2000 final results presentation
27 February 2001
Nigel Northridge and Mark Rolfe
Slide 1 |
(Gallaher) |
Slide 2 |
(Nigel Northridge) Good morning everybody. Thank you for joining us to discuss Gallaher's record results for 2000. We have secured significant achievements across our business, through both organic growth and the acquisition of Liggett-Ducat - greatly strengthening our international position. In the UK, our strong performance underpinned our record year. Before I discuss our operating performance in more detail, Mark will take you through the results. |
Slide 3 |
(Mark Rolfe) Thank you, Nigel, and good morning everyone. In my first full-year presentation to you, I am very pleased to be reporting this strong set of financial results which reflect the exciting developments we have seen this year. Turnover grew by 2.5% and, more significantly, we lifted net turnover by 8.1%. We have grown operating profits - before amortisation - by over 5%, to a record £445mn. Group operating margin was 41.8% - the slight fall arising from the strong increase in the contribution to Group profits of our fast-growing, but lower-margin, international operations, including the new contribution from Liggett-Ducat. Interest charges were higher in 2000, as we financed both a step-up in the level of share repurchases and the acquisition of L-D. Partially offsetting these increased costs was a small reduction in the average cost of debt to 6.5%, from 6.8% in '99. A tax holiday in Russia, and the partial release of deferred tax provisions set up against the low-taxed retained earnings in Ireland, have helped reduce the tax charge - our effective rate for the year was 26.8%. In the near future, we expect to see some continuing benefit from these factors, although an increasing level of non-deductible expenditure - mainly goodwill amortisation - will partly offset them. |
Slide 4 |
We broadly maintained UK operating profit in 2000, despite the cigarette volume decrease - largely attributable to the increased penetration of non-UK duty-paid products into the market. This solid result mainly relates to an improvement in operating margin to 48.9%, and our net turnover performance - which benefited from two manufacturer price increases in the year, and the effect of the first full year of ownership of the Dorchester and Dickens & Grant businesses, acquired in April '99. |
Slide 5 |
In 2000, the percentage split between the first and second halves of the year - of roughly 45/55 - reflected the significant contribution from forestalling in the second half of the year. This year, pre-payment of duty ahead of a duty increase has ended, so we will not benefit from this activity at the operating profit level. At the UK pre-tax profit level, the effect will not be material as we will also not incur the associated financing costs relating to the additional duty payments. Therefore - dependent, of course, on the timings of MPIs - I expect the UK earnings split between the two halves of our financial year to move nearer to 50/50. The UK government has introduced measures to tackle smuggling - and, suffice to say, the rate of decline of the UK market is directly related to their success. We believe that these should have some impact on the growth in this trade - and our current expectations for the UK are based on the rate of decline of the duty-paid market slowing gradually. |
Slide 6 |
Stripping out the contribution from L-D, our underlying international business had an exceptionally strong year - even after the impact of the continued weakness of the euro. Organic cigarette volume growth of 39%, and price increases led to an increase in net turnover of some 13%. This increase, coupled with the improvement in underlying operating margin to 32.6%, resulted in a growth in operating profit of over 19% - to a record £87mn. The margin benefit was largely a result of the price increases and production cost savings, which were partly offset by increased marketing and selling costs. |
Slide 7 |
Having just discussed the impact of our manufacturing cost reductions on our UK and international performance, I'd like to expand on these achievements. Lisnafillan continues to benefit from the completion of the manufacturing rationalisation programme, and despite the de-stocking arising from the cessation of forestalling in the UK, we achieved further year-on-year productivity improvements. |
Slide 8 |
This performance, combined with continuing benefits from both leaf and packaging initiatives, have contributed to further reductions in our cigarette unit costs - 7.5% in real terms. Additional mid-speed making and packing machinery, together with new leaf processing equipment - intended to improve both quality and yield - are currently being trialled, ahead of further investment in 2001. |
Slide 9 |
We are now benefiting from the introduction of our new in-house cigar filler expansion process - we recorded a reduction in cigar unit costs of 4.8% in real terms. Going forward, significant improvements to productivity and quality are expected from the commissioning of new, state-of-the-art, individual cigar-wrapping machines. |
Slide 10 |
