2001 interim results presentation
5 September 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 interim results for 2001. Today we are able to report an extremely strong start to what will be a transforming year for Gallaher. The strength of our UK presence has enabled us to make substantial progress with our international strategy. We are reporting a record increase in our organic international EBITA of over 20%. I am extremely pleased with the progress of Russia's leading tobacco manufacturer, Liggett-Ducat, which fully met our expectations in the first half. 2001 will see the first full year of ownership of L-D, and we are in the process of completing our acquisition of Austria Tabak - with its leading positions in Austria and Sweden - which will substantially strengthen our platform for growth going forward. As we develop these exciting growth opportunities around the world, we are also making solid progress in our traditional domestic markets. Mark will describe them in detail, but I would underline the importance of the strength of our position in the highly cash-generative UK market - it facilitates our overseas expansion. Before I discuss our operating performance so far this year in more detail - and update you on our ongoing offer for AT - Mark will take you through the results. |
Slide 3 |
(Mark Rolfe) Thank you Nigel, and good morning everyone. In summary - and as you can see detailed on this slide - in the first six months of this year, we have grown net turnover, EBITA, operating profit, and profit before and after tax. |
Slide 4 |
A record organic international performance - and the contribution from Liggett-Ducat - means that our overseas businesses contributed 42% of net turnover, and some 30% of EBITA, to the Group results this year - up from 27%, and 22% respectively. Before including the contribution from L-D - which operates at significantly lower margins than the Group level - our underlying Group EBITA margin increased from 42.9% to 46.5% this year. |
Slide 5 |
This international performance was underpinned by the solid results from the UK. Reflecting the underlying operating environment in this market - declining volumes, albeit at slightly lower rates than in the recent past - UK turnover declined. We continue, however, to successfully manage the balance between volume declines, the price sector mix of sales, price increases and cost savings, maintaining our UK profitability in the first half. As you all know, our full year figures will reflect the introduction of regulations regarding the pre-payment of duty ahead of a duty increase. In 2000, and in previous years, UK operating profit benefited from forestalling - additional profits earned on the sale of stock, after the government's budget, upon which UK duty had been paid at the old rate. The March 2001 budget was the first budget to see the impact of the government's regulations restricting the level of duty pre-payment. However, as I have stated previously, a reduction in interest costs associated with the financing of the duty pre-payment will largely offset the resulting decrease in UK operating profits for the year, such that the net effect on UK pre-tax profits is not expected to be significant. And, of course, subject to the timings of price increases, our UK operating profits will now be split roughly 50/50. |
Slide 6 |
We increased our total international EBITA by over 46%, with a record organic performance enhanced by the first-time contribution from Liggett-Ducat. |
Slide 7 |
Our 2001 organic international cigarette volumes, of 8.5 billion cigarettes, matched 2000 on a like-for-like basis, as the good volume growth in certain of our key markets - largely reflecting the benefits of our long-standing investment in our brands - offset reductions in the travel sector and in emerging markets. We increased margins, through price increases and cost efficiencies, across our core international business - most notably in Ireland and Kazakhstan - and, reflecting this volume performance and the improved margins, we lifted organic international profits by more than 20%. Of course, while opportunities to do so are available to us, we plan to continue investing across our international operations - perhaps at a slightly higher level than in the first half - so as to ensure we are in even stronger positions going forward. |
Slide 8 |
With the sale of 24.9 billion sticks in the first six months of this year, Liggett-Ducat has contributed: - £90mn to net turnover; - £11.5mn pounds to EBITA; and, - £6.5mn to operating profit. This financial performance is fully in line with our expectations, with the EBITA in the first six months of 2001 almost four times that recorded for the full year ended December 2000. This growth is a consequence of L-D's successful strategy to move its mix of sales up the margin ladder, building on our investment in a national distribution network, and in the factory - set against, what is currently, a relatively stable macro economic and political environment. |
Slide 9 |
Net interest expense in the period was £38.9mn, down £2.3mn from the comparable period last year. The overall net reduction in interest cost is a result of a general lowering of UK interest rates, and the absence of the need to finance UK duty pre-payments following the introduction of the forestalling restrictions. These benefits were largely offset by the cost of increased borrowings to finance the share buyback programme undertaken in 2000, and the acquisition of, and subsequent investment in, L-D. |
