英美煙草 (BTI) 2002 Q3 法說會逐字稿

Please stand by the conference is about to begin. Good day welcome to the British American Tobacco third quarter 2002 conference. During the presentation all participants will be in a listen only mode. Afterwards you will be invited to participate in a question and answer session. At that time if you have any questions you will press one on your touch tone telephone to register.

As a reminder this conference is being recorded on October 29th Tuesday 2002. I would now like to turn the program over to Mr.

of

go ahead please sir.

Good morning everyone. This is

of

welcoming you to British American Tobacco's nine months results conference call.

Today in London we have Paul Adams - Managing Director, Paul Rayner Finance Director and

General Council.

Paul please begin.

Good morning everyone and welcome to British American Tobacco 2002 nine months results presentation. For those of you listening to this our on our web site bat.com I'm Paul Reyner - Finance Director of British American Tobacco.

During this presentation the power point slides can be viewed on our web site.

As usual there will be an opportunity for people to ask questions at the conclusion of the presentations from myself and Paul Adams.

Let's start first with group volumes where for the discreet third quarter volumes were down just two percent with good quarter growth - with good growth from the Europe region. For the year of the whole we expect volumes to be down approximately down three percent in line with our guidance to the market. For the nine months volume was down almost four percent. Volumes grew two percent in the

region due to mainly by South Korea.

In Europe volumes were flat with growth in Eastern Europe offsetting the loss of the UK partnership business. Elsewhere in Latin America there were volume declines in Brazil and Argentina reflecting the difficult economic environment there. And in the Asian Pacific and African Middle East regions volumes were affected by action we have taken in global duty free and declines in India, Indonesia and

. In Q3 international brands grew by two percent driven by the four global drive brands lucky strike Kent, Dunhill and

which achieved an average of nine percent here to date and were particularly strong in the third quarter with growth of 15 percent.

The global drive brands accounted for 13.5 percent of total group volumes during the first nine months. Now on to the financials starting with the top line net revenue for the nine months filled by three percent and was £8.7 billion excluding the effective exchange differences net revenue was flat at constant rates. Looking briefly at the regions there was a good performance in the

regions with profit up four percent at £769 million as a result of continued high contributions from each of the markets.

The seven percent increase in profit and local currency Imperial Tobacco Canada was a result of improved margins despite lower volumes following high excites increases at the federal and provincial level. The loading in quarter two ahead of the Canadian excites increases had a depressive affect on third quarter volumes. Paul Adams will discuss

performance in more detail later. The five- percent increase in profit in dollar terms was a result of price increases and lower expenses and discounting. Kent and Kool did well in Japan where group market share has risen to 8.2 percent. Profit due to better volumes and favorable foreign exchange hedging.

In South Korea the impressive performance has continued and group market share now stands at 10 percent. Dunhill Lights has more than doubled volumes in that market. In Asia Pacific there's been profit growth in Australia, Malaysia and

offset by the reduction in duty free exports and reduced profitability in Singapore. There was strong growth in Australia due to higher margins reduced overheads and savings in the supply chain. In Malaysia profit rose on improved margins following excite driven price increases late last year. Dunhill continues to perform well increasing market share to 46 percent. Both profit and volumes were significantly ahead in Cambodia and Vietnam but the excise led price increases led to lower volumes in Indonesia.

Singapore was adversely effected by competitive pricing and the emergence of a low price segment. There were good profit performances from the South Asia markets, mainly due to price increases and margins improvements.

In Latin America operating profits fell four percent to, to 321 million pounds, an excellent performance in exceptionally difficult economic circumstances, when you consider the Brazilian Real has devalued by 17 percent, the Venezuelan

by 53 percent and the near total collapse of the Argentinean peso, this result demonstrates the strong quality of BAT management in the region.

Despite the impact of exchange Brazil and Venezuela who recorded increase profit in sterling terms and our subsidiary in Argentina still remains profitable.

The Europe region has delivered another increase in profit despite the significant loss of profit arising from the dissolution of the UK partnership. Excluding the UK the rest of the regions look good double-digit profit growth. Paul will also cover the group's performances in Russia and Germany in detail later.

In the Africa and Middle East region profit was 45 million pounds lower at 206 million pounds, effected by the severe devaluation of the South African And, cost incurred in setting up the operation in Turkey and lower duty free volumes.

