2003 interim results presentation
3 September 2003
Nigel Northridge and Mark Rolfe
Slide 1 |
(Gallaher) (Nigel Northridge) Good morning - and thank you for joining us to discuss Gallaher's 2003 interim results. I've been reliably informed that the entire sound system will go down if you don't turn your mobile phones off as opposed to just silent, so could I just ask you to .. thanks. OK. These results once again demonstrate our ability to build a successful business across eurasia, creating enhanced shareholder value. A combination of volume and profit growth, share improvements where we target them, and a determination to take out costs where they don't add value, will ensure we continue to fulfil our's, and our shareholders' aspirations. I'm particularly pleased to see growth in total international EBITA of just under 12%. Mark will now take you through the financials. (Mark Rolfe) Thank you Nigel, and good morning everyone. |
Slide 2 |
In summary, we grew cigarette volumes, gross and net turnover, EBITA and profit before tax and amortisation - resulting in a 5.4% growth in adjusted earnings per share. Our divisional financial performance has been affected by foreign exchange translation effects this year - positively in respect of the stronger euro, and negatively due to the weak dollar. These divisional effects, however, are partly offset by Group hedging activity, so that, overall, our adjusted EPS growth largely reflects underlying performance. The comparative results for the first half of last year have been restated, following the adoption of the new accounting policies reflected in our 2002 full year results. These included the implementation of the new retirement benefit standard, FRS 17 - which has reduced 2002's first half EBITA by £3mn, and interest expense by £4mn. In addition, we have re-classified certain sales incentives, which impacts turnover and margins but not reported profits. |
Slide 3 |
In May, following an extensive review, we announced the restructuring of our European operations. We intend to cease manufacturing in Dublin, and to reduce jobs in Austria and the UK - in total, affecting around 430 operational jobs. In these half-year results we have included an exceptional charge of £38mn, primarily relating to estimated redundancy payments, and accelerated depreciation of operational plant and machinery. About another £12mn will be charged over the next 18 months. Benefits will build over time, and once the project has completed, by the end of 2005, we expect annualised savings of at least £15mn. |
Slide 4 |
The reduction in UK turnover arose from a volume sales decline of 8.2%, continued downtrading within the UK market - albeit at a moderated rate compared to previous years - partly offset by price increases. The volume decline reflected: - the impact of the personal limits change announced by the UK government, in October 2002, the main cause of a reduction in the UK market of around 5%; and, - the phasing of trade sales at the end of 2002, ahead of new health warnings on packs. In line with our increase in UK cigarette market share, underlying UK volume sales - excluding the phasing effect at the end of last year - were down around 3.5%. The impact on adjusted EBITA of the lower volumes has been largely offset by price increases, and lower costs - largely volume-related - thereby benefiting margin. All-in-all, and ironing out changes in market share, phasing of trade sales, and marketing expenditure, we believe full year results in the UK will be in line with our original expectations. |
Slide 5 |
The results of our continental Europe division demonstrate the continuing success of our acquisition - and integration - of Austria Tabak. This division has delivered strong underlying growth, and has benefited from the translation of euro earnings into sterling - more than offsetting the negative impact on margins from exports outside the euro-zone, and the losses arising from new activities. |
Slide 6 |
In the second half of last year, we consolidated all our exports to Africa and the Middle East - AMELA - within our rest of world division. Also last year, we ceased contract manufacturing in Sweden following the closure of the Malmö factory. So, although reported volume sales were down, CED's underlying volume growth in the first half was up nearly 6% - despite the total market declines in some of our European markets. Adjusted EBITA was up nearly 13% to £90mn - with the very strong performances in our southern European markets, and net exchange benefits, more than offsetting the costs of our investment into Gustavus, and our joint venture with RJ Reynolds, RGI. The initial start up costs in Poland in the second half are expected to be offset by continued trading benefits elsewhere in Europe. |
