英美煙草 (BTI) 2005 Q2 法說會逐字稿

Good morning everyone and welcome to British American Tobacco's 2005 interim results presentation. A warm welcome also to those of you listening to the conference call and watching at our website, bat.com. For those of you listening in, my name is Jan du Plessis, Chairman of British American Tobacco. With me here this morning we've also got Paul Adams, Chief Executive, and Paul Rayner, our Finance Director. After my opening remarks, the two of them will comment on the results in more detail.

So, let's begin with the headline numbers. The 1% increase in the reported profit from operations obscures the real progress that we've made this year. The 8% increase in profit on a like-for-like basis provides a better indication of our good underlying trading results. And Paul Rayner will, in his presentation, discuss with you the various accounting issues or exceptional items, and explain the difference between these two numbers.

My two colleagues will also review with you, in detail, the real drivers behind the exceptional 25 -- 23% growth in adjusted diluted earnings per share.

I should point out that the 10% increase in the interim dividend does not provide you with any guidance for the year as a whole. You will recall that we announced in February our new practice of declaring an interim dividend, which is equal to one third of the prior year's total dividend. The Board will review the 2005 dividend payout next year, when we approve the 2005 accounts.

I believe that this is an excellent set of results, which underlines that our corporate strategy, that we've had in place now for some time, really is working well.

The environment in which we operate continues to be challenging and we have in recent months seen excise shocks, the introduction of public smoking restrictions, and wider macroeconomic trends that have resulted in consumer down trading. However, despite these conditions, our own business is strong and improving.

Now, I feel top line growth is important for the long-term sustainability of all sustainable -- of all successful consumer goods companies, regardless of the sector in which they operate. And I just cannot understand why tobacco companies should be any different.

In the results that we have announced this morning, we have achieved organic volume growth of 2%. We've demonstrated that our global driver brands are doing well and our top line is growing, with net revenues on a like-for-like basis and the current rates of exchange up 5%. A figure that any consumer goods company would be pleased with and moreover, it's coming through to the bottom line.

So I believe these results really do demonstrate the long-term sustainability of our business.

We also continue to focus on productivity, as cost savings are an important driver of profit growth. We consequently continue to place a strong emphasis on cost reduction in the areas of overheads and indirect costs, as well as within our supply chain.

I believe that the willingness of this Group to contemplate the possible closure of our factory in Southampton, where cigarettes have been produced for about eight decades and really is part of B.A.T. heartland, shows management's absolute determination to reduce our cost base.

[Indiscernible] the dialogue in the social reporting process is an integral part of our focus on responsibility. We have, a few days ago, published our fourth social report and I would urge people to look at the report on our website. A brief summary will be sent to shareholders, but in the interest of the environment, the full report will reside on the website.

In discussions dealing with our harm reduction strategy, certain [sectors] have for some time been urging us to look into the area of non-combustible tobacco. In response thereto, we have in May launched Swedish style snus in two test markets, Sweden and South Africa. The product was launched under the Lucky Strike brand in both markets, and also under the Peter Stuyvesant brand in South Africa. The early signs from the test markets are encouraging, particularly in South Africa, where snus is a virtually unknown product.

Now clearly, none of these strategies would work unless we have the right people and the right working environment. And that really is the essence of our winning organization strategy. While from our experience this is often a topic which is not of particular interest to external audiences, let me assure you that internally it probably receives as much attention as our focus on growth, productivity or responsibility.

Overall, we have had an exceptional half year, although I feel obliged to remind you that the comparisons with 2004 will inevitably become more demanding in the light of the one-off tax benefit incurred in the second half of last year. There are also considerable uncertainties associated with forecasting finance costs under IFRS.

However, in a challenging environment for global consumer goods companies, we are demonstrating our ability to achieve organic volume growth. Encouraging profit growth from four of our five regions, the continuing benefit arising from the Reynolds American transaction and the real momentum behind our global drivers, all point to a highly satisfactory year.

Now, our medium and long-term goal remains to grow earnings per share, on average, by high single figures. Our results in the first half-year, especially when viewed against the background of our achievements over the last five years, would suggest that this is indeed a realistic and achievable objective.

I will now hand you over to Paul Adams, who will discuss our first half progress in more detail.

Thank you, Jan. Good morning everyone. I would like to pursue the growth theme in just a little more detail. British American Tobacco is about growth. Certainly bottom line growth, but if you're interested in the long-term growth, and we are, then there also has to be net turnover growth.

As I said at our investor meeting in May, I'm pretty open-minded as to how that net turnover growth is achieved - sales mix, geographic mix, pricing or volume. Any and all can, and do, contribute. But I believe that organic volume growth will be an important driver behind net turnover growth. Which is not to say organic growth is the be-all and end-all, but it's the way to bet for the foreseeable future.

Organic volume growth is also a major of the competitive strength of the business and its vitality in the marketplace. So how have we done so far this year?

