2005 final results presentation
1 March 2006
Nigel Northridge and Mark Rolfe
Slide 1 |
(Gallaher) (Nigel Northridge) Good morning - and thank you for joining us to discuss Gallaher's 2005 results. Before we commence, could I please ask that all mobile phones and blackberries are turned off - not just put on silent - in order to avoid any interference with the sound system. Thank you. |
Slide 2 |
Despite challenging conditions in certain European markets - brought about by tobacco excise duty hikes and intense price competition - the successful execution of Gallaher's strategy for growth has enabled us to grow volumes, profits and earnings per share for the year. We grew our strategic brand volume sales by 11.5%, and we increased underlying Group EBITA by 4.5%. We increased our core markets EBITA by 2.3% underpinning strong growth - of some 9% - from our investment markets, in spite of challenging conditions. Our ongoing drive to improve operational efficiency resulted in increased manufacturing productivity, a reduction in production unit costs and lower working capital. Our drive for sustainable growth - underpinned by exploiting our strategic brand portfolio, adopting a lowest cost approach and best route to market - has ensured that we have grown earnings in 2005. Mark will now take you through the financials. (Mark Rolfe) Thank you Nigel, and good morning everyone. |
Slide 3 |
We grew sales, EBITA and PBTA in 2005, delivering a 7.5% growth in adjusted earnings per share. These results reflect both the cost of investments in new opportunities, and the benefits from returns from investments made in previous years. Excluding benefits from foreign exchange translation, incremental restructuring savings, and the contribution of acquired brands - and stripping out additional investment in new markets, selling and marketing - Group EBITA was ahead by 4.5%. |
Slide 4 |
We increased the combined EBITA from Austria, Ireland, Sweden and the UK by 2.3%, in spite of overall market declines across these four core markets. Our investment markets, driven by the success of our CIS division, showed excellent growth, despite adverse conditions impacting on some key western European markets and significantly increased investment - with EBITA rising by 8.8%. In fact, excluding Spain - where the market dynamics severely impacted margins - these markets delivered growth of over 13%. |
Slide 5 |
We are making good progress with the restructuring of our European operations. We charged an additional £35mn in 2005, taking total exceptional charges to date to £91mn. Included within these charges are costs associated with the recently announced restructuring of our German vending subsidiary, ATG, and the gain on disposal of our former factory site in Dublin. We expect costs to total around £95mn. Once all restructuring is completed, we expect annualised savings of at least £30mn by the end of 2007. |
Slide 6 |
UK net sales grew by almost 1% - in spite of increased sales incentives - as the impact of manufacturer price increases more than offset volume decline and continued downtrading. The contribution to EBITA from price increases has been assisted by lower volume-related operating costs, restructuring savings and reduced sponsorship expenditure. |
Slide 7 |
Although difficult trading conditions persisted in western Europe, Gallaher delivered some excellent performances, notably in the Republic of Ireland, and central and eastern Europe. These - together with the acquisition of trademarks in Cyprus and Malta, good growth in our Lekkerland associate and the increased profits from German singles - resulted in broadly stable profits for the division. |
Slide 8 |
Factory-made cigarette volume sales were down 6%. Strong performances in our central and eastern European regions - notably Slovakia, Romania, Czech Republic and Hungary - as well as market share growth in Spain and the Republic of Ireland partly offset the total market declines in a number of our other European markets. The increase in tobacco net sales and total costs mainly reflects the change in mix of sales and increased sales and marketing investment, notably in central and eastern Europe. EBITA decreased 1.5% to £194mn. |
Slide 9 |
Our distribution operations were impacted by the total market declines in Austria and Germany. In Austria, our focus on costs, and price increases in the premium sector, fully offset the market effect. ATG benefited from cost reductions, and optical pricing parity between retail and vending which took place for most of 2005. Our associate, Lekkerland displayed strong growth, aided by synergies driven out of the Lekkerland Europa acquisition. This has led to an overall 3% increase in EBITA, to £65mn. |
Slide 10 |
The CIS division continues to demonstrate our successful development in the region, with good returns from our investments. Volumes grew by 6.5%, and the mix of sales improved, despite excise duty increases in Russia and Ukraine, and manufacturer price increases. We grew both gross and net sales by over 15% reflecting the increased volumes, price increases and sales mix improvement. EBITA increased 17% to £67mn, with our significant increase in investment behind our brands and sales forces partly offsetting the increase in net sales. |
Slide 11 |
Our rest of world EBITA grew to £34mn, another 17% increase. This mainly reflects: - volume growth in Poland, which - together with price increases - has moved the operation into profit in line with expectations; and, - a good performance in Sweden - assisted by increased trade demand in December 2005 ahead of tax increases. These factors have more than offset the impact of start-up investments in Denmark, Lithuania and South Africa, as well as weaker African and Middle Eastern volumes. |