Slide 7 |
Our distribution operations also benefited from the strong euro, which - along with the improvement to EBITA margin, underpinned by efficiency improvements - led to a 23% increase in EBITA, to £33mn. |
Slide 8 |
CIS turnover - despite the impact of the substantially weaker dollar - increased by almost 9%, and net turnover grew by 1%. This reflects our growing presence in the higher-price sector in Russia, and an 11% increase in CIS volume sales. A decline in Russian volumes - due to the phasing of trade sales ahead of January's duty increase, and the extended factory holiday - was more than offset by strong volume growth in Kazakhstan, and Ukraine. EBITA decreased to £14mn due to: - incremental marketing investment in Russia; and, - a wide industry absorption of the duty increase in January - compounded by the inflation-adjusted strength of the rouble in relation to the dollar. The second half of this year will be a more comparable period to 2002's second half - as the incremental Russian marketing investment commenced in July last year. I therefore expect our full year CIS profits to reflect the region's traditional six monthly trading split, of roughly one-third / two-thirds. |
Slide 9 |
Reported cigarette volumes in our rest of world operations grew sharply. After adjusting 2002's volume figures to include all the Group's sales to AMELA - pro-forma volume growth was 10%. This strong volume performance - along with the impact of the strong euro in translating our Irish results into sterling - drove the sharp increases in turnover and adjusted EBITA. In Ireland, manufacturer price increases, and tight control of our operating costs, more than compensated for lower volumes in the reduced Irish market. And, strong volume sales growth in Asia Pacific and AMELA more than offset the impact of negative exchange rate movements on margins - with invoiced sales being denominated in the weak US dollar, but much of the cost base in the euro. |
Slide 10 |
The Group's net interest charge was £64mn - including an FRS 17 net financing credit of £3mn. We have benefited in the first half from lower rates - averaging 5.5% - and positive cash flow, but these gains were offset by the translation of euro interest payable into the sterling equivalent. Adjusted EBITA interest cover was within our target range, at 4.6 times. Net debt increased by £89mn since the year-end - to £2.58bn - wholly as a result of the stronger euro, which added £101mn to the period-end figure. |
Slide 11 |
The tax charge of £57mn represents an increase in the effective rate to 35.3%. This largely reflects the higher level of non-deductible goodwill amortisation - arising mainly due to the strengthening euro - and also the low effective rate of tax credit applicable to the exceptional charge. Removal of these two effects gives an adjusted effective tax rate of 26.7%, roughly in line with last year's first half. I expect the full year rate to be broadly at that level. |
Slide 12 |
After deducting minority interests of £3mn, adjusted earning per share increased by 5.4%, reflecting the growth in underlying earnings. We have declared an interim dividend of 9.45p per share - an increase of 7.4% over 2002. |
Slide 13 |
Turning now to cash flows. Excluding joint ventures and associates - and adjusting for the exceptional charge - EBITDA grew 8%, to £343mn. After working capital fluctuations, the cash conversion rate is 82%. The increase in working capital is primarily due to a temporary higher level of duty-paid stocks in the UK - reflecting the timing of our 1st July price increase - offset by higher tobacco duty creditors in various overseas markets. |
Slide 14 |
Total cash flow. In the first six months of the year, we re-paid a net £12mn of debt, after net capital investment of £63mn. We continue to invest in kiosks and gantries in the UK, and vending equipment in continental Europe, as well as further investing in our manufacturing facilities, including in the CIS. This programme of investment will continue for the full year, and I expect our level of capex in 2003 to total around £150mn, which includes our investment in Poland following the acquisition. Lower corporation tax payments are due to favourable timing differences, principally relating to our Austrian business. Looking forward, I continue to target net cash flow of around £100mn this year, before payments relating to our exceptional charge and M and A activity. And I would expect to see this £100mn figure growing in subsequent years. |
Slide 15 |
