2002 interim results presentation
4 September 2002
Nigel Northridge and Mark Rolfe
Slide 1 |
(Gallaher) |
Slide 2 |
(Nigel Northridge) Good morning everybody. |
Slide 3 |
Thank you for joining us to discuss Gallaher's 2002 interim results. Organic international growth continues - enhanced by the new divisional structure we have put in place. Our acquisitions have fully met our expectations - and are delivering integration benefits to the Group. We have taken the opportunity of the more predictable UK market to increase investment behind our big brands - while we can. And, we have cemented relationships in Europe and Asia - ventures which will expand our eurasian vision. |
Slide 4 |
In short, this strong start to 2002 confirms that the foundations we have laid over recent years place us in a position to deliver slightly accelerated growth going forward, against our previous expectations. However, before I discuss our operating performance - and our strategic moves - in more detail, Mark will take you through the results. |
Slide 5 |
(Mark Rolfe) Thank you Nigel and good morning everyone. |
Slide 6 |
Organic growth, and our acquisitions - which not only met their stand-alone expectations, but are already delivering integration benefits - drove our results for the first six months of this year. In summary, we grew net turnover, EBITA, and profit before tax and amortisation - resulting in a 16% growth in adjusted earnings per share. |
Slide 7 |
Our strong international growth continues to be underpinned by solid results from the UK. Reflecting the continuing success of customs' activities - and the slow-down in the rate of duty increases - the UK duty-paid market has remained roughly stable compared to last year, which, in turn, has contributed towards a slight increase in net turnover. Over recent years, we have shifted our sales and marketing expenditure towards those avenues that we believe will remain open to us in the future - in particular, expanding and developing our sales force, and rolling out our state-of-the-art merchandising units. This year, we have increased the support behind our key brands - principally Benson & Hedges, Mayfair and Hamlet. Currently, we are assuming that we will not be able to advertise from next year. This increased investment has resulted in a 4% decline in EBITA - in line with our expectations. - and we will continue this programme of incremental investment behind our brands during the second half. Underpinned by the - now - broadly steady UK duty-paid market, we expect our medium- and long-term performance to be largely stable. |
Slide 8 |
Following strong organic growth, and the first-time contribution from Austria Tabak, our international operations comprised 85% of the Group's volume sales, and 49% of EBITA. At the start of this year, we restructured our international businesses into distinct divisions - so designed to reap the full benefits of our recent acquisitions by ensuring two-way learning, and revenue and efficiency savings at a regional level. |
Slide 9 |
Our continental European businesses are managed from Austria, and our CIS operations from Russia. Accordingly, we have re-cut our international segmental analysis to reflect this operational restructuring - as shown here. If you require more detail later, you will find an appendix in the back of your slide book giving 2001's results under the new segmentation - and, also, the performances of the stand-alone Austria Tabak and Liggett-Ducat operations in the first half of this year. Looking forward, however, we shall focus on reporting these regional divisions. |
Slide 10 |
In continental Europe, the first time inclusion of Austria Tabak greatly assisted the sharp increases in net turnover and EBITA - while the inclusion of Austria Tabak's lower-margin distribution businesses reduced the EBITA margin. |
Slide 11 |
In total, AT contributed £72mn to EBITA - £47mn to tobacco, and £25mn to distribution. The AT tobacco results were underpinned by: - robust first half volumes in Austria; - volume increases and operational savings in Sweden; and, - a strong performance in AT's export business. Overall AT tobacco delivered a 17.5% increase in volume over last year's pro-forma. Stripping out Austria Tabak's operations, Gallaher's European tobacco businesses have already benefited from their integration into a single continental European division. Volume and margin improvements grew EBITA by 9% - to £33mn - and EBITA margin to 43.7%. Overall the distribution businesses are performing in line with expectations. Tobaccoland in Austria is continuing to expand its product offering, while also benefiting from the strong first half volume sales in Austria. ATG, our 64% owned German vending business, has stabilised its operations in 2002 - operational improvements, together with cost-cutting exercises, have meant profitability is in line with expectations. And Lekkerland-Tobaccoland, the 