2006 interim results presentation
6 September 2006
Nigel Northridge and Mark Rolfe
Slide 1 |
(Gallaher) (Nigel Northridge) Good morning. Thank you for joining us to discuss Gallaher's 2006 interim results. Before we begin, could I please ask that all mobile phones and blackberries are switched off, not just put on silent, in order to avoid interference with the sound system. Thank you. |
Slide 2 |
We continue to establish a balanced portfolio of interests across mature and emerging markets. Although we experienced, and dealt with, significant challenges in a small number of our European territories, we are reporting solid performances from our mature markets, and substantial growth from our emerging markets. We grew strategic brand volume sales by 11.2%, and we increased EBITA, excluding the impact of acquisitions, by 3.2%. Our investment markets delivered significant growth - EBITA up 21%. We increased manufacturing productivity, and reduced production unit costs. Our drive for sustainable growth, underpinned by exploiting our strategic brand portfolio, adopting a lowest cost approach and best route to market, has ensured that we have grown earnings in the first half. Mark will now take you through the financials. (Mark Rolfe) Thank you Nigel, and good morning everyone. |
Slide 3 |
We grew sales, EBITA and PBTA in 2006, delivering a 3.3% growth in adjusted earnings per share. These results reflect both the cost of continued investments in new opportunities, and returns from investments made in previous years. Excluding the small loss from CITA, and the incremental benefit from our acquisition of trademarks in Cyprus and Malta in April last year, Group EBITA was ahead by 3.2%, despite challenging conditions in some markets, and increased sales and marketing investment. |
Slide 4 |
As a result of the intense price competition that took place in Austria during the first half of the year, and the phasing of trade sales in Sweden, our combined core markets' EBITA was down 3.1%. I expect these markets to deliver an improved performance in the second half, as Austria and Sweden's results recover, although the core markets' 2006 performance is likely to be below our 1% to 2% long-term growth range target. On the other hand, our investment markets delivered growth well in excess of their long-term target of 10%, with their combined EBITA up 21%. This excellent performance was driven by the success of our CIS division, despite increased investment. I expect these markets to continue to outperform for the full year. |
Slide 5 |
We continue to make good progress with the restructuring of our European operations. We charged an additional £6mn in 2006, taking total exceptional charges to date to £97mn. With these programmes substantially complete, we expect total restructuring costs to reach around £100mn, with annualised savings of at least £30mn by the end of 2007. |
Slide 6 |
UK net sales grew by 2.8% as the impact of manufacturer price increases more than offset volume decline and continued downtrading. The contribution to EBITA from price increases was, however, slightly eroded through operating cost pressures outweighing the benefit of lower volume-related costs. |
Slide 7 |
We delivered a 3.2% increase in Europe EBITA, as a number of strong performances more than offset difficult trading conditions in some markets, and CITA's first half performance. |
Slide 8 |
Factory-made cigarette volume sales were up over 12%, driven by our acquisition of CITA in January. The increase in tobacco net sales and total costs mainly reflects the inclusion of CITA, and increased sales and marketing investment, notably in Austria, Iberia and central and eastern Europe. Strong performances in a number of markets, together with the increased returns from RGI and German singles, were largely offset by : - market conditions in Austria and Germany; - pressure on our Spanish and tourist businesses; and, - the phasing of trade sales in the Czech Republic, as a result of a change in distribution arrangements. EBITA increased 2.1% to £100mn. As a result of the challenging conditions in Spain, CITA reported a small EBITA loss, but, assisted by restructuring, it is expected to move into profit in the second half. We have revised our expectations for CITA, and now expect its original return targets to be met in 2008. Although trading conditions in the Spanish domestic market and Austria have moderated since the first half, the profit pools have not recovered to previous levels. In addition, following the tax change, we have stopped selling German singles, and, during the summer months, increased price competition is likely to exacerbate the impact of the declining, high-margin, tourist volumes - issues which will impact our second half results. As such, we continue to target 2006 Europe tobacco EBITA to be marginally ahead of 2005. |
Slide 9 |
Our distribution operations performed strongly, in spite of increasing price competition in Austria and Germany. In Austria, despite lower margins resulting from the price war, the overall market improvement through reduced cross-border activity increased TOBA's volumes and fully offset the pricing effect. And, TOBA's relative performance benefited from a weak comparative period in 2005. ATG benefited from cost reductions resulting from our restructuring in the second half of last year, which offset the impact of increased cross-border activity in Germany, and the growth of the singles market in the first half. In addition, our associate, Lekkerland delivered an increased return. These have led to an overall 7% increase in distribution EBITA, to £32mn. I do not expect this growth rate to apply to the full year, as the relative second half performance will be impacted by the stronger comparator period in 2005. |
