2004 interim results presentation
8 September 2004
Nigel Northridge and Mark Rolfe
Slide 1 |
(Gallaher) (Nigel Northridge) Good morning - as just demonstrated by Nigel Simon ... thank you for joining us, but could you please turn your mobile phones off. Claire's told me that if you put them on silent it's still liable to cause the entire sound system to come down. So please if you don't mind checking ..... |
Slide 2 |
I am pleased with our performance in the first six months. Despite facing extremely tough conditions in some parts of Europe we grew earnings and paid down debt, demonstrating the strength of Gallaher's strategy, and the platform for growth it has created. We maintained our lead positions in our core markets in western Europe which, in turn, fuelled our ability to invest in developing markets. We grew total Group volumes 7.6%, and we increased our market share, in the UK, in a number of European markets, and right across the CIS. We grew by acquisition, and subsequent share gains, in Poland and we launched Memphis in China. We also enhanced our operational efficiency and we drove down costs. Group cigarette manufacturing productivity improved 12.5% and unit costs reduced 6.7%. Mark will now take you through the financials. (Mark Rolfe) Thank you Nigel, and good morning everyone. |
Slide 3 |
We improved all key financial performance indicators, culminating in a 4.4% growth in adjusted earnings per share. Our performance was negatively impacted by the effects of foreign exchange translation. Continental Europe, and the Republic of Ireland in the rest of world division, have been impacted by the marginally weaker euro, and the CIS by the more significant weakening of the US dollar. These effects, however, are partly offset by Group hedging activity, particularly in respect of the euro. We are making good progress with the restructuring of our European operations. |
Slide 4 |
The increase in UK turnover was driven by a volume sales growth of 3%, and price increases, which more than offset moderate downtrading within the UK market. Underlying UK volumes were broadly level. However, the increase in actual volumes reflects a weak comparator period last year, due to the effect of trade sales phasing, ahead of new health warnings on packs in December 2002. The impact on EBITA of the higher reported volumes has been further improved through lower operating costs, following the operational restructuring begun last year, and lower marketing expenditure, as in 2003 we invested incrementally ahead of the ban on advertising. |
Slide 5 |
The increases in continental Europe turnover and costs are driven mainly through the acquisition of Lekkerland Europa by our associate Lekkerland-Tobaccoland in January 2004, and our acquisition of KT Merkury - our Polish operation - in July last year. Gross turnover after stripping out the impact of these acquisitions decreased by 1%, while net turnover decreased by 4%. The reported results of this division have suffered through the translation of euro and Swedish krona earnings into sterling. |
Slide 6 |
Reported cigarette volume sales were up 10%. Underlying volume growth in the first half, after excluding volumes from the Polish acquisition, was 2%. This growth reflected the strength of our German generic business, as well as our joint venture with Reynolds American and growth in the Balkans region. This development in growth areas helped to offset the total market declines in some of our other European markets, notably France, Sweden, Austria and the German branded market. The growth in tobacco net turnover and total costs mainly reflects the first time inclusion of Polish sales, and a change in the accounting treatment of Italian market sales. This change has resulted in: - a £9mn increase in both net turnover and costs; - no impact on EBITA; and, - a slight dilution of tobacco EBITA margin. EBITA was down 4% to £86mn - mainly reflecting the start-up losses in Poland, and currency effects, as well as volume and margin pressures. |
Slide 7 |
Our distribution operations gained through the contribution from Lekkerland Europa. This helped offset the impact of the weaker euro - and led to a 2% increase in EBITA, to £34mn. |
Slide 8 |
The reported results of the CIS division have been impacted by the substantially weaker US dollar. Volumes grew nearly 10%, and the mix of sales improved, despite excise duty increases in Russia and Ukraine, and manufacturer price increases. These factors more than offset the effects of foreign currency on gross turnover, which increased by 4.5%, but only partly offset the currency impact on net turnover, which reduced by over 2%. EBITA increased to £15mn, with an improved EBITA margin due to: - manufacturer price increases; - improved production cost efficiency; and, - continued growth of higher-priced brands in Russia and Kazakhstan. |