Slide 12 |
Net finance costs were down £14mn, including the benefit from a £2mn increase in IAS-related credits. This was driven by a reduction in net debt and lower interest rates. The net debt reduction of £98mn primarily reflected positive cash flow - after investment and acquisition expenditure. We reduced average net debt by £150mn to £2.1bn. EBITA interest cover was 5.9 times, and our cash flow to net debt ratios were within our target ranges. |
Slide 13 |
The tax charge of £144mn represents an effective tax rate of 28%. This rate is distorted by the low effective rate of tax credits applicable to the higher exceptional charges in 2005. This year's lower adjusted effective tax rate of 26.8% - which strips out the effects of exceptional charges and the amortisation of intangible assets - largely arises from the reduction in the Austrian corporate tax rate from 34% to 25% from 1st January 2005. |
Slide 14 |
After deducting underlying minority interests of £5mn, adjusted earnings per share increased by 7.5%. And, we are proposing a final dividend of 22.9p per ordinary share, which would bring the total dividend payment to 33.5p - an increase of 6.3% over 2004. |
Slide 15 |
Turning now to cash flows. Excluding joint ventures and associates - and adjusting for the exceptional charge - EBITDA was £727mn. After working capital fluctuations, the cash conversion rate was 101%. Working capital remains a focus of the Group. In 2005, our net investment in working capital reduced by a further £16mn. In the last two years - in spite of our successful business expansion into new markets - we have cut working capital by nearly £100mn, a reduction of 26%. The increased taxation payments of £53mn primarily reflect tax assessments in Austria. These are reviewed periodically, and have now been brought into line with current levels of profitability. |
Slide 16 |
Total cash flow. In the year, our £90mn of debt reduction from cash flow was after net capital investment of £155mn. This included the purchase of trademarks from BAT in April, and the disposal proceeds arising from the sale of the former factory site in Dublin. In 2006, I expect net capital investment to be around £230mn, reflecting investment in the business, the £70mn acquisition of CITA and start-ups in Turkey and Singapore. |
Slide 17 |
And finally, I should like to take you through our excellent manufacturing performances. In Group terms, our cigarette manufacturing productivity increased by 6.5%, and we achieved a real-term reduction in unit costs of 2.7%. |
Slide 18 |
Productivity at our Lisnafillan cigarette factory was adversely affected by lower volume as a result of the UK market decline, the transfer of some of our developing markets production volume to Poland, and a planned reduction in UK finished goods stock levels. Despite this, UK real term unit costs improved by 1.8%. Cigarette productivity at our Austrian factories was up 2.4%, in spite of lower western European volumes and the disruption caused by the closure of Schwaz in August. This contributed to a real-term cut in unit costs of 4.7%. In the CIS, we increased cigarette productivity 8.4%, assisted by higher volume, the benefits of investment in higher-speed machinery and improved working practices. This increase in productivity assisted a real-term reduction in unit costs of 1.1%. We also made excellent progress in Poland, improving productivity and reducing unit costs - and we established a local production facility in South Africa by re-deploying displaced equipment from Dublin, Russia and Ukraine. |
Slide 19 |
In tobacco, we increased productivity by 6.6%, assisted by our investment in a new primary processing line at the end of 2004. |
Slide 20 |
Cigar productivity was up 11.6%, in spite of a smaller UK medium cigar segment and an increase in the Group's brand pack variants for export markets. This improved productivity, driven by the benefits of the restructuring programme - including the closure of the Austrian cigar factory last year - resulted in a reduction in real-term unit costs of 7.1%. And now back to Nigel. (Nigel Northridge) Thank you Mark. |
Slide 21 |
These results again demonstrate Gallaher's central commitment to deliver value to its shareholders - maximising cash flow from our core markets in order to fund profitable expansion. Our investment market volumes increased by 6.8% - with notable performances in the Group's longer-established markets - for example, Russia, Kazakhstan and Spain. In addition, we made excellent progress in our more recent on-shore investments in Ukraine, Poland and Romania, and in our newer export markets - like the Czech Republic, Slovakia, Hungary and Lithuania. Although we successfully defended our strong share positions in our core markets, the declines in the overall size of the cigarette markets in Austria, UK and Sweden resulted in anticipated lower volume sales. |
Slide 22 |
Our strategic brands were fundamental to the success that we achieved in 2005. The portfolio - which now constitutes 48.2% of Group cigarette volumes - grew its volume sales by 11.5% in the year. LD's performance was underpinned by strong growth in the CIS, Poland and Denmark. And, having successfully introduced Ronson as a key value proposition in newer markets - within northern, central and eastern Europe - the brand's volume sales increased by 41% in 2005. The Sovereign house performed well throughout the Group's established CIS markets, and benefited from exports to new territories, including Kyrgyzstan, Mongolia and Armenia. Sobranie continued to make gains in Asian travel retail, central and eastern Europe and right across the CIS. |