After making allowances for the Reynolds American transaction and the change in terms of trade in Italy, organic volume from our subsidiaries grew by 2%, ahead of what we would expect from the business over the medium to long term. We have seen year-on-year share growth in many of our strategic markets - Japan, Russia, South Korea, Australia, Pakistan, Romania, Taiwan, Venezuela, Brazil, Germany, France, Turkey and Hungary, as well as many others.

Global drive brand volumes are up 6%, with important brand share gains in many of our key markets. Faster growth of the global drive brands is a key measure of overall mix improvement.

Let's spend a few minutes to see how volume growth has translated into growth at the net turnover and profit lines.

This chart shows volume and net turnover development for the first six months on a like-for-like basis and excluding the associates. In Europe, volume is down slightly for the six months, with lower industry volumes in Germany, Italy, Benelux and Hungary offsetting excellent volume growth in Russia. I'm pleased to report that in the discreet second quarter Europe volumes grew 2%. However, despite the adverse geographic mix in Europe, net turnover rose 2% at constant rates, as a result of price increases and the growth of global drive brands.

In Asia-Pacific there has been an adverse movement in geographic mix, with lower industry volumes in Malaysia and South Korea, resulting from excise-driven price increases. However, the lower volumes in these two markets have been more than offset by strong volume growth in Bangladesh and Pakistan. Both volume and net turnover have grown in the region but it is volume growth that is driving net turnover growth.

In Latin America it's a different story. A welcome return to volume growth of almost 1%, with higher volumes in Brazil and Venezuela partly offset by lower volumes in Argentina, as a consequence of the rise in illicit trade in that market. There is also an improvement in sales mix across the region and strong pricing, leading to double-digit growth in net turnover.

Africa and the Middle East is showing strong double-digit volume growth, mainly from Turkey and Iran, both the new opportunity markets. Turkey continues to be an important investment market for the Group and we're beginning to see rewards for our efforts in that market.

America-Pacific is affected by lower industry volumes in Japan and down-trading in Canada. But volume and net turnover growth elsewhere means that Group net turnover has increased 3% at constant rates and a very good 5% at current rates. This shows the strength of our geographic portfolio and underlines the sustainability of our business.

Looking at operating profit development, on the same like-for-like basis. Europe benefited from the price increases in Germany, good performances in Eastern Europe and lower costs.

In Asia-Pacific, lower profits from Malaysia were more than offset by good performances in Australia, South Korea, Pakistan, Taiwan and lower costs.

Latin America saw good performances across the board, with improved mix, pricing and higher volumes.

Africa and Middle East benefited from strong performances in South Africa and Nigeria, combined with lower costs.

I will cover two America-Pacific markets in a few moments. But excluding these two markets, the four other regions have demonstrated the effectiveness of our strategies.

After a relatively slow start to 2005, our global drive brands returned to form in the discreet second quarter, with growth of 9%, building on the cumulative annual growth rate of 8% since the year 2000. Compared to the first six months of 2004, our global drive brands have been led by Kent's 16% rise in volume, with strong growth in Russia and Romania now spreading into other markets in Eastern Europe.

Our mild volume growth of 18% was driven by gains in excess of 50% in Germany, Malaysia, Romania, Hungary and Poland.

Lucky Strike's performance is encouraging, up 1% the first half of the year and up 6% in the discreet second quarter, as solid share performances in several core markets and developments in its investment markets mitigated the effects of industry volume declines in Western Europe.

Putting aside the industry volume distortions in South Korea, Dunhill has met our expectations with a resilient performance in Malaysia, following last year's unprecedented excise hike, and good performances in the Far East and European test markets.

Some quick reports on key markets, which have been of particular interest to investors.

Following the introduction of a virtual indoor smoking ban in Italy, the industry's cigarette volumes are down 5% in the first half of the year, but just 1% in the second quarter.

Group profit is clearly affected by the disposal of the distribution business and change in the terms of trade. But on a like-for-like basis, it is down £4m, reflecting the lower industry volumes. Group share is stable at 30%, with the global drive brands Pall Mall, Lucky Strike and Dunhill each performing in line with expectations, while MS is stabilizing with a 15.5% share.

In Germany, profits increased during the period through price increases, improved market share and cost reductions. Lucky Strike and Pall Mall both increased share in a declining overall market. In particular, Pall Mall now has 5% of the total tobacco market, an increase of more than a share point year-on-year. Our share in the cigarette segment increased from 24.4% to just over 25%, whilst our share of the total tobacco market is also just over 25%.

The important takeaway is that our business in Germany has positive momentum and that makes us far more confident when we look at the implications of further excise restructuring in that market.

There were improved results from France, with market share and volumes up slightly. This was driven by Lucky Strike, Pall Mall and Vogue, each growing share, while profits benefited from lower costs.

Russia continues to be an excellent market, with volumes growing by 10% during the period. The growth was driven mainly by Kent and Vogue, with Kent further consolidating its position as the number one premium brand and increasing its share to above 4% in the top 30 cities, a rise of over a share point, which was also achieved in the top 100 cities and in Moscow. An improved product mix, therefore, together with a strong increase in volumes, led to a significantly higher profit.

