英美煙草 (BTI) 2004 Q1 法說會逐字稿

Good day. [OPERATOR INSTRUCTIONS]

And at this time, I would like to turn the program over to your moderator, Mr. Robert Caputo (ph).

Good morning, everyone. This is Robert Caputo of Financial Dynamics, and I along with my colleagues in London would like to welcome you to British American Tobacco's First Quarter 2004 Results Conference Call.

Today in London we have Paul Adams, Chief Executive, Paul Rayner, Finance Director, Neil Withington, General Counsel. Paul, please begin.

Good morning, everyone. I'm Paul Adams. Before we begin, I would just like to urge investors to read the complete forward-looking statement that can be seen on our Web site.

Starting with the headlines of today's announcement, operating profit before amortization of goodwill and exceptional charges was up 3% at 640 million pounds.

Pre-tax profit after the charging of a further five million pounds to some of the restructuring projects announced last year, and goodwill amortization was down 3% at 454 million pounds.

And adjusted diluted earnings per share rose 6% to 15.59 pence.

The dominate factor affecting these numbers was the strength of Sterling on the translation of the profit inter-sterling, which had a 34 million pound impact on operating profit.

As we remarked at the end of February, exchange will continue to have a significant impact on our results for the year. Ignoring the translation effects of exchange, operating profit would have been up 9% at constant rates with good, underlying performances recorded in all regions.

Good volumes grew 4.6% to 192 billion. Excluding acquisition volume, the organic growth was just over 1%. International brands grew 1.4%, and our four global drive brands rose 3.2%.

The volume decline in America Pacific follows lower industry shipments in the U.S., Canada and Japan, and lower volumes in South Korea. I'll address each of those markets in a few moments.

There were good volume performances in Asia Pacific, and the 1.1% volume gain in Latin America follows last year's acquisition in Peru. In Europe, the recently acquired ETI volumes accounted for 5.4 billion cigarettes, and there was strong growth in Russia, partially offset by the industry declines in France and Germany, following excise increases.

Excise also had an impact on volumes in South Africa, which accounted for half of the volume decline in the Africa and Middle East region.

After the very strong performance of recent years, there may be some surprise that the dry brands grew by just 3%. Lucky Strike volume was flat, a commendable performance considering the industry volume declines in its two key markets, Germany and France.

Kent grew 8% with an excellent performance in Russia. Pall Mall volumes rose 14.5% continuing the strong progress made in 2003.

Dunhill's 8% decline is due to the timing of shipments and a very strong Q1 last year in Malaysia, where the brand was re-launched with new packaging, and the launch of a competitor's product in South Korea in the fourth quarter of last year. The group share in South Korea slipped one share point to 11.9%. However, volumes in Malaysia have improved, and following the recent launch of a one milligram Dunhill line extension, we have seen a recovery in South Korea.

Despite the slow start, we expect to see a stronger performance on the global dry brands as the year progresses.

For the next few minutes, I'll be reviewing the key markets starting with Canada. Last week when Martin Broughton commented on current trading prospects in his AGM statement, he cited Canada where market factors are likely to impact profitability. In Canada, total industry volumes have declined steadily and significantly since July 2002, when the Federal and Provincial Governments imposed swinging tax increases on tobacco products.

Year-on-year, industry volumes have fallen a further 5.3%. This slide shows how dramatic the price increases have been since February 2001, with an average 80% increase in retail prices per carton of 200 premium cigarettes. It is worth remembering that back in early 2001, the value from money segment was virtually non-existent.

As a result of the excise-driven price increase, consumers have become more price conscious. Elicit trade has grown, and more recently a value-for-money segment has emerged.

In February 2003, RBH launched number seven at a value-for-money price. Imperial followed with the repositioning of a small brand, Peter Jackson. At present, the price gap between premium and value-for-money brands is around $2 Canadian per pack.

In a relatively short time, the value-for-money segment has grown to the point where it represents 20% of the total market and the growth continues.

While Imperial's strength is in the premium segment, its overall market share has slipped to just over 60%, despite its premium share, rising two share points to 71.3%.

In the value-for-money segment, Imperial is underrepresented, although it has added 19 share points year-on-year to 22.1%.

For the decline of the premium segment, Imperial's profit is 13% lower due to the following volume. The consequent shift in the sales mix and adverse exchange rates. At constant rates, the decline was 8%.

Imperial's management is addressing these market factors in order to maintain leadership in the market. Although it is likely that Canada's profit will come under further pressure.

In the U.S. market, total industry volume was down in Q1 by 3.5% with continued de-loading at the wholesale level. We estimate that underlying consumer demand was down about 1.5%.