Slide 23 |
The key to success in our markets is to defend our strong positions in order to optimise revenue. Despite lower volumes and negative mix - resulting from downtrading - we successfully increased the average net take per stick in all four of our core markets in 2005. These price increases, together with improved cost efficiencies, have more than offset the volume declines - thus delivering the increased profitability of 2.3%, that Mark spoke of earlier. |
Slide 24 |
In the UK, the duty-paid market for cigarettes declined by an estimated 4%, and downtrading from higher-priced cigarettes into value products continued, albeit at a more moderate rate. These negative influences were successfully offset by an increase in average manufacturer prices of around 6% in the year. Our total market share was flat at 38.6% and we retained our commanding lead of the premium sector. The ongoing successful execution of our value sector strategy, meant that we made further share improvement within this growing sector. Effective portfolio management in recent years means that the Group's sales profile by price sector broadly matches that of the market in 2005. |
Slide 25 |
Mayfair was the fastest-growing cigarette brand in the UK in 2005. Stemming from the success of Sterling in the multiple grocers channel, we extended distribution of the brand to the convenience and independent channels at the beginning of this year. |
Slide 26 |
Packaging innovation, emphasising Silk Cut's premium characteristics - and the introduction of Benson & Hedges Gold 14s - have moderated our more recent share decline in the premium sector. We maintained our lead of this high-margin sector with a share of over 45%. |
Slide 27 |
Total cigar market volumes continued to decline, albeit at a slower rate than in the first half of the year due to growth in the miniature cigar segment. We maintained our lead of the market with a share of 46.6%, and successfully grew our share of the miniature cigar sector to a little under 36%, assisted by our innovation in merchandising and packaging. In the handrolling tobacco market, duty-paid volumes grew by some 5%. Old Holborn had a more moderated decline in share and Amber Leaf retained its title as the fastest-growing HRT brand in the UK - growing its share now to a little under 19%. We maintained our lead of the small pipe tobacco market, with a share of around 49%. |
Slide 28 |
Volume sales in the Group's European investment markets were up by 4.8%, in spite of continued difficult trading conditions in western Europe. We delivered some good share gains, notably in Spain and a number of markets within central and eastern Europe. In Spain, however, competitor activity in the value segment intensified in the fourth quarter, impacting margins last year, and into this year. |
Slide 29 |
After adjusting for the phasing of trade sales - the duty-paid cigarette market in Austria declined by approximately 10%, largely as a result of increased cross-border trade from new EU member states. Our market share reduced, as anticipated, to a little under 43% following the repositioning of Memphis Classic to higher-pricing levels - which, in turn, has led to an increase of 12.8% in our manufacturer take per pack. In the last few weeks there has been heightened competitor activity in the value segment. In order to defend our overall market position, we have reduced the prices of Ronson, Benson & Hedges Red and Smart. We continue to monitor competitor activity, and, additionally we await the outcome of the Austrian government's review of the duty regime. |
Slide 30 |
In the Republic of Ireland, underlying cigarette market volumes were broadly flat in 2005, reflecting a return to more stable conditions following the ban on workplace smoking that was introduced in March 2004. We maintained our lead of the market with a share of 49%, underpinned by a strong performance from Benson & Hedges Gold. |
Slide 31 |
Trading in Germany remained difficult. Total factory-made cigarette market volumes fell 14.7%, due to substantial increases in taxation, cross-border trade and the growth of singles. However, it is anticipated that singles volumes will contract substantially following the removal of the tax advantage, which is due next month. Our share of singles reached 9.1% in December compared to 2.1% in 2004. |
Slide 32 |
In France, the market for duty-paid cigarettes was broadly stable. Robust performances from our higher-margin Benson & Hedges metal range partly offset share losses of the value brand portfolio marketed by RGI. We performed well within the French cigar market. Growth from Hamlet and the newly-introduced Benson & Hedges cigars drove an increase in our market share to 1.5%. |
Slide 33 |
In Spain, although the duty-paid market remained broadly stable, competition intensified in the value segment in the fourth quarter of 2005 - in addition to which, the market has now experienced further margin reduction following duty absorption by the competition. Simplistically, if market volumes remained flat and there was no further movement between price sectors, industry pro-forma 2006 net sales would be some 36% lower. Reflecting our share of this reduced industry profit pool, we expect that there will be an impact on our European profits this year, reducing our targeted 2006 Europe tobacco growth rate. |