And finally, I'd like to discuss our manufacturing achievements. We have a long record of being at the forefront of European efficiency - and for consistently reviewing our operations so as to seek additional improvements. Our most recent review - which I mentioned earlier - further demonstrates this ongoing focus. |
Slide 16 |
In the first half, before any benefits from this review, Group cigarette productivity increased by over 4% - reflecting improvements across our divisions. This enhanced productivity, and increased efficiency, underpinned a 4.2% real reduction in cigarette unit costs. Productivity at our UK cigarette factory increased 10.7%, driven by greater usage of latest technology. These gains drove the 5.3% reduction in real unit costs. The efficiency of our continental European factories continued to progress due to ongoing organisational and technical improvements, including those arising from the transfer of Swedish volumes to Austria last year. Productivity increased 3.6%, underpinning a real reduction of 4.8% in unit costs. In the CIS, our factories substantially increased total first half output to meet the growing demand for our brands. Productivity increased 3.4% as a result of the investments that we have made, and the increased proportion of production accounted for by filter cigarettes. However, this improvement in productivity was more than offset by the change in sales mix - contributing to a 1.8% rise in real unit costs. Our ability to meet the growing demand in the CIS for our products has been enhanced during the first half by the installation of new machinery, including primary processing equipment in Ukraine, and additional cigarette production lines in Kazakhstan. And now back to Nigel. (Nigel Northridge) Thanks Mark. |
Slide 17 |
Gallaher has had a productive first half. We've made solid progress with our strategy to create value for our investors through the development of a balanced portfolio of interests across Europe and Asia - delivering organic growth, developing our bolt-on acquisitions, and progressing our strategic relationships. |
Slide 18 |
This year, we have achieved excellent organic growth in significant markets across southern Europe, the CIS and AMELA - founded on our leading cash generative market positions in the UK, Austria, Sweden and Ireland. Group volumes were up 5.2%. |
Slide 19 |
In the UK, we continue to increase our share of the growing value cigarette sector and of the handrolling tobacco market, and to maintain our leading positions in the high-margin premium cigarette and cigar sectors - seeking to balance volumes and margins. |
Slide 20 |
This long-standing strategy has underpinned our international expansion. In the first half of this year, we increased share in cigarette, cigar, handrolling and pipe tobacco. As Mark detailed earlier, our underlying UK volumes were down around 3.5% in the first half, reflecting our growth in year-on-year market share. That share improvement resulted from our absolute growth in the value segment, and the continued slow-down in the rate of downtrading from premium. |
Slide 21 |
Primarily as a result of the less severe duty increases in recent years, the premium sector's rate of decline has moderated from the levels seen in the late 1990s. And, of course, having lost many of the more price-sensitive smokers, we are now reaching a core base of more loyal consumers. For Gallaher, the Benson & Hedges franchise has proved very resilient, with Silver now running at over 1% market share. |
Slide 22 |
During the run-up to the advertising ban on February the 14th, we took the opportunity to reinforce the equity of our UK brands - most notably Benson & Hedges, Silk Cut and Hamlet - through investment in a final round of advertising. We also continued our ongoing programme of investment in the promotion of Gallaher's brands to smokers at the point of sale. We're well-positioned at the point of sale in the UK. In the first half, the majority of consumer cigarette purchases made through merchandising units were made through Gallaher units - an important advantage in a market where communication with smokers is now largely restricted to the point of sale. And we have strengthened our sales force through additional recruitment, and the introduction of automated information systems. We are well-positioned to compete in the post-ad ban market. |
Slide 23 |
Our primary houses, Benson & Hedges - which maintained its leading share of the premium sector - and Mayfair, both performed well this year. We grew Mayfair's volumes by over 20%, thereby increasing its share of the total market to over 10%. That strong performance drove Gallaher's growth in the value sector, where we now have a 33% share of sales. |
Slide 24 |