In Australia, profits continued to grow, despite a small decline in volumes. The increase in profits was as a result of higher margins and an increase in overall market share, due to a continued strong performance by Dunhill and Winfield.

Profit in Malaysia fell, due to declining volumes, an adverse mix, higher marketing investment and compliance costs following the severe excise increase in September 2004. Pall Mall increased its share to 7% but lower Dunhill volumes resulted in a small decline in overall market share.

In the first quarter, there were some concerns over the significant industry volume decline in South Korea, following last December's excise increase and higher levels of competitive activity. I'm pleased to report that the Group's retail share rose a share point, to 13.2%, driven by Dunhill. And despite the significantly lower industry volume, profit was up strongly following the timing of excise payments.

In Brazil, price increases, mix improvements and a stronger local currency, resulted in good profit growth. Volumes also increased, due to an increase in anti-illicit trade operations. Both Lucky Strike and local brand, Hollywood, increased share. And whilst we're talking about Latin America, in Venezuela share rose 1.6 share points to 89.6%, not bad going.

In the Africa and Middle East region, profits grew strongly in South Africa as improved pricing, product mix and currency helped offset slightly lower volumes as the overall market declined.

In Turkey, volumes continued to grow significantly, with both Pall Mall and Viceroy increasing share on last year.

Canada. For Canada, the key developments in Q2 have been the lack of developments. The absence of excise increases means that the industry has had a period of relative stability following the excise shocks of 2003. The value-for-money segment is stabilizing at 40% of the total market. Our share of that segment is hovering at just under 40% and during the quarter there have been small manufacturers' price increases. Perhaps the key feature of the second quarter is the flat profit year-on-year.

But before there are any celebrations, I would warn that this stability is very fragile and can be disturbed by further excises increases or competitive actions. Nonetheless, a short period of relative stability is very welcome in Canada.

In the other America-Pacific market, we have good news. Japan has been intensely competitive over the past year, with Japan Tobacco raising its game and Philip Morris regaining control of its key brand in that market. Despite those developments, Group share rose to an all-time high in the second quarter, of 8.9%, making 8.8% for the year and for the half year. Kent and Lucky Strike both maintained share, while Cool's share rose slightly.

Finally, before I hand over to Paul, a brief comment on associates. Almost 60% of the associates line now comes from Reynolds American, which published a pleasing set of second quarter results yesterday.

In India, ITC's results benefited from strong volume growth and some one-off items. The Group's share of the post-tax results of associates rose to £196m. I'll now hand over to Paul Rayner.

Good morning, everyone. Paul's taken you through the regional segmentation of net revenue and profit from operations on a like-for-like basis. This slide shows profit from operations at current rates of exchange, prior to unallocated center costs and the exceptional items.

Under IFRS, we show net corporate costs not directly attributable to the regions. These are up £14m, at £56m, mainly due to exchange gains in the 2004 comparative. Excluding this effect, unallocated costs were down on last year.

There were two exceptional items in the second quarter. A £42m charge, principally arising from fixed asset impairment charges in respect of the U.K. operations, following the decision to transfer part of the U.K. production. We have initiated consultations on proposals to cease manufacture in the U.K. and Ireland, which would raise these restructuring charges to approximately £160m.

The other exceptional item is a profit of £68m arising on the sale of certain trademarks to Gallagher. Netting off the favorable exchange differences relating to the regional profits from the unallocated cost exchange differences gives a translation gain for the half year of £9m, which approximately equates to the 1% increase in profit from operations of £1.253b.

Taking into account the transfer of the Brown and Williamson business, the changes consequent on the sale of Etinara and the new terms of trade in Italy, and backing out the second quarter exceptional items, profit from operations on a like-for-like basis was up 8%.

Of all the lines in the IFRS profit and loss account, the net finance cost line is the most difficult to forecast. This is partly because financial instruments, such as derivatives, have to be recognized at fair value. This will be explained in more detail on the next slide.

The strong performance of associates, up £144m, represents our share of our associates' post-tax profits. And it's due to the inclusion of a pleasing result from Reynolds American, up £114m, and a good result from ITC, up £33m, due in part to an exceptional tax credit of £26m.

Here we have the breakdown of the net finance costs, which came in at £43m lower, due mainly to the recognition of a benefit in the half year, under IFRS, for derivatives that did not qualify for hedge accounting, plus exchange differences previously included in reserve movements under U.K. GAAP.

If we exclude the impact of IAS39 and IAS21, net finance costs were down £16m on last year. This reflects the Group's cash flows since June 30, 2004, a high level of investment income due to interest rate levels, and a strengthening of certain Latin American currencies.

The balance of the net finance costs are derived from exchange and interest rate movements, which are difficult to predict, so they may be volatile. We will review the issue later in the year, to see whether they should be included in the adjusted diluted earnings per share calculation.

