2002 final results presentation
5 March 2003
Nigel Northridge and Mark Rolfe
Slide 1 |
(Gallaher) |
Slide 2 |
(Nigel Northridge) Good morning - and thank you for joining us to discuss our 2002 results. |
Slide 3 |
2002 represents another strong year of progress for Gallaher. Our acquisitions have been successfully integrated, and the enlarged Group is already showing its growth potential. We grew our businesses across Europe, the CIS and Asia, increasing pro-forma volumes by 18% to 153 billion cigarettes. This growth was matched by a strong financial performance. Group EBITA increased by 23%, PBTA by 16%, and earnings per share grew by 9%. Gallaher is in an excellent position to generate further growth, and we are excited about the Group's future. Now, I'll hand over to Mark who will take you through the financials. |
Slide 4 |
(Mark Rolfe) Thank you Nigel, and good morning everyone. |
Slide 5 |
These results reflect another good year of progress. They include the first full year contribution from Austria Tabak, and adjustments to last year's results for some accounting policy changes - which I'll detail shortly. We grew net turnover, EBITA, profit before tax and amortisation, and EPS. |
Slide 6 |
As detailed in the prelim news release, we have adopted two new UK accounting standards, and made some cost reclassifications. The only change that impacted reported profits is the adoption of FRS 17. This reduced 2002 EBITA by £9mn, and reduced interest cost by £7mn. We have also made a number of cost reclassifications, which impact turnover and margin figures - but do not effect reported profits. We have restated our 2001 figures to reflect these policy changes - and slides providing you with reconciliations to our 2001 results, as they were reported historically, are in the appendix to your slide book. In short, the net impact of FRS 17 on our 2001 numbers is a reduction in EBITA of £8mn, and an increase in PBTA of £6mn. Restated EPS in 2001 increases by 0.8p, to 46.9p. All the comparisons in this presentation use the restated figures. |
Slide 7 |
Returning to our 2002 performance. At the end of October, the UK government announced an increase to 3,200 cigarettes - from 800 - as a new guide level for personal travellers returning from the EU. This had a negative impact on the UK duty-paid market at the end of the year. The effect was partly mitigated by our growing market share during the second half - overall volumes declined only marginally. Incremental marketing investment ahead of the advertising ban implemented last month impacted both turnover and EBITA. As a result of additional sales incentive expenditure charged in 2002, net turnover declined 2%. This decline - and an increase in costs charged - are the principal reasons for the 5.6% reduction in EBITA. The adoption of FRS 17 reduced UK EBITA in 2002 by £8mn. Following the change in guidelines for EU personal travellers, we expect to see some negative impact on the size of the UK duty-paid market continue in the near-term. However, the government's announcement also included additional measures for customs to tackle criminal gangs who trade in contraband cigarettes and tobacco, which should partly offset the impact in the medium-term. |
Slide 8 |
The results of our continental Europe division reflect a strong organic performance, plus the first 12-month contribution from AT - which delivered integration benefits, and fully met our acquisition assumptions. The division's low EBITA margin of 9% reflects the full year inclusion of the lower-margin distribution businesses acquired in 2001. |
Slide 9 |
The integration of Austria Tabak and Gallaher's organic businesses has driven incremental benefits for the tobacco business. Revenue growth across the region more than compensated for the decline in margin, which was largely attributable to the higher proportion of lower-margin volumes. These benefits outweighed the initial losses arising from Gustavus, the start-up costs of our new joint venture with RJR - including the new marketing investment behind the Reynolds brand - and the loss of licensed manufacturing following our acquisition of AT. We are, today, announcing that we have signed a purchase agreement to acquire KT Merkury, a Polish cigarette manufacturer. Although there will be initial losses arising from this move on-shore in Poland, we expect good returns from this new opportunity in the medium-term. Looking forward, we expect good growth in this region, as a consequence of: - the extraction of continuing integration synergies; - benefits from the closure of the factory in Malmö, and the transfer of production to Austrian factories; - higher volumes arising from the increase in the guide levels for UK personal travellers returning from the EU; and, - benefits from the RJR joint venture, RGI. |
Slide 10 |
The distribution businesses performed well, reflecting: - increased non-tobacco product offering, and improved efficiency, in Austria; - the stabilisation of the cigarette vending market in Germany, and our post-acquisition restructuring of ATG; and, - stable tobacco sales, and increased pre-paid phone card volume - along with efficiency improvements - at Lekkerland-Tobaccoland. |
