley has potential, as well as Mayfair, which we intend to launch this month. |
Slide 21 |
'99 was about margin enhancement in France. We lifted our take on American Blend by over 34% - and, as we expected, there was limited volume fall-out. B & H Virginia, on the other hand, grew volume and share again. Our enlarged - and sophisticated - salesforce also enjoyed good success with Davidoff. Having priced B & H American keenly, and with reinforced promotion - this year is about volume progression for both brands. |
Slide 22 |
In Germany, BAT ran down its Benson & Hedges' stock levels at the year-end, ahead of the transfer to Reemtsma. Our continuing house volumes were up last year - gold benefiting from Heinz Harald's phenomenal success, and with the launch of Lights. Our new distributor is enthusiastic about the prospects for Bensons. Its focused sales effort, and further marketing investment, should prove exciting, while, from day one, we benefit from a more favourable stock delivery arrangement. |
Slide 23 |
Again, we were the fastest-growing major tobacco company in Greece. Shortly, the salesforce will be fully computerised - as they are in France - with our distributor fully integrated into our systems, giving us a valuable competitive edge. We intend to continue building our share of the domestic market, while looking to develop tourist business, largely through the introduction of Mayfair and Sovereign. |
Slide 24 |
Our ability to grow B & H when we own it was evidenced, yet again, in Spain. Prior to '99, our Spanish strategy had been largely mono-brand, and focused on the tourist sector. There is certainly logic for increasing the brands on offer - while initial research indicates there is strong potential for Bensons in the domestic market. |
Slide 25 |
In the Canaries, we continue to perform with our UK brands in the tourist sector. B & H American's favourable price position, adopted in the second half of '99, is spearheading its growth - we've started the year with an almost doubling of volumes, albeit from a very low base. |
Slide 26 |
Demand for international brands remain suppressed in Russia, but Sovereign has stabilised. We believe that now is the opportune time to invest for the future - while others are still more vulnerable. We are working with our distributor, training a sales force to our standards - focusing on key cities. But, we need to evaluate our brand strategy and examine options for local manufacture. These issues are being addressed as I speak. |
Slide 27 |
Despite the problems, Sovereign still commands tremendous salience in Kazakhstan - and the domestically produced product has retained its cachet. Again, we are investing for the future, and working closely with our J / V partner to develop a leading sales force. And, the brand's equity will benefit from a new campaign starting in the spring. To further build our presence, we will enhance the brand portfolio, initially in the value end of the market - a strategy we are considering with our J / V partner. |
Slide 28 |
Although a small proportion of our current volumes, Asia Pacific's performance justifies our attention to-date. 1999 saw the consolidation of our distribution base, and in-market sales in Japan, Taiwan and China rising 19%. The full Sobranie range was successfully introduced in most major airports across the region - new listings were obtained in China, Hong Kong, Indonesia, the Philippines and Korea. We are developing a one milligram Pinks and Mints offering, initially for Japan where the sub-sector is growing rapidly, and continuing to invest in building brand equity. In China, we are in the process of completing negotiations which should lead to an increase in our official import quota. This will greatly enhance the ongoing potential. |
Slide 29 |
Within the remaining duty free market, we increased our share in the second half - and took the opportunity to review our range of pack and packaging specifications. With our key customers, we are developing new packaging initiatives following the end of vendor control at duty free outlets, and planning to invest in additional promotional activity. Building on our kiosk and gantry expertise in UK retail outlets - particularly the experience gained through our solus agreements with the major multiples - we are currently developing new merchandising equipment for installation at Gatwick. |
Slide 30 |
We grasped with both hands the potential offered on the RMOs - ferries to you and me. We have installed merchandising units on a number of ferries, and - again - we are developing packaging and point-of-sale initiatives. We continue to examine our product offerings, so as to increase the choice of our brands on board. |
Slide 31 |
