2004 final results presentation
2 March 2005
Nigel Northridge and Mark Rolfe
Slide 1 |
(Gallaher) (Nigel Northridge) Good morning - and thank you for joining us to discuss Gallaher's 2004 results. Now before I begin, and I've said this before, I've been reliably informed by Claire that unless mobile phones are off, as opposed to on silent, the entire sound system will go down. So please just check ..... Thank you. |
Slide 2 |
2004 was challenging. Trading was tough, with substantial increases in taxation and changes in regulation resulting in significant market declines in some key European markets. However, even with these difficult conditions, we grew volumes and profits - demonstrating the strength of our strategy and the platform for growth it has created. In 2004, the success we've achieved in the EU accession states, the Balkans and right across the CIS is particularly encouraging. We maintained our leading positions in our mature markets in the EU and we developed our business in newer markets in Europe and the CIS. We also enhanced Gallaher's operational efficiency. This ability to grow our business organically, and consistently drive down costs, resulted in both earnings growth and increased cash generation during 2004. Mark will now take you through the financials. (Mark Rolfe) Thank you Nigel, and good morning everyone. |
Slide 3 |
We improved all key financial performance indicators, producing a 6.1% growth in adjusted earnings per share. Our performance was negatively impacted by the effects of foreign exchange translation. Continental Europe, and the Republic of Ireland, have been affected by the marginally weaker euro, while the CIS, and parts of the rest of world operations, have been impacted by the more significant weakening of the US dollar. These effects, however, were partly offset by Group hedging activity at the earnings per share level. |
Slide 4 |
But in spite of the currency effects, our core tobacco business has shown excellent EBITA growth of almost 5.5%, lifting its margin to 38.2%. |
Slide 5 |
We are making good progress with the continued restructuring of our European operations. Of those programmes currently underway, we have charged an additional £17mn in 2004 - taking the total exceptional charge to date to £56mn. We still expect costs to be close to £65mn in total for these projects once they are completed. In addition to this, we announced further proposals in January, covering the closure of the Schwaz cigarette and Fürstenfeld cigar factories in Austria. We also plan to further restructure production at our cigarette and cigar factories at Lisnafillan and Cardiff, and reorganise some aspects of our distribution network. Quantification of costs and savings will be available after consultation with works councils and trade unions about these proposals have been completed. |
Slide 6 |
UK cigarette volumes were marginally lower, although 2003 was adversely affected by the phasing of trade sales. The increase in UK turnover was driven by duty and price increases, which more than offset the lower volumes and moderate downtrading. Cigarette market share continued to improve in 2004. The contribution to EBITA from price increases has been further improved by lower operating costs. These resulted from the operational restructuring which took place throughout 2004 and 2003, and lower marketing expenditure. You will recall that in 2003 we invested incrementally ahead of the ban on advertising. |
Slide 7 |
The increases in continental Europe turnover and costs are driven mainly through the acquisition of Lekkerland Europa by our associate Lekkerland-Tobaccoland in January 2004, and the contribution of Gallaher Poland - following our acquisition of KT Merkury in July 2003. Underlying gross turnover, after stripping out the impact of these acquisitions, decreased by 2%, while net turnover decreased by 6%. The reported results of this division have suffered through the translation of euro and Swedish krona earnings into sterling. |
Slide 8 |
Reported cigarette volume sales were up 6%. Underlying volume growth, after excluding volumes from the Polish acquisition, was 1%. This performance reflected good growth in our central and eastern European regions, and the strength of our joint venture with Reynolds American - RGI - as well as our generics business. This development in growth areas helped to offset the total market declines in a number of our other European markets. The growth in tobacco net turnover and total costs mainly reflects the full year effect of Polish sales, and a change in the accounting treatment of Italian market sales. EBITA increased 2% to £176mn - mainly reflecting price increases and operational efficiencies throughout the region. |
Slide 9 |
Results of our distribution operations also reflect the weaker euro and the impact of the reduction in both the German branded cigarette market, and the Austrian cigarette market. This has led to an overall 7% decrease in EBITA, to £66mn, despite the positive first-time contribution from Lekkerland Europa. |