Brown & Williamson's shipment share fell slightly year on year to 10.4%, due to a .8 share drop in the non-strategic brands, which was not quite matched by the .6 share rise of the strategic brands. There were good performances from Kool, Pall Mall and Misty.

The rise in operating profit to 46 million pounds reflects lower secondary supply chain and marketing costs, following a one-off trade cost last year, partially offset by exchange, lower volumes and lower net pricing.

As far as the proposed transaction with RJR is concerned, there is not much more to add today. The deal remains on track, and subject to regulatory approvals should be completed around the middle of the year.

In Japan, industry volume was down 4.8% year-on-year, following a 40 yen excise-driven price increase last July.

Despite the lower industry volume, BAT Japan maintained volume and grew market share with good performances from Kent and Kool.

Australia continues to go from strength to strength. Market share has risen to 45% with good performances from the premium brands Winfield and Dunhill. Higher margin and volume has resulted in strong profit growth.

As I mentioned earlier, the share loss and lower Dunhill volume in Malaysia was largely due to the timing of shipments between Q4 and Q1. Price increases linked to higher margins and profit in local currency.

In India, ITC grew volumes and profit in local currency.

In Brazil, Souza Cruz's share fell 2.2 share points to 75.1 as a result of price increases and competitor pricing activities. Improved margins lead to a higher profit in local currency, but the financial result was affected by depreciation of the real against sterling.

In Mexico, the group share fell 1.3 share points to 41%, following a price increase in January, which led to a fall in share and volume due to the timing of shipments.

As with Brazil, a higher profit in local currency, due to the low available costs in secondary supply chain expenses was affected by exchange devaluation.

In Europe, Q1 saw a first time profit contribution of around 43 million pounds from the new business in Italy, of which 38 million in attributed to ETI.

The combined share of the business rose .8 of a share point to 33.5% with Pall Mall almost doubling its share of the market to 8.3%.

Following price increases, the industry volumes in Italy are down 2.8% relative to a strong first quarter last year, when there was trade stalking ahead of an excise increase.

Consumer off take is down about 1%. The current price per pack of MS and Pall Mall is two euros 80 and Saks (ph) is two euros 60.

The integration of the business is on track, and we are confident that last year's ETI deal will prove to be a very good acquisition.

In Germany, prices were increased in March, following the first of three projected excise increases, which should collectively raise prices by one euro per pack by September 2005.

Year-on-year, industry volumes of cigarettes are down from 6%, a figure which we believe will deteriorate as the year progresses. The ETI Germany share of the cigarette market has been maintained at 22.5%, with Lucky Strike's share flat at 5.1%.

But Kool, Gauloises Blondes and Pall Mall grew share, the latter, being rolled out into Western Germany. BAT Germany's profit is affected by lower volumes in margins, although the country profit has been mitigated in part by a strong performance from other tobacco products.

As series of excise increases in France has seen a significant reduction in industry volume, down some 23%. As consumers turn to cheaper alternatives, we expect consumption to be significantly higher than shipments, and this will put further pressure on licensed retailers. In this environment, the ability to take further price increases in uncertain.

ETI France's market share rose .4 of a share point to 15.9%, with good performance from Winfield and Lucky Strike; however, profit was affected by the lower volume and margin.

On a more positive note, BAT Russia delivered an excellent result, with a significant increase in volume over the comparative quarter last year. BAT Russia continues to gain share in the top 30 cities and Kent delivered an excellent performance, which resulted in significantly higher profit.

In South Africa, our overall market volumes declined 5%, due to an 8% excise-driven price increase. BAT South Africa's share declined 1.1 share points to 92%, although there were share gains by Peter Stuyvesant and Dunhill. Both grew with margins, profit grew with margin gains and improved mix.

In Nigeria, the group share was 2.2 share points, to 73.4%, as Benson and Hedges benefited from improved distribution. In the Middle East area, volumes were similar to last year, but profit was down reflecting the increased investment in Iran following the move to local manufacturing. I'll now pass on to Paul Rayner, the Finance Director, who will take you through the remainder of the presentation.

Thank you Paul, and good morning everyone. Net revenue was clearly affected by the ETI acquisition. Up to 46% increase in turnover for the Europe region, we estimate that ETI contributed 323 million pounds, of which 250 million pounds came from the non-BAT brand that Etinera distributes. If we exclude ETI, the Europe region's net revenue would have been up 5%, and total group revenue down 5% at current rates.

The America Pacific, 21% decline in net turnover at current rates translates to a 30% decline at constant rates. Part of that decline can be attributed to the lower volumes in the high turnover markets in the U.S. and Canada. With another factor being removed to efficient premium price delivery for Kool in the second quarter of last year.