In South Africa stable volumes and higher margins from improved sales mix saw higher profits in local currencies.

Profit in Nigeria was well ahead of last year due to volume and price gains compared to the start up costs incurred last year. Benson & Hedges and Rothmans did particularly well in that market.

Operating profit before amortization of goodwill fell one percent to 2.061 billion pounds. The impact of exchange differences was significant and disguised some excellent underlying performances.

Many of you will recall that we used to report regional operating profit on a prior years-constant currency basis before we moved to current rates. We thought you might find it interesting to see the underlying performances of the regions before the impact of exchange.

As you can see exchange differences resulted in the operating profit number going from four percent above to one percent below last year. This four- percent rise is consistent with the guidance we issued last December before the weakening of many key currencies.

America/Pacific was eight percent ahead and Asia/Pacific fell one percent due to the loss of global duty free volume. Latin America came in ahead by five percent, but it is the African/Middle East region that was most effected by exchange due to the fall in value of the South African Rand which accounted for the 15 of the 18 percent fall in the regions operating profits.

A quick look at margins. The profit per one thousand cigarettes during the period improved three percent on the same period last year and now stands at £3.56 the group operating margin rose from 23.3 percent to 23.7 percent bearing in mind these figures are at current rates and after the effects of devaluation's.

Let's look at the drivers behind the adjusted diluted earnings per share growth of eight percent. This is particularly important in understanding why we expect to achieve high single figure earnings growth this year despite the one off decline in volumes this year and the adverse movement in exchange rates based on fully diluted shares number of 2.3 billion the operating profit number of £2.061 billion equates to 89.6 p per share.

Net interest was 35 percent lower at £142 million benefiting from the groups cash flow, lower interest rates and in the third quarter interest received as a result of a reassessment of

tax payments in the U.S.

For those of you who may be interested gross interest cover stands at 8.6 times. Adjusted profit before tax this year has therefore improved by three percent to 83.4 pence per share.

Excluding good will the underlying tax rate was 34.9 percent and improvement on the same period due to favorable mix of profits last year. In the third quarter at 33.4 percent was an improvement over the first two quarters this year.

At this stage there are possible one off factors that may result in the tax rate for the whole year remaining at around 33 percent. The adjusted profit after tax this year increased by five percent to 55.3 pence.

The minority interest charge was lower at £112 million because of the buy out of

minorities and the dissolution of the U.K. partnership last year. As you can see the fully diluted adjusted earnings per share was 49.5 pence - up eight percent on 2001.

Paul Adams will now discuss some of the trading aspects before we move to your questions.

Thank you Paul. Good morning everyone.

the tobacco sector has certainly received more than it's fair share of attention during the past six weeks particularly in respect to the

case in California and the increased levels of discounting in the United States.

I do not intend to discuss the merits of Mrs.

claim Brown & Williamson was not a defendant however I have no doubt that the judge will reduce the magnitude of the award and Phillip Morris will appeal the decision. Not withstanding the magnitude of that verdict we do not consider that there has been any material change in aggregate legal risks faced by Brown and Williamson.

At results meetings I normally comment on the progress we have made with our proposals in China. I'm pleased to say that continue to make progress but beyond that I have no further news today. In the meantime we continue to look at other investment opportunities for example we have lodged our interest with the Italian government in respect of

and indeed are looking forward to other privatizations. So let's return to the US where discounting and price promotion have reached unprecedented levels.

A great deal has been written about the US market over the past month or so and we tried to clarify things by talking to analysts around our US market strategy. Despite the difficult environment of higher state taxes and escalating discounting by our competitors. Brown & Williamson posted a five- percent increase in profit in US dollar terms which translates in to £284 million at current rates. This is an impressive performance achieved through focus, brand repositioning and effective and efficient pricing and promotional programs. On a shipment basis Brown & Williamson's market share has been stable for the past four quarters although Q1 2002 fell slightly due to significant trade inventory ships following the January excite increase.

For the nine months shipment share increased from 10.9 percent to 11.1 percent and retail share is flat at around 10.,4 percent. The important message is that the market share decline that followed the master settlement agreement at the end of 1998 appears to have stabilized. It is premature to say that this stability will continue. But the performance so far speaks for itself and our underlying ability to compete has improved substantially. Speaking of which let's look at the performance of the US strategic brands.

