英美煙草 (BTI) 2007 Q2 法說會逐字稿

I think it's ten 'o clock. Good morning everyone. I'm Jan Du Plessis, Chairman of British American Tobacco, and with me are Paul Adams, our Chief Executive, and Paul Raynor, Chief Finance Director.

First of all, let me apologize for the late start this morning. This was due to a security alert, resulting in the closure of the road outside. I'm happy to say that the all-clear has been given, so that I'm told that it is now indeed safe for us to take you through our interim results.

There will as usual be an opportunity at the end of this for questions from the audience. There is also a facility for those of you who are listening on the conference call, or watching via our website bat.com, to email your questions to Rachael Brierley. The address is rachael_brierley@bat.com. Rachael will pick up your questions and will send them through to us in the auditorium so we can take them as well.

But before giving you my main impressions on our results today, let me begin by briefly running you through our headline numbers. Overall, volume declined by 2%, affected by a number of one-off factors, which we reported earlier this year, although sales of our global drive brands increased by 6%. Revenue was lower due to adverse currency movements, but in constant currency terms grew strongly by 4%. Profits from operations, excluding exceptional items, was particularly strong; up 9% at current rates of exchange, and an outstanding 18% at constant rates.

Our associated companies continue to perform well, although our share of their post tax results, excluding exceptionals, was down by 2%, mainly due to currency, and a particularly strong second quarter last year for Reynolds American. In constant currency terms, our share of their profits would have grown by 6%. With only relatively minor movements in the interest, tax, and minority lines, adjusted diluted earnings per share rose by 9%.

We continue to reward our shareholders with increased dividends. Our policy of paying an interim dividend representing one third of the previous year's total dividend, resulted in our interim dividend being increased by 18%. You will also recall we announced earlier this year that our dividend payout ratio for [for reference] adjusted diluted earnings per share, will rise to 65% by 2008.

However, stepping back from the detailed numbers, what are to me the three most important features of these results? Firstly, (inaudible) can demonstrate the ongoing improvement in the quality of our business, which has been a feature of our performance in recent years.

Although we continue to be confident in our ability to achieve organic volume growth of 1% to 1.5% per annum on average over the long term, volume in the first half has been affected by a number of one-off factors, and consequently declined by 2%. However, our brand strategy, with its focus on our portfolio of global drive brands, continue to drive a favorable change in sales mix, with our premium priced brands consistently outperforming our lower margin local brands.

In addition, we continue to invest behind innovation, and over the last six months we've seen some exciting new product launches, such as Kent Nanotek in Russia. We will also continue to achieve price increases. And taken together, these initiatives have enabled us to translate a 2% volume decline into 4% revenue growth at comparable currencies.

Secondly, we continue to derive significant strength from our unique geographic diversity. We are pleased about the fact that we have achieved growth in profits from operations at comparable rates in four of five regions, with Africa and the Middle East up 25%, and Latin America up 35% on the previous period.

And thirdly, the weakness of the dollar and dollar-related currencies during the period, and indeed the strength of sterling against virtually all currencies, including the euro, have had a significant adverse impact on our results, and reduced our profit from operations by GBP115 million. Notwithstanding this, we have been able to report earnings per share growth of 9%, in my view, a tremendous achievement; truly sterling results in a strong currency.

However, our commitment to product innovation, the geographic rollout of our drive brands, and the strengthening of our distribution channels, require investment, and the level of investment this year is weighted more to the second half. In addition, we have in recent weeks seen some significant excise increases in a number of key markets, such as South Africa, Brazil, and Malaysia. As a result, we expect our growth in profits from operations at comparable rates of exchange to slow in the second half of the year.

Overall, these are in my view a good set of results which demonstrate once again that our strategy is working in delivering value for shareholders.

So on that note, I pass you over to Paul Adams.

Good morning, everyone. Thank you again. As Jan said, Group volume is at GBP330 billion; we're down 2%, mainly as a result of the high level of shipments in some markets in the fourth quarter of last year, ahead of excise-driven price increases. Russia in particular was affected, ahead of the January excise increase. Group volume was also affected by the change in distribution arrangements in Iran and Turkey and the loss of StiX in Germany. Despite volumes being down 3% in the first quarter and down 2% for the half-year, we expect volume to grow in the second half, and full-year volume to be similar to last year's. Global drive brand volume grew 6% to GBP72 billion, up 8% if the move from Pall Mall StiX to Pall Mall RYO in Germany is included. The global drive brands now represent 22% of total volume.