Slide 11 |
Our performance in the CIS saw net turnover increase by 25% - largely driven by volume growth of 26% to 74 billion sticks. EBITA grew 40%, to £42mn - despite the adverse currency impact from the weakening US dollar, which negatively impacted this division. In Russia, the market continues to move up towards the higher-price sector, driving top-line growth and margin improvement. Our growth in Russian EBITA and margin was achieved after substantial incremental sales and marketing investment behind our higher-price brands, as well as investing in ST Dupont through our joint arrangement with Sampoerna. Kazakhstan's turnover and EBITA continue to benefit from: - its integration into the CIS division headquartered in Moscow; - the move on-shore of primary production; - the expansion of the product portfolio, with the introduction of LD in 2001, and the launch of Sobranie Classic in 2002; and, - the continued growth of Sovereign. Overall strong earnings performances in Russia and Kazakhstan have more than compensated for the start-up losses in Ukraine. We continue to expect that enhanced growth in the CIS division will largely offset the incremental marketing and sales investment in Russia in the short- and medium-term. We are confident that the integration of the CIS operations - together with the incremental investment in Russia - will continue to provide revenue and efficiency benefits, leading to strong long-term growth prospects. |
Slide 12 |
Gallaher's remaining overseas operations increased net turnover by 19%, with volumes increasing to 11.3 billion cigarettes. This volume growth was largely driven by the recommencement of the lower-margin African, Middle East and Latin America - AMELA - business. The impact of adopting FRS 17 has reduced the division's 2002 EBITA by £2mn. Ireland had another good year. Although the market softened, we held our volumes - and now have a market share of over 50%. Improved efficiency from factory investment, and mix benefits from the continued growth of Benson & Hedges contributed to EBITA growth. However, the growth in Ireland was offset by: - incremental marketing support behind brands in Asia - in particular, in Korea and, with our partner Sampoerna, in Malaysia; and, - a reduction in profitability of our AMELA business as costs associated with recommencing distribution increased. We expect steady growth in Ireland, and that increased returns from our current investment in Asia will enhance the performance of this division. |
Slide 13 |
Our manufacturing operations performed impressively in 2002. In the UK, we installed an SAP resource planning system at Lisnafillan. This system covers the complete manufacturing process, from the collection of sales forecasts, to the planning of machine schedules, and has helped to significantly improve operational planning. The installation of new machinery has led to improvements in quality and productivity. Cigarette productivity at Lisnafillan increased by 9% during the year - and cigarette unit costs were reduced modestly in real terms, despite short-term increases in tobacco and non-tobacco material costs. These costs increases partly relate to our volume growth in higher-margin products - including Sobranie Classic in Asia - with the significantly more expensive packaging. Clearly, in the UK, and our other EU factories, pressure on NTM costs are likely to continue with the complexities arising from EU tobacco regulations - in particular, DG5, which, amongst other matters, requires us to change all our European packaging by the end of 2003. The continued introduction of state-of-the-art packing machinery at our cigar factory in Cardiff drove improvements in efficiency. Overall productivity increased by 14%, and unit costs were reduced by 4%. The Lisnafillan tobacco factory performed strongly, achieving a 4% improvement in productivity, and reducing unit costs by 3.5%. |
Slide 14 |
Our Austrian cigarette factories achieved an underlying productivity increase of 3% - having successfully faced the challenges associated with machinery transfers from Malmö, and the training of new machine crews. We increased production considerably in the CIS to meet the growing demand for our brands across the region. Our Moscow factory increased volumes and enhanced efficiency, while remaining highly flexible. Overall productivity grew by 44%. Our Kazakhstan factory more than doubled volume output, and increased productivity by 46%. And, we began production in Ukraine in February 2002. Our Cherkassy factory has continuously increased volume, productivity and flexibility throughout the year. |
Slide 15 |