Slide 10 |
The reported results of the CIS division have been impacted by the substantially weaker US dollar. Volumes grew by over 10%, and the mix of sales improved, despite excise duty increases in Russia and Ukraine, and manufacturer price increases. These factors more than compensated for the effects of foreign currency translation on gross turnover, which increased by 10%, and net turnover, which increased by over 4%. EBITA increased to £57mn, with an improved EBITA margin due to: - manufacturer price increases; - improved production cost efficiency; and, - continued growth of higher-priced brands in Russia and Kazakhstan. |
Slide 11 |
Our rest of world EBITA decreased to £50mn. The reported results of this division have been impacted by the weaker euro in translating our Irish results into sterling, and the weaker US dollar impacting our AMELA business. In the Republic of Ireland, manufacturer price increases, and the factory closure in 2003, have helped to compensate for lower volumes in the reduced Irish market. We have also been able to mitigate the effects of reduced volumes in the AMELA region through tight control of the cost base. These factors have led to the improved EBITA margin within this division. |
Slide 12 |
The Group's net interest charge was £122mn - including an FRS 17 net financing credit of £6mn. We reduced average net debt by some £200mn to £2.2bn, and have benefited from the marginally favourable translation of euro interest. However, these benefits have been offset by higher interest rates on variable rate debt, and the cost-of-carry for the issue of an 800 million eurobond in June 2004 which, with internal cash flow, refinanced the 900 million eurobond that matured in January 2005. These factors resulted in a higher average interest rate for the year of 5.8%. EBITA interest cover was 5.1 times, within the Group's target range of between 4.5 and 5.5 times. |
Slide 13 |
The tax charge of £135mn represents a reduction in the effective rate to 31.5%. This largely reflects the low effective rate of tax credit applicable to the higher exceptional charge in 2003, and the flat level of non-deductible goodwill amortisation. The adjusted effective tax rate of 26.6%, which removes these effects, is roughly in-line with last year. |
Slide 14 |
After deducting minority interests of £4mn, adjusted earnings per share increased by 6.1%. We are proposing a final dividend of 21.5p per ordinary share, which would bring the total dividend payment to 31.5p - an increase of 6.4% over 2003. |
Slide 15 |
Turning now to cash flows. Excluding joint ventures and associates - and adjusting for the exceptional charge - EBITDA was £708mn. After the working capital reduction, the cash conversion rate is 108%. Higher sales volumes and prices increased both trade debtors and excise tax creditors in 2004, although the increase in debtors was held back by improved cash collection. This net benefit, combined with lower leaf stocks held across the Group, drove a further reduction in working capital this year. As reported in September, our ongoing focus on working capital management has reaped benefits to-date, and although it's difficult to achieve continuous reductions in working capital in an expanding Group, this focus will remain throughout 2005. |
Slide 16 |
Total cash flow. As with the lower interest charge, reduced interest payments reflect gains from the strong cash generation, partially offset by the cost-of-carry of the June 2004 bond issue and higher variable rates in the year. Taxation payments of £90mn were £9mn lower than in the previous year. We invested, net of disposal proceeds, £100mn. Investment was targeted at our manufacturing facilities throughout the Group, kiosks and gantries in the UK, and vending equipment in continental Europe - although the latter was at a lower level than in 2003. Net cash flow amounted to £245mn, and after a translation adjustment of £1mn, net debt reduced to £2.21bn. |
Slide 17 |
For the forthcoming financial year we are required to prepare our consolidated financial statements under international standards. Although there are differences between these standards and UK GAAP, the total adjustment to our 2004 EBITA under IFRS amounts to only £3mn - principally relating to a change in treatment of associates and joint ventures. However, at EPS level, there may be increased volatility in the future with non-cash items, particularly in relation to financial instruments and deferred tax. We have provided reconciliations from UK GAAP to IFRS for the year ended 31 December 2004, and the six months ended 30 June 2004, in appendix one to our preliminary announcement. And, following the board changes in October, and the transition to international standards, we have reviewed the segments under which we report our financial information. Appendix two to the news release contains IFRS reconciliations between the former and revised segments. |
Slide 18 |