Kool,

have each grown year on year and the face of recession, state excise increases, the growth of the non-big four manufacturers and the intense level of competitive discounting. By focusing on these strategic brands the growth has offset the decline of the

brands. Market share performance and financial result is testimony to the zigzag philosophy everyday low pricing and continually working to build brand equities. Another market that has received much attention recently has been Germany. For British American Tobacco it is the largest contributor of profit in the Europe region that has been overtaken in volume terms by Russia.

But how've we done in Germany this year? Well volumes are up three percent to 24.6 billion during the first nine months of the year. Our market share has risen consistently since 1998 to a shade over 23 percent whilst the other major manufacturers have in the recent past lost share to the trade brands. It looks as though the trade brands peaked earlier this year at 15.5 percent and have now declined to 15.4percent in September. During 2002 power key brands - Lucky Strike, Pall Mall and

have grown share particularly Lucky Strike, which now has a 5.1 percent share of the market.

However it is in the adult smokers under 30 segment, which hopefully you can see on the slide, where the success of the key brands which has enabled BAT to take 32 percent of the segment at the expense of our major competitors.

Germany continues to be highly competitive and margins have fallen since January 2002, and the excise increase was not fully recovered. Despite the competitive environment our brands continue to make good progress.

Now I can't let today pass without commenting on some excellent performances in Eastern Europe. As you know we encountered distribution problems in Russia in the first quarter of the year, which effected the low-end volume. To date BAT Russia has enjoyed record sales of Kent,

and Pall Mall and total volumes are now four percent ahead for the nine months which translates into a 19 percent increase Q3 on Q3 2001.

But Russia is not just about volume, it is about quality of volume and performance in the premium segment. BAT continues to grow share as measured by independent retail audit, and has almost 22 percent in the leading 30 cities, where Kent is now the leading premium brand.

Kent volume has grown in Russia by 112 percent this year, Pall Mall by 52 percent and

by 34 percent. This all translates into financial results and BATs Russia's profit is significantly ahead of last year.

In the space of a year or so Ukraine has become a relevant source of profit to the Europe region through the continued growth of Pall Mall and

For the nine months total BAT volume has risen by more than 25 percent and the groups market share exceeds 30 percent.

Volume growth has translated into a very strong increase in profit and

is now the market leader.

Of the remaining key markets in Eastern Europe, Hungary and Poland have made good progress this year. Poland is recovering from last year's price war, the financial result is significantly better and market share and volume is up on the comparative period.

In Hungary, following our move to direct store distribution, profit is strongly ahead despite a reduction in prices by our competition last year. Volume is up eight percent and market share has risen four points to 47 percent. The last of the Eastern European key markets is Romania where increase competitor activity has reduced margins, despite the aggressive pricing we have grown share to almost 30 percent led by Viceroy, but volume is down slightly and profits have

.

Price wars are not new and our response will be to remain competitive and use whatever strategies are most appropriate for the market. So what are the important take out from today's announcement - earnings growth is inline with expectations with adjusted EPS up eight percent at 49.47 pence as you heard from Paul earlier the one percent decline in operating profit masked a good underlying performance given the much lower duty free sales this year and the very material weakling of key currencies.

EPS growth has come as result of lower net interest, tax rate and minority charges off setting adverse foreign exchange movements. The four- percent underlying operating growth at constant rate was entirely consistent with the guidance we issued last year.

Group companies has performed effectively in highly competitive conditions. The Brown & Williamson shipment share is up, its retail share is stable and it's profit up. There has been an impressively

performance in Latin America. The performance in Eastern Europe and Germany are strong. Our global drive brand volumes continues to forge ahead up 9.3 percent for the nine months.

We will maintain our focus on improving operating margins through the quality of our volume and through cost reductions and we are making progress in China and are continuing to review acquisition opportunities including privatization's.

And for the rest of the year we still expect to achieve high single figure EPS growth for the year.

Thank you we will now take your questions.

if you would like to ask a question please press one now on your touch-tone telephone. To withdraw yourself from the queue press pound.

Once again to ask a question please press one now on your touch-tone phone. We'll take our first question from the

of Mr.

of Morgan Stanley go ahead please.