Dunhill was up 8%, driven by strong performances in South Korea, South Africa, Russia, and Saudi Arabia. Kent was up 11%, with solid growth in Russia, Romania, Ukraine, and Chile. Lucky Strike volumes were down 3%, as good performances in several markets were more than offset by the impact of industry declines in Germany and Japan. Excluding these two markets, Lucky Strike volume was up 6%. Pall Mall increased volumes and share in a number of markets, and although volume only rose 4% due to the loss of StiX in Germany, volume would have been up 9% if sales of RYO in Germany are included.

Turning now to the regions. Profit in Europe grew 6%, mainly as a result of higher margins in Russia, Romania, Hungary, and Spain. Volumes, however, fell 4% due to the loading by the trade seen in Russia and Serbia at the end of 2006 and the loss of StiX in Germany. Although volume was lower in Russia, profit grew strongly, with both Kent and Vogue performing well. In Italy, higher margins offset the loss of profit following the sale of the Toscano business in July 2006. Volume rose with both Lucky Strike and Pall Mall increasing share. Germany continued to be impacted by the loss of StiX; however, Pall Mall grew its market share. Results improved in Spain, significantly, benefiting from price increases and Lucky Strike continue to grow both volume and share.

Asia Pacific maintained its strong performance from the first quarter with revenue, volume and profits all higher. Profit grew 10% despite the adverse impact of exchange. Australia continued to grow profits, despite some competitor discounting and increased its market share with good performances from Dunhill, Pall Mall and Winfield. Malaysia continued to be impacted by lesser trade and the growth of the low price segment.

Both South Korea and Vietnam recorded strong profit growth from higher volumes and lower costs. Pakistan grew both profits and volumes, leading to an increase in overall market share. Profit in the Latin America region grows strongly due to good performances in Brazil, Venezuela and Chile, partly offset by the adverse impact of weaker local currencies.

Brazil was particularly strong as a result of price increases in anticipation of an excise increase which took effect in July. The second half performance in Brazil will be tempered by the excise increase. The Africa and Middle East region continued its strong profit performance, despite the impact of weaker currencies exchange, impacted revenue, which was down 9% at current rates, but would have been up 4% at constant rates. Volume growth was held back due to the disruption of supply to some Middle East markets, and a change in the distribution model in Turkey. In South Africa share growth and higher prices and improved product mix led to good profit growth.

In the America Pacific region, profit was 15% lower, mainly due to Canada and the impact of weaker exchange rates. Industry declines in both Japan and Canada led to lower volume. Canada continues to be affected by the growth of a listed product, which now accounts for one in three cigarettes in some provinces. This, together with the continued down trading to lower price products, and the higher initial costs of direct distribution, lower volumes and exchange, resulted in profits falling GBP29 million to GBP107 million.

In Japan, market share grew to over 10%, due to good performances from Kent and Kool. Industry volumes were lower following the trade loading in the comparative period in 2006 which had an adverse affect on profits.

Paul Raynor will now take you through the rest of the presentation.

Good morning everyone. The next two slides show graphically the impact of weaker currencies on revenue and profit on a region-by-region basis. Revenue at constant rates grew 4%, despite volume being 2% lower. Latin America was a star performer with revenue up 15% at constant rates and 9% at current rates of exchange, as a result of higher prices, phone cards and better lease margins in Brazil. In Asia Pacific, stronger volumes and improved pricing resulted in a 3% rise in revenue, despite the impact of exchange. Revenue growth in Africa, Middle East and Europe was negated by exchange.

Looking at profit on the same basis, the 18% rise in profit at constant rates and lower volume of 2%, reflects improved pricing and the favorable timing of spend in some markets. At current rates, the exchange hit was GBP115 million, because of the timing of spend and excise increases, we do not expect this level of profit growth at constant rate to be sustained in the second half of the year.

The Group's profit per (inaudible) was up 12% at current rates to GBP4.61. With the exception of America Pacific, each region recorded good growth in profit per (inaudible). Each region has also improved its operating margin, and the Group's margin has improved from 28.9% to 32.2%, and the Latin America region now has the highest margin at 40.9%. Not only will the Latin American margin be reversed in the second half of the year following July's excise increase in Brazil, but the Group's margin will also be reduced on the first [tile].