Slide 9 |
Our rest of world EBITA increased 9.5% to £27mn. This is despite the impact of the weaker euro in translating our Irish results into sterling, and the weaker US dollar impacting reported turnover and margins in the AMELA business. In Ireland, manufacturer price increases, and favourable changes to the cost structure as a result of the factory closure in 2003, more than compensated for lower volumes in the reduced Irish market. We have also been able to mitigate the effects of reduced volumes in the AMELA region through tight control of the cost base. |
Slide 10 |
The Group's net interest charge was £60mn - including an FRS 17 net financing credit of £3mn. In the first half we achieved strong positive cash flow - while average cost of debt has remained stable at 5.5%. In addition, we have gained through the weakening of the euro, when translating euro interest payable into sterling. |
Slide 11 |
The tax charge of £64mn represents a reduction in the effective rate to 32%. This largely reflects the low effective rate of tax credit applicable to the higher exceptional charge in 2003, and the flat level of non-deductible goodwill amortisation. The adjusted effective tax rate of 26.9%, which removes these effects, is roughly in-line with last year's first half. I expect the full year rate to be broadly at this level. |
Slide 12 |
After deducting minority interests of £2mn, adjusted earnings per share increased by 4.4%. We have declared an interim dividend of 10p per share - an increase of 5.8% over 2003. |
Slide 13 |
Turning now to cash flows. Excluding joint ventures and associates - and adjusting for the exceptional charge - EBITDA was £338mn. After working capital fluctuations, the cash conversion rate is 129%. The net working capital reduction in 2004 was mainly the result of higher excise tax creditors in Ireland and the UK, partly offset by higher UK duty-paid finished goods following our manufacturer's price increase in June. A number of these factors are largely seasonal and are expected to reverse in the second half of 2004. However, we have also seen benefits from our ongoing focus on working capital management, which we aim to build on for the full year. |
Slide 14 |
Total cash flow. In the first six months of the year, we re-paid a net £174mn of debt, after net capital investment of £58mn. We continued to invest in our manufacturing facilities throughout the Group, as well as kiosks and gantries in the UK, and vending equipment in continental Europe. Lower interest payments are due to the lower charge, and favourable timing differences. Net debt has decreased by £252mn since the year-end - to £2.2bn - as a result of strong cash flows of £174mn, and a translation benefit of £78mn from the weaker euro. Before exceptional items, and taking into the account the seasonal fluctuations, we are targeting second half cash flow to be broadly neutral. |
Slide 15 |
And finally, I'd like to talk about our manufacturing achievements. Our factories delivered an excellent performance - boosted by benefits from our European restructuring. We increased overall cigarette manufacturing productivity 12.5%. This increased productivity, and a reduction in leaf and NTM costs, reduced unit costs 6.7% in real terms - again demonstrating the quality of our manufacturing assets and people. In the second half we will begin standardising pack specifications across the Group as part of our restructuring process. We expect this to impact productivity in the short-term, but lead to greater benefits in the longer-term. |
Slide 16 |
Productivity at our Lisnafillan cigarette factory - which mainly serves our UK and rest of world divisions - increased nearly 28%. This was mostly due to benefits arising from the restructuring programme, including job reductions, and higher volumes at the factory. We cut real-term unit costs at Lisnafillan 14%. This reflected both the increased productivity and lower tobacco and NTM costs. Cigarette productivity at our continental European factories in Austria increased some 17% - assisted by the restructuring and higher volumes. We reduced real-term cigarette unit costs in Austria 9.6% due to the increased productivity and lower leaf and NTM costs. In the CIS, we grew cigarette productivity 6.6%, driving a real-term reduction in unit costs of some 3%. The investments that we have made in our CIS factories in recent years enabled us to both increase production, and meet the growing demand for our intermediate and higher-priced products across the region. And now back to Nigel. (Nigel Northridge) Thanks Mark. |