In the UK cigar market, original Hamlet grew its lead of the large whiff sector, and Hamlet Miniatures increased its share of the growing, albeit lower-margin, small whiff sector to over 32%. We maintained our position in the handrolling tobacco market - assisted by the continued success of Amber Leaf, which increased its market share to 15.8%, offsetting the ongoing decline of Old Holborn. And, we increased our lead of the pipe tobacco market - growing share to over 50% - due to gains from Clan and Mellow Virginia. |
Slide 25 |
In continental Europe, we aim to maintain our leading positions in Austria and Sweden - balancing volumes and margins to maximise profitability - while growing share elsewhere. |
Slide 26 |
Gallaher traded robustly in continental Europe, despite tough conditions in several large markets. Our total volumes, of 22 billion cigarettes, represent an underlying increase of 5.7% on the comparable period last year. The key achievement of the period was the strong volume growth - of 26% - in our key target markets, which was underpinned by Austria and Sweden. I am particularly pleased with this performance, bearing in mind the significant total market declines we have seen in some countries this year - for example, France and Germany. |
Slide 27 |
We maintained our lead of the Austrian cigarette market with a 46.2% share of sales. Our key growth brand Memphis Blue grew market share to 6.1% - up from 5.5% - and, since the start of the year, we have stabilised Memphis Classic. We began a programme of marketing support for our leading mature Austrian brand Memphis Classic this year. The brand has been promoted to smokers using posters, press ads, point of sale material, and limited edition packs - and to retailers in the trade press. This campaign is underpinning the popularity of Classic, and the brand's market share has now steadied at around 13%. |
Slide 28 |
We maintained our leading cigarette market position in Sweden with a 39.7% share of sales. Our growth brand Level increased volumes by over 40%, and it continued to gain market share - averaging 7.4% in the first half, up from 5% last year. We are now rolling Level out to neighbouring Scandinavian markets. |
Slide 29 |
Gustavus has made solid progress. We increased national distribution coverage during the first half, to reach around 60% by June. This helped to drive a significant increase in volume sales. By the end of the first half, Gustavus had established a 1.3% market share. And, we are about to strengthen Gustavus' appeal by being the first to market with a new pack, which incorporates an integrated pouch for used snuff. |
Slide 30 |
Elsewhere in the EU, Gallaher's trading performance was robust. In Germany, we performed well - increasing our share of the resilient generic sector, while maintaining our branded cigarette market share. And in Greece, Gallaher broadly maintained cigarette market share at over 5%, and we increased our share of the handrolling tobacco market to more than 38%, due to growing demand for Old Holborn. |
Slide 31 |
Sales of the virginia blended Benson & Hedges metal range underpinned the Group's success in western Europe. Strong volume growth from RGI drove Gallaher's market outperformances in France, Italy and Spain. The growth of Benson & Hedges American Blend and Reynolds led to an increase in Gallaher's sales of American blended cigarettes - of over 30% in France, and more than eightfold in Italy. In Spain, sales of Red and Reynolds drove a fourfold increase in American blend volumes. |
Slide 32 |
We have continued to develop our operations in central and eastern Europe - growing volumes by over 3% - and laying foundations for further growth by opening an office in Belgrade. And we began trading in Poland in July, following the successful completion of the acquisition of KT Merkury. Our acquired brands hold a current market share of 1.7%. We intend to build on the base provided by those brands by launching selected international cigarettes from our portfolio - utilising our proven ability to develop strong positions in emerging markets. Last month, we began that process - we launched LD in selected cities. |
Slide 33 |
Our distribution businesses performed well in the first half. In Austria, the improvements that we made to TOBA's warehouses and information systems in 2002, underpinned enhanced margins, which more than offset the impact of lower first half cigarette market volumes. And in Germany, ATG continued to make good progress. The company gained share of both the total and vending markets - assisted by the acquisition of new vending sites, the continued introduction of enhanced technology machines, and advantageous vending pack pricing relative to retail. |
Slide 34 |