Paul has already discussed the drivers behind the regions' operating profit, so a comment on allocated costs. These were down GBP15 million at GBP45 million, due mainly to the timing of expenditure and recoveries. GBP45 million is probably a good guide to the level of unallocated costs in the second half of the year. Profit from operations, excluding exceptionals, was up 10% at GBP1,521 million.

Restructuring costs were GBP40 million for the period, and arose principally in respect of the costs associated with restructuring the operations in Italy. By this time next year, all operations in Italy should be consolidated in the last remaining plant in Lecce, and bearing in mind that we acquired seven factories at the beginning of 2004, the consolidation to one factory has been an outstanding achievement. The GBP11 million gain arose as a result of the sale of the Group's pipe tobacco trademarks to Orlik Tobacco for EUR24 million.

Net finance costs at GBP126 million were just GBP2 million higher, and I will discuss this in a moment. Our share of the post tax results of associates was GBP21 million lower at GBP222 million, and this was due to the one-off tax gain at Reynolds America in 2006, an adverse exchange. If you exclude the exceptional item, the result for associates would have been 6% higher at comparable rates of exchange.

Net finance costs are GBP2 million higher than last year, reflecting lower net interest payable which has benefited from translation gains. This was more than offset by a lower credit from movements in fair value and exchange than we had in 2006. In the second half, it's expected that finance costs will be impacted by the increase in the dividends and the higher share buyback program.

For the purpose of the adjusted earnings per share calculation, the underlying tax rate was slightly higher at 30.8% for the quarter, compared to the 30.6% for the comparative period last year, the small increase the result of the 2006 result, including a tax credit, following the successful resolution of prior tax audits which is not repeated in 2007. But that's partly offset by mixed benefits in the current year. We are targeting a rate for the year of between 30% and 31%. Profit for the period rose 8% to GBP1,168 million.

The strong performance at constant rates of exchange was the main driver behind the growth in adjusted earnings per share. Net finance costs were slightly positive and associates contributed just over 1% to the growth in adjusted earnings per share.

Tax was virtually neutral, but the higher profit from Brazil resulted in an increase from the minorities charge. The share buyback benefited earnings by 0.8%, and the calculation was based on 2,052 million shares. We intend to resume the share buyback following the publication of these results.

The adverse foreign exchange rates had a 9% impact on adjusted earnings per share, bringing the figure down to 53.5p which was a rise of 9%.

Finally, cash flow. Is cash from operating activities increased GBP332 million, reflecting the benefit of favorable working capital movements in the first half, and the growth of the operating performance. However, it is expected that these working capital benefits, compared to last year, will reverse in the second half.

Capital expenditure is also down on the first half of 2006, but we expect a higher level of capital expenditure in the second half of the year, resulting in an increase over the 2006 full year level, as we continue the restructuring of the factory footprint, and increased manufacturing capacity in Russia.

Higher levels of dividends and share buyback mean that net debt has risen from just under GBP5 billion at the end of 2006 to GBP5.4 billion at the end of June 2007.

That's the end of the presentation, so I'll hand over to Jan, who will start the question and answer session.

Thank you Paul. We move on questions and answers. And is the custom, if I can ask you in each case, when you ask your first question just to give your name and the name of the organization that you represent. Yes?

(Inaudible) with JP Morgan. I just wanted to get comments on some of the regions. First about Brazil. If you could talk about what that means for the second half in more detail; what needs to be tempered. Is it fair to assume we might see profits flat year-over-year in the second half?

Secondly, with respect to Russia, is it fair then to assume that we'll see a recovery in volumes, and does that mean we should expect an acceleration in Russian profit?

And thirdly, with respect to Asia Pacific, is it fair to think that that could continue at current levels, even with the Malaysian tax increase? Or will that have a meaningful impact?

Thank you.

For the purpose of the webcast, I'll just say that the question was inviting comment on the outlook for the second six months of the year, with regard to particularly three areas. Firstly was Brazil, and the question was actually, whether we were expecting Brazil essentially flat profits for the second six months of the year.

The second related to Russia and then an invitation to comment on volume developments.

And thirdly, the outlook for Asia Pacific. Might it be a fair assumption to assume that Asia Pacific profit growth will continue in the second half along the trend of the first six months?

Paul?

Okay, why don't I take Brazil?

Yes there was a 30% excise increase in Brazil just recently. And price increases were taken in anticipation of that excise increase well before that. So if you like, there's been a sort of windfall because the price increases were in place well before the excise took place. And that explains a lot of the Brazilian performance in the first half of this year.