The lower underlying tax rate for subsidiaries is 31.3%, which is slightly lower than the guidance they gave at the first quarter results, which was an IFRS tax rate of 32%. The lower rate is mainly due to the IFRS gains that I referred to earlier, which arise in the U.K. and are not taxable.

Going forward, the underlying tax rate should still be around 32%, if you exclude this volatility in the net finance costs. Apart from this, the principal drivers for the lower tax rate than last year are mixed. In other words, reduced profits in Canada, the absence of Brown and Williamson profits in 2005, together with the benefits of some debt restructuring. This gives a straight £1b of profit for the period, of which the minority interest of £62m, lower than last year, due mainly to Malaysia where we own 50% of the stock.

If we look at the drivers of adjusted earnings per share growth of 23%, this slide shows the drivers. Not all of these will be necessarily so beneficial in the second half of the year.

Underlying operating performance was up 8%, excluding the impact of the Reynolds American transaction. The Etinara sale and the new terms of trade in Italy had a marginal negative effect on earnings per share growth. The benefit we saw in the first quarter from the earlier recognition of profit in respect of stock in the distribution system has now been negated by the loss of the Etinara profit stream.

Lower net finance costs gave rise to a 6.8% improvement in earnings per share. And as I said earlier, they may be quite volatile in the second half of the year.

The earnings-enhancing effect of the Reynolds American deal is evident, with earnings per share improved by 3.3%. The improvements in tax from minorities are as I explained earlier. We intend to recommence the share buyback soon and the calculation is based on 2,125m shares. We bought back 25m shares during the first half of the year, at a cost of £264m.

Turning to cash flow, IFRS requires a different format for the cash flow statement. But the main change is that the statement explains the change in cash and cash equivalents, rather than just cash under U.K. GAAP.

Net cash from operating activities was £71m lower, at £880m. This reflects the impact on cash generated from operations, following the disposal of Etinara, the Brown and Williamson business and Laine, and the associate dividends received from Reynolds American, as well as the timing of cash flows and the run-off of restructuring provisions.

Once the full synergy benefits have been realized and dividends increased, we anticipate that dividend income from Reynolds American will exceed the Brown and Williamson cash flows that we would have expected if the deal hadn't been done.

Net cash inflows from investing activities was £40m, compared to outflows of £43m in the first half of 2004, despite slightly higher levels of capital expenditure. This was mainly due to the disposal of brands in 2005. Net cash outflows from financing activities were £890m, down £523m on 2004, mainly due to swings on borrowings. In 2005, proceeds from new borrowings outweighed repayments by £308m, while in 2004 repayments outweighed proceeds by £246m.

Other principle outflows include dividends of £670m and as I said before, the purchases under the share buyback program of £264m. These flows resulted in a net increase of cash and cash equivalents of £30m, compared to a decrease of £505m in 2004.

I'll now hand over the proceedings to Jan.

Thank you, Paul. Well, that finishes, of course, our formal presentation. Any questions? Before we take questions, can I just ask that you just identify yourself by reference to your name and the organization that you represent? I would also just ask if you ask the questions very briefly, summarize or repeat your question for the purposes of the webcast.

Mark Lynch from Goldman Sachs. Second quarter volumes were up about 3.4%, first quarter about 0.6%. Is there any particular reason why there was this dramatic acceleration in the quarter?

Your question relates to the apparent increase or acceleration in volume growth in the second quarter compared to the first quarter. And I guess, Paul, you'd like to comment.

Yes. A lot of it has to do with industry volumes, particularly in South Korea. If you remember, our volumes in South Korea were down considerably. There's been some comeback, also Italy was down, industry volumes were down in Italy by, what was it, 9% in the first quarter and they were down only by 1% in the second quarter. So we've had some help from market sizes with those volumes. We've also seen a relatively benign situation in Canada in the second quarter. So as a result of that, plus good momentum from our global drive brands, where there was a lot of activity behind our global drive brands, launches, re-launches, product improvements in the second quarter, and you put those two together and that's how you get that figure.

Just on South Korea, following up on that, can you just explain a bit more about why the strong profit growth came in, you talked about the timing of excise payments?

Yes. [Indiscernible] people that regards to your comment on the increase for the profit growth in South Korea and the relationship between excise payments and volumes.

Yes. It's -- the short explanation is it's similar to what used to be forestalling in the U.K. So excise went up on December 30. A lot of British goods by all manufacturers paid excise at the lower rate before that. That volume was sold in the first quarter at a higher price but at a lower rate of excise, hence you get the extra profit.

David Allen from ABN Amro. One follow-up question on the interim dividend. An interim dividend of one third of last year's total dividend would have been up 9% rather than 10% that you've announced today. A year ago, when you reduced your policy dividend growth from 10% to 8%, you said that's more realistic to reflect what we think we could aim to achieve over the next five years. I just wondered if you could clarify what signal a 10% interim dividend is sending and in what timeframe. And are you saying that you are now more optimistic over the medium term?