25% owned German wholesale distribution business, benefited from strong volume led performance. You will note the particularly low EBITA margin of 2.5% on the distribution businesses. While TOBA is responsible for paying excise duty in Austria - and this amount is therefore stripped out to calculate net turnover - elsewhere tobacco products are purchased duty-paid, and therefore the EBITA margin is low. Looking at the rest of this year, our overall expectations remain in line with our previous views - with the initial losses at Gustavus in the second-half offsetting the accelerated growth elsewhere in continental Europe. In the medium- and long-term, however, we expect that the revenue and efficiency synergies - and the benefits from the joint venture with R.J. Reynolds - will lead to accelerated growth in this region. |
Slide 12 |
With volumes up by 25%, CIS net turnover grew by 29% and EBITA by 34%. These results largely reflect the ongoing strong performance of Liggett-Ducat in Russia. Continuing sales mix improvements, and volume growth, saw L-D grow net turnover by 17%, EBITA by 55% to £18mn, and EBITA margin up to 16.9%. In Ukraine, following the acquisition of an on-shore manufacturing facility at the end of last year, we began domestic production of LD, City and Ovals during the first half. Start up costs - and the current trading losses of this operation - offset the volume and margin growth in Kazakhstan which is benefiting greatly from its integration into the CIS region, through: - the in-market growth of LD; and, - an acceleration of the growth in Sovereign arising from the implementation of Liggett-Ducat-style sales and promotion techniques; plus, - the installation of a primary processing capability in 2002. Currently, we are also incurring initial start-up costs associated with the Sampoerna joint venture in Russia, which commenced in June 2002. Overall the CIS has seen EBITA margins grow to 14.4%, through improved sales mix and operational efficiencies - although underlying margin improvement is masked by the first-time loss making contribution from the Ukraine. Looking forward, we intend to significantly increase our investment behind premium brands in Russia, as the accelerating market trend towards the higher-price sector provides longer-term growth opportunities. However, the benefits to the expected performance elsewhere in the region - arising from the integration of Kazakhstan, and the expansion into Ukraine - will largely offset the incremental marketing investment in Russia over the next two-to-three years. In the long-term, therefore, we are confident that this division will deliver accelerated growth for the Group. |
Slide 13 |
Although volumes in our rest of world operations grew by 3.5%, and net turnover increased marginally, EBITA declined to £19mn. The Irish market declined slightly in the first-half - although with our stable volumes, we increased market share. As such, with an increase in operating expenses offsetting price increases, overall profitability was in line with last year. In Asia Pacific, we increased marketing and sales support for Sobranie Classic and we are incurring start-up losses in our joint venture in Malaysia. Results in Africa and the Middle East were negatively impacted by two factors. As announced in March, we ceased trading with a principal distributor in these markets towards the end of last year. To-date, there have been no adjustments to the provisions made in respect of this distributor. In Nigeria, increases in import tariffs at the start of this year impacted the margins on volume sales to this market. Looking forward, we have negotiated a contract with a new business partner for these markets - which went live in May 2002 - and we are integrating all of our African, Middle East and contract manufacturing businesses into a single operation to improve overall performance. |
Slide 14 |
I'd now like to turn to the performance of our manufacturing division. We achieved productivity improvements across the Group - reflecting the benefits of our increased investment and our growing volumes. In the UK, our cigarette factory's improvement in productivity was more than offset at the unit cost level by increases in tobacco and NTM costs. Some of these raw material cost increases relate to short-term issues - 2001's rise in tobacco leaf costs, which feeds through to unit costs over a 12 to 15 month period, and the immediate impact of changes to packaging requirements from EU regulations. However, there is also an impact to NTM costs from the volume growth in our higher-margin Sobranie Classic in Asia - with its significantly more expensive packaging. |
Slide 15 |