Slide 17 |
We have made good progress with our strategy to create value through the development of a balanced portfolio of markets, in Europe and Asia. Despite extremely tough trading conditions in some key markets, we grew Group volumes 7.6% to over 79 billion cigarettes. This strong performance was largely due to share gains in our developing markets in Europe and the CIS. It demonstrates Gallaher's success in generating organic growth - even in tough times. |
Slide 18 |
The duty-paid market in the UK has been comparatively stable and we have performed well. Total volumes only declined by 1.5%, and downtrading from premium and mid-price cigarettes into value continued - albeit at the more moderate rate we have seen over the last couple of years. |
Slide 19 |
Building on last year's gains, we grew our total market share to 38.7%, and retained our commanding lead of the premium sector. Once again, we improved our position in the growing value sector, achieving a 35% share. As would be expected - with slightly lower market volumes and slightly higher market share - Gallaher's underlying UK volumes were broadly flat. |
Slide 20 |
I'm very pleased with the performance of our key cigarette brand houses. We've increased Benson & Hedges' house market share to 9.5%, and grown Mayfair's share to 11.3%. These share gains demonstrate that brand equity is still important in the post-ad ban situation. We've focused on communicating with smokers at the point-of-sale over the last few years, and - as you can see from our next generation gantry outside - we are continuing to make advances. |
Slide 21 |
Total cigar market volumes declined over 8%, and downtrading from medium to small cigars continued. Nevertheless, Gallaher performed well and we maintained our lead of the cigar market with a share of 46.7%. Conditions in the handrolling tobacco market were more positive and total market volumes increased. Our growth brand, Amber Leaf, continued to take share and accounted for 16.6% of the market in the first half. Finally, we maintained our lead of the small pipe tobacco market, with a share of 49%. |
Slide 22 |
Duty-paid cigarette markets within the EU experienced substantial volume declines this year, caused by disruption from increased taxation and cross-border trade. The magnitude of the volume declines that we have seen in some countries has been greater than anticipated. The Austrian market was down around 8%, the French market nearly 25%, and the German market 13.5%. |
Slide 23 |
Gallaher delivered a strong performance in continental Europe in the face of these substantial market challenges. Our mature market positions underpinned strong growth - of 12.3% - in our key target markets. The growth that we have achieved in Poland, since acquiring KT Merkury, contributed to total continental European volume growth of 10%. And, if you exclude Polish volumes, underlying continental European volumes still grew - by 2% - with gains in some of our developing market positions more than offsetting declines in mature markets. |
Slide 24 |
We maintained our leading position in the Austrian cigarette market with a share of 45.8% - representing a modest decline over the first half of last year. This solid performance was due to the strength of our core Memphis brand. We have stabilised Memphis Classic's market share and continue to grow Memphis Blue's share - thus growing the entire Memphis family. House share increased to over 27% in the first half. |
Slide 25 |
Cigarette market volumes in Sweden were down some 4%. This decline partly reflected a strong comparator period in 2003, which benefited from some additional trade buying ahead of a price increase. Our total market share in Sweden declined as expected by about 1% to 38.6%. The reduction was largely due to the ongoing decline of our mature brand Blend. However, these negative factors were more than offset by margin improvements. Our Swedish snus operations are developing well. We have gained share in the growing snus market, up to 2.4% by the middle of this year. |
Slide 26 |
Trading in Germany has been tough. Total duty-paid cigarette market volumes fell 13.5% in the first half, and branded cigarettes significantly under-performed the wider market. As expected, the private label sector benefited from downtrading, increasing its share of the total market to 17%. Given the circumstances, our performance in the German cigarette market was strong. We increased our share of the total market held through private label cigarettes to 8.5%, and maintained our small share of the branded market. In Greece, the cigarette market experienced accelerated downtrading from premium to lower-priced brands. This impacted our principal brand Silk Cut, which experienced a 7% volume decline. Independent market share data for Greece is not available at the moment, but sample data suggests that Silk Cut's niche appeal is helping it outperform other premium brands. We performed well in the handrolling tobacco market, with Old Holborn - a premium offering in Greece - achieving an 18% volume uplift. |