Slide 10 |
The CIS division continues to demonstrate our successful development in the region, with excellent returns from our investments. Volumes grew by 4%, and the mix of sales improved, despite excise duty and manufacturer price increases across the region. We grew both gross and net sales sharply, reflecting the increased volumes, price increases and sales mix improvement. EBITA increased to £35mn, with another significant increase in investment behind our brands and sales forces partly offsetting the increase in net sales. This first half growth rate of over 50% is not representative of our expectations for the full year, as the disparity between first and second halves is becoming less pronounced. However, we are targeting strong full year results, and continue to aim for the CIS full year EBITA growth rate to be ahead of last year's 17%. |
Slide 11 |
Rest of world EBITA reduced to £5mn. This largely reflects : - the phasing of trade sales in Sweden; - increased sales and promotional investment; and, - reduced volumes in Poland following our decision not to reduce prices in line with other competitors. These factors more than offset the favourable effects of stronger volumes in Taiwan, Asia Pacific duty free and Guinea. We continue to target rest of world full year EBITA to be around last year's level. |
Slide 12 |
Net finance costs were down £3mn, including the benefit from a £4mn increase in IAS-related credits. The £1mn increase in borrowing costs is driven primarily through higher average interest rates, while the net debt increase of £100mn primarily reflects investment and acquisition expenditure, and phasing of working capital movements. Average net debt remained broadly neutral at £2.1bn. EBITA interest cover was 5.4 times, and our full year estimated cash flow to net debt ratios remain within our target ranges. |
Slide 13 |
The tax charge of £72mn represents an effective tax rate of 27.8%. This rate is slightly distorted by the relatively low effective rate of tax credit applicable to the exceptional charges. The half year's adjusted effective tax rate of 27.2%, which strips out the effects of exceptional charges and the amortisation of intangible assets, is slightly higher than in 2005, and reflects changes in the overall mix of Group profits. |
Slide 14 |
After deducting underlying minority interests of £2mn, adjusted earnings per share increased by 3.3%. And, we have declared an interim dividend of 11.2p per share - an increase of 5.7% over last year. |
Slide 15 |
Turning now to cash flows. Excluding joint ventures and associates, and adjusting for exceptional charges, EBITDA was £350mn. At the end of June, we had invested an additional £94mn in working capital since the end of last year. This compares with a reduction in working capital of £87mn in the first half of 2005. The usual favourable first half trend, driven by the increase in duty creditors in Germany and Ireland following shorter credit terms in December, has been more than offset through : - the relative timing of the UK manufacturer price increase; - the timing of duty increases in the Czech Republic; - greater investment in Poland and South Africa; and, - demand across the CIS. Much of this adverse movement has already reversed. The reduced taxation payments of £19mn primarily reflect differing stage payments on tax assessments, and a one-off payment in 2005, in Austria. |
Slide 16 |
Total cash flow. In the period, our £103mn of cash outflow takes into account net capital investment of £108mn. This included the purchase of CITA in January, and the disposal proceeds arising from the sale of former factory and depot sites in Austria. In 2006, I now expect gross capital investment to be around £200mn, reflecting : - investment in the business; - the £60mn pre-debt acquisition of CITA, and, - start-ups in Turkey and Singapore. Partly offsetting this is £12mn of proceeds from the disposal of surplus assets in the first half. |
Slide 17 |
Our ongoing drive to improve operational efficiency meant our factories delivered another excellent performance. Group cigarette manufacturing productivity was up 6.1%, and we achieved a real-term reduction in unit costs of 4.8%. |
Slide 18 |
Reflecting the restructuring since 2003, and improvements to working practices, Lisnafillan delivered an exceptional performance with increased productivity of 11%, and a UK real-term unit cost improvement of 6.7%. This was achieved despite lower production volumes as a result of the UK market decline, and the transfer of some UK manufacturing volume to Poland. Cigarette productivity in Austria was up 8.6%, benefiting from the restructuring programme, and improved efficiencies as a result of further investment. This contributed to a real-term cut in unit costs of 6.7%, in spite of lower manufacturing volumes in western Europe. In the CIS, we increased cigarette productivity 3.6%, assisted by improved working practices and the benefits of investment in new technology. This increase in productivity, and a strong cost focus, resulted in a real-term reduction in unit costs of 2.1%. |
Slide 19 |
In tobacco, we increased productivity by 12.1% and reduced real-term unit costs by 8.5%, assisted by : - the benefit of a new primary processing line; - increased demand for Amber Leaf; and, - improvements arising from the restructuring programme. |