Stripping out the impact of the major reorganisation required as a result of the closure of Malmö, underlying productivity in Austria was up 5%. In addition to the straight transfers of cigarette volume from Sweden to Austria, we have begun to take advantage of the improved manufacturing flexibility we now have - moving Benson & Hedges American Blend, and B & H Red from Lisnafillan to Linz, and the handrolling tobacco volumes from Malmö to the UK. In the CIS, our Moscow factory's outstanding performance reflects the benefits of our investment programme, and the continuing strong shift in sales mix from the more labour intensive Prima sector to hard-box filter cigarettes. In Kazakhstan, productivity in the short-term is being affected by the significant reorganisation we are undertaking at the factory to meet the growing demand for our brands. From a standing start, the month-on-month improvements in productivity in Ukraine have resulted in the factory already operating at high efficiency levels by June. Finally, productivity in the Republic of Ireland increased 7%, with further investment in higher-speed making and packing equipment underway. |
Slide 16 |
Net debt has increased to £2.5bn, from £1.2bn at June 2001. This increase largely reflects the acquisition of Austria Tabak but also increased investment across the Group. It has resulted in net interest expense in the period of £68mn. We have benefited in the first half from the favourable phasing of cash flows and lower cost of debt. Lower rates, and increased exposure to cheaper euro-based debt, has helped reduce our weighted average cost of debt to 5.8%. Interest cover - after adjusting for goodwill amortisation charges - for the first half was 4.3 times, and is progressing towards our target of between four-and-a-half and five-and-a-half times. I anticipate our 2002 second-half interest charge to be marginally ahead of the first-half - but over the medium-term, we are expecting to see a slight acceleration in the reduction of debt outstanding, and to maintain an average overall borrowings rate of around 6%. |
Slide 17 |
The tax charge for the period has increased to £59mn - giving rise to an effective tax rate of 31.7%, up from 28.5% last year. This increase in the effective rate is attributable to the higher level of non-deductible amortisation charges arising on the acquisition of Austria Tabak. Stripping out these charges, our PBTA effective rate of 26.5% is marginally down on last year. The acquisition of Austria Tabak has exposed Gallaher to higher underlying tax rates on local earnings, although the effect of this has been mitigated by tax efficient acquisition structures, and the ability to mix dividends with our low-taxed earnings in Ireland. Looking forward, I expect our effective rate - after adjusting for amortisation charges - to continue to benefit from these factors, and in the short- to medium-term our rate should remain around 26.5%. Finally, I am pleased to announce that in May this year the inland revenue confirmed that the interest paid in respect of the debt we assumed on our demerger, in 1997, will be deductible for tax purposes - in line with the treatment that we have been adopting to date. |
Slide 18 |
The 16% growth in adjusted earnings per share reflects a 23% increase in adjusted earnings, after charging £1.9mn this year for minority interests. This growth has been partly offset by a 6% increase in the weighted average number of shares in issue, following the placement of 35.7 million shares to part finance the AT acquisition. In addition to these factors, basic EPS has been impacted by amortisation charges of £37mn - up from £9mn in 2001. We have declared an interim dividend of 8.8p per ordinary share, an increase of 8% on last year. |
Slide 19 |
Turning to cash flows. Excluding JVs and associates, EBITDA has grown by 33%. After adjusting for working capital fluctuations, the cash conversion rate is 88%. The marginal increase in working capital in the first six months of this year is largely attributable to higher finished goods in continental Europe and Russia, partly offset by an increase in tax creditors. Last year, the higher cash conversion rate reflected a reduction in inventory levels, and higher-duty creditors, following the introduction of regulations that restricted the level of duty pre-payment ahead of the UK budget in March 2001. |
Slide 20 |
In the first six months of this year, there was a net cash inflow of £27mn, after net capital investment of £47mn - but prior to repayment of £68mn of debt. In the UK we have completed the first phase of our SAP implementation project, which successfully went live in June. We have also continued to invest in our portfolio of kiosks and gantries and in our production sites - increasing our longer-length cigarette capacity, and fully commissioning additional UHS machines. In continental Europe we continue to upgrade vending equipment to comply with youth protection legislation - and to improve the rates of return from machines - as well as further investing in our manufacturing facilities. In the CIS we have invested in all three production locations - to satisfy the growing demand for our products - and in our distribution network, to control and grow our distribution coverage. This programme of investment will continue for the full year, and I still expect our level of cap-ex in 2002 to total around £135mn. |