Because excise has gone up by 30%, and prices have gone up -- sorry not prices have gone up, but excise has gone up, that is obviously going to affect our margins, and we will expect to see some slow down in the volume. But it's a question of, principally margin, but also a slight drag on volume. We still expect to do well in Brazil. We're still expecting to see profit growth in Brazil in the second half of this year, and just for the record, we expect to see profit growth in the second half of this year for BAT, just in case anyone was wondering. So, yes, profit will do nicely in both cases.

In terms of Russia, yes, Russian volumes were down 4% for the first half of the year. They were up 1.5% in the second quarter, so we lapped the fourth quarter loading of last year in Russia now, and we're now seeing volume growth. We anticipate seeing volume growth in Russia at a similar level as we saw in the first quarter.

It's worth bearing in mind that although Russian volumes in the first half of the year were down 4%, net revenue was up 10% in Russia, principally driven by the growth of those premium brands, global drive brands in Russia. This is testimony to the premium brand strategy.

Profit yes. We were picking up price increases; we've taken three price increases in Russia in the first half of this year. I think as I said, either at the prelims or the first quarter, we'll need to get through to about November until there are sufficient price increases to recover the excise increase in Russia, but even so, prices are going up and we expect revenue to grow strongly in Russia.

Asia Pacific. Who's going to comment? Paul do you want to pick that up?

Yes, I'll pick up Asia Pacific. It had very strong profit growth in the first half, but the rate of profit growth in the second half will not be as strong, mainly because of the timing of marketing spend and the excise increase that we've had in Malaysia. We still expect a small profit growth in Asia Pacific in the second half, but it won't be as strong as the first.

And just adding to what Paul said on Brazil. The result will be very strong for the year, but it's going to be hard to have profit growth in the second half, because the excise is going to significantly hit volume in margins compared to the first half.

Right, next question. Yes, go ahead.

Hi, David Hayes from Lehman Brothers. Two questions, again.

Just on Canada, there were signs from (inaudible) early in the week that Canada might be improving. Their volumes are up year-on-year, and maybe it's an indication that the illicit trade has at least stabilized. I wonder if you can comment on that; whether you'd agree with that; whether there's a trend and there are some improvements.

And then just on the third quarter looking forward, I noted that in Europe, I think the organic profit growth in the third quarter was negative about GBP23 million last year. I was just wondering whether you were expecting an easy comp; something we should be aware of year-on-year that makes Europe bounce back in the third quarter of this year.

Right, two questions just to summarize for the webcast.

The first question relates to Canada. Comments made by the (inaudible) organization in Canada a few days ago about the improving volumes and possibly also a reduction in the levels of illicit trade in Canada.

And the second question relates to the third quarter result we expect in Europe, and the proposition is that the comparable numbers last year were quite weak, and therefore we are dealing with easy comps in the third quarter.

Okay. We see the markets being down about 9% in Canada for the first half. Our volume declined by about 13%. So the market is decreasing, at least the legitimate market, if I can call it that way; the market is decreasing. We're still seeing down trading. The share of value for money continues to grow versus premium.

Illicit trade is still a problem, and a growing problem. Illicit trade in Canada is about 22%. If you look at Ontario and Quebec provinces, remember that something like 65% of our volume in Canada is from those two provinces, we're very strong in Quebec and Ontario. Those, of course, are where the Indian reservations are, and illicit trade in those two provinces is running at over 30%.

So just to try and give you some context of the RBH results, remember that they're quoting Canadian dollars, we're quoting sterling. And secondly, they are far less impacted by illicit trade than we are.

Next, yes?

[Elise Badoy] from Goldman Sachs.

Sorry? (Inaudible). I do apologize.

Yes, yes; I'll comment on that. We expect the second half to continue to be strong for Europe. Again, there's a skew in marketing spend which distorts some regions more than others, but we would expect Europe to basically continue on in terms of -- profit terms, with the same trend as we had for the first half.

Okay, lady at the back.

Three questions. The first one on the (inaudible) in Europe. If you could perhaps give me the main factors behind the improvement in the first half.

The second question's on the outlook for volume growth. I think at the end of this first quarter, you had said that the last three quarters would grow around 1%. Does that still stand and is that what we should be looking for?

I'm sorry. Could I ask you just to repeat the last sentence? I missed you there.

Yes, sorry.

You're asking for volume in Europe?