Good afternoon everyone.

Hello

.

Paul first a question about excise tax increases in '03 other than the second half of the German

tax - are there pending tax increases in any major profit market that you'll be facing - that you are aware of at this point?

I don't think so

.

OK. Can you talk secondly within the U.S. market the extent to which in broad terms Brown Williamson is responding promotionally to the market leaders actions?

Yes I think as I mentioned before we anticipated that there would be a much more increased level of promotional discounting and pricing activity in the second half of the year. So we always factored that in

our planning and our budgeting. Clearly we weren't anticipating quiet the extent of the promotional activities as have been recently announced. As a result of that we will be increasing the amount of spend in the fourth quarter in Brown & Williamson but not to a level that would materially affect group profit.

OK. And then lastly Paul can you share with us your view recognizing that you're not the pricing leader in the US market but what do you think the US market is evolving to in terms of it's profit structure? Do you think it's been permanently altered or you know when do you think you'll be in a position to make that call?

I think we're probably going to have to wait until the second quarter of next year. I think we'll have to see what happens to the

payments and how that affects pricing both in terms of the non-big fall and in terms of the big fall. We'll have to see what happens to volume. Remember that this year in the first quarter was a particularly strong first quarter in volume terms because of the inventory load so we'll see what happens on that and we'll have t o see what happens on pricing overall. I mean general price increases I don't mean sort of discounting.

Right. What's - last question actually - what's Brown & Williamson's assessment of the effectiveness and the extent of the standard attorney general and enforcement of the

legislation?

I think there assessment would be that it's not there yet and I think that one of the issues which is what will happen in the non big fall paying in to

. As I understand it there's only a number of states. Not the full amount of states have actually implemented that legislation and having implemented that legislation I think there are a number of small companies that are still flying under the radar so how much of that will impact pricing of the non big fall I think remains to be seen and that's one of the uncertain variables.

OK. Thank you for taking all those questions.

A pleasure.

Our next question comes from the site of

with Salomon Smith Barney.

Hello everyone.

Hello

.

I guess I have one question about your - this retail rights program. Can you talk a little bit about that? I read an article about how you're pursuing - you know joining forces with some others to kind of combat the anti competitive practices in the US market. Could you just touch on that for a little bit and just tell us the status of that and really what you're hoping to achieve?

Yeah If I've understood your question correctly and if I haven't understood it correct me. But we think that the

program retail leaders in the United States is restricted practices.

Right.

As a result of that we're seeking in both litigation and through legislation some address of that issue. That is still pending. We're still pursuing those two and we'll see what happens.

Because right now the retail leader law suit that was dismissed earlier this year that's on appeal correct?

Correct.

OK. And then secondly could you talk a little bit more about your strategy regarding pricing of your three you know key brands in the US

I'm just curious to understand maybe from a wholesale price level where they are relative to you know premium brand and maybe even like a deep discount plan right now just trying to understand where they fit into, you know, the different price tiers.

OK, well, Kool is premium and we will do some buy downs and buy some get some free promotions to remain competitive against our competitive set on Kool. Pall Mall and Misty are at everyday low price so we obviously we need to adjust the pricing for promotional programs and it's not really discounting it's buy some get some free promotional programs, so that we stay in touch with both the premium brands that are coming down when they're on promotion and also if you like the mid price brands that are generically up that price point, so we have to watch both the premium brands and the value for money or mid priced brands against Pall Mall and Misty.

So Pall Mall and Misty where do you think they're taking share, which brands are they taking share from - from other price value brands or is it what are you seeing.

I think my understanding is that they're picking up share not particularly from any particular brand but sort of across the board A) from premium down traders but also from mid priced brands, it's not a particularly, there's not one brand that I'm aware that's particularly loosing to us.

OK and just talking of the trades, I'm aware of the everyday low price and my understanding of that would have been possibly an advantage for you is that the wholesalers are paid up front you know can you just talk about that a little bit you know why you've seen that strategy in terms of your pricing strategy work in this environment, you know what's the feedback you're getting from your customers meaning the wholesalers.

OK I can't answer that

. I don't know what the feedback is from the wholesale trade, I think our pricing strategy is particularly relevant to consumers and I think what consumers appreciate is a consistency of pricing so that they know which ever store they're going to go in they're going to be able to buy brands at a value for money price rather than to have to shop around and look for a deal.