Slide 21 |
In respect of future earnings. We expect the UK to remain broadly stable. International growth - as a result of the successful reorganisation of our overseas operations - we now believe will be at a slightly accelerated rate than our previous expectations. Our increased marketing investment in Russia over the next couple of years will be largely funded through the enhanced performances elsewhere in the CIS. In Europe, we now expect underlying EBITA growth from next year to be in the high single digits - which, taken with the benefits from current investments in our rest of world operations, will more than offset the remaining impact of the incremental Russian investment. As such, from 2003 onward, we expect our total EBITA to be slightly ahead of our previous expectations. As we expect to see a slight acceleration in the reduction of debt outstanding - with the improved cash flow position - and to maintain an average overall average borrowings rate of around 6%, we now expect our ongoing interest charge to be slightly less than our previous expectations. Therefore, together with an ongoing PBTA tax rate around 26.5%, we expect our earnings per share to slightly exceed previous expectations. And now back to Nigel. |
Slide 22 |
(Nigel Northridge) Thanks Mark. |
Slide 23 |
Gallaher has delivered robust growth in the first six months of 2002. The strong growth in our cigarette volumes has been led by sales of our core international strategic brands - Benson & Hedges, Silk Cut, Memphis, LD, Sovereign and Sobranie. Sales of our regional brands - including, Mayfair, Ronson, Novost and Troika - have also grown, while we continue to benefit from the strong foundations that local and oval brands provide in our key markets. Gallaher's eurasian expansion is underpinned by our strong UK market position. |
Slide 24 |
The UK duty-paid market has remained stable compared to last year - reflecting customs' activities, and the slow-down in the rate of tobacco duty increases. Downtrading from the premium sector into low-price cigarettes continued this year - albeit at a reduced rate than in previous years. However, the mid-price sector - which is primarily longer-length cigarettes - has been affected by the recent development of a longer-length segment in the low-price sector. |
Slide 25 |
Two of our brands - Benson & Hedges and Mayfair - feature in the top three in the UK, and Silk Cut continues to lead the low tar sector. Our balanced portfolio of brands places us in pole position to continue strengthening our relationships with our trade customers. We grew volume sales in the low-price sector by 8% in the first half - led by strong performances from Mayfair, Dorchester and Sterling - and we continue to lead the high-margin premium sector. |
Slide 26 |
Powerful brands and innovative products have helped our strong performances in the UK cigar, handrolling tobacco and pipe tobacco markets. Hamlet continues to underpin the Group's leading share of the UK cigar market - and Hamlet Miniatures grew share again. Amber Leaf achieved a volume uplift of 15%, supporting our growth in total handrolling tobacco volumes of 6%. The Group's share of the pipe tobacco market grew to 49.6% - driven by a strong performance from Condor. |
Slide 27 |
The additional investment that we are putting behind our core brands in the UK will strengthen the Group's position going forward. Benson & Hedges and Mayfair King Size have recently benefited from well-targeted press and poster campaigns, while Hamlet has been supported by award-winning press and radio advertising. |
Slide 28 |
The launch of Mayfair Superkings in June gives Gallaher an enhanced presence in the increasingly important longer-length segment of the low-price sector. The launch has been supported by adverts in the press, and a poster campaign, and Mayfair Superkings has already achieved high levels of distribution in both the multiple and independent retail sectors. |
Slide 29 |
And - in addition to our brand support - we have further strengthened our position at point-of-sale. The roll out of our new state-of-the-art kiosk units, and category management assistance, is helping to further develop our partnerships in the multiple grocer channel. 56% of consumer cigarette purchases made through merchandising units are now made through Gallaher units - up from 47% last year. |
Slide 30 |
We have made great progress in our continental European division this year. The benefits of the integration of Austria Tabak are already evident - pro-forma cigarette volume sales grew by 12%, to 23.1 billion sticks. I am particularly pleased with the growth in Group export sales to central and eastern Europe - we more than doubled volumes to 2.5 billion cigarettes. |