We also continue to cut tobacco unit costs in real terms - 2000 saw a real reduction of 2.2%, primarily a result of leaf and packaging improvements. We expect further improvements to be delivered by new packing, wrapping and parcelling equipment that has been installed to meet the growing demand for the Amber Leaf piece pack. |
Slide 11 |
In August, we completed the acquisition of Liggett-Ducat. In the five months since acquisition, L-D has contributed £64.1mn to total international net turnover, and its post-acquisition operating profit was £4.9mn before amortisation. |
Slide 12 |
For the full-year 2000, L-D grew its total volumes, net turnover and EBITDA sharply over its performance in '99. These strong results largely reflect L-D's move to its new state-of-the-art factory in June '99, which allowed the company to increase its production capacity - particularly in higher-margin lines - to current levels. In 2000, however, L-D's depreciation charge rose well above previous levels - following the move to the new factory - and the company's performance in its first-half reflected substantial costs relating to the initial implementation of its growth strategy. Liggett's successful strategy has enabled the company to enter the intermediate-priced sectors through the development of new brands - quality at an affordable price - and the company has been investing heavily in building up its distribution, sales and merchandising presence on the ground. Prior to our ownership, this investment resulted in a loss at the operating profit level. The operating benefits from the improved presence on the ground began coming through in August - the month in which we acquired the company. We shall continue investing in L-D's successful strategy - and so as to maximise the opportunities for further growth, we are investing some £40mn in the factory to expand annual production capacity to around 65 billion cigarettes. Clearly, in the short-term, operating results are impacted by the costs associated with the disruption to the factory caused by the machinery installation programme - and with the up-front costs arising from the heavy investment in the sales and distribution divisions. I am particularly pleased, therefore, with Liggett's performance in the last five months of 2000 - and remain confident that its outlook remains in-line with expectations. |
Slide 13 |
Turning to cash flows. Operating cash flows have historically been influenced by changes in timing of UK duty increases - which in the last two years both took place in March. Accordingly, the year-on-year variations in working capital were not as significant in 2000 as for '99. However, there remain short-term distortions, which have reduced the reported cash conversion rate. The increase in year-end stocks reflects both: a higher level of investment in finished goods, primarily supporting the strong organic growth of our international operations, including L-D; and, increased investment in leaf stocks to take advantage of pricing opportunities. The decrease in creditors and provisions relates to: a lower level of tobacco duty liabilities - which were at a high level at the end of '99 following a peak in December sales prior to the millennium; and, the cessation of our UK cigarette gift schemes, including a provision release of £7mn. This release partly offset the higher than expected advertising expenditure arising from the overturning of the EU ad-ban directive. The underlying strong cash generative nature of the business remains unchanged, however, despite such short-term distortions in reported cash conversion levels - EBITDA is at a record level of £479mn, up 6.5% on '99. |
Slide 14 |
As I explained earlier, interest expense increased in 2000. Although the tax charge fell year-on-year, tax payments increased by £25mn. In '99, we benefited from a high level of tax relief for expenditure charged against provisions. In addition, in 2000, the UK inland revenue's transitional rules relating to payments on account require earlier settlement of current year tax liabilities. Capital investment has increased by £7mn. Year-on-year this increase was mainly attributable to the factory expansion programme in L-D, partly offset by a reduction in the total level of expenditure on trademarks. In the immediate future, capital investment will remain above the Group's historic norm. In addition to our investment in L-D, which should amount to around £30mn this year, we are: investing further in advanced machinery in our UK cigarette, cigar and tobacco facilities; commencing the introduction of SAP information systems; installing a primary line in Kazakhstan - to enable us to expand our brand portfolio in this market; all while we continue to undertake our normal maintenance, and merchandising, investment programmes. In total, therefore, I expect our level of cap-ex in 2001 to total nearer £100mn. |
Slide 15 |