OK so you actually listening to you answer that question you know thinking about the environment we're in right now with the deep discount trends at I think record levels, maybe you'd tell me I think they're probably about 8.5 percent market share it seems like

you're actually thriving in this environment right now, giving your pricing and positioning of your brands .

Yeah I think yeah there are two aspects one is as I've mentioned the consistency of pricing the predictability of value in pricing to consumers and picking up your point about wholesalers, with the every day low pricing we're not reliant on free goods and of course the trade makes money at wholesale level on everyday low price they don't make money on free goods.

Exactly, OK thank you so much.

Once again if you would like to ask a question press one now on your touch tone telephone. We'll take our next question from the set of

of Merrill Lynch.

Thanks good morning everyone.

Hello Martin.

Good afternoon I should say. A few questions, just following on from the discussion that you just had on the US, if the major manufacturers in the US were to go to an

policy or the fact that they have chosen deliberately not to, clearly that should continue to be an advantage for you, or put another way if everyone was to sort of to follow the route that

adopted some time ago that would be tougher on BMW - is that a fair assessment?

I'm not sure that it is because the fact that Philip Morris are able to leverage their promotional and discount dollars through the retail leaders program means that their able to leverage what we believe are to be restricted parties. So they have a lot of leverage through that so I can see why they do it and I can see why they might be resistant going to everyday low price because to some extent they are not able to leverage their retail leaders program.

Right but it clearly suits you for as long as this environment continues where you have

and they don't.

Yeah we think it's working for us. We think that as I've said it's not only effective but its efficient use of money.

Right Paul can you give me a bit of

market share just in the last few weeks or in the last period you have available and the same period last year?

OK funnily enough I predicted that question may come up so I can give it to you. OK Kools share - I'm taking shipments to wholesale - Kool share year to date is 3.1.

Kool share in the third quarter was 3.2. In Q2 it was 3.5. Q1 it was 2.7 and in Q4 '01 it was 2.6.

You don't pay your

out of the retail share do you?

I'm sure I do one second. Year to date the Kool retail share is 2.9 - I beg you pardon yes 2.9 year to date and in the - in September it was 2.97 I think you will allow three.

OK, OK that's good. Just on a completely different subject in Germany what do you think will happen once the second part of the

tax comes in. I mean we've seen virtual stabilization on actual stabilization in the last few months in the discount segments. There have been proposals as you are no doubt aware for even further excise tax increases in Germany.

If - I mean once we get the second

tax increase and if there were to be any further increases what do you think happens to the environment do you think that the discount segment continues to grow or that it's in fact stable - it's some how reached it's structural peek.

I think it's reached its

to say it's reached it's peek but I think the steam has been significantly taken out of it. I don't anticipate that it will rise significantly if indeed it rises at all. In terms of excise I mean the excise increase of one Euro per cent per

in January the 1st 2003 of course is another specific excise which hurt the trade brands more than it will the higher price brand.

Additionally the German government is levied now an minimum excise so they're on to it so my prognosis is that I don't see much of an increase in the trade brands in Germany.

OK, OK that's helpful you made the cryptic comment looking forward to other privatization's can you give us any order of ranking of how much you are looking forward to each of them?

No I don't want I don't want to get too drawn on that. But there I mean there are a number of small ones around. I mean the

as you'll probably be familiar with. There's North Africa there's Italy and there's a few out in the Far East which are bigger but will probably take ages before they come to market.

So we're alert to that but I would if you like those would not represent when we talk about an acquisition strategy they would be part of it but not the major part of it.

Right Paul just a general point on that. Do you expect to see the doubt-ments I mean just generally sell their businesses to a single buyer or perhaps try and do what the Polish did and break their businesses up. I mean anti maybe broken up into distribution and manufacturing I mean well do you think you may be successful at buying the business at sort of lock stock and barrel.

Well there are two things the Governments do when they

. One is they try to

the whole lot. And secondly they expect an outrageously large sum of money for it and we saw that in the

.

And what we need to do is persuade the governments that in fact they're far better off putting it into more manageable parcels of business because they will get more money as a result of doing that and arguably if they split our factories then they will get more competition.