Slide 31 |
Group volumes in Austria grew by 1%, to 3.9 billion sticks. Our core brands in Austria have performed well. Memphis volumes increased 4%, while volumes of B & H grew by 6%. As expected, these increases were partly offset by a decline in the Group's tail-end Austrian brands. |
Slide 32 |
In Sweden, we strengthened our cigarette market-leading position. Volumes grew some 7%, taking our market share to 41.8%. This impressive performance was led by the growth of Level. Although only launched last year - Level achieved a 5% share of consumer sales in the first half of 2002. |
Slide 33 |
Our acquisition of Gustavus - a manufacturer of both loose and portioned moist snuff - further strengthens our market position in Sweden, and brings new expertise to the Group. The Swedish snuff market has enjoyed robust growth in recent years, and now accounts for approximately 25% of total tobacco sales to consumers. |
Slide 34 |
The Gustavus brand was initially launched in December 2001, and is the first new participant in the Swedish snuff market for some time. Distribution is currently being rolled-out across the country, and our factory at Vårgårda may be extended in the autumn to handle potential demand. |
Slide 35 |
In France, our cigarette volumes remained broadly stable - while we entered the cigar market for the first time. Utilising the rapid-response, short-runs, capacity at our Austrian cigar factory in Fürstenfeld, we developed Terranos - specifically with continental European cigar smokers in mind. Since its launch in May, the brand has already beaten its initial distribution targets. In Germany, Benson & Hedges, Silk Cut and Nil led pro-forma branded cigarette volume growth of 18% - while our leading position in the generic sector was also strengthened by a 16% volume increase. |
Slide 36 |
We outperformed the market in Greece, increasing our cigarette market share to 5.2% - and lifting Old Holborn's volumes by 49%. In Spain, the growth of Benson & Hedges led the increase in sales volumes of 14% - while in Italy, cigarette volumes grew by 86%. |
Slide 37 |
Group volumes to central and eastern Europe increased over 130%, led by the success of Memphis and Ronson in the Balkans - while B & H Silver was successfully introduced into four EU accession states. |
Slide 38 |
Our European distribution businesses have performed in-line with expectations this year. We continue to identify and implement efficiency savings at TOBA in Austria, at our German vending business ATG, and at Lekkerland-Tobaccoland in Germany. We have also identified some innovative opportunities to improve trading - such as extending the range of non-tobacco offerings through TOBA, and the possible use of change giving machines by ATG. |
Slide 39 |
Our European operations are well-placed to deliver further growth. We are developing our business across the continent of Europe - building domestic brands for indigenous smokers. We are particularly excited about our American blend partnership with R.J. Reynolds - initially in France, Spain, the Canary Islands and Italy. We are both licensing brands to the joint venture company - as such, creating a complementary brand portfolio. The JV's strengthened resources will benefit Bensons' American Blend and Red, and Reynolds - with its innovative packaging - will enhance our opportunities in these markets. |
Slide 40 |
We grew CIS volumes by 25% to 32.6 billion sticks. In Russia, our performance was in line with our acquisition targets - while Kazakhstan delivered another outstanding performance, and Ukraine more than doubled in-market sales. |
Slide 41 |
We grew our share of Russian consumer sales to 13.1%, and we continue to improve our sales mix - around 75% of our volume sales came from the intermediate- and higher-priced sectors, compared to just over 60% in the first half of last year. |
Slide 42 |
In the intermediate sector we increased our share to 18.1%, capitalising on our sales and distribution strength. We have also increased marketing support behind our brands in this sector - all four major tobacco companies are now investing relatively similar amounts supporting intermediate-priced brands. LD's strong market position - in the value segment - was supported by the sharp growth of Novost, Troika and Saint George in the base filter segment. In fact, we now lead the base filter segment, with a 14.7% share - up from 12.1% this time last year. |
Slide 43 |
The higher-price sector continues to grow its share of the market - up to 22.1%, from 18% last year. In the mid-price portion of this sector, Sovereign performed well - achieving volume sales in the first six months of this year which were ahead of last year in total. And, in premium, Sobranie Classic was successful launched in four large cities - exceeding initial distribution targets before the end of June. Currently, however, our major competitors invest significantly more than us in this sector. |