The Group's net interest charge was £127mn. Following the adoption of FRS 17, the 2002 net interest charge includes a credit of £7mn from returns on pension scheme assets, less interest charged on pension scheme liabilities and other post-retirement obligations. The 2001 charge has been restated for FRS 17, and includes a net credit of £14mn. EBITA interest cover - combining both interest and operating components of FRS 17 into a net pension expense within EBITA - was 4.4 times, close to our target range of between 4.5 and 5.5 times. Our year-end net debt increased slightly to £2.5bn. However, this increase in year-end balances masks the continued high cash generation of our business, and arises because: - the strengthening of the euro in the last quarter of 2002 led to an adverse translation effect of £74mn on our predominantly euro-denominated debt; and, - at the end of 2002 - for reasons I shall explain later - we saw an increase in short-term working capital investment, which has already been largely reversed this year. The weighted average net debt position during 2002 was £2.3bn. |
Slide 16 |
The tax charge of £119mn represents an effective rate of 31.6%. The increase in the effective rate largely reflects: - the higher level of non-deductible goodwill amortisation charged in 2002; and, - the release in 2001 of a deferred tax provision for UK tax payable on dividends paid by non-UK subsidiaries. However, we continue to benefit from efficient finance structures - after removing intangible amortisation charges, our effective tax rate was 26.2%. Over the medium-term, the adjusted effective rate is expected to increase slightly to 26.5%. |
Slide 17 |
After deducting minority interests of £4mn, basic earnings per share increased by 3%. This reflects a 6.4% increase in earnings - offset by a 3.2% increase in the weighted average number of shares following the share issue in July 2001. Before amortisation charges, and the exceptional charges in 2001, adjusted EPS grew by 9.2%. Stripping out the impact of FRS 17, adjusted EPS increased 11.6%. We are proposing a final dividend of 18.75p per ordinary share, which would bring the total dividend payment to 27.55p - an increase of 8.3% over 2001. |
Slide 18 |
Turning to cash flows. Excluding JVs and associates, EBITDA grew by 24%. After adjusting for working capital fluctuations, the cash conversion rate was 81%. The increase in working capital was largely attributable to short-term factors, mainly: - higher-trade debtors in the UK at the end of the year; - higher levels of duty-paid finished goods in continental Europe and in the Republic of Ireland, largely reflecting tax stamp purchases related to duty increases; - higher-trade debtors in the CIS - with normal increases in a growing business augmented by the duty increases in January 2003, and the extended winter holiday period; partly offset by, - increased excise duty payable in the UK. This working capital position has already been largely reversed this year. |
Slide 19 |
Now - total cash flow. I've already addressed most of the key areas, but I'd like to spend a moment on capital investment. Total capital expenditure was £130mn, although this was partly financed by proceeds of £29mn, largely from the disposal of non-core assets by Austria Tabak - including the sale of the Malmö factory site. In the UK we continued to invest in our production facilities, kiosks and gantries, and in the SAP information systems. Continental Europe saw continued investment in the vending business of ATG, ahead of the German regulatory requirements impacting in 2007. And across the CIS we continued investment in production facilities and distribution networks. It is anticipated that this level of total capital expenditure will continue in the short-term. And now back to Nigel. |
Slide 20 |
(Nigel Northridge) Thanks Mark. |
Slide 21 |
Gallaher had an extremely productive year. The Group's international expansion was underpinned by its strong position in the UK market. Full year cigarette sales totalled 153 billion sticks, representing a pro-forma increase of 18%. Sales of Gallaher's strategic brands increased 10% to over 61 billion cigarettes, and sales of the Group's regional brands grew by 70% to 37 billion sticks. Our acquisitions are providing new opportunities. We have established a solid platform for future growth through the formation of four distinct business units, supported by central marketing, buying and production functions. This is already producing benefits. |
Slide 22 |
The integration of Austria Tabak has created an exciting platform for growth in continental Europe - enabling us to access new opportunities. We would not have formed the joint venture with RJR - or been in a position to develop the potential of Gustavus - if AT was not part of the Group. Founded on our strengthening position in western Europe, we have made swift progress in central Europe - increasing volumes by over 56%, and today we have announced that we are acquiring a business in Poland. Further east in the CIS, we have had an equally successful year. Gallaher has increased its presence in the higher-price sector in Russia, consolidated its position in the higher-price sector in Kazakhstan, and established substantial market share in Ukraine. Our rest of world operations have made solid progress too. We have extended Gallaher's market-leading position in Ireland, strengthened our network of relationships in Asia Pacific, and increased exports to Africa and the Middle East. Following the formation of our regional operating divisions, the Group's central marketing function has reviewed the portfolio of brands in each of these regions, in accordance with the contribution that they make to top-line growth and bottom line profitability. |
