英美煙草 (BTI) 2010 Q2 法說會逐字稿

Well, good morning, everyone, and welcome to our results presentation. I am Paul Adams, Chief Executive of British American Tobacco. And with me are Nicandro Durante, Chief Operating Officer, and Ben Stevens, Finance Director.

This morning we'll be taking you through the half-yearly results, after which there will, as usual, be an opportunity for people in the audience to ask questions. And good morning to those of you who maybe listening on the conference call, or watching via our website, bat.com.

Before giving you my main impressions of today's results, let me begin by briefly running through the headline numbers. Overall volumes, at GBP348 billion, were down just GBP1 billion on last year. Excluding the Bentoel acquisition in Indonesia, organic volumes were down 3%, mainly reflecting total industry declines in some key markets, such as Romania; Turkey; Japan; and Pakistan.

Global drive brand volume rose 6%, with good share performances from each of the brands, although Kent volume has been affected by industry declines in some of its key markets.

Revenue and profit from operations, both up 8%, have benefited from