As Paul mentioned earlier, unfavorable foreign exchange translation movements have been the most significant factor affecting operating profit this year, which unfortunately masked good underlying performances in many markets. Despite the difficult trading conditions in key markets in North America and Western Europe, BAT's unique strength comes from its geographic diversity, demonstrated by the strong contributions from Asia Pacific, Latin America, and the Africa and Middle East region.

At constant rate of exchange, the (inaudible) of the group continues. On this chart, you can see that despite a six% fall in volume in the America Pacific region, operating profit at constant rate was up 5%, held by a favorable comparison in the U.S. in Q1 2003. The weaker U.S. and Canadian dollar made a negative 2% variance at current rates.

Margin improvement in Asia Pacific was as a result of strong performances, mainly in Australia, India, and Malaysia. But again, currency reduced operating profit to an increase of 4%. Cost savings and price increases saw significant margin enhancement in Latin America. The acquisition in Peru did not have a material impact on the result.

However, the weaker Brazilian real and Mexican peso resulted in a one% decline in operating profit at current rate. In Europe, it was largely ETI and a geographic mix issue. The high margin markets of France and Germany saw volume declines, while there was volume growth in the lower margin markets of Eastern Europe, and high levels of brand investment in the region.

While margins improved in Africa and the Middle East as a result of price increases and improved mix in South Africa, the region's profit was reduced from a growth rate of 5%, to 2% because of weaker currencies. Moving now to the profit and loss account. Restructuring costs for the quarter were five million pounds, and these related to the factory closures announced in the U.K. and Canada last year.

Net interest during the quarter increased due the impact of the share buy back program, and the cost of acquisitions carried out in 2003. Gross interest cover now stands at 7.6 times. The tax charge was seven million pounds higher, at 202 million pounds, and represents an underlying tax rate of 45.3%. The increase in the tax rate reflects an adverse change in the mix of profits, mainly due to the first prime recognition of ETI's products, which are subject to a higher rate of tax.

The minority interest charge decreased 11% to 33 million pounds, largely due to the Latin America region. Profit for the period was down seven% at 219 million pounds. Finally, the adjusted earnings per share calculation. In the first quarter, the group purchased a further 20.1 million shares, at a cost of 164.5 million pounds. The total number of shares now bought back this year is 24 million, at a cost of 197 million pounds.

The buyback program will soon be resumed. The adjusted EPS calculation is based on 2181 million shares. The adjusted net profit for the period was 340 million pounds, which gives an adjusted diluted earnings per share of 15.6 pence.

That concludes the presentation.

Kevin, could you go through the procedure for Q&A, please.

[OPERATOR INSTRUCTIONS] And it looks like our first question comes from Bob Campagnino with Prudential Securities.

Good morning everyone.

Morning Bob.

Couple of quick questions. First, with your comments relative to Canada, I think it would be fair to say that we'll see further excise tax increases and therefore likely further growth in the value for money segment. You mentioned you're unrepresented in that segment. Can you sort of give us some idea of what your plans are for that piece of business?

Yes, Bob. You're absolutely right. In terms of the excise environment, Quebec and Ontario, provincial governments, are both making noises about increasing the excise rates. As you know those two provinces account for about 65% of the total Canadian market. So the excise environment is not looking positive from our point of view going forward, and that's likely to increase the size of the value for money segment.

Secondly, there's also been some competitive launches in value for money segment, which will fuel the further growth of that. We have been wary of competing too strongly in the value for money segment, wary of fueling it's growth beyond what it would naturally do.

I think we've now gotten to the point where we realize that we have to move, if you like, from a defensive posture to an offensive posture. And that is likely to impact profitability going forward. In terms of the actual plans, wouldn't want to get into that, obviously for competitive reasons. But we do intend to be competitive.

OK, and you've been very efficient and very vocal in terms your ability to take costs out of the business. I know you speak to cost saving numbers on an annual basis. Can you give us a quarterly update, or is that not something that you want to do?

It's probably something we don't want to do, to be honest, but I can tell you, it's on track. You're right, we intend to give an annual update in terms of the actual cost savings we've achieved for the year. We are on track to achieve the overhead and indirect savings target that we've talked about at 200 million pounds per annum by 2007. We continue to do things to ensure that we'll achieve their target.

We've recently announced, scaled down to their cost levels in Germany, we're taking some people out of the head office there, which is part of the overhead and indirect cost program. But there's really nothing more to report at this stage.

Thank you very much. One final question, on this conference call, Altrea spoke about its intention relative to introducing a potentially reduced exposure product. Can you speak to your plans potentially for a similar positioned product?