Our strategy in the CIS is to grow regional market share, while increasing the proportion of the brands that we sell in the intermediate- and higher-priced sectors, across the region. |
Slide 35 |
Gallaher continued to trade strongly in the CIS. We increased regional scale, grew market share in Russia, Kazakhstan and Ukraine, and increased total volumes by over 11% to more than 36 billion cigarettes. Much more significantly, we increased our filter, hard box, volumes by nearly 24%. |
Slide 36 |
In Russia, we grew our share of the total market to average 14.5% during the first half. And by June, our market share had reached over 15%. Within our sales mix, we continued to increase the proportion of our brands sold in the intermediate- and higher-price sectors. In the first half, sales in these sectors accounted for 92% of Gallaher's Russian volumes, up from 76% last year. By continuing to improve our sales mix, since December we have grown our average rouble price per pack by over 7% - at the same time as growing our market share. |
Slide 37 |
We are achieving this success through building brand equity in Russia. We are increasing our share of the growing premium sub-sector, averaging 2.2% in the first half, up from 0.3% last year. This growth resulted from improved distribution, and the marketing investment we have placed behind our brands - establishing, for example, Sobranie as a premium international cigarette. Volumes sales of the Sobranie house grew by 9.8% in the first half, and the house has been strengthened by the launch of a new aspirational brand - White Russian. |
Slide 38 |
We grew market share to nearly 28% in Kazakhstan. Strong demand for our brands - including Sovereign, LD, Novost, and Sobranie - drove a volume increase of over 50%. Sovereign extended its market-leading position, growing first half share to 14.4%, and LD increased market share to 6.4%. |
Slide 39 |
We grew our share of the Ukrainian market to over 11%. Volume sales increased sharply as brands including LD, St George and Troika gained market share. The Group's main brand in this market, LD, increased share to 3.5%. |
Slide 40 |
In our rest of world division, we seek opportunities for growth in Asia Pacific, Africa and the Middle East, and aim to maintain our leading position in the high-margin Republic of Ireland market - again balancing volumes and margins. In the first half of 2003, we grew rest of world volumes to 5.3 billion cigarettes, representing a pro-forma volume increase of over 10%. |
Slide 41 |
Gallaher's performance in Ireland has remained resilient. We have maintained our lead of the cigarette market, albeit with a reduced market share, and of the cigar market. Trading conditions in this market have, however, been challenging, with market volumes down some 8%, impacted by the substantial increase in excise tax that took place last December. |
Slide 42 |
Gallaher grew first half pro-forma volumes in Africa and the Middle East by 24% to over three billion cigarettes - with strong growth in Africa more than offsetting a fall in Middle East volumes due to disruption associated with the conflict in the region. In Africa, we maintained our leading cigarette market position in Guinea, and grew volumes in certain other markets, including Nigeria. |
Slide 43 |
We have made good progress in Asia Pacific - growing regional sales volumes by 5.6% - and building consumer awareness for Sobranie Classic. Since last year's signing of a letter of intent with the CNTC, excellent progress has been made by the Gallaher and Shanghai Tobacco project team towards reciprocal manufacturing, and distribution, agreements in China and Russia. Following the signing of a heads of agreement in March this year, we have now successfully concluded negotiations on license agreements for each market. These are currently awaiting formal approval from the STMA, which is expected shortly. The brands to be licensed by each party have been agreed, and initial production is expected to commence in 2004. |
Slide 44 |
To conclude: Gallaher's strategy is delivering. Our achievements have transformed the Group into a leading eurasian tobacco company - enabling us to evolve as tobacco markets change, and to continue to create value. Our ability to establish relatively small positions in target markets - sustaining local overheads - means that we are in a strong position to accelerate growth in those markets when the opportunities arise. This year's good organic growth in significant markets across southern Europe, the CIS, and further afield, strengthen our platform for the future - as always, grounded on that leading cash generative position in the UK, Austria, Sweden and Ireland. Thanks for your attention. |