We acquired Dorchester in April, not just the UK business, but the trademark worldwide (except in a few Middle Eastern markets). There was no doubt in our minds that this brand has tremendous potential overseas - and we set about refining the right brand positioning, and the best market opportunities. Having identified the priority opportunities, we developed Dorchester International in just six weeks - pretty rapid speed to market for a new blend and new packaging. Our strategy of sell a little / earn a little / spend a little with Sovereign in the early 90s allowed us to build the brand - from an initial trading start. Dorchester International will develop in a similar pattern. To date, it's gone well, and bought us new African markets. We are now concentrating on building its existing base, while developing other markets. And, to provide additional security for our volumes, we will continue to examine other products' potential. |
Slide 32 |
We are also looking at some new market opportunities for our core brands, and some new brands for our established markets. The number of Brits visiting Italy each year is around 1.8 million. We are considering putting our own people on the ground, as we believe that B & H and Silk Cut have yet to get their fair share of the tourist sector. Of course, with Jarno Trulli on board, the potential in the domestic market for heightened awareness of Bensons through Formula One, is tremendous - Italians are even more keen on fast driving than their German neighbours. Holland has the second highest margins in continental Europe. With little in-market presence we have been growing our volumes - but we have identified this highly profitable market as one which is ripe for our premium brands. We are close to finishing a thorough review of our international brand portfolio. We have examined our blends, trademarks and price positioning. In many markets, there are definitely exciting prospects for us to expand the choice of our brands to the consumer. All in all - our organic growth prospects have never looked brighter, although the euro isn't helping. |
Slide 33 |
Now, turning to manufacturing, a few years back, our cigar factory in Cardiff achieved forefront of the world status in terms of productivity and - with the help of our leaf and packaging purchasing divisions - total unit costs. Yet, each year since, we've achieved more. '99 was no exception - and we have more initiatives underway, particularly in cigar packing, to complement the high-speed machinery installations progressively undertaken in rod-making, over-rolling and pressing. We are currently evaluating investment opportunities to further improve our handrolling tobacco efficiencies - while exploiting more flexible working practices to meet the growing demand. |
Slide 34 |
Dublin and Kazakhstan are extremely efficient factories, in their class, already. But, we continue to explore means by which more cost effective processes can be introduced. |
Slide 35 |
Lisnafillan's productivity levels are now at the forefront of Europe, operating at over 35,000 equivalent cigarettes per paid hour. And, although the big rationalisation program is largely complete, we have already identified new initiatives for UK cigarette manufacture. |
Slide 36 |
But let us not forget the larger components of our manufacturing cost base - leaf and packaging. '99 saw the benefits from the great work done by our purchasing teams - and they plan to do more. While 2000, and on, will see the full benefit of the cigarette rationalisation program. |
Slide 37 |
If you'd asked us in 1986 whether we would reduce actual costs by approaching 10% to 45% real - by the millennium, we'd have said we would aim to, but were not quite sure by what means. As time moves on, so does technology and other processes. Looking forward, I can't predict exactly which of the numerous draft initiatives that are in Bill's drawer will come up trumps - but I am absolutely certain that some of them will. |
Slide 38 |
We generate lots of cash - and our current balance sheet structure has the potential to assume significantly more debt. With our cash generating nature - and bearing in mind the priorities of a significant number of our shareholders - we maintain a high dividend pay-out ratio. We maintain the debt flexibility, so as to be in the position to examine value-enhancing opportunities. There is no doubt in my mind, that the right international opportunity would be in the business' best interest and in our shareholders' best interests. And, there are opportunities out there - of different sizes, and at different stages of development. However, as Phil has already mentioned, we wish to gear up the balance sheet. As we sit today, I see scope to step-up our share buyback programme. I'm not going to be drawn on a target figure, but I believe that we will have returned a substantial amount of cash to shareholders by the end of this year. |
Slide 39 |
My own business philosophy is based around three key tenets: keep it simple; stay accountable; make it happen. Hopefully you will agree that the presentation has demonstrated the first two - it's now up to us to deliver the third. Thank you all very much for your attention. |