Slide 23 |
The strength of our positions in the UK market underpins our international growth. Our UK cigarette market share grew consistently throughout the second half of 2002. We lead the cigar and pipe markets, and have a solid position in the handrolling tobacco market. |
Slide 24 |
We placed incremental investment behind our key brands throughout 2002, and into early 2003 - when the introduction of restrictions have not only affected the tobacco industry, as those of you commuting into London will know. |
Slide 25 |
However, marketing is not just about traditional advertising. Existing evidence from markets that already have advertising bans in place, such as Italy or France, demonstrates that marketing restrictions alone do not reduce overall consumption. |
Slide 26 |
Gallaher is very well-positioned at the point of sale in the UK. Currently, 56% of consumer cigarette purchases made through merchandising units are made through Gallaher units. In 2002, we increased our investment in our sales force, and we introduced new merchandising equipment which is now being rolled out in several major accounts. |
Slide 27 |
The change in custom's indicative allowances for personal travellers is having a negative impact upon the UK market. However, our share growth in the second half went some way towards mitigating the effect of this market decline on our volumes last year. In particular, we grew volume sales of value brands by over 10% - with volumes of our leading value brand Mayfair increasing by some 18%. The launch of Mayfair Superkings in June assisted the brand's solid market share growth. By December, Mayfair's market share was approaching a record 10%. |
Slide 28 |
Our brand innovation continued this year, with the launch of a new brand - Benson & Hedges Silver - at the end of last month. Distribution targets have been achieved in record time. |
Slide 29 |
In the cigar market, the Hamlet house was strengthened further in December by the launch of two new products - Hamlet Miniatures Filter and Hamlet Aromatic. And, we launched a new handrolling tobacco brand - Mayfair - last month, to build on the success of the Amber Leaf flip top box, and to leverage the equity of the Mayfair cigarette brand. |
Slide 30 |
In continental Europe, the integration of Gallaher's existing operations with those of Austria Tabak is already producing benefits, establishing a strong platform for future growth. We grew pro-forma cigarette volume sales 10.5% to 46 billion sticks, conducting numerous brand launches, improved the performance of our distribution businesses, and continued our expansion in the central European countries between our strong positions in the EU and the CIS. |
Slide 31 |
In Austria, Gallaher maintained its lead of the cigarette market with a share of some 49%. The Group's strategic brands - notably Memphis Blue and B & H - performed strongly. Memphis Blue increased volumes by 15%, and grew market share to some 6%. Bensons' growing presence in the Austrian market was supported by the launch of Benson & Hedges Red 25s. The expected decline in sales of traditional local brands was partly offset by the volume growth of these brands. |
Slide 32 |
In Sweden, Gallaher increased its lead in the cigarette market, achieving a share of over 41%. This strong performance was led by the growth of Level, which obtained a 6% market share in 2002 - despite having only been launched the previous year. Level was introduced into the Danish market in January 2003, and we are launching it in Norway this month. |
Slide 33 |
Acquiring Gustavus gave us the manufacturing capability to enter the growing Swedish snuff market in 2002. The Gustavus brand was introduced into a selection of outlets throughout the last quarter of the year, and has been well-received by retailers and consumers. The brand's ongoing growth is being assisted by increased national distribution coverage and Gallaher's Swedish sales force. By the year end, Gustavus' share of the Swedish snuff market was approaching 1%. |
Slide 34 |
We've had a good year in Germany. Sales of our own brands - principally B & H, and Nil - grew by over 3% - and we maintained our leading position in the generic sector, with a volume increase of more than 14%. |
Slide 35 |
In Greece, our cigarette market share stood at over 5%, and our share of the handrolling tobacco market increased to some 37%. There is evidence that consumers throughout Europe and Asia are increasingly relating to local brands, as well as the more famous multi-national trademarks. In recognition of this opportunity, we launched Odyssey, a new cigarette formulated specifically to appeal to local Greek smokers, in January 2003. |
Slide 36 |