Slide 10 |
The tax charge for the period has fallen to £49.2mn from £50mn in 2000 - giving rise to an effective tax rate of 28.5%, down from 32.3%. The lower effective rate is largely a consequence of the acquisition of Liggett-Ducat - and the tax holiday in Russia this year - plus the presence of low-taxed earnings in Kazakhstan. In addition, the UK government's decision to permit limited on-shore mixing of dividends has removed the need to provide for UK taxes on dividends receivable from Gallaher Dublin. These benefits partly offset the increase to our effective rate that arises because of the higher level of non-deductible goodwill amortisation related to the acquisition of Liggett-Ducat. Looking forward, our effective tax rate will rise with the significant increase in non-deductible amortisation charges that will occur when we own Austria Tabak. We have, however, structured this acquisition in a tax efficient way. Although certain changes to the routes available to us - which were announced by the UK inland revenue at the end of July - will have some impact, we are now assuming a worst case effective tax rate of around 34% in 2002 - equating to around 29% on profit before tax and amortisation. |
Slide 11 |
The 29% growth in our fully adjusted earnings per share reflects the strong growth in profit after tax I referred to earlier - of some 18% - and the benefits of the share repurchase programme last year. The growth in basic EPS is impacted by the increased amount of goodwill amortisation charged to the profit and loss account. We have declared an interim dividend of 8.15p per ordinary share, an increase of 6.5% on last year. |
Slide 12 |
Turning to cash flows. This time last year I explained how changes in timing of the UK government's increases in duty distorted period-on-period operating cash flows. This year, we have seen a pattern of duty and price changes consistent in timing with last year. However, following the introduction of the restrictions on forestalling, we have not seen the level of stock build that we saw last year, and the reduced stock levels in the period reflect our move towards much lower stock holding levels of finished goods. The increased investment in debtors in the period is primarily attributable to the growth in our international operations. The cash inflow from higher creditors reflects higher duty liabilities at the period end - a consequence of carrying less duty-paid stock on our balance sheet. |
Slide 13 |
We generated £168mn of free cash flow in the period - increasing cash balances by £13mn, and repaying £155mn of debt during the first half. This was after having increased capital expenditure by £33mn - to £50mn. |
Slide 14 |
Gallaher's commitment to invest in our business - to improve efficiencies and quality, while maintaining the flexibility to support our sales and marketing requirements - has resulted in an increased level of cap-ex this year. We are installing SAP information systems in the UK, and introducing an ERP system in Ireland, and across our operations we are investing in a wide-range of new machinery to enhance our performance. This programme of investment will continue for the full year, and I expect our level of cap-ex in 2001 to total around £100mn. |
Slide 15 |
Reflecting the success of our history of investment - and the benefits of ongoing leaf and packaging initiatives - UK cigarette unit costs continue to reduce. Despite the impact of the change in production schedules resulting from no longer holding high stock levels ahead of a UK budget - to enable duty pre-payment - we cut cigarette unit costs by some 3% in real terms this year. |
Slide 16 |
Our tobacco factory has coped admirably with significant production scheduling disruptions this year. Rapid changes in the handrolling tobacco market - with our 25% increase in UK volumes this year - and the disruptive effect of the installation and commissioning of new machinery, to meet the growing demand for some of our products, caused our tobacco unit costs to rise in the first half. Looking forward, however, I believe that the long history of unit cost reductions will resume soon, as the benefit of the recent investment starts to feed through. |
Slide 17 |
We installed a second high-speed cigar-wrapping machine complex in the first half - and will install a third such machine by the end of this year. In addition, we have completed two key environmental improvements in the cigar factory - which will also lead to energy efficiency savings. All told, we achieved a 1.8% cigar unit cost reduction in real terms in the period. |
Slide 18 |
I'd now like to turn to Austria Tabak, and the implications of the financing of this acquisition. In June, we announced our intention to purchase the Austrian Republic's stake in Austria Tabak - at a price of €85 per share - and that we would make a subsequent offer for the outstanding shares in issue. During August, we acquired just under 1% of AT in the open market, and on the 23rd we completed the purchase of the 41% shareholding. Last Thursday, we launched the offer for the remaining shares, at €85 per share. This price per share values the entire issued share capital of AT at €1.9bn - around £1.2bn - and, on completion, we will also assume AT's indebtedness, which stood at €283mn at 30th June. As initial finance for this acquisition, Gallaher raised new bank facilities amounting to €1.7bn, and we replaced our existing syndicated bank debt with a new £900mn facility. |