The question relates to our announced interim dividend and the relationship between the interim dividends last year, the final dividend, and what can people read into it. I guess that's more or less the question and I'll just respond to that myself.

Now, what we said last year, that because we don't think it makes any sense for us as a Board to consider this stage of the year what we think the full year results might be. And we know that investors read all sorts of things into your increase in interim dividends, which we think is rather pointless, and that is why we said last year that indeed our interim dividend will be equivalent to one third of the previous year's full year dividend. In fact, I remember, we specifically saying that to give you guidance and we think our interim dividend for this year would be £0.14.

So our interim is exactly what we said it would be, really, that is equivalent to indeed a 10% increase. I doubt that you'll get anything in terms of dividend policy for the year and we will consider our dividend policy -- our dividend for the full year in the first quarter of next year, when we approve the full year results. So you can't read anything into the dividend that is declared now.

Next?

[Inaudible]. If I may, can I ask you four questions? Hopefully, some will be simple. My first one is on South Korea. Obviously, there has been a lot of volumes in terms of destocking and the [indiscernible] project. Could you give us a number in terms of profit, in terms of pounds, to [indiscernible] that we can expect now and in the future?

Secondly, on Canada, am I right in thinking that the -- if you look at Q2 versus Q1, the decline of premium, that's essentially the whole market [indiscernible] jobs? In other words, I appreciate your remarks that Canada is now fragile, but it appears to me that maybe something's wrong, that the down-trading is essentially a favor, if you compared Q2 versus Q1.

Thirdly, on Italy, I note you said that shipments in Q2, industry shipments, were down 1%. Do you have a idea in the [indiscernible] for consumer trends in Italy? In other words, that's a major improvement, on my understanding, of what happened in Q1, and also my understanding of what happened April and May, in terms of consumer trends. So can you address that one?

And finally, while I'm wittering on, can I ask a question of Neil, who I think's somewhere there, about the [law brief], British Columbian law case in the Supreme Court? Firstly, is there any news on it? And secondly, if the Supreme Court [indiscernible] British Columbia reconstitution of it, what are the implications for you?

Paul, while you just check your numbers on the first three questions, shall I just repeat them very briefly. Paul is asked firstly to comment on the position in South Korea, where we need to expand further on the profit impact of forestalling and been invited to quantify what is referred to as the so-called funnies in South Korea.

Second, with regard to Canada, we referred to the apparent slowdown in decline of the premium sector in Q2 compared to Q1. What does that really signal?

Thirdly, with regard to Italy, where we made the remark about Q2 shipments. And the question is in Italy, regard to Q2, is there a difference between industry shipments and consumer trends. I will hold the legal question until we get there, Neil.

Okay. Do you want to have a crack at Korea?

I'll have the crack at the first question. The answer's somewhere between £5 and £10m, but that isn't an exact number.

I will take the point on Italy. I think you will see a decline in Italy in the overall market size, which is probably what you are trying to get at. Certainly higher than the 1% decline which we saw in the first quarter, probably somewhere between 4 to 5%, I would think, overall decline in Italy.

And you're quite right about shipments. Consumers though, are, how shall I put it, in Italy adjusting their behavior to take account of the smoking restrictions, particularly in [Horica]. So the consumers are moderating their behavior. But I still think you will see a decline, but it won't be anything as benign as that second quarter.

The final question is addressed to Neil Withington, our Senior General Counsel, and that relates to the legal position in British Columbia. And I guess, Neil, could I ask you to come to the --?

Just do Canada.

I'm sorry, I do apologize. Paul back on Canada.

Okay. On Canada, we can do it either way but let me just give you the size of the premium statement in Canada. And what I'll do is I'll give you four numbers - Q3, Q4, Q1, Q2 - and they're rounded to the nearest whole number. So Q3 was 64%, Q4 was 62%, Q1 61% and Q2 60%. So there's a slight decline in the size of the premium, very slight. But I think you can legitimately use the words stabilizing, we're not the only ones who've used that word. I think you can legitimately use that.

The point to bear in mind is that that has yet -- we have yet to see any further excise increases. There were no excise increases in Q2. Ontario and Quebec have made noises about increasing excise. We may well see excise increases in the second half of the year. Neil, we may well see further significant competitive activity in the value-for-money segment in the second half of the year. Which is why I describe the somewhat benign situation in the second quarter in Canada as very fragile, so I wouldn't take that second quarter performance and just run that out now. I think we may yet see further declines in the premium; we may see yet further increases in excise that will fuel that decline.

Okay. And I think finally, Neil, could I can ask you to come to the front? Neil Withington is Senior General Counsel. We'd invite you to comment on the legal position in Canada and specifically with regard to the developments in British Columbia.