No, for volume growth for the Group. You said at the end of the first quarter that the last three quarters would grow around 1%, on the conference call. So does that still stand as the average? Is that still what we should be looking for, around 1%?

And then the last question, Imperial has now made a formal offer for Altadis. Should we expect that you won't distribute in the future Gauloise Blonde in Germany? And how does that change your view of the situation in Spain?

Three questions. I'll just summarize them very briefly. The first comment; are we likely to margin developments for the European business, H1 compared to H2?

The second question invited comment on the outlook for volume growth in the light of comments made at the Q1 results presentation about the expectations of volume growth of about 1% for the remaining three quarters.

And the third related to the formal offer made by Imperial for Altadis. Will we in future continue to distribute Gauloise in Germany? And what does that mean for our distribution structure in Spain?

Shall I pick up the volume growth and --?

Yes. Paul, you pick up --? You take the margin?

Yes, I thought the question on Europe was, what was the reason why Europe result was up for the first time versus last year? Is that right?

[Inaudible - microphone inaccessible] the margin evolution; what drove it. The sense of my question was, is it savings; is it pricing? What drove the margin?

Yes, there are significant cost savings coming through in Europe, okay? And significant positive brand mix coming through in Europe, and significant positive price. And they are the key reasons why --. You see, you've got all three things happening in Europe. You've got price happening across most of the regions, but -- all of the regions. But in Europe especially, the cost savings came through in the first half, and that was the key thing as well.

Just on the volume outlook, we're down on volume by 2% for the first half of the year as we said. We expect the volume for the year to be round about flat, so that would suggest a volume improvement in the second half of 1.5% to 2%.

In terms of -- well, we haven't got Altadis yet. It's a little early. But we do have a contract which has got some way to run, and I won't say any more about that. I'm sure Imperial would have picked that up in their due diligence. And yes, distribution in Spain (inaudible).

Right. Maybe I should pick up a question from Rachael's email system just to make our other guests realize that we do take their questions as well. The question relates to Malaysia which, of course, we need to keep in mind is actually a separate publicly quoted company, so I'll mention that up front. The question states essentially, would it be possible to estimate the possible impact on profit from the excise increase; this is Malaysia? What do you think of JTI's comments that there is risk of another price war? Is the prospect of minimum pricing -- or I think it means, has the prospect of minimum pricing now gone, or are they still hopeful that there will be minimum pricing? And how concerned is the government in Malaysia about illicit trade worsening further?

Paul?

Yes, it is possible to calculate, but if Malaysia hasn't given out a number, I don't think I should. What I will say is that we don't believe the number will be material in Group terms.

Comments about a possible price war; it may be possible. We hope that's not the case. Maybe JTI knows something we don't, but I hope there isn't one.

And as regards minimum pricing -- I think on Malaysia if you've got a 25% excise increase which came as a shock, normally those excise increases are announced at budget time, which is normally September. Prices have gone up in Malaysia very quickly to cover that excise increase. The downsides are, what will that do to down trading as a result of prices going up; down trading both to very low price brands, and indeed to illicit trade? What those higher prices will do to volume, and we have to see what the consumer reaction will be, and whether that will, if there is down trading, whether that will trigger a price war. All of those things are possible so it's difficult to put a figure around it.

We've run some scenarios in Malaysia. We don't believe that it will be material in Group terms. We hope a bad situation does not get exacerbated, either by government actions. And the government has been pretty good at getting on to illicit trade in Malaysia. And it increased following the very large excise increase but appears to be holding stable. Let's hope it continues to hold stable because of their actions in Malaysia, and let's hope there isn't a price war.

Other than that I can't comment.

Right. Go to the right. Yes?

Adam Spielman from Citigroup. Two questions if I may. One very briefly on Canada. I think, Paul, you've said that in 2008 you hope that the profit situation there will stabilize. There won't be -- and I think that's what you said publicly in the past. If you can just confirm that or not, despite all the bad things.

And the second question is on Russia, and without getting bogged down on quarterly volumes and stocking and de-stocking, we've had a big change in the regulations there. You've got minimum pricing; you've got a much more, I assume transparent pricing environment. Overall, is that good for you and how did it affect the market, just in general terms? Does it help premium players? Does it help discount players?

Two questions. The first deals with Canada where Paul is asked to comment on what apparently he said some time ago, which is that we expect in 2008 profit to be stable in Canada? Is that still our view?