Slide 20 |
Cigar productivity was maintained, in spite of the overall reduction in the UK medium cigar segment, and an increase in the Group's brand pack variants for export markets - but we still achieved a real-term unit cost reduction, of 5%. And now back to Nigel. (Nigel Northridge) Thanks Mark. |
Slide 21 |
We successfully managed conditions in our core markets, and made excellent progress elsewhere - extending our footprint through exports and on shore investments. Although total volume growth was driven by CITA, our underlying performance was slightly ahead, after adjusting for the impact of the phasing of trade sales. Critically, our strategic brand portfolio continued to perform strongly. We grew the volumes of our strategic brands by 11.2%, accounting for over 50% of total Group sales. LD sales continue to increase rapidly following its successful launch into more countries in central and eastern Europe, Africa, Asia and the Middle East, as well as further growth in the CIS. Ronson continues to go from strength to strength - the brand's volume sales were up 86% as we establish it as a key value proposition across a wide selection of markets. Higher-priced Sobranie sales are up 27%, driven by strong growth across the CIS and good performances in Asia Pacific. |
Slide 22 |
In the UK, our largest core market, our strategy to balance volumes and revenues to drive cash flow, delivered again. Although the UK market declined by around 4% to 5%, and our volumes were down 3.9%, our increased average manufacturer take per stick, even after the impact of downtrading, drove the increased EBITA. Our total market share was up slightly, at 38.6%. And, we retained our commanding lead of the premium sector, and continued to improve our share of the growing value sector. Effective portfolio management in recent years means that the Group's sales profile by price sector continues to broadly match that of the total market. |
Slide 23 |
Gallaher's value-for-money portfolio continues to perform strongly. Benson & Hedges Silver, Sterling and Mayfair continue to grow their market shares. The success of the slide pack has assisted Benson & Hedges Silver in growing its share to 2.4%, and the extended distribution into the convenience and independent channels in January has helped Sterling to increase its share to 3%. Various brand initiatives such as the introduction of Benson & Hedges Gold 14s, and new product packaging for Silk Cut, have helped reduce the rate of decline of the Group's brands in the premium sector. In fact Silk Cut grew its share of the sector to 19.6%. We maintained our lead of this high-margin sector with a share of over 45%. |
Slide 24 |
We estimate that the total UK cigar market is declining at a slower rate than previously, by around 4% to 5% versus the average decline for the last three years of over 7%. Gallaher maintained its lead of the cigar market with a share of 44.8%, through strong brand performances from the Hamlet house, in particular Hamlet Smooth, which has been the market's fastest-growing cigar brand this year. The Group showed another strong performance in the growing UK handrolling tobacco market. We increased our share to 29.1%, with Amber Leaf remaining the fastest-growing handrolling brand in the UK - it now accounts for 20% of the sales. And, we maintained our lead of the small pipe tobacco market, with a share of 49%. As you know, a public places' smoking ban was introduced in Scotland at the end of March. Monthly trade sales just before and since the implementation of the ban have shown considerable fluctuations, influenced by factors such as de-stocking in the vending channel. However, initial in-market sales data from ACNielsen indicates that the incremental impact on the Scottish cigarette market is an additional volume decline of some 3% to 4%, and that the cigar market is down by an incremental 5%. Although it is still too early to assess what the true impact of the ban will be, these initial indications are broadly similar to the experiences in other markets. |
Slide 25 |
Excluding CITA's volume sales - and despite the pressures on Memphis in Austria, and on B&H and Silk Cut tourist volumes - our strategic brand portfolio performed well, growing its share of the European division's total volume sales. The decline in the portfolio's total volumes was driven by the phasing of trade sales in the Czech Republic. Without this factor, our strategic brands' volume sales would have been up over 2%. |
Slide 26 |
Gallaher estimates that the underlying duty-paid Austrian cigarette market was broadly stable in the first half, as there appeared to be no growth in cross-border activity. We responded quickly to our competitors' price moves, by lowering the price of Smart, which grew its market share to 8% before the implementation of a minimum selling price. However, the pressure on Memphis and other higher-priced brands resulted in an estimated decline in our market share of around 3%. The Austrian government implemented the minimum selling price on the 15th of May, amounting to €3.25 per pack. Although its market share has fallen, as the value sector is no longer at such a discount to Memphis and Marlboro, Smart remains the clear leader of this new price segment - its market share has remained above 5%. More importantly going forward, since the implementation of the minimum price, the market share of Memphis has shown signs of stability. Nevertheless, this activity has led to a reduction in the Austrian profit pool, and, reflecting the adverse impact of the exacerbated downtrading, the average net take per cigarette across our portfolio did drop from last year's level. However, with a return to market stability, and our continued focus on balancing volumes and revenues to drive cash flow, I am confident that Austria's tobacco EBITA should improve in the second half. |