I think it was British Columbia, Adam, there's no news. If you remember, the application to appeal to the Supreme Court of Canada was June 2004, but it was June 2005 that that hearing took place. My guess is that we may hear something from the Supreme Court before the end of this year, but it's in their hands. The implications, if the Supreme Court find the BC statute to be constitutional, is that the matter goes back into the trial process within British Columbia, and off we go. We're into the trial process itself. Which will take some years.

There's the whole question of what the shape of the case is going to look like, what documents are going to be discovered, what evidence is going to be taken pre-trial and that will take some considerable period of time. In parallel, there's the issue of the non-Canadian manufacturers, where Mr. Justice Holmes found that the so-called ex-juris defendants, the non-Canadians, are actually in the case.

That matter will be appealed and that will take some time. We think we're pretty strong on the arguments in that. In fact, the view of the Canadian industry is that they've got pretty strong arguments on the unconstitutionality of the BC statute in any event. So there's a way to go on it. We'll see what happens.

Okay.

Anything else?

I was going to follow up. The general consensus is that litigation in the U.S. is, everyone's pretty comfortable with it because [inaudible]. To what extent would you say that if this turns out to be constitutional, it's quite different -- would you agree with the statement that it looks quite different from the environment, given unpredictable litigation under the statute to litigation [indiscernible] the various U.S. legal [indiscernible]?

You can answer, but can I just sum you up for the webcast? You said that Neil's being asked to compare the litigation position in the U.S. today with what you find in Canada currently, and comparing the litigation in Canada, which is under constitutional arrangements.

The simple answer is it's very different, because the statute in British Columbia is a unique statute, which uniquely tilts the playing field in a way in that the Canadian industry and ourselves believe is fundamentally unconstitutional. So the environment is different. It's not a traditional smoking and health case in that sense.

On the other hand, one can find oneself surrounded by opportunity in circumstances where people use unique theories and unique statutes in an attempt to make it easier for them to recover. So it will be different, but the Canadian legal system is a good legal system with good judges, good procedures, good counsel, and the opportunity to state your case is clear and unambiguous. It will take time.

Thank you Neil.

Okay.

Next question. Chris?

Chris Wickham from Lehman Brothers. Just three quick questions. One, on Canada, there's always been comments from your large competitor there, that one of their incentives for lowering the prices for cigarettes has been for themselves to shift their product mix out of fine cut into the factory-made cigarettes. Given that they have already been through that process, and had some of the profitability benefits, do you really sense that they would have a big incentive or interest in seeing further competitive activity in the final two quarters of this year?

I was wondering, secondly, if you could clarify just your position again on snus and those non-smoking tobacco products, especially the [indiscernible] that Hanson has done, comments in the market about interest in listed companies that were producing in that area.

And thirdly, I was just wondering if you could perhaps revise again or just let us know on the impact of currency this year, because clearly you do have a long-term interest in producing high-single-digit earnings growth. Which I guess we'd consider that to be satisfactory, and this year we are expecting a highly satisfactory year. And I was just wondering whether, in the context of the 8 or 9, highly overrides that.

Paul, will you take the first two questions on Canada and snus? The first question deals with the situation in Canada and the question deals with the intentions of our major competitor in Canada to shift the market and the relationship between fine cut and factory-manufactured cigarettes and what we think currently their intentions might be.

And second, you're also, Paul, you're asked to comment on test launches of snus with respect to Sweden and South Africa. And then we'll hold the currency question.

On Canada, I'm somewhat reluctant to speak about our competitors in Canada. I think you're right, though, that the size of the roll-your-own segment in Canada has decreased significantly, as people have switched into low-price cigarettes, and to some extent that has run its course. And the size of the value-for-money segment, as we've said, has pretty much run its course, in terms of its increase.

So as you say, one might argue for stability, one might argue, therefore though, that our competition will be looking for growth and where's it going to come from. I doubt they're be able to get it from the premium segment, so they may have increased activity in the value-for-money segment in an effort to get further growth. I don't know what their strategies are, but I certainly wouldn't rule out more increased competitive activity.

The last half, they did this because they were getting themselves up-trade in terms of their product mix. They were able take that activity and enjoy a profit increase at the same time, whereas Q3, Q4, they would necessarily suffer a decrease.

Right. Sorry, on snus, Chris, can you just -- I'm not sure I understood your question on snus.

If you could give us some comments about the [inaudible] buy a bigger interest in that whole area, [indiscernible] corporate activity?

No.

Just to clarify for the webcast, Paul Adams just confirmed there really is no likelihood of there being "corporate activity" in the field of snus.

Just to clarify that, we remain open minded. But I think it's unlikely at this point in time, just in case I get rung up by the take-over panel.

So finally, before we take the next question, so Paul, I think generally you're encouraged to ask to comment on the whole impact of currency developments last year and this year and what might it mean in terms of [proper] guidance.

The effect of currency on the first half, as you know, Chris, wasn't that substantial. It was about £9m gain which took us up from 7 to 8% when you looked at the like-for-like basis and improvement in profit.

If rates stay where they are, and, of course, that's a big assumption, for the second half, the second half translation gains should be higher than the first half. They could be 2 to 3 times higher.