At the year-end we had committed facilities of some £1.8bn, with some 50% of our borrowings as fixed rate debt. In anticipation of the bank facilities maturing in March 2002, earlier this month we arranged a £1bn European medium-term note programme. In line with our stated intention to maintain an efficient balance sheet, 2000 saw us step-up our programme of share repurchases in the market. During the year we returned some £166mn to shareholders through the purchase of 50 million shares, at an average price of £3.31 per share. The debt assumed for the on-market purchase of shares, and the acquisition of Liggett-Ducat, resulted in a reduction of our interest cover to 4.6 times, within our target range of between four and five. Although year-end net debt was affected by the working capital distortions I referred to, our core debt remains around £1.1bn. We shall, of course, continue to seek the best balance between reducing our cost of capital, while retaining the flexibility to respond to future investment opportunities. |
Slide 16 |
In 2000 we achieved growth in net income of 3%. Assisted by our share repurchases, basic earnings per share rose 8.9% to 39.3p, from 36.1p in '99. Adjusting to remove the goodwill amortisation charge arising from the acquisition of L-D, EPS rose by 10.5% to 39.9p. And, excluding all amortisation from both years, EPS of 41p in 2000 grew 11% over '99. |
Slide 17 |
We are proposing a final dividend of 16.1p per share. This gives a total dividend of 23.75p for the year, an increase of 6.7% over the '99 dividend. The normalised dividend cover remains at around 1.65 times, having taken into account the net effect of some one-off tax advantages - offset by the increased financing cost in relation to L-D. These are yet again a record set of results - and for more of that, back to Nigel. |
Slide 18 |
(Nigel Northridge) Thank you Mark. Although consumption remains flat - or perhaps slightly rising - theUK duty-paid market has declined again this year - by some 10% - principally as a result of bootlegging, with around 30% of all cigarettes consumed in the UK originating from a non-UK duty-paid source. During 2000, the government introduced measures strengthening customs' activities to reduce the growth in smuggling of tobacco products. In addition to the further recruitment of officers, the first of a national network of X-ray scanners was introduced in October together with tougher penalties for smugglers. We support these measures and while we await the results of these efforts, we do anticipate a degree of success. |
Slide 19 |
In line with its white paper - and following the ECJ ruling on the EU directive - the UK government intends to bring in primary legislation to ban advertising. This comes as no surprise to us - in fact, we had planned for there to be no advertising in the UK before now - and I expect to see this law in place before a general election. Of course, this will have little impact on total consumption - but it does create challenges when communicating with our consumers. But our pre-eminent position at point-of-sale, and the brand equity we have built over many years, stands us in good stead for the future. To add to the increasing regulations, the UK cigarette market has been burdened by the continuing impact of duty increases in recent years - leading directly to the growth in the smuggled market for cigarettes and to downtrading. And we await the chancellor's actions next week. |
Slide 20 |
Gallaher's focus is to drive the bottom line - this is achieved by managing the top-line, and through our ongoing commitment to cutting costs. The tough challenges we face on volume levels continue to be met by our comprehensive brand portfolio - and our policy of taking appropriate manufacturer price increases. Having secured our portfolio through launches in the lower-priced sectors in the 90s, we have been taking consistent MPIs across all our brands - in 2000, we took two price increases and we have already secured one this year, earlier on this month. Our successful balance between volumes and MPIs - with our net take in the low-price sector lifting by around 10% a time - stands us in good stead to face the current market dynamics. |
Slide 21 |
Last year all prices went up at the same time following the duty increase in March. As a result, we witnessed a lower level of downtrading across a shorter time period, resulting in less of a drop in the premium sector's share of the market. Gallaher continues to lead this highly profitable sector, capturing over half the sales in this market. Benson's continues to demonstrate resilience - while Silk Cut continues to dominate the low tar market. Our commitment to developing strong international industry relationships continues - our UK commercial division began distributing Shanghai Tobacco's brand, Chunghwa, in selected outlets in London last month. |
Slide 22 |
We outperformed our competitors in the low-price sector - lifting our share to over 30%. Mayfair strengthened its number three spot in the market, while benefiting from significant manufacturer price increases. Since acquiring Dorchester, we have more than doubled its share of the total market through carefully selected key outlets and trade segments. |
Slide 23 |
The Hamlet range continues to provide momentum for our achievements in the highly profitable cigar market. During the year Hamlet Miniatures became the number one small whiff cigar - the development of innovative packings enhancing our success. To complement our cigar portfolio we launched the Sobranie Cuban Classic range in June. |
Slide 24 |