Slide 34 |
In spite of the Spanish market dynamics, I believe that the acquisition of CITA provides a number of opportunities for the business that will provide revenue and cost synergies over time. In particular: - an enlarged cigarette brand portfolio and, more specifically, the international rights to the valuable Coronas trademark - outside of the Americas; - greater scale in Spain, the Canary Islands and Portugal, which effectively translates to improved distribution and stronger sales teams in these markets; - tax-efficient on-shore manufacture in the Canary Islands; and, - finally, the enhancement of our cigar brand portfolio through the introduction of CITA's brands that cover premium-, mid- and value-price sectors. |
Slide 35 |
In central and eastern Europe we continued to make strong progress, growing volume sales in new EU member states and in the Balkans. We drove share higher in the Czech Republic, Hungary and Slovakia, and increased our share of the domestic market in Romania. |
Slide 36 |
In Slovakia our share increased to 6.4%, driven by the ongoing success of our value brand, Smart. We strengthened our weighted distribution significantly, as our former import partner merged with the country's largest retail chain to form a new distribution enterprise - with whom we now have an excellent relationship. Considering the early stage of the business model, our profit neutral position for the full year is a good achievement. We launched LD in Hungary in May, and we have quickly established just under 2% share of that market. This follows our successful export strategy in the Czech Republic, where we grew our share of the market to 6.6% - with Ronson now the fourth largest brand in the market. We doubled profitability in 2005. |
Slide 37 |
In Romania, we grew our cigarette volume sales - including duty-free by 34%. Our share of the domestic market - excluding duty free - reached 3.2% in December due to good performances from St George, Ronson and LD. This successful top-line growth, together with efficiency improvements at the newly-established production facility, has meant that we have progressively grown margins - for the combined domestic and duty free businesses - over the past three years. In accordance with the Group's objective to expand its geographic footprint, we have recently acquired land and buildings in Turkey for the purpose of establishing on-shore manufacture. |
Slide 38 |
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 manufacturer price increases, offset the impact of the total market decline. This year, however, the sharp growth in the value sector may preclude any further margin enhancement. In Germany, ATG was affected by market declines and downtrading from branded cigarettes to cheaper alternatives. The effect of these unfavourable conditions was, however, mitigated by optical pricing parity between vending and retail channels for premium brands, for the majority of the year, and a continued focus on cost reduction. |
Slide 39 |
In 2005, we continued the trend of increasing the margin per pack, offsetting that ongoing volume decline. This year, the improved performances from our distribution operations should partly offset Europe's tobacco weaker growth rate. |
Slide 40 |
Turning to the CIS, we continued to deliver profitable volume growth, assisted by our strong distributor relationships. We drove share gains, in all markets, and improved our product mix by outperforming market trends within the intermediate- and higher-price sectors in the region. Our total CIS volumes grew by 6.5% to 97 billion cigarettes, in spite of excise duty increases in both Russia and Ukraine. In addition to which, we took manufacturer price increases across the region - demonstrating increased consumer spending power as a result of strengthening economies. Our strategic volume sales in the region grew by around 31% - driven by excellent performances from LD, Sovereign and Sobranie. |
Slide 41 |
Consumers continued to trade up to higher-margin products in the year - as reflected by the share of retail sales accounted for by the premium and mid-price sectors in the region - growing to 11.7% and 20.8% respectively. |
Slide 42 |
In Russia, we grew our share of the total cigarette market to 16.9%. We worked closely with our distributor to further optimise our product flow - such that 20% of our sales are now made direct to retail. We had good performances from a variety of brands across the intermediate- and higher-priced sectors. LD delivered a robust performance in the value sector, at higher-prices, with market share of 5.3%. Our share of the higher-priced sector grew to 4.2% during the year. Sovereign increased its share of mid-price, and Sobranie Slims drove our share of the premium sector to just under 5%. We expect further improvement, following the national roll-out of Sobranie Red and Sobranie Blue this month. |
Slide 43 |
We grew our share in Kazakhstan to over 37% in 2005. LD is now the number two brand in that market. With continued leverage of the Golden Fever campaign, our leading brand - Sovereign - attained a record 17.9% share of the market in December. Together with Sobranie, Sovereign assisted in maintaining our lead of the higher-price sector, with a share of around 57% for the year. We also grew exports to neighbouring countries - such as Kyrgyzstan and Mongolia - with volume sales in excess of 1.6 billion cigarettes in the year. |
Slide 44 |