Slide 19 |
The placing of 35.7 million shares shortly after the announcement refinanced £150mn of the initial facilities. It is our intention to refinance more of this bank debt in the short- to medium-term - and, to this end, subject to market conditions, we are launching a benchmark euro-denominated bond issue this month, following an investor roadshow starting next week. Standard & Poor's and Moody's have confirmed our credit ratings at investment grade - but, looking into the immediate future we intend to increase interest cover such that we can improve our ratings, with an objective of obtaining mid-triple B equivalent ratings from both rating agencies. We are targeting to achieve an EBITA cover of five times within a reasonable timeframe. And now I'd like to hand you back to Nigel. |
Slide 20 |
(Nigel Northridge) Thank you Mark. That detailed presentation of the figures provides you with a clear picture of the way in which these record results have been achieved. The expansion of sales and operating margins in our organic international markets demonstrates how we can exploit the potential of the positions we have built. In addition, Liggett-Ducat has fully lived up to our expectations and the development of the Russian market gives us exciting opportunities in the short- and medium-term. But it is the strength of our position in our traditional UK and Irish markets which has allowed Gallaher to achieve this transformation. I will begin my review of operations by describing what has been happening in the UK. I am pleased to say that the operating environment in the UK - although still challenging - has, as we anticipated, improved slightly this year. Since mid-98, we have commissioned pack swap surveys from OmniMAS and we have been able to follow the trend in smokers' sources of purchase. I say trend advisedly - we have been aware that this survey has consistently under-called the true level of non-UK duty-paid purchases. The level of these purchases normally rises during the summer months, and I'm sure this year will probably prove no exception. However, largely reflecting the success of customs' activities - particularly on the level of purchases sourced from outside Europe - the total level of non-UK duty-paid flattened out in the first half. All told, non-UK duty-paid cigarettes are still probably accounting for around 30% of consumption - but I feel that this level has reached its peak. I believe that the success of customs' operations has led directly to the slowing down in the rate of decline of the UK duty-paid market - to around 7%. I should also like to take this opportunity to record how pleased I am, that the government seems to have begun to recognise that its level of duty increases has a direct bearing on the situation. The increase in March, which was broadly in line with inflation, did widen the price differentials further - but it was a step in the right direction, after years of well-above inflation increases. |
Slide 21 |
The level of direct downtrading from the premium sector to the low-price sector probably also benefited from the changed policy on duty increases. However, I believe that some of this year's growth in share of the low-price sector - to over 48% of UK consumer sales - is related to the transfer of purchases back into the UK from other sources. The low-price sector's total volumes declined some 2% in the first half, while we maintained our volumes - thereby increasing our share of the sector to 31.1%, from 30.5% in the comparable period last year - this strong performance led by Mayfair and Dorchester. And, with Benson & Hedges' pre-eminent position, we maintained our commanding lead of the premium sector, with over half the volume sales in this high-margin segment of the market - and, of course, Silk Cut continues to lead the low tar sector. |
Slide 22 |
As I've often said, however, it is not the shares of these sectors in of themselves which drives our strong UK performance - it is our successful balance of volumes, managing the price sector mix of our sales, and price increases which underpins our UK operations. Having secured an across the board MPI in early March, we have announced a second price increase this month. Despite the impact of downtrading and a declining market, our average net take per cigarette unit continues to increase - which, together with our record of cost efficiencies, largely offsets the effect of the challenges we face. |
Slide 23 |
Hamlet continues to spearhead our commanding leadership of the cigar market. And, Hamlet Miniatures improved its number one position in the small whiff sector, with volume growth of over 15%. |
Slide 24 |
The UK handrolling tobacco market has also benefited from external factors this year - we have increased our UK volumes by some 25%. The Amber Leaf piece pack continues to drive the brand forward - and, although, as Mark explained, its strong growth has impacted on our unit costs, we increased the brand's total volumes by over 45% this year. |
Slide 25 |