And finally, I'd like to highlight our manufacturing achievements. We have further enhanced our position at the forefront of operational efficiency. Our factories delivered an excellent performance in 2004 - assisted by benefits from the European operational restructuring programme which we announced in May 2003. We increased overall cigarette manufacturing productivity over 15%. This increased productivity, together with lower leaf and NTM costs, reduced unit costs 6.6% in real terms. As I have already mentioned, we have announced proposals to further enhance our competitive position going forward. |
Slide 19 |
Productivity at our Lisnafillan cigarette factory increased 22%. This was due to higher volumes following the transfer of production for the Republic of Ireland from Dublin in late 2003, and a re-organisation of working practices, which included some job reductions. We cut real-term unit costs at Lisnafillan some 12%. This reflected both the increased productivity and lower tobacco and NTM costs. We also grew productivity and reduced costs at our pipe and handrolling tobacco factory in Lisnafillan. However, productivity at our cigar factory in Cardiff was affected by a significant increase in the number and complexity of brand packs produced to serve export markets. These changes led to a rise in cigar unit costs. Cigarette productivity at our continental European factories in Austria increased some 11% - assisted by restructuring and improved efficiency. We reduced real term unit costs in Austria some 7%. If our proposals to reorganise production in continental Europe are adopted in-line with our announcement, I would expect this to impact on productivity in 2005. We made good progress in Poland last year, where we also achieved a strong increase in productivity, together with a reduction in unit costs. And we commenced on-shore production in Romania in October, following the leasing of a factory in Bucharest. In the CIS, we grew cigarette productivity 14.5%, assisted by higher volumes. Together with stable raw material costs, this increase in productivity assisted a real-term reduction in unit costs of over 4%. And now back to Nigel. (Nigel Northridge) Thanks Mark. |
Slide 20 |
We continued to create value for investors in 2004, building a platform for future growth through the development of a balanced portfolio of interests in established and developing markets. We grew volumes 6.5% to over 170 billion cigarettes - despite extremely challenging trading conditions in some key markets. This strong volume growth was driven by market share gains across the CIS and in certain continental European countries, including Italy, Poland, Romania and the Czech Republic - all demonstrating our ability to generate organic growth, even in tough times. |
Slide 21 |
In the UK, total duty-paid cigarette market sales to consumers declined by an estimated 2.5%, and downtrading from premium and mid-price cigarettes into value continued. Duty-paid market volumes softened during the second half of the year. |
Slide 22 |
However, we grew our total market share to 38.6%, retaining our commanding lead of the premium sector. Once again, we improved our position in the growing value sector, achieving a share of over 35%. Our UK volumes reduced slightly to a little over 20 billion cigarettes. This decrease reflected the reduced market size, partly offset by the small increase in our market share and the phasing of trade sales out of 2003 into 2002. |
Slide 23 |
Once again our largest UK cigarette brand houses, Mayfair and Benson & Hedges, performed well. They both grew market share, with Mayfair's average share increasing to 11.7% and Benson & Hedges' share reaching 9.5%. |
Slide 24 |
Total cigar market volumes continued to decline, falling by an estimated 9%. Downtrading from medium to small cigars continued. Nevertheless, Gallaher performed well and we maintained our lead of the cigar market with a share of 46.3%. In the handrolling tobacco market conditions were more positive, with total duty-paid volumes growing by more than 5%. Our lower-priced growth brand, Amber Leaf, continued to take share and accounted for 17% of the market. We maintained our lead of the small pipe tobacco market, with a share of 48.6%. |
Slide 25 |
Gallaher delivered a good performance in continental Europe - maintaining its leading market positions and growing elsewhere - in spite of the difficult operating environment. We increased our underlying continental European volumes 1.2% to over 46 billion cigarettes - largely due to growth in Italy, the Czech Republic, the Balkans, and generics. And the growth that we achieved in Poland, following the acquisition of KT Merkury, drove a 6.4% increase in our total continental European volumes - to 50.5 billion cigarettes. |
Slide 26 |