Yeah, we've been working on that for some time, we've made very good progress. Clearly, there are two aspects to it, one is actually coming out with the product, and secondly to engage with regulators, the former slightly easier than the latter. So we do have capabilities coming to fruition, and we don't think we will be unprepared. I think that's about it on preps.

You wouldn't be willing to sort of put a time frame on that?

No.

OK, thank you for your time this morning.

Thank you, Bob.

And our next question comes from Martin Feldman with Merrill Lynch.

Thanks, good afternoon everyone.

Hi Martin.

Hi. Paul, if we just take a big picture look at the business, I think your global volumes were up about 1%. And if I remember, you've used the comment that your goal is to have annual average volume growth up about 1.5-2%. Is that correct?

Correct.

Do you see the current period as a little bit of an apparition, and do you see yourself comfortably getting back to that 1.5-2% range, either for the balance of this year or generally on average in the future?

Sorry, Martin, I misheard you, or rather I was thinking that what you were saying was going to be what I have said. What we have said in the past is it is 1-1.5% per annum. And we see that range achieved in the first quarter, and we see that range for the year.

Another question, just on the same point, I know it's difficult to look at the business as a whole, but what proportion of your product is at the popular premium end of all the markets you look at, you do business in?

I think premium is about 20% of our volume, something like that.

OK. So to the extent, so Paul, to the extent that you do, that down trading takes place either because of national economic conditions or excise taxes, not on a market by market basis, but across the board, doesn't that tend to benefit the company more than hurt it?

In volume terms yet, in margin terms, less so.

OK.

We still feel, if you look at the premium price, the premium price was about static in 2003, as a segment across the world. Historically, it's increased despite the economic conditions, and if you project that segment out not only in volume but in monetary value, that is still where the growth is. So we're still keen to do well in premium.

But you're right, BAT has a very balanced portfolio, it's something that we've worked hard on, it's something that we believe in. And I might add, not only in the cigarette business, but if you're interested in Europe, we have a strong position in other tobacco products, i.e. roll your own and sticks, where generally our market share in other tobacco products is larger than our market share in cigarettes. And we have a pretty good share in cigarettes.

I might have missed this on the call in your results. But if you look at your local currency earnings out of Germany, how did they change over the same quarter last year?

In local currency, earnings in Germany were down around a quarter. There wasn't much movement between Euro and Sterling, so in Sterling terms, they are around about the same.

Down about 25%?

Yeah.

And the primary reason for that being the...

The primary reason for that was the volume reductions in the first quarter, there was some spend increase. But the primary reason for the first quarter was volume reductions.

Right, and your share in Germany?

Volumes were down around about seven%.

And your share?

Your share was flat, Martin.

Share was flat.

If I can just give you a minute on Germany. The industry, the cigarette business, the total market for cigarettes was down about 6%, and our share was broadly flat. So we were down by about the same amount. Now, if you look at the total tobacco market in Germany, that was down around about 2%. Because obviously, RYO and NYO as it's called, and sticks business, both of those segments grew substantially, and we have a good share in those markets.

Paul, what do you think happens to the make your own and roll your own segments as Phillip Morris Internationals products hit that segment sometime in the next few months?

Well I think it accelerates the growth of the roll your own and make your own.

That's a good question, I don't think it's going to be dramatically impacted by Phillip Morris to be honest. I think that market is going to grow quite significantly. Clearly, Phillip Morris will pick up some share of that. But I don't see Phillip Morris on its own fueling that growth. It's going to happen anyway simply because of pricing.

OK, and just two other quick points. Can you comment at all either on your continued confidence in Reynolds American closing as you originally described? And can you give us any commentary at all on developments in terms of getting the deal done with the FTC?

I really can't add too much to that. The price certainly continues on track. We still await the approval of the FTC, and also the tax authorities in the U.S. And the discussion and information that we've had to present to those people, as will be presented in a thorough fashion. And we're pleased with the progress that we've made.

So there's nothing, sorry, go on.

We've got to the point where I think they've got all the information they now require, and we're waiting to hear from them. And that's where we're up to right now. If we receive the various approvals, then we do have time for the document, the S-4 document to be mailed to the Reynolds shareholders, and for the deal to be completed by the middle of the year.

But I think it's basically out of their hands now, because we've provided all the information that can be supplied to the various authorities, and they're considering it. I don't think our view has changed from where it was when we announced the deal, that we remain confident that our arguments are very strong, and there's a very strong chance that the authorities will approve the transaction in its entirety. So we haven't swayed from that, but obviously, until we hear from them, there's not much more we can say.