I'm really pleased with the progress that RGI is making. Following the formation of this joint venture last summer - and the transfer of American blend production to Austria - sales of B & H American blended cigarettes have gained momentum in France, Spain and Italy, complimenting our virginia blend market positions. In France, Gallaher's total market share grew to nearly 3%, assisted by an increase in Bensons' American blend volumes of some 14.5%. We performed well in Spain, growing total volumes sales by 6%, and increasing sales of B & H Red by over 20%. |
Slide 37 |
And, in Italy, the EU's second largest market, our total cigarette volumes more than doubled - spearheaded by sales of B & H American Blend, which increased nearly eightfold when compared to 2001. By the end of the year the brand had a market share approaching 2%. Reynolds was launched in the Canary Islands in October last year, before being introduced into the French, Italian and Spanish markets in early 2003. Initial trade and consumer response to Reynolds has been very positive. |
Slide 38 |
We expect restrictions on the promotion of tobacco products to increase across our markets in Europe and Asia. We do not believe that these restrictions will impede Gallaher's growth or our ability to compete. The success of Gallaher's operations in continental Europe supports this belief. France and Italy are existing dark markets - and we grew market share in both last year. We achieved this by: - understanding what smokers want; |
Slide 39 |
- offering smokers interest and differentiation through the actual product and using novel packaging - such as the Reynolds slide box; - having strong relationships with retailers; and, - ensuring that our brands are prominently displayed at the point of purchase. In short, the right product, at an appropriate price point, in the right retail outlets, sell. And, of course, the equity that we have built in our brands over many years - I hope you all enjoyed the examples of some of our best adverts, that were playing on the screen over coffee - stand us in good stead for many years to come. |
Slide 40 |
We achieved strong growth in central and eastern Europe in 2002. This growth has been aided greatly by the Group's enlarged brand portfolio, and by the knowledge and expertise that has been shared between our original and acquired businesses. Full year export sales to EU accession states in the Baltics and central Europe, and Balkan markets, increased by over 56% to nearly six billion sticks, after more than doubling in 2001. We grew volumes in the Baltic accession states by 36% and this growth was driven by the launch - in early 2002 - of Vermont. We also strengthened our positions in the central European accession states by opening offices in the Czech Republic and Hungary, and, by launching the B & H metal range - that's gold, silver and platinum - throughout the region. These growing positions should also serve as some protection against the inevitable cross-border trade that will arise as the EU is expanded. Further south, sales to Balkan states increased sharply, driven by the success of Memphis and Ronson. By the end of 2002, the Group held a market share across the Balkans of some 4%. |
Slide 41 |
Gallaher has entered into a purchase agreement to acquire KT Merkury, a domestic Polish cigarette manufacturer. We intend to develop a solid position in the large Polish market - building on the existing 2% share currently held by Merkury's brands. Although this market is highly competitive, I believe we are entering at a good time - and that our proven business model in emerging markets stands us in good stead. We will expand production capacity in the Gostkow factory, and launch one or more of our major brands. |
Slide 42 |
Turning to distribution. Our distribution businesses performed well in 2002. They have benefited from the additional focused management brought to them by Gallaher, and the rationalisation and improvement of their physical infrastructures and employee base. In Austria, Tobaccoland's sales of both tobacco and non-tobacco products increased - and improvements were made to its infrastructure and working practices. The benefit of being a vertically integrated tobacco company in Austria was illustrated by the signing of a three-year distribution contract with Philip Morris, through to the end of 2005. This contract complements our manufacturing agreement with that company. The performance of our cigarette vending operation in Germany - ATG - started to stabilise in 2002. ATG benefited from improvements in vending market conditions and operational efficiency. |
Slide 43 |
CIS volume sales increased by over 26% to total 74 billion sticks, and we grew share in each of our three key markets. Gallaher is now the joint second largest tobacco company in the entire region. |
Slide 44 |
In Russia, the Group increased total volume sales by 13% to 63 billion sticks. Our full year retail market share grew to 13.3%, driven by the strength of our brands and increased national distribution coverage. |
Slide 45 |