Following the continuing success of the Amber Leaf piece pack, its share of the handrolling tobacco market has grown rapidly - to 11%. And, we continue to lead the pipe tobacco market. |
Slide 25 |
Last year we restructured our UK commercial division. Four marketing channels have been designed to match our business more closely with the shopping preferences of our consumers and with the needs of our trade customers. These changes, combined with an expanded sales force - which has enabled our independent outlet penetration to increase from 22,000 to 42,000 outlets on a four and eight weekly call frequency - and our new secure trade information website, continue to strengthen relationships with our trade customers. In the independent trade alone we installed 4,400 merchandising units, 37% of which are new sites for Gallaher - and we further enhanced our relationships with a number of the leading multiple grocers, who continue to recognise our high standing. |
Slide 26 |
Our investment in state-of-the-art merchandising units builds brand awareness, where it counts, and increases our consumer sales exposure in prime sites - up to 47% in 2000. The main benefit of these kiosks and gantries is the influence over the eye-level shelves - control over these shelves increases our share in any one outlet. |
Slide 27 |
Internationally, we had a tremendous year, achieving substantial organic volume growth in our western European markets and extensive in-roads into our new emerging markets business principally in Africa and the Middle East. The acquisition of Liggett-Ducat, Russia's leading tobacco manufacturer in August, offers great potential to our international strategy. But, more on this later. |
Slide 28 |
We recorded powerful organic growth in sales throughout our established European markets, providing a strong foundation for future initiatives. |
Slide 29 |
In Ireland, our established brands, Benson & Hedges and Silk Cut continue to thrive, providing a solid foundation for new opportunities. The introduction of Berkeley, and, more recently Mayfair, are proving successful, complementing our already profitable brand portfolio. |
Slide 30 |
Following the margin enhancements in '99, volume gains in France have progressed successfully, with Gallaher recording the second largest volume increase by any tobacco company last year. Our in-market sales were ahead by 9.3%, despite the overall market decline of 1%. Both Bensons' variants grew volume and market share, benefiting from our marketing skills and an expanded sales force. |
Slide 31 |
Once again, Gallaher outperformed the market in Greece - we continue to build our share of the domestic market. The Silk Cut house underpins our expansion plans, and provided the foundation for the launch of State Line in August. The development of UK tourist business complements our operations, with Bensons, Mayfair, and Sovereign contributing to this growth. |
Slide 32 |
The initial performance of B&H Lights has been encouraging - its volumes in 2000 representing the most successful launch in Germany in the last two years. It is now established in the market, providing a strong contribution to the maintenance of Gallaher's overall market position. Although invoiced sales were ahead sharply - largely reflecting the change in distribution arrangements at the start of the year - total in-market sales were just over one billion cigarettes. |
Slide 33 |
To-date, the significant volume gains achieved in Spain have been supported by the tourist trade. Having achieved a 1% share of the total market, we have positioned ourselves for expansion into the domestic market. We have developed Benson & Hedges Red, an American-blended cigarette, for local consumers - and it was launched in January. |
Slide 34 |
The remainder of our European operations grew overall volumes too. 2000 saw strong volume growth in the Canaries, Benelux and - albeit from a very low base - Italy. In duty free, Silk Cut continues to strengthen its position, and a more extensive portfolio available on the RMOs from this January will further enhance our position on the ferries. |
Slide 35 |
We continue to evaluate the opportunities and requirements for setting up local offices and putting people on the ground. We opened a new sales office in Madrid, in the second half of the year, and we have subsequently trebled the direct sales force in Spain. The new local management in Italy is now fully operational from their new office in Rome, supported by a network of agents covering a number of the major Italian cities. And, as I mentioned, in France, we have reorganised - and expanded - the sales force. |
Slide 36 |
Economic conditions continue to make a steady recovery in the CIS, following the volatility experienced in '98 and '99. Invoiced sales in Kazakhstan continue to grow, with mid-price Sovereign recovering back towards '98 levels - with a total market share of some 9% in December. Clearly, however, we needed to enhance our brand portfolio through the introduction of lower-price products. We launched State Line in July 2000, and we are investing in a primary line at our Almaty factory, so as to significantly reduce payment of cut-tobacco import duties. Our operations will continue to benefit from strong marketing support - and the establishment of a network of sales offices has provided added focus to sales and distribution. |