Slide 44 |
The Russian market is evolving swiftly. Having declined sharply after the events in 1998, the premium segment is growing in importance - it accounted for 7.6% of consumer sales in the first-half of this year. To date, our success in Russia has been distribution led - driven by our expanding distribution base, currently being extended to over 50 owned warehouses. To maximise the long-term potential in this market, we intend to develop a position in the premium sector - where currently we hold less than 0.5% market share. We have been trialling certain brands - including Sobranie Classic - this year, and the results of our market research are encouraging. As such, we will now move into the next phase - to create image-led consumer off-take. |
Slide 45 |
We have already increased our share of voice in the first half of this year - to 8%, from 5% last year - but, to maximise the long-term growth opportunities in Russia, we need to invest behind our brands in the short- and medium-term. |
Slide 46 |
Our market share in Kazakhstan doubled, to reach over 18%. This performance was underpinned by the growth of Sovereign - which is now the country's leading brand. We introduced LD in Kazakhstan last year, and achieved a 3.5% market share in the first six months of 2002 - while premium-priced Sobranie Classic, which was only launched earlier this year, is approaching 1%. In Ukraine, we also more than doubled our market share, to 6%. This growth has been led by a strong performance from LD. |
Slide 47 |
Gallaher's growth in Russia, Kazakhstan and Ukraine during the first-half of 2002 has fully demonstrated the benefits of integrating our CIS operations into a single division. We are confident that the Group will achieve impressive growth in the region going forward. While incremental marketing investment will be required to support the growth of higher-priced brands in Russia - this will be largely offset by the accelerated growth in Kazakhstan and Ukraine. |
Slide 48 |
In the Republic of Ireland, our strong performance continued - our cigarette market share grew to 50.7%, with stable volumes - while Benson & Hedges extended its number one position. |
Slide 49 |
Volume sales to Africa and the Middle East increased by 3% to 718 million sticks - despite an increase in Nigerian import tariffs which impacted margins. Going forward, we are integrating the Group's African, Middle Eastern and contract manufacturing businesses into a new division, which should improve overall performance. |
Slide 50 |
We continue to grow in Asia Pacific. Total volume sales increased by 8%, led by another strong performance from Sobranie Classic - which achieved a sales uplift of over 50%. Gallaher's performance was particularly strong in Korea, where Sobranie Classic was launched in 2001, and across duty free markets - that's the region's shop window in effect - where volumes grew by 35%. |
Slide 51 |
Our joint venture with Sampoerna gives Sobranie Classic a presence in the predominantly Virginia blend, premium, Malaysian market - and represents the first on-shore manufacturing of a Gallaher brand in the Asia Pacific region. |
Slide 52 |
Today we have announced the formation of a joint project team with the CNTC, which will lead to a Gallaher brand - yet to be finalised - being manufactured in China. We have been in discussions with the CNTC for over two years now - perhaps you may recall that we first cemented our relationship when we began distributing Chungwha for Shanghai Tobacco in the UK last year. All our discussions have been based on the principles of equality and mutual benefits. Having signed a formal letter of intent, we have now formed the joint project team to finalise the firm details for dual contract manufacturing and distribution agreements in Russia and China. Both companies expect that these agreements will be in place within the next 12 months. Although these agreements in of themselves will not transform our volume prospects, they are a very exciting step in Gallaher's eurasian progress. |
Slide 53 |
In summary, there are four key points I want to highlight. Firstly - we continue to demonstrate organic volume and EBITA gains across our international business, and have created an organisational structure which will accelerate that momentum. Secondly - the acquisitions of Liggett-Ducat and Austria Tabak are performing in line with expectations. As a result of the market dynamics, we now see opportunities to increase marketing investment in Russia, and to deliver on the revenue synergies across the CIS region. Thirdly - we have taken the opportunity of the more predictable UK market to increase investment behind our big brands while we can. And, lastly - our relationships with H.M. Sampoerna, R.J. Reynolds, and now the CNTC, coupled with our successfully integrated core business, will expand our eurasian vision. Thanks for your attention. |