On an underlying basis, the Austrian market declined by around 7% in 2004, largely as a result of increased illegal cross-border trade from new EU member states. The actual decline, however, was reduced to around 5%, because of a pre-duty increase pull forward of sales in December. Clearly, this will impact the phasing of trade sales in 2005. Our Austrian market share was 45.2% - which was a moderate reduction over 2003 compared to the trend in recent years. That solid performance was due to the stabilisation of our core brand Memphis - its total market share increased slightly to 27%. This accomplishment was underpinned by modest growth from Memphis Classic. |
Slide 27 |
In Sweden, the duty-paid cigarette market volumes reduced some 5%, with an increase in cross-border trade from new EU member states adding to the underlying rate of mature market decline. Our total market share reduced as expected by 1% to 38.2%, with growth from our newer brand Level being more than offset by the ongoing declines of our mature brands Blend and Right. However, operating margin improvements more than compensated for those negative factors. Our Swedish snus operations continue to develop, in the face of strong competition from new competitors. We gained share in this growing market, up to 2.4%. |
Slide 28 |
Trading in Germany has been tough. Total factory-made cigarette market volumes fell 15.5% in 2004, due to substantial increases in taxation, retail prices and cross-border trade. As expected, the private label sector benefited from downtrading, increasing its share of the total market to 17%. In the circumstances, our performance in the German cigarette market was good. We increased our share of the total market held through private label to 8.5%, and maintained our small share of the branded market. During the second half we broadened our portfolio in Germany by launching a range of Ronson products - including singles. Initial volumes have been very encouraging. |
Slide 29 |
In France, the total duty-paid cigarette market declined over 21%, as a result of successive steep increases in cigarette taxation. Nevertheless, both our Benson & Hedges metal range, and the cigarettes marketed by RGI - including the recently launched Austin - performed well. Our total French market share increased slightly to 3.1%. We also performed well in the French cigar market. Growth from Hamlet drove an increase in our market share to 1.2%, up from just 0.7% last year. |
Slide 30 |
In the context of the other large continental European markets, duty-paid cigarette market volumes in Italy and Spain were relatively stable, with respective declines of around 2% and less than 1%. Our growth in Italy continued with Benson & Hedges American Blend driving an increase in our total market share to 4.9%. Our performance in Spain was steady, with market share increasing slightly to 1.7%. |
Slide 31 |
I am very pleased with our results in central and eastern Europe. We have made strong progress in the new EU member states and in the Balkans. In Poland, our market share grew, driven by gains from our international brands, LD and Level. In December, our share was 4.9%, up from 2.6% in December 2003. |
Slide 32 |
We have also grown share in the Czech Republic and Estonia. As a result of the accession of the Czech Republic to the EU, and the abolition of import tariffs, we have been able to compete in the market at various price points. We made strong progress in the second half, with our total market share reaching 6.2% by December. This success was driven by sales of our value brand Ronson to domestic smokers. In Estonia, we grew our market share to 28% - up from 23% last year. That success driven by the launch of brands, including LD Slims. |
Slide 33 |
In the Balkans we increased market share to 5.6%. We have strengthened our platform for further growth in the region - we've begun on-shore production in Romania, where Ronson, Memphis, LD and St George are making good progress, and by starting contract manufacturing for our brands in Bosnia and Macedonia. |
Slide 34 |
Our distribution businesses were impacted by the market declines in Austria and Germany. In Austria, a continued focus on operational costs at TOBA, together with higher-margins following price increases, largely offset the impact of the total market decline. In Germany, ATG was affected by the decline in total market volumes, and downtrading from branded cigarettes to generics as well as other tobacco products. In addition, ATG was impacted by disadvantageous optical pricing in the vending channel following the duty increase in March - although the subsequent duty increase in December has created pricing parity between the cigarette vending and retail markets for premium brands. The effect of these unfavourable market conditions on ATG was mitigated by our focus on operational cost reductions, and higher-margins following the price increases in the German market. The lower German cigarette market volumes also impacted Lekkerland-Tobaccoland. However, that impact was more than offset by L-T's acquisition of Lekkerland Europa at the beginning of the year. |
Slide 35 |