Second question deals with Russia, and we're asked to comment on the potential impact of regulatory changes in Russia, on the outlook for the industry, and also for our business.

Paul?

Yes, that's still our view on Canada.

In terms of Russia, yes, the excise change in Russia we thought was beneficial, particularly for premium players. You've got two things; a) you've got a minimum collectable, which tends to push the bottom price up, which is good for premium players. Secondly, they've put a maximum retail price on, which is also good, because what tended to happen was that the prices used to get bounced, i.e. the trade used to take the prices and add on a bit more so they would have nice fat trade margins. Now what's happened there's much more price discipline because of that maximum retail price. So trade margin is much more manageable.

So that whole excise system I think works very well for us, and we'll have more transparency on pricing.

Now having said more transparency on pricing, one of the things that the whole industry needs to do is to take price increases, as I've said over the course of the year, to recover that increase in excise. Not everybody follows quite with such alacrity as we would hope, but we seem to be getting there.

David Ireland from ABN Amro. A two part question for Paul Adams on acquisitions. In today's Cantos interview, Paul, you say we still think there's a number of sizeable possible acquisitions that can still be done. I wonder first of all, given some people's views on antitrust, if you could elaborate in general terms whether you might be looking at some different types of combination.

And secondly in your own case, do you still hold the view that acquisition prices are excessive?

Two questions from David Ireland dealing with acquisitions and referring to Paul Adams' comment in this morning's Cantos interview, referring to our continued willingness and ambition to execute sizable acquisitions, but of course the issue is now really in the light of antitrust developments. To what extent will that stop us from doing deals, and to what extent may that lead to different types of deals being done?

The second question is inviting comment from us with regard to prices. We've in the past often said that public companies are trading at very high prices. Is that still our view at the moment?

Paul?

Yes, we still think some acquisitions are out there. To take the usual suspects, Turkey, Egypt, possibly Algeria, we still think those are possibilities. I don't know if they're going to be too expensive or not because I imagine they'll go to public bids, so I have no idea what the expense will be. I have to figure that out as and when they come on the auction block.

Maybe I can quickly take --. Just one moment. I'll take another question from the email which I might just respond to myself. The question is that Reynolds American commented yesterday about starting a buyback program if it had approval from BAT. Could you share with us whether you would participate in the buyback and what are the financial implications, particularly on the tax front?

Well all I think we can say today is that we certainly, in principle, support their willingness to look at a share buyback program. In terms of what we will do and whether we would participate and what the financial implications might be, we are not prepared a comment publicly at this stage on that score. But we certainly support the principle of them looking at a buyback program.

Next question from the audience?

Robin Asquith from JP Morgan Asset Management. Question about European pricing, where there seems to have been a big swing from very negative a few years ago to being positive. Question about sustainability, where that is in Southern Europe during the (inaudible). Just the flavor of that.

And a second question more generally about industry consolidation. As that continues in Europe, how does that impact the profit pool in Europe? You think of Poland and things like that. And would we actually see that in BAT's P&L? Is it significant enough to be seen in a BAT [company]?

Two questions. One deals with European pricing; the second with industry consolidation.

Firstly, on European pricing, the proposition is that we've seen actually a significant increase in the whole pricing environment in the last year or two. How do we see the pricing environment developing going forward?

Secondly, with regard to industry consolidation, particularly in Europe, and particularly, of course, the Altadis, Imperial and Gallaher, JTI transactions, what do we think the impact of those transactions might be on the profit pool available to the European industry? And how might that impact on our P&L account?

Okay, European pricing. Yes, European pricing is a lot better than it was. I don't think there's any doubt about that. It's worth just a quick aside to say that doesn't mean that there aren't little tense moments down at the bottom end of the market off that higher base, but generally speaking, pricing is a lot better.

What is the sustainability of that pricing? I think the sustainability of that pricing is good; should be good, anyway. I've said many times before that I think the consumer's ability to pay more is there. It's the industry behavior which is preventing price increases rather than the consumer's inability to pay. And, for example, the German economy and disposable incomes are growing very nicely, and one would hope that there's an opportunity for price increases in Germany, just as an example. So I would hope that it's not only sustainable, but in fact it can be taken on more.

In terms of consolidation, it's a similar kind of thing. I think with more consolidation, hopefully there'll be more pricing discipline. We've seen already some signs with JT's acquisition of Gallaher a slightly different approach to the business, let me put it that way, which I think is better. And do I see both of those adding to BAT -- to the industry profit pool? Yes. Do I see them adding to BAT's P&L? If it translates the way I've just outlined, and I hope that it will, then yes.