Slide 27 |
The steep increases in French tobacco taxation have caused a 25% decline in the duty-paid cigarette market, and eroded manufacturers' margins. Nevertheless, both our Benson & Hedges metal range, and the Benson & Hedges American Blend cigarettes marketed by RGI, both performed well. Our total French market share increased slightly to 3.2%. |
Slide 28 |
When compared with France, duty-paid cigarette market volumes in Italy and Spain were relatively stable. Our excellent performance in Italy continued with Benson & Hedges American Blend driving an increase in our total market share to 4.8%, up from 3.1% a year ago. Our performance in Spain was fairly steady, albeit our market share declined very slightly to 1.6%. |
Slide 29 |
I am really pleased with our performance in central and eastern Europe. In Poland, total cigarette market share continued to grow throughout the first half, reaching 4% by June. Our success in Poland is being driven by the introduction of a range of brands from our international portfolio, including LD, Level and Benson & Hedges. We have also made solid progress in the Balkans where we increased market share to 5.3%. We have strengthened our foundations for further growth in the region by leasing a small factory in Romania, and are currently installing machinery from Dublin. |
Slide 30 |
Our distribution businesses were impacted by the difficult market conditions in Austria and Germany. In Austria, TOBA's tobacco distribution operations were affected by the decline in total market volumes. However, we broadly offset this with increased efficiency, and our ongoing focus on the distribution of non-tobacco products. In Germany, our vending operation, ATG, was impacted by the decline in total market volumes, and downtrading from premium cigarettes to lower-priced tobacco products - particularly after the duty increase in March. In the three months following this increase, ATG's cigarette volume sales declined over 23%. This reflects a 21.6% decline in branded cigarettes, with an even greater decline in mid and premium - and the impact of the disadvantageous optical pricing now in place. Our associate Lekkerland-Tobaccoland was also impacted by the decline in the German cigarette market, but this was offset in operating terms by growth outside Germany following its acquisition of Lekkerland Europa in January. |
Slide 31 |
We made excellent progress with our strategy to maximise value in the CIS, by growing market share, and increasing the proportion of our brands sold in the intermediate- and higher-priced sectors right across the region. We raised total CIS volumes 9.6% due to gains in market share in Russia, Kazakhstan and Ukraine and some export growth to adjacent markets - notably Kyrgyzstan and Uzbekistan. |
Slide 32 |
Our markets in the CIS continued to develop, with an increased proportion of smokers choosing intermediate- and higher-priced brands. This trend was particularly pronounced in Russia where the higher-priced sector's share grew to over 29%, and, within this, the premium sub-sector share reached 10%. |
Slide 33 |
We grew share of the total cigarette market in Russia to nearly 16%. This growth was driven by the success of a variety of brands in the intermediate- and higher-priced sectors including St George, Troika, LD, and Sobranie. We also continued to enhance our sales mix in Russia, increasing share of the higher-priced sector to 3.4%, and of the intermediate-priced sector to some 24%. Within that higher-priced sector, we grew our share of premium to 3.6% for the first half. |
Slide 34 |
We grew share in Kazakhstan, averaging 34% in the period. This achievement was driven by gains from brands across the higher-, intermediate- and low-priced sectors including Sovereign, Sobranie, LD, and Klassica. Although we increased our share of all of the price sectors, what's particularly pleasing is our performance in the higher-priced sector. We grew share to nearly 60%, and within this, we grew our share of the premium sub-sector to some 30%. This excellent performance is testament to the brand-building skills of our marketeers, and Gallaher's ability to generate organic growth. |
Slide 35 |