Our strategy of gaining market share in the CIS, while continuing to enhance our sales mix across the region, delivered great results. We grew our total CIS volumes over 10% to 91 billion cigarettes - increasing market share in Russia, Kazakhstan and Ukraine. And we improved our mix of sales. |
Slide 36 |
Our markets in the CIS continued to develop in association with wider economic prosperity, with an increased proportion of smokers choosing intermediate- and higher-priced brands. In the region's largest market, Russia, the higher-priced sector's share of the total market increased to over 30% and the intermediate-priced sector maintained its share at some 59%. |
Slide 37 |
Importantly, in addition to this positive price sector development, prices within sectors increased - particularly in the intermediate sector - without negatively affecting overall volumes. Our brands, including Ducat, Troika and St George, took price increases throughout the year. We grew share of the total cigarette market in Russia from 15% to 16.4%. This achievement was driven by the success of a variety of brands across the intermediate and higher-priced sectors. We increased our share of the higher-priced sector to 3.7%, and our share of the intermediate-priced sector to 24.5%. |
Slide 38 |
We grew share in Kazakhstan, averaging over 35% in 2004. This achievement was driven by gains from brands across price sectors including Sovereign, Sobranie and LD. We grew our share of the intermediate- and higher-price sectors combined, increasing our lead of the higher-priced sector itself to 58.7% - again demonstrating our ability to build brands and create organic growth. |
Slide 39 |
In Ukraine, we continued to win market share, averaging 14.5% over the year. This growth was mainly driven by gains in the intermediate-price sector by St George, and Level, which we introduced into the market in the second half of 2003. Our share of the intermediate-priced sector in the Ukrainian market reached 22% toward the end of the year. |
Slide 40 |
In our rest of world division, we continued defending share in the Republic of Ireland market, while establishing positions elsewhere. Our total ROW volumes declined 11.3% to 8.9 billion cigarettes. This decline was due to lower Africa and Middle Eastern volumes and a reduction in Irish market volumes. |
Slide 41 |
The total cigarette market in the Republic of Ireland declined 11.3% in 2004. That reduction was influenced by repeated above inflation duty increases and the ban on workplace smoking that came into force at the end of March. We maintained our lead of the cigarette market in the Republic of Ireland with a share of over 49%. Benson & Hedges increased its market-leading position to 20.1%. |
Slide 42 |
Our AMELA volumes reduced 13.2% to 4.9 billion cigarettes. Growth in Nigeria was more than offset by a reduction in volumes elsewhere, including those manufactured under contract. We are planning to increase our flexibility and competitiveness in developing markets by employing lower-cost production for these markets, using our factory in Poland or on-shore facilities where appropriate. We have agreed to purchase a small factory site in South Africa, and we intend to commence local production of our mainstream brands for that market during 2005. |
Slide 43 |
We achieved a 14.6% increase in our Asia Pacific volumes to 447 million cigarettes due to gains in China, Taiwan and Asia's regional duty free market. We are making good progress in China, where we have increased distribution coverage for Memphis and have received permission to import LD into that market. We also made good progress with our cigar sales in Asia following our agreement with Japan Tobacco in January 2004 to operate its domestic cigar business. |
Slide 44 |
Our results reflect a good performance across the business, despite difficult trading environments in many markets. I am pleased with the market share and volume gains that we have realised. We continued to make progress with our ongoing drive to increase efficiency and reduce our operating costs. We successfully defended our leading positions in our core markets in EU, and these markets continue to provide the resources to invest in our expansion in developing markets, where we are gaining profitable volume and share. We achieved significant market share gains in EU accession states, the Balkans and right across the CIS in 2004 - this success demonstrating the benefits of our strategy. Our exposure to those markets is beginning to make a significant contribution to our growth platform. The management will continue as we always have to concentrate on four areas of focus: - firstly, to endeavour to be the lowest-cost manufacturer everywhere we operate - benchmarking wherever possible; - secondly, to use real vigour to examine supply chain opportunities for improvement, and route to market; - thirdly, to develop our brand portfolio to address all key price points in our chosen markets; and, - lastly, to ensure we recruit, train and motivate our people to win. Thanks for your attention. |