Slide 27 |
In the Republic of Ireland, the total cigarette market showed a small increase of around 0.5% in the first half. The Group maintained its lead of the cigarette market with a share of 49.3%, and we increased our average net take per cigarette again. Excluding distributed brands, Gallaher's share of the cigar market increased to 47.7% and our share of the handrolling market increased to 27.4%. |
Slide 28 |
Our business in Spain falls into two categories - our legacy market position in the small, high-margin, virginia segment, and, following our acquisition of CITA, our strengthened position in the domestic sector, which encompasses American blend and dark tobacco, complementing the RGI portfolio. The total market declined by 2.5%, but the small virginia segment fell by over 21%. Although we increased our share of this segment, our virginia brands' share of the total market did reduce, to 1.2%. |
Slide 29 |
However, the significant issue impacting our first half was the reduction in the profit pool caused by the intense competition in the domestic value sector, and the government's reaction. Following the introduction of a minimum tax at the end of February, prices have now broadly stabilised - and the discount between Marlboro and the value sector has narrowed. As there is now a selection of international brands competing in the value sector, our domestic brands' share of the total market did reduce, down to 4.3% in the first half. I am pleased, however, with the performance of our key domestic brand, Coronas, which increased its share of the market to 1.6%. Our CITA cigar portfolio performed well, increasing its share of the market to 11.6%, from 10.9%. And, finally in Spain, recent price competition in the virginia sector has intensified - although prices are still above Marlboro, the leading domestic brand, so there should be no further impact on market pricing in general. However, this increased competition will impact total margins in the second half, which covers the key summer months. |
Slide 30 |
In central and eastern Europe we continued to make strong progress, growing market share across new EU member states and in the Balkans. These excellent performances were mainly driven by the roll out of our strategic brand portfolio. In the EU accession markets of Hungary, the Czech Republic, Slovenia and Slovakia we grew in-market sales again. We continue to build our presence in the Romanian domestic market - now fully supplied by our small on-shore facility - and we successfully launched LD into Bosnia-Herzegovina, achieving an estimated share of 7.3%. |
Slide 31 |
Since the creation of our other-tobacco-products division three years ago, we have had great success in expanding our handrolling tobacco and cigar footprint across Europe. Old Holborn is firmly established as the number one brand in the growing Greek tobacco market - we increased its share to over 45% this year. And, in Italy, Old Holborn also grew share, up to 13%, as did Hamlet, which now has over 4%. |
Slide 32 |
TOBA had a good first half of the year, as the business benefited from higher volume sales and the ongoing focus on operational costs. In Germany, the ATG business was affected by the cigarette market decline brought about by the growth of singles, and heightened cross-border activity. However, these adverse market conditions were largely offset through the benefits of restructuring, which were more marked in the first half, as many of the measures were introduced in the second half of 2005, as well as a continued focus on operational efficiency. In 2006, we continued the trend of increased machine park efficiency. By removing lower performing machines, and focusing attention and investment where we see the returns, we have reduced our overall machine park by around a third since 2002, and, at the same time, increased the turnover per vending machine by nearly 50%. |
Slide 33 |
Now to the CIS, where we have delivered an exceptional performance. Our strategy to exploit our strategic brand portfolio, with an ongoing focus on lowest cost production and improved product mix, continues to deliver profitable volume growth. We drove share gains across the region, and improved our product mix by outperforming market trends within the intermediate- and higher-price sectors. Our total CIS volumes grew by 4% to 46 billion, in spite of excise duty and manufacturer price increases across the region - demonstrating increased consumer spending power as a result of strengthening economies. Our strategic volume sales in the region grew by around 26% - driven by excellent performances from LD, Sovereign, Sobranie and Ronson. |
Slide 34 |
In Russia, our share of the total cigarette market was 16.9%. Reflecting the Group's improvement in sales mix, our share of the intermediate-priced sector grew to 26.6%, and we increased our share of the growing premium segment to 4.8%. LD, which increased its lead of the value segment, continues to underpin our move up the margin ladder, and we strengthened our platform in mid-price through the launches of Glamour, and Sobranie Red and Blue. |
Slide 35 |