Right. Maybe a question from the email to Paul Raynor. The question says that, Paul, you've talked about increased marketing investment in H2. Could you give us a bit more color on which particular markets might we expect brand launches and distribution expansions to take place?

Well, as much as I'd like to give more color, I actually don't think it would be appropriate to say where we plan to do brand launches.

But to answer the question generally, in most of the regions, apart, perhaps, from [Am Pac], where Japan in the second half is better than the first half, because of the timing of shipments, you're going to see a skew in marketing toward the second half versus the first half, and I think when I was asked this question last year, I think we said that marketing spend is usually skewed 45/55 first/second half, and it's probably even more slightly skewed than that this year toward the second half. And that's generally speaking across many of the regions. So you'll see that coming through in Latin America, Asia Pac, as I answered the earlier question, I still think Europe profit result in the second half will be in line with the first, but there'll still be higher marketing spend, and Africa/Middle East.

Okay, Paul. Maybe one quick question. Go ahead.

Hi, it's Jon Fell from Deutsche Bank. A couple of things, actually.

First of all, I think I might be being thick on Brazil, but did you say you expect second half volumes to decline because of the tax increase, and if so, why? And the other thing is on Australia; just an update there on the pricing skirmishes. Have they got any worse, or have things stabilized there?

Two questions from Jonathan Fell. The first deals with Brazil. He suggests he might be thick in not understanding the volume trend. Jonathan is asking for the comment on the outlook for volume in Brazil in the second half of the year. Might it actually be declining because of the excise increases?

And Jonathan's second question deals with the pricing environment in Australia. Latest news there.

Antonio, help me out on this one will you?

I will translate for the webcast. Antonio Monteiro de Castro says that he expects volume in Brazil in the second half to actually be lower than in the first half. And Paul, do you want to comment on Australia?

Yes. There was a price skirmish in Australia. That looks as if that is significantly easing.

Can I take a quick one from the webcast before I come back to the audience? Question from (inaudible) in Johannesburg, Investec. He says to Paul Raynor, why has the tax rate guidance dropped from 31% to 32%, to now 30% to 31%?

Yes. A couple of reasons. The first one is, just a change in the mix, and that's certainly come through in the first half. And so it had lower profits in Canada, Germany, which have got higher rates of tax, and higher profits in Russia, which have lower rates of corporate tax.

The other thing, which is going to help us going forward is the lower rate of corporate tax in Germany. The combined German corporate tax rate was around 39%. Beginning next year, it'll come down to 32% from the beginning of 2008, and we'll also get a benefit in the second half of the year, because the value of our deferred tax asset will increase, and that'll come through in the income tax charge in the second half of the year because of the lower German tax rate. So they are the main reasons we changed our guidance.

Thanks, Paul. Back to the audience.

Very quickly, Mr. Paul Raynor, following up that question. The lower guidance on tax, 30% to 31%, is that an ongoing guidance, or is that only for 2007?

Paul, can I just say for the webcast? Paul is asked to comment back on the tax guidance whether the revised guidance is a guidance only for this year, or whether it is a guidance which may be relevant looking forward.

The 30% to 31% is a guidance for this year. Going forward after that, we expect the guidance to come down and be closer to 31%. Before I said it would between 31% and 32%; now it'll be around about 31%.

Just coming back on the Brazil question, just to understand, just to make sure. The tax [rise] obviously came in in July. There's been no retail price rise at all though actually to pass any of that to. Is that right? I'm just a bit confused as to why the volumes would come down if the retail price effectively stays the same in the second half. And then in fact (inaudible) easier comp because I think the price rise at retail came through in the middle of the fourth quarter. I'm just trying to understand whether there's been any retail price change.

Could I quickly say that the question was that with regard to Brazil, considering that the excise increase took place in July, which was indeed thus far not followed by a retail price increase, why would that actually have an impact on sales in the second half of the year? Paul?

There was no retail price increase. We just anticipate volumes will be slightly softer.

(Inaudible - microphone inaccessible) retail price on the end of next year and one in May of this year. So when you add both retail prices, there was a price increase of around 16%. Does that have an impact on volume?

Now, for the record, Antonio is saying that indeed we've had two price increases, one at the end of last year, and the second one in May of this year, which in total made for an increase of about 16%. That has actually therefore in a sense preceded the excise hike.