So it's better for the government both in terms of what they're trying to achieve and in an orderly and competitive and also they should get more money from it and it's easier for buyers to buy.

So the flip side of that is clearly any of your competitors would might be the other buyers.

Correct.

And you're happy with that environment.

We expect it to be competitive bidding yes.

Right, OK, just ...

We

happy with that but we do expect it.

Ok just a quick question for Paul Rayner. Paul clearly you benefited I mean from the difficult county environment this quarter you benefited as you described from lower interest and lower interest payments and lower tax payments.

Can we assume that the rate of tax the effective rate this quarter is an effective rate going forward. I mean certainly for the fourth quarter and into next year and is the issue in the US with the reassessment of the tax situation there which I don't quite understand. Could that make a difference for the future.

Ok the rate the effective rate of tax for the full year in the context of my presentation I just did said that because of some one off factors that we expect

in the fourth quarter we expect the effective rate of tax for the full year for the group should be around the 33 percent.

So the fourth quarter is going to be an unusually lower rate of tax. That's our expectation at this stage and we're saying for the full year again we expect our effective rate of tax would be round about 33 percent.

Going forward looking at the underlying rate of tax for the group taking out the one off positive factors that we expect in the fourth quarter of this year. The underlying rate of tax I think the forecast purposes is closer to round about 34 if not approaching 35 percent between those two numbers.

It does get affected significantly obviously by the mix of profits. It has moved favorably our way this year. We had done some restructuring this year, which has also benefited our effective tax rate. Looking forward into next year therefore we're looking at that slightly lower underlying rate of tax, but I mean there are some ominous signs in relation to government announcements about rises in corporate tax rates, that's happened in the US, there's no legislation yet, also in Germany and also there've been pronouncements by governments about disallowing interest costs, again in Germany and the Netherlands.

Now legislation in relation to those announcements has not taken place but I mean going forward if you're trying to predict corporate tax rates or effective tax rates obviously they'll be effected if there's legislation changes that take place.

In relation to the lower interest costs for the third quarter that is really a one off, as we said it's a result of reassessment of net tax payments in the US. We did receive a check from the authorities there in relation to a reassessment, a net tax payments of prior years, it was effectively an interest refund and that resulted in our net interest costs for the third quarter being substantially lower.

In terms of predicting net interest costs going forward a better running rate is to look at what the first half net interest costs was for us and that I think gives a better indication, that was about 108 million pounds I think for the first half of net interest costs.

So I think that gives a better indication, going forward of what our net interest should be so though we did get that benefit in the third quarter.

OK Paul thanks for that is it fair to perhaps characterize next year as a

where you don't have the favorable non operating environment clearly as you've just described with tax and perhaps with tax situation and the interest environment but you do have the favorable lapping with the sales to the global duty free business, I mean improving off a more favorable base.

Yes we don't have the - we had obviously the one off hit to volumes this year but substantially effected profit but despite that profit at constant rate has been up so you're right that doesn't happen again so that's a positive that compared to this year. We're not going to - we expect to get some of the one off benefits we've got through interest this year but we never know.

The underlying rate of tax I think is probably a touch lower going into next year but I don't expect we'll get the one off benefits that we've got in the fourth quarter, so some plusses and minuses. I mean the big thing going into next year Martin is really what happens to exchange rates. I mean exchange rates have had a significant influence on our profits for the three quarters, you can see that, and it's really your prediction you make in relation to exchange rates next year and hence the translation in our profits into sterling that's going to drive earnings projections to a large degree.

Is there anything you're doing on that front in terms of hedging that you haven't done in the past to try to mitigate against the un-favorability of currencies for next year.

We hedge dividend flows where we can but to a large extent it's fairly difficult to hedge the translation against the losses that we have through movements and exchange.

OK. Thanks very much.

Thank you Martin.

There are no further questions at this time. I'd like to turn to the program over to our host for any concluding remarks.

Sorry that's me. I thought it was Robert. I beg your pardon everyone. All I wanted to say is that we think it's in difficult circumstances as been a good performance by BAT. We expect to meet a high single figure of earnings per share growth and on that I think I'll let it rest. Thank you all for listening in and asking your questions.

This concludes today's conference call. You may now disconnect your lines and thank you for participating.