Within the Russian cigarette market, the higher-price sector continues to grow its share of sales. Within this sector, the premium sub-sector is becoming increasingly significant. We are addressing this growing consumer preference through the introduction of higher-price brands. |
Slide 46 |
Within our sales mix, we have continued to increase the growth of our brands in the intermediate- and higher-price market sectors. When we acquired Liggett-Ducat in 2000, 55% of volumes were in the oval sector. This figure fell to just 18% last year. Oval volumes have fallen sharply each year in absolute terms, while our volumes in the intermediate- and higher-price sectors have more than doubled. In 2002, LD's established market share underpinned sharp volume growth for Troika, Saint George and Novost in the intermediate-price sector, and, from Sovereign and Sobranie in the higher-price sector. Our share of the higher-price sector increased to 3.5%. This growth was driven by our strong share gain in the premium sector. |
Slide 47 |
Gallaher's growth in the premium sector has been supported by increased marketing activity. We intend to continue this incremental investment behind our brands in the medium-term, so as to improve our long-term growth prospects in Russia. |
Slide 48 |
In Kazakhstan, volume sales more than doubled to some six billion sticks, and our full year market share reached over 20%. More than 90% of our sales were in the higher- and intermediate-price sectors. Sovereign became the leading cigarette in Kazakhstan, LD gained a market share in excess of 5% - despite only having been launched in 2001 - and Sobranie Classic - which was only launched earlier last year - gained a 1% market share by December. |
Slide 49 |
Gallaher also gained market share swiftly in Ukraine. Our brands accounted for 7.5% of sales to consumers for the full year, and volumes totalled 5.5 billion sticks - with some 70% of our sales in the intermediate and higher sectors. |
Slide 50 |
In Ireland, Gallaher's cigarette brands maintained volume sales despite a modest decline in the overall market. Our market share grew to some 51%. This solid performance was led by Benson & Hedges, which widened its number one brand-leading position. |
Slide 51 |
Our AMELA division's volume sales were significantly ahead. This strong performance was driven by impressive growth from Sovereign and Dorchester International, which increased combined sales volumes by more than four times as they re-entered certain markets, and strong growth from Ronson in west Africa. |
Slide 52 |
We made good progress with our growth in Asia Pacific. In-market sales increased by over 11% to 345 million cigarettes. We've significantly strengthened our network of relationships in the region during the year. The principles of our agreement with the CNTC are progressing well - we now have formed a formal project team with Shanghai Tobacco. Following a number of successful meetings, we have now jointly signed a formal heads of agreement. The team is developing the plans for the commencement of the on-shore manufacture and distribution of a Gallaher brand in China - and of a Shanghai Tobacco brand in Russia - and we are all working towards the original timetable set out in our letter of intent signed in September. Additionally, we have strengthened Gallaher's position in China through the acquisition of our representative agent Gold Bond. We have subsequently established offices in Beijing, Shanghai and Guangzhou. |
Slide 53 |
In conclusion, 2002 has been another year of good progress for Gallaher. The successful integration of our acquisitions has given us wider geographic coverage, enhanced expertise and a more comprehensive brand portfolio. The creation of our new international operating divisions has realised tangible benefits. Solid volume growth was delivered across the business - and the foundations for future growth were laid through brand launches, the opening of new offices, the acquisition of Gustavus, and the successful cementing of joint ventures and relationships across our geographic reach. Since demerger, we have transformed Gallaher from a predominantly UK and Irish company into a leading eurasian Group. Compared to 1998 - our first full year as a public company - we have more than tripled our volumes to 153 billion sticks. International volumes have increased eight-fold to account for 86% of sales. We have grown EBITA from £385mn to £582mn - while operating cash, as measured by EBITA before depreciation and excluding JVs and associates, has increased 55% to £644mn. And adjusted EPS has increased by a compound annual growth rate of 12.3%. |
Slide 54 |
We continue to expand our eurasian vision - strengthening our positions in the EU, central and eastern Europe, central Asia, and Asia Pacific - and, where appropriate, entering new markets such as Poland. I'm excited about Gallaher's future. I believe that we have got the infrastructure, the brands, expertise, but above all, determination, to achieve continued value creating expansion throughout eurasia. Thanks for your attention. |