Next question from the audience. Right from the back.

Chaz Manso from Dresdner. Can I ask a cash flow question? Your cash flow from (inaudible) was up GBP300 million or so, driven by working capital. You said in the presentation that you expect that to reverse in the second half. Can you tell us whether you expect it all to reverse in the second half, or whether there is a genuine improvement in earnings to cash conversion coming through?

Question to Paul Raynor from the webcast. The question relates the cash flow. With significant improvement in cash flow from operations in the first six months, which Paul has previously said is expected to partially reverse in H2. I think the question just asked, Paul, can you be a bit more specific? How do you see this going?

No, I would expect all of those working capital movements to reverse in the second half. And what we had last year was stock build-ups in the first half in Japan and places in Eastern Europe; Poland and Czech. And they effectively reversed in the second half of last year. And in the first half this year, we had the receipt of the [Engall] bond. We had benefits coming through from [DSD] in Canada.

So they're the four main things why the first half was so significant compared to the first half last year, and it's going to reverse in the second half.

The other reason on cash flow, which I pointed out, Chaz, in my presentation, is we do expect high levels of capital expenditure in the second half of this year than we had last year. And we do expect net capital expenditure for the full year to be higher. The reason for that is two things. One, high levels of capital expenditure, plant expansion, product innovation in the second half. And also in the second half last year, we sold a building. We had a significant cash receipt from the sale of our building in Germany, which won't repeat. That was quite significant. So net capital expenditure for the year will be up, and for the second half will be up. So that will obviously come through and affect cash flow as well.

So working capital for the full year, movements will be around the same as last year, we expect at this stage.

Rogerio Fujimori from Credit Suisse. Two questions. First, one on South Africa. If you could comment on volume trends in the second quarter and the outlook for the full year.

And second question just on Brazil. This 16% combined cumulative price increase, how much of that was taken in May, please?

Thanks.

Two questions. The first one deals with South Africa. Paul is asked to comment on volume trends in Q2, and what might that suggest for the outlook of volume growth in the second half of this year in the South African business.

The second question comes again back to Brazil. Can we just clarify, and maybe Antonio can look at that, I can see him opening his file. The question is on Brazil. Of the 16% aggregate price increase that we referred to a few moments ago, how was that split between the increase at the end of last year and the one in May of this year?

Paul, do you want to deal with South Africa?

Because illicit trade came down in South Africa, we picked up a slight volume increase as a result of that, so I would anticipate that overall consumption in South Africa has declined. But, if you like, the market that we can go for, because it's now legitimate volume, meant that we took a very slight increase in volume in South Africa.

In terms of pricing, Antonio has indicated -- what happened was, there were two price increases. There was a price increase in Brazil in September or October of last year, and there was a price increase in May of this year. The two together would have covered the excise increase. The price increase in May was about 5% to answer your question.

Right. Any more questions? Yes, Chad.

Two questions. One on (inaudible) price mix. Mix is an important element; mix of the global drive brands. Is there any way you could tease out for us the split -- your constant currency price mix in the first half is about 6%, I think. Could you somehow tease out what's price and what's mix?

And perhaps (inaudible) could you expand on Mexico; the issues facing the Mexican market for you at the moment

Two questions. The first possibly goes, I guess, to Paul Raynor. Paul Raynor is asked to comment on the relationship of price and mix; sales mix and price changes in the first six months which seems to make up for roughly 6%. I think we're moving from the 2% volume decline through the 4% revenue increase in constant currency. Paul Raynor will comment on that in a moment.

And the second question deals with --?

Mexico, yes.

Paul Raynor is asked to comment on developments in Mexico. But let's deal with the first one.

It's mostly price. If you look at the profit improvement, price is clearly the most significant factor. Obviously, we've had a downturn in volume, but offsetting that was a significant, favorable price variance in all of the regions. And we did have favorable brand mix, and it was significantly favorable, as I've said before, in Europe, but for all of the regions, price was the most significant factor by a long way.

On Mexico, there was an excise increase in Mexico, and therefore the market has declined. Our share has also declined. Our premium brands are doing reasonably well in Mexico, but we're losing volume share at the bottom end of the market. So the market's declined and our share is declining.

Do we have any more questions, or is it time to close?

Well, in that case, let me just thank you all for coming, and I say again, we apologize for the slight confusion earlier this morning, but nevertheless, thanks for coming.