Slide 37 |
2000 saw in-market sales in Japan, Taiwan and China rise by 29% over '99. Pinks and Mints continue to record strong growth, capitalising on Sobranie's brand equity - and, to complement this we successfully launched one milligram variants of both brands in Japan, plus Sobranie Classic in Taiwan. We have also acquired new duty free listings for the Sobranie portfolio throughout the Asia Pacific region. In China, Shanghai Tobacco continues to lend support to the growth of Sobranie. |
Slide 38 |
Sovereign Classic and Dorchester International have spearheaded our move into new emerging markets, principally in Africa and the Middle East. 2000 has been a year of capturing new markets, and we continue to lay the solid foundations for future growth in these regions. A number of third-party manufacturing agreements have also been negotiated during the year, which will commence in 2001. |
Slide 39 |
Returning to Liggett-Ducat. Mark has already discussed the basic thrust of L-D's successful strategy - affordable quality/widely available - and 2000 has been a year of tremendous achievement by the team at Liggett. The heavy investment in establishing a nationwide distribution network is beginning to pay off - and we are well-positioned for significant growth. |
Slide 40 |
With its reputation for quality, our Prima accounts for over a third of the Prima market - providing a bedrock of demand from Russian consumers, and, therefore, the trade. But, rapid future growth hinges on our ability to grow intermediate-priced volumes - these brands generate significantly higher margins than Prima. L-D, the company, launched LD, the brand, in June '99. Since then, LD has consistently grown - for the full year 2000 it achieved a top 10 position in Russia, and it moved to number eight in December. |
Slide 41 |
We now have a comprehensive brand portfolio to address the total Russian market, and have begun the process of moving consumers up the margin ladder - without damaging our bedrock. As part of this process, we ceased production of papirossy cigarettes - the cheapest Russian product - transferring capacity to Prima. |
Slide 42 |
The increased hard box/filter production capacity enabled Liggett to grow its intermediate-priced volumes to around 30% of its total volumes in 2000 - up from 15% in '99. And, there is growing demand for our brands from adjacent markets, including the Ukraine and Belarus. |
Slide 43 |
In Russia, 2000 has seen the market dynamics move up the margin ladder too. The higher- and intermediate-priced sectors now account for 53.7% of consumer sales - up from 47.5% in '99. With its successful launches, Liggett grew its share of the intermediate sector to over 14% - up from 2.7% the previous year. LD has spearheaded this performance, supported by other brands - including Ducat and City. What's more, we successfully launched a higher-priced extension to the LD house - LD Gold - and a slims brand - La Femme - towards the end of 2000. Just last month, we launched Elements - a range of cigarettes titled air, earth, fire and ice. And, in September, we began on-shore manufacturing of Sovereign. |
Slide 44 |
As Mark has already discussed, L-D has invested heavily in building up its distribution, sales and marketing presence. From a virtual standing start, the company established a strong national position - and we shall continue to invest in these areas so as to maximise the growth opportunities. |
Slide 45 |
We are on target in our investment programme to increase production capacity to around 65 billion cigarettes per annum, and are on track to install seven new making and packing complexes - and the second primary line - by the end of this year. And we are witnessing some healthy competition between Group factories. L-D has wrested the packing world record from Lisnafillan - although our UK factory does still hold the making and packing world record at just over 20 million cigarettes in 24 hours. |
Slide 46 |
Let me finish with my personal thoughts on the business. Year one complete, a record year. A really solid UK performance in the face of tough conditions relating to the continued increase in non-UK duty-paid product, the introduction of fiscal marks, the anticipation of an advertising ban and a total internal reorganisation to address the changing trading environment. A fabulous top and bottom line performance from our organic international business. Volume and profit growth in virtually every market, a growing organisation of young and committed people and the launch of new brands from Spain to Taiwan. Our footprint is getting bigger. And, of course, a major acquisition into a huge market with a dynamic group of executives and a very committed workforce. Russia is a market of great potential and affordable quality available everywhere is a strategy I am totally committed to. Costs, efficiencies and productivity improvements keep us at the forefront of our industry. Everybody at Gallaher looks forward to continued success. My vision remains for Gallaher to be the most effective, efficient, energetic and enthusiastic tobacco company both you and we know. Thanks for your attention. |