Paul, just generally in terms of providing the information to the FTC, the talks that have taken place, just all the interaction so far, do you think it's fair to characterize those as in the usual course of business, and nothing that has been too alarming in any real sense.

I think it would be inappropriate to actually comment specifically on the discussions we've had with the FTC.

OK, last question I think for Paul Adams, Paul, you spoke about a mix improvement in South Africa. I was just slightly curious there, unless I'm wrong, I thought in that market, virtually all brands are priced similarly.

No, they're sort of premium, and there's high price. And we've done well particularly on Dunhill, which is at the top end of pricing. So there is some mix of pricing in South Africa.

OK, OK. And was that mixed material, where the improvement was in material, or not?

I wouldn't say it was material, but it was certainly encouraging and helped.

OK, great, well, thanks very much.

Thank you, Martin.

And our next question comes from David Addleman from Morgan Stanley.

Good afternoon, everyone.

Hi David.

I have a couple of questions. First, are you surprised by the rate of the French volume declines coming into '04? Clearly they were going to be down, but are you surprised by the magnitude?

Yeah, I think that would be fair to say that we were slightly surprised. We were giving our view on what the French market would do this year, in February. We said that we thought the market would decline by about 15%, down to about $60 billion, this is in terms of shipments. We saw the first quarter down by 23%. I don't think the year will be down 23%. It's more likely to be closer to 20% down, rather than 15% down, and the total market shipments are more likely to be closer to 55 billion than the 60 billion, so it would be to say it was a surprise, yes.

And the comment you made about obviously a difficult environment to take pricing, were you referencing both manufacturer price increases but also the government's ability to take additional excise tax increases?

I was referencing the industry's ability to take price increases. The French government have said that following the latest excise increase, there is basely a moratorium, I think, for a couple of years if not three. So, referencing industry.

OK. Next, the-what is your degree of interest or willingness to approach the EU's smuggling and counterfeiting issue in a manner in which PMI appears to be addressing it?

We're not involved in that issue, so we're very happy of course to cooperate with the EU and indeed any government on anything that can stem counterfeit and contraband, but we're not actually in that issue.

OK. The-can you quantify the extent of the one time cost that Brown & Williamson incurred in the first quarter a year ago?

In relation to what specifically?

The release reference that the comparative for Brown & Williamson's operating income was flattered by one-off trade costs last year. I think it had to do with the change in going to three-day pricing on Kool.

I think it was between 10 and 15 million, something like that.

OK. And then, lastly, what are your expectations now going forward for the pace of consumption declining in the Japanese market?

I'm guessing here, David, because I don't know and I can't recall the estimates from the market, but I think what we're seeing is a shipment decline, which is probably larger than consumption decline, so I would think 2-3% would be a reasonable guess.

OK, and one last thing, in the conventional manufactured cigarette market in Germany, going from essentially three price points now to four tiers of pricing, what's your assessment of the long term impact to mix or to profitability in the market as a result? If you isolate it from everything else that's going on in Germany, just of that shift.

I think it's likely that there'll be downtrading in the German market. Two things to bear in mind. One is that consumers, they clearly are downtrading to other tobacco products, the margins there are good and as good as cigarettes, and secondly there was a price increase of 40 euro cents per pack in March and that was higher than the excise increase, so we anticipate that the gross margin level will be, despite the volume decline, gross margin will go up for the industry in Germany.

OK, thank you very much.

And our last question comes from the site of Donald Lipkin with Bear Stearns.

Hi, I just want to find out what your U.S. volume was for the quarter. Brown & Williamson. You know you have it America-specific but you don't break it out by the U.S.

For Brown & Williamson for the first quarter it was $8.9 billion.

Thank you very much.

Thank you.

It appears that we have no further questions at this time.

Paul, do you want to make any closing remarks?

Yes, I do. Just to wrap up, as you will have heard and seen, there are some markets with structural market issues, mostly excise driven, these would be, for example, Canada, France and Germany. There are a few markets with shorter term trading issues and those should unwind in the balance of the year, South Korea and Malaysia being the principle ones. The global drive brands got off to a relatively slow start, principally because of market rather than brand issues and the combined volume of those global drive brands should pick up speed in the balance of the year. Some markets are doing very well, Russia, Australia, Nigeria, Iran, Vietnam, Japan and Pakistan which shows the geographic strength and diversity of BAT business, and the net result is a very solid first quarter performance, carrying forward the momentum of the last year.

There was good volume growth, both organic and through acquisitions, and strong profit growth at constant rates, but obviously impacted by the currencies. And there's Italy delivering what was promised and more. Thanks very much.