We grew share of the Ukrainian cigarette market to 13.3% for the first half. This growth was mainly driven by gains in the intermediate-price sector from St George and Troika, and the introduction of Level into the market in the second half of last year. Our share of the intermediate-priced sector in the Ukrainian market is now approaching 18%. |
Slide 36 |
We made progress in our rest of world division with our strategy of defending our position in the higher-margin market in the Republic of Ireland, while establishing platforms elsewhere. Our total rest of world volumes declined 8.2% to 4.9 billion cigarettes. This decline was due to lower AMELA volumes - including those manufactured under contract - and a reduction in Irish market volumes. |
Slide 37 |
The total cigarette market in the Republic of Ireland declined around 7.5% in the first half. This decrease was influenced by successive above inflation duty increases, which have affected the affordability of tobacco products and impacted cross-border trade with the north. The ban on smoking in the workplace, which came into force at the end of March, has also had some incremental impact on market volumes. Monthly volumes have shown considerable fluctuations since the introduction of the ban. This has been influenced by factors including de-stocking in the vending channel, and the weather - warm rain in the summer, as opposed to cold rain in the winter. It is really too early to assess what the longer-term impact of the ban will be at this stage - but we will of course keep you informed going forward as the situation develops. We maintained our lead of the cigarette market in the Republic of Ireland with a share of 49%. |
Slide 38 |
Our AMELA volumes reduced 8.1% to 2.9 billion cigarettes - with a solid performance in our core west African markets being more than offset by a reduction in volumes elsewhere. Gallaher's AMELA operations have now been included within our developing markets' management structure - which also incorporates our CIS operations. We intend to increase focus on AMELA markets going forward to build on our success in west Africa. |
Slide 39 |
We achieved a modest increase in our Asia Pacific volumes, to 230 million cigarettes - most notably due to gains in China, where we launched Memphis in May, and we increased our proportion of the import quota with Sobranie. We hope that in the longer-term, China's entry into the World Trade Organisation may present significant growth opportunities for international companies. We are well-placed to achieve growth in China. We have good relationships with our Chinese partners, and we are working with them to develop the equity of our Sobranie and Memphis brands. |
Slide 40 |
Our first half results reflect a good performance across the business, achieved in the face of tough trading environments in many markets. I am pleased with the market share and volume gains that we have realised. We grew revenues, and made very real progress with our ongoing drive to increase efficiency and reduce operating costs. We successfully defended our leading positions in our core markets in the UK and western Europe, and these markets continue to provide the resources to invest in our expansion in developing markets. We have achieved significant market share gains in Russia, Ukraine, Kazakhstan, Italy and the Balkans. We also expanded our share in Poland following the acquisition of KT Merkury last year, and began selling Memphis in China, which, although early days, is exceeding our forecasts. Obviously, we are concerned at the volume dislocation in markets such as France, Germany and Austria. Our exposure to Austria is mitigated by growth in adjacent accession countries, but our German vending business is proving difficult in the face of significant declines in the German premium sector and optical pricing differentials. However, our organic improvements - coupled with our strong, and improving, cash flow generation - underpin my confidence for the future. Just before I finish, I would like to thank Nigel Simon for the tremendous contribution that he has made to Gallaher over the last 20 years. Nigel, who is retiring from the board at the end of this month, has been instrumental to our success - latterly as head of our continental European division. Nigel's responsibilities will be taken over by Neil England and Stewart Hainsworth. Neil - who is currently commercial director for the UK and Ireland - takes over continental Europe, apart from Scandinavia and the Baltics, which Stewart will add to his responsibilities. Stewart - who as you know, will be joining the board on 1st October - and has made an outstanding contribution to Gallaher since he joined us in 2000, when we acquired Liggett-Ducat - most recently heading up our CIS and developing markets operations. Thank you for your attention. |