Internationally, the continued strong volume growth in our key overseas markets offset the declines in the travel sector, and the reduction in sales in our new emerging markets division. Across Europe, we gained further momentum this year - lifting sales to domestic smokers, increasing market share, and strengthening our foundations for the future. We are in a strong position to capitalise on these foundations with Austria Tabak - but I shall return to this later. |
Slide 26 |
In Ireland - a market with no low-price sector - we extended our cigarette market lead, and Benson & Hedges achieved the number one slot. We continue to extend our portfolio in this market, and are well-positioned for when the severe marketing restrictions that are proposed are implemented. With minimal marketing - and the inability to compete on price - it will be the strength of the brand equity we have created that will underpin our future in this market. |
Slide 27 |
In our northern Europe division, the major operation - France - continued to outperform the market. Spearheaded by B & H American's growth in in-market sales of some 22%, we grew share again. In the second half, we are introducing new pack designs and sizes for the brand, which should assist American's market position further. In Germany - where the level of invoiced sales is not directly comparable to last year, as Reemtsma built up stock at the start of the distribution agreement in January 2000 - our in-market sales performance has been affected by the market dynamics. I'm pleased, however, that Bensons' has maintained its share of consumer sales. And, albeit from small bases, we have grown in-market sales of cigarettes and handrolling tobacco in Austria and Switzerland this year. |
Slide 28 |
In Greece, again, we outperformed the market. Silk Cut, and B & H, led our increase in cigarette market share, while Old Holborn's continuing strong performance resulted in an increased handrolling tobacco market share too. Last year, we set up an office in Rome, and established a network of sales agents. The results from this initial investment are now coming through - we were the fastest-growing tobacco company in Italy this year, lifting in-market sales by 38% - and we shall continue developing opportunities in this market. |
Slide 29 |
We also opened an office in Madrid last year, and trebled the sales force - and, again, we are seeing positive results from this investment. We increased in-market sales in Spain by some 19%. This growth was led by B & H Virginia, but - as you know - we launched B & H Red in January. Although it's early days yet, we are very pleased with the level of brand awareness we have achieved following the launch campaign - over 40% prompted recognition - and we have achieved our target levels of distribution in the primary channel. We are now focusing attention on gaining distribution through the all-important secondary channel - Horecas - which is the main point of purchase for the brand's target smokers. Sales in the Canary Islands are down, reflecting the timing of price increases and the impact of trade customers' stock piling in 2000 - clearly, we anticipate a recovery in the second half. Again, from small bases, in-market sales in Portugal and Gibraltar were buoyant - up 24%. |
Slide 30 |
Overall, our volumes in the travel sector were down 21%, with the significant decline in volume in the BeLux region, partly offset by volume increases in duty free and on the RMOs. I believe that this overall decline mainly demonstrates the recent success of customs' initiatives - and, the impact of foot-and-mouth on cross-channel travel. |
Slide 31 |
Volume sales were also down in our new emerging markets division, as we changed the emphasis of sales. Last year, we initiated sales to a wide variety of markets, through a range of distributors - adopting the first two parts of our sell a little/earn a little/spend a little strategy we so successfully adopted to the CIS in the early '90s. Now, we are determining which specific markets we want to focus on, and, as such, those which warrant the third element of our trading strategy - spend a little. Dorchester International has begun to develop a solid brand position in certain markets in Africa and the Middle East - in particular, Nigeria, Mozambique and Syria. Looking forward, we are now examining the opportunities available to us to develop the brand further - building equity for the future. |
Slide 32 |
Total in-market sales grew some 55% in Asia Pacific. This strong performance was spearheaded by Sobranie Classic in Taiwan - which we launched last December - and the benefits from new duty free listings across the region. We are seeing the benefits of our increased co-operation with Shanghai Tobacco - Sobranie sales in the Shanghai region were up some 15% on last year. During the second half of this year, we will be launching Sobranie in new Asian markets - spreading its base beyond the current three - and we are planning further expansion in duty free. |
Slide 33 |