In Kazakhstan, the uptrading trend amongst consumers continues. At the same time as taking price increases across most brands, we grew our share of the total cigarette market to 37.2%. Sovereign's leading market share reached an impressive 17.6%, while premium-priced Sobranie increased its share to 4.2%, with volumes up 14.8% on last year. Together, these brands maintained our lead of the growing higher-price sector, where we account for more than 50% of sales. LD remains the number two brand in the market, despite an anticipated slight decline in market share to 9.7% as prices were raised. Exports to neighbouring countries, such as Kyrgyzstan, Mongolia and Armenia, continued to grow, with volume sales in excess of 600 million cigarettes in the first half. |
Slide 36 |
In the Ukraine, we grew our share of the total cigarette market to 16.6%. Gallaher's product mix has also improved, in particular aided by successful launches of Glamour and Sobranie Red and Blue. We grew our share of the growing higher-priced sector to 2.3%. Our share of the intermediate-priced sector reached 23.7%, driven by the success of Ronson, which was launched in May of last year, growing its total market share to 2.4%. |
Slide 37 |
Although our rest of world volumes were down over 9%, our strategic brand portfolio performed well - despite the challenging trading conditions in Poland, and the phasing of trade sales in Sweden. Ronson grew sharply, driven by good performances in Poland and Guinea, while LD increased sales across the division. We launched premium-priced Silk Cut in seven new markets - Sweden, Denmark, Norway, Estonia, Lithuania, Latvia and Poland. |
Slide 38 |
The underlying total cigarette market in Sweden declined by around 4%. Actual trade sales, however, declined sharply as a result of trade demand ahead of the January tax increase. Gallaher maintained its leading position, with the growth in Level being more than offset by the expected decline of our mature brands, Blend and Right. Although first half profitability was hit by the impact of the phasing of trade sales, we have, again, lifted the average net take per cigarette - balancing volumes and revenues to drive the long-term cash flow from this core market. Having achieved our initial target share of the snus market, we took price increases across the portfolio in the second quarter - and still sold more cans this first half than we had sold in the second half of last year. |
Slide 39 |
In the first half of the year the Polish market experienced significant price movements and duty absorption by competitors. Gallaher chose not to reduce prices and consequently experienced an anticipated decline in volumes, although by maintaining margins the impact on our profitability was not as severe as the overall impact on the Polish profit pool. However, competitive conditions are beginning to show signs of improvement and the Group's share of total industry shipments has begun to rise again, reaching 5.9% in May/June. Throughout the challenging conditions of the first half, LD showed a particularly resilient performance, and Ronson performed strongly, growing share to 1.6%. |
Slide 40 |
Our African volumes increased 3.9%, with growth in Guinea and South Africa offsetting lower Nigerian volumes due to trade phasing. In South Africa, domestic market share for the first half was 1%, and we recently launched Mayfair as a mid-priced proposition. We have established the operation as a platform for exports to neighbouring markets. |
Slide 41 |
We nearly doubled our Asian cigarette volumes, due to new launches, trade stocking and the expansion of regional duty free. In this region, our growth is driven by our strategic brands. Sobranie was the original brand introduced into Japan, China and regional duty free, and it continues to grow its total regional volumes year-on-year. Memphis was the brand chosen by Shanghai Tobacco for on-shore production in China, and the brand now has around 1% of the market in Singapore. LD was launched in Taiwan at the beginning of the year, and is performing well, while it is now firmly established as the third Gallaher brand on sale in China. |
Slide 42 |
We delivered good organic growth in spite of difficult conditions in a few markets, and the impact of the phasing of trade sales on the first half - growing pre-acquisition EBITA by 3.2%. We continue to execute the Group's strategy, maximising our strategic brand portfolio, optimal cost advantages and best routes to market - resulting in increases in market shares and profitability. In line with our focus on balancing volumes and revenues in our core markets, we achieved net take per cigarette increases in three of the four - largely mitigating the negative pressures. We built on the positions we've already created in many of our more recent market entries, and we extended our footprint by entering new markets. We grew our strategic brands' volumes by 11.2%. We improved Group cigarette productivity by 6.1% and reduced unit costs by 4.8%. The portfolio of interests we have built across mature and emerging markets creates a strong platform. During the first six months we met, and dealt with, a number of challenges. At the same time, our mature markets showed solid performances, and our emerging markets reported substantial growth. We remain confident of the outcome for the full year. Looking further ahead, although our businesses will face external challenges - as it has done over many years - many of those markets which have experienced reductions in profit pools are now beginning to show signs of stability. Accordingly, our longer-term target of high-single-figure adjusted EPS growth remains in place. |
Slide 43 |
Thanks for your attention. |