In Ukraine, we grew our share of the market to 16.2%, delivered by strong performances in the intermediate- and higher-price sectors. LD, Level, Ducat and Ronson, all contributed to growth in our intermediate share to just under 23%. Together with good performances from Sovereign - including the recently launched, Sovereign Slims - and Sobranie, we improved margins further. To update you on what we said in September - our Ukraine business actually achieved a post-tax cash flow return in excess of 13% for the full year. |
Slide 45 |
Finally, in our rest of world division, we successfully defended our mature position in Sweden and grew our volumes in northern Europe, the Baltics and Asia Pacific. Our total RoW volumes increased by 7% to 14.8 billion cigarettes, attributed to excellent performances in Poland, Denmark, Lithuania and Nigeria - in addition to higher volumes in Sweden due to the phasing of trade sales ahead of a tax increase in January this year. |
Slide 46 |
The underlying total cigarette market in Sweden declined by a moderate 1% in the year, despite the public smoking ban which came into force on 1st June 2005. It is, however, too early to ascertain what the true impact of the ban may be. We delivered a robust performance with a share of the Swedish cigarette market of 39.1%, driven by a strong performance from Level. Together with increased prices and improved efficiencies we drove strong cash flow for re-investment across the Group. We further consolidated our position in Estonia, maintaining share broadly stable at around 27%. LD grew its share of the market by two percentage points to just under 5%. |
Slide 47 |
We also made excellent progress in our newer export markets of Denmark and Lithuania. In Denmark, our investment in local infrastructure and the successful launch of LD in February, has driven our market share to 5% in the three months to November. And, in Lithuania, the outstanding performance from St George has driven our share to 14.9% of that market. Our share gains in these markets are encouraging, however we are still largely in the investment phase, and expect profitability improvement to come in the medium-term. |
Slide 48 |
In Poland, we lifted volumes by 30.5% to 5.4 billion, increasing our market share to 7.3% - driven by LD which continued to take share at higher prices. There is also ongoing price competition in this market, but we are confident of our position given our strong brand portfolio covering all the price points. You may recollect that the business turned profitable in the first quarter - and, again, to update you on what we said in September, Poland posted a post-tax cash flow return greater than 8% for the full year. |
Slide 49 |
I am very pleased with the progress that we have made in the Swedish snus market. Following the successful introduction of LD Red, in August, we grew our share of the total market to 5.4% in December. We increased our sales to just under five million cans in the second half compared to around three million cans sold in the first half. Following this successful launch, we have extended our LD portfolio by introducing two new flavours. In addition, we have also launched LD in the loose and mini portion segments. Although declining, these segments accounted for around 40% of the total market. |
Slide 50 |
Our Middle East and Africa volumes reduced to 3.4 billion cigarettes versus 4.9 billion last year. Growth in Nigeria was more than offset by lower sales in Guinea, and the termination of a distribution agreement in the Middle East. In South Africa, less than one year into the venture, we are still in investment phase. In December, with a weighted distribution of only 20%, we achieved a share of the total market of 1% - primarily through LD. |
Slide 51 |
Our Asian volumes grew by around 9% to 540 million cigarettes, driven by growth in the China licensed brand, Japan and regional duty free. We are making good progress in China, where we estimate that Sobranie and LD together accounted for around 7% of official imports in 2005. Our reciprocal agreement with Shanghai Tobacco continues to make progress, with volume sales of both Memphis in China and Golden Deer in Russia in line with expectation. Finally, in order to augment the Group's position in Asia, we have begun construction of a small manufacturing facility in Singapore, which is due for completion by the end of this year. |
Slide 52 |
And so to conclude - in 2005, we delivered good organic growth in spite of a very competitive pricing environment in Europe. We continue to execute the Group's strategy, maximising our strategic brand portfolio, optimal cost advantages and best routes to market - resulting in increases in both volume sales and profitability. We defended our leading positions in our core mature markets in the EU, and made market share gains across the CIS, northern, central and eastern Europe and in certain Asia Pacific and African markets. We extended our footprint by entering new markets, and increased our strategic brands' volumes by 11.5%. We improved Group cigarette productivity by 6.5% and reduced unit costs by 2.7%. All of which resulted in an increase in underlying EBITA of around 4.5%. Adjusted earnings per share grew 7.5%. Our £90mn of debt reduction from cash flow was after net capital investment of £155mn. Looking ahead, our business will face many of the same external challenges that it did during 2005. Nevertheless, we remain in a good position to take advantage of the platform that we have created, thus being able to deliver ongoing value for our shareholders. Thanks for your attention. |