Most currencies have moved our way when you compare the average rates this year. And even though there's -- and even though there's -- and recently, obviously the U.S. dollar's been strengthened. That helps us a little bit as well. So in the second half if the rates stay where they are we will have a more positive effect than the first half, which his good to see compared to what we have had in prior years.

Gerry Gallagher, Deutsche Bank. Just to come back on the currency, if we're going to run our models out to '06 and beyond that, use the current rates to the material benefits [the distance] in '06. Your competitors in the past when things have been in their favor have used that excess profitability, if you want to term it as that, at the source of A&P behind the brands. Would you contemplate doing that or would you just see the currency as something that comes through naturally?

No. I think we'd stick to our strategy. The cost savings are generating savings which we can reinvest in the brand. That's our strategy. In the past we have had to wear the translation gains. We have been able to make up the EPS from below-the-line activities, interest and tax savings. I think, going forward, we just have to take each 6 months as they come. But no, we wouldn't have any plan to do, as you say, in terms of reinvest in those gains and brands, no.

Thank you. Michael Smith from JP Morgan. The slide where you show the drivers of adjusted earnings growth I find particularly useful, and now factoring in those foreign exchange comments and obviously trying to figure out the full year numbers. The Reynolds American benefit of 3% you give in the first half compared to 5% Q1. I'm just wondering if they deliver in line with their own guidance for the full year, what would be the benefits to your approved earnings level of that transaction stand alone?

And secondly, just to understand the mix improvement a little better, during the period 2000 to 2003, I remember very strong dry brand performance but weak international brand performance. We appear now to have both. What's changed? Which are the brands that have really moved outside of dry brands? Which of the international brands are growing and is it sustainable? Do you see that for ongoing [indiscernible]?

I think the first question should go out to [indiscernible] related to the contribution of the Reynolds American transaction to overall earnings. And it was pointed out that in the reconciliation of the key drivers which explain the 23% adjusted EPS growth, the Reynolds American transaction, or deal, contributed approximately 3% after approximately 5% in the first quarter. Your question is to Paul, what might be the impact in the full year on the assumption that, indeed, Reynolds American produce the sort of results that that [indiscernible] market. Do you want to take that?

Yes, I'll deal with that. The figure could be closer to 4, a bit over 4%, taking their numbers. That's assuming that the adjustments that we take to the Reynolds numbers are in line with what we took in the first half.

Now there aren't that many adjustments now. If you take a straight extrapolation of the Reynolds figure for the first half, you get £119m last year, and we took [£114m]. The only difference of that was [life of] accounting. So as to what the [life of] accounting might do in the second half, they can drive that figure, one way or the other.

But putting that aside, I'd expect it to improve because [indiscernible] actually had quite a good result in the second quarter last year. So it will be closer to 4%, if not a touch over.

Okay. Second question relates to the question of advanced mix and the relative performance of the global dry brand and the other international brands. It was pointed out that a few years ago in 2001, 2002 and 2003, the global dry brands did well but, indeed, the other international brands did less well. And the question is is there a change taking place there.

Yes, and there is. Just to give you the numbers. The global dry brands, on a like-for-like basis, grew by 6%. That's having taken out the windfall that was gained in Italy where they would have been included. If we include the windfall it would have been 7%. But on a like for like, 6%.

Now, total IBs in the same period increased by just under 7%. So where's -- what's happening in other IBs, what's happening in other international brands. And the answer is Viceroy and Vogue. Viceroy was up 41% and Vogue was up 22%.

Now I say this with some temerity because we haven't approached them -- the analysts with this yet but, internally, we look at 4 plus 2. We look at 4 global dry brands and plus 2. The plus 2 are Vogue and Viceroy, which is not to say that we've now got 6 global dry brands. We only have 4 global dry brands. But internally, we talk about the 4 plus 2 strategy. And we're pushing Viceroy and Vogue. 1 is super premium and the other is value for money international. So those are what's really driving the other IBs.

But the other little piece of good news is if you look at our local and regional brands in the same period on a like-for-like basis, they declined by under 1%. So almost flat for our local and regional brands. And, of course, the secret to gaining growth is not only to get growth but to stop decline. And so that's helping us.

Next?

[inaudible]. [Out in the Middle East] your volumes are up 11%, your net turnover is up [6] roughly, so [next to] 5% price mix. Can you just run through which market and what was driving that?

And secondly on Turkey, great volume market share -- market share. But where are we in terms of profitability contribution [and the price mix].

Paul, you take the 2 of them? The 2 questions relate first of all to the position Africa, Middle East, where the reported volume growth of 11% but near turnover growth of between 5 and 6%, Paul, ask you to comment on the differential.

And second, with regards to Turkey, where did we stand on Turkey in terms of potentially reaching profitability?

Well, the main driver of the differential is, in fact, Turkey, where volumes are up substantially, over 400%. And the margins in Turkey are very low. So that's the main reason for the low improvement in net turnover compared to volume.