Now I would like to look at our exciting new growth opportunities - Kazakhstan, Russia, Austria and Sweden - and I will start with our operation in Kazakhstan. When we acquired L-D, we thought that there was an opportunity to leverage some of Liggett's skills into Kazakhstan - so we moved Stewart's deputy, Richard Johnson, from Moscow to Almaty. We had already decided that we needed to enlarge Gallaher's brand portfolio in this market - and had begun the process. With his extensive experience of the Russian market - and with access to the Liggett brands, in particular, LD - our new general director in Kazakhstan has brought a fresh perspective to the operation. In the first six months of this year, we showed volume growth of 135% - selling almost as many cigarettes in Kazakhstan as in the whole of last year. We ended the period with our brand portfolio encompassing value - that is, State Line - through to premium, with Sobranie. With the increased focus on sales, merchandising and distribution, our strength in Almaty itself is beginning to spread throughout the country. Once the primary line is up and running, I believe that this operation should move from strength to strength. |
Slide 34 |
The results from Russia in the first six months fully confirmed our expectations - as Mark has already highlighted, we have achieved an EBITA for the first half which is almost three times the full year figure for 2000. This strong performance demonstrates the success of our strategy in Russia - affordable quality, available everywhere. While maintaining our bedrock with Prima, we have grown our higher-margin volumes again - intermediate and higher-price unit sales accounted for some 54% of our total volumes in the period, up from 31% in 2000. |
Slide 35 |
However, we still have good room for growth within the current market environment. The intermediate and higher-priced sectors now account for over 60% of the market - up from 51% last year. We continue to grow our shares of these sectors, but from small bases - there is definitely the potential to grow share further, once the increased production capacity is fully commissioned. |
Slide 36 |
The result of this successful move up the margin ladder, is a further increase in the average pricing per pack. L-D has also successfully begun exploiting export opportunities to surrounding markets - in particular, to Belarus and the Ukraine. Having developed a solid demand for our products through importation, we are now considering moving on-shore in the Ukraine. We have entered into discussions with Reemtsma, with a view to acquiring their factory in Cherkassy. Clearly, if the due diligence proves successful - and only if the projected returns beat our project-specific WACC - we shall proceed. But, until then, we shall continue with the current export strategy. |
Slide 37 |
And now, Austria Tabak. Having now acquired the OIAG stake, we have been able to begin the integration process. Eight Gallaher representatives - including Peter Wilson, Mark and I - were elected to the supervisory board on completion of our purchase of the 41% holding, and at this board's first meeting, we appointed Nigel Simon to the management board with effect from the 1st November. We also appointed Rudi Wagner - previously a general manager within Austria Tabak - to the management board, to succeed Jorg Schram as finance director. Fortunately, however, we shall not be losing the benefit of Jorg's experience, as he will be joining us on the supervisory board in October. And another senior Gallaher manager - our VP for northern Europe - Pascal Biehler, who is here today, will be moving to Vienna. Nigel is, of course, already liaising closely with Heinz Schiendl, to develop the integration plan. Clearly, we have already identified the key issues we must address. In the short-term, we want to ensure that we maximise the immediate benefits from this acquisition - and, as such, cross-functional teams addressing areas like purchasing have already been established. Austria Tabak itself is very focused on looking forward - as you already know, last month AT announced the closure of its Malmo factory, by the end of 2002, as part of its ongoing commitment to continue improving manufacturing efficiencies. Of greater importance going forward, however, is the need to ensure that the integration process results in the optimal structure being put in place to reap the medium- to long-term rewards. I look forward to sharing this structure with you all - once it has been finalised, and shared throughout the Company. |
Slide 38 |
When I began today's presentation, I referred to 2001 as a transforming year for Gallaher. The transformation is demonstrated, most accurately, by the way in which we have been able to use the strength of our traditional markets to open up opportunities in areas of the world with substantial growth potential. Our organic international operations delivered a 20% profit increase, and Liggett-Ducat's strong performance was a further substantial boost to our overseas growth. When we acquired L-D - and announced Austria Tabak - I said our footprint was getting larger. I am pleased to be able, today, to demonstrate that we are making bigger strides in growing Gallaher's sales and profits as a result. I am confident that we can continue the transformation process. And, we are well on our way to completing the acquisition of AT. This acquisition will considerably strengthen our platform for growth - with the benefits of scale Austria Tabak brings underpinning our moves into central and eastern Europe. With L-D looking east, and our axis in Vienna, the enlarged Group is well poised to take advantage of the substantial opportunities that are out there. We all remain very excited about Gallaher's future. Thanks for your attention. |