Turkey is still incurring losses. Lower levels of losses than we have experienced in the past. We have got off to a tough start to the year, especially in the first quarter, where they had to absorb some excise increases before they were able to realign their product and new excise system.

The second quarter wasn't too bad. But still running a level of losses. We're not at break-even point yet. So in the longer run we expect higher volume or an improvement in this profitability, which is not very strong, but it is getting better. And it's nowhere near the level of losses we have experienced in the last 2 years.

Chas Manso from Dresdner. On your EPS you mentioned 2 exceptionals, net finance cost and the Indian associates tax credit. Could you give us what your EPS would be without those exceptionals?

Yes, the question about EPS, I will just state [as a misunderstanding], there's a question related to EPS growth and suggest that in the EPS growth the 2 exceptional, that is, the 1 relating to the net finance charges, and secondly, the 1 related to the special tax credit in India. Paul, do you want to comment?

Yes. The special tax credit in India is not included in the adjustment diluted earnings per share calculation. That has been excluded. So we had 2 exceptional gains. 1 on the associates and 1 on the subsidiaries, both of which were about £26m, I think. But they're both excluded from the calculation.

Net finance cost is included. Overall, that drove a growth in earnings per share of around 2.3p or 6.8%. And, as I said in the presentation, a large part of that is due to the IFRS adjustment in relation to derivatives and movements that previously used to go to reserves. A small part of it is due to lower interest cost which obviously is not affected by IFRS.

So, does that answer your question?

A couple more. Could you -- your marketing spend last year was up £100m. I understand it was up again in the first half. Could you give us an indication of how much it was up in the first half?

And on your global market share, could you tell us where you think your global market share now is on Q2 versus a year ago?

The 2 questions relate first of all, Paul, you take the marketing spend, the first question is last year our marketing spend was reported to have increased by £100m, what is our marketing spend during the first half of this year.

And then the second one deals with our share of the global cigarette market which will [indiscernible].

Without giving a specific number, marketing spend was up in the first half in the low single-digit percentage area. When we get to the full year when we disclose our full-year cost savings from the various productivity programs, we give some more detail as to where that money has been spent. But at the half we won't do that. But I can say, for the half, it is up slightly.

Chas, I understand the question. I'm sorry, I can't answer it. I haven't calculated what our global market share is in the second quarter. Far too focused on driving earnings.

Right. Are there any more questions? Right in the back there.

It's [John Phelps] from Morgan Stanley. 2 things. First of all, for [finance call], you used to say, I think, that around half your earnings were effectively generated in U.S. dollars. With the changes you've been making with sorting and managing your business for the last couple of years, has that changed at all?

And second thing, on your capital structure, there has been a bit of comment the last quarter about your balance sheet. I wonder if you could tell us a little bit about how you view your current capital structure. In your view, is it optimal? Are the rating agencies holding you [back] from the kind of coverage and gearing ratios you'd like? And would you ever consider using more aggressive buybacks to gear up your balance sheet?

So, 2 questions for our Finance Director. The first relates to the question of currencies where there was a time when approximately 30% of earnings related to those from dollar-related areas. And the question to what extent has, as a result of the way in which we have restructured the business, how has that shifted or changed.

And second, Paul, you have to comment generally on our Group's capital structure, the same for the balance sheet, the impact of rating agencies and decision making with regard to the balance sheet. And do you think it is likely that we may be prepared to consider, I think the question was, a more aggressive share buyback program in the foreseeable future?

On the first question, the percent of our profits, if you include associates, is U.S. dollar denominated, and this is prior to Malaysia just recently changing their structure and not being pegged to the dollar, was about 38%, to be fairly precise. That's the way we saw it for this year, for 2005. If you take out Malaysia we'd be getting close to down to 35%. And the next highest currency after that is euro, which is now about 22%. So those 2 make around 60%.

In terms of the capital structure, we have said many times that we want to maintain a credit rating which is at least 1 above the minimum investment grade. We are 2 notches above now. I think you will see, historically, we have been generating sufficient cash to both pay and increased dividend and pay back and buy back shares. And the rate of share buyback has been round about £500m per annum. And that's left our net debt levels round about the same.

I think that's where we are right now and that's how I see things for the immediate future. I don't think that our credit rating is going to change in the near term. The credit rating agencies are concerned about the potential litigation cases in the U.S. that may get resolved.

But even if they are resolved they still will look very closely at cash flows as a percentage of net debt. And we are not at the ratio levels yet that I think would require -- would mean that we would be able to have a permanent increase in our credit rating. And if we continue as we are to basically return all our cash to shareholders, then obviously our net debt is not going to go down. So I think where we are now is probably a good guess as to where we will go in the future.

I think, ladies and gentlemen, probably time's up unless there is somebody who's desperate for a question. But if I don't see any hands pop up immediately, can I thank you all for coming this morning. And we look forward to seeing you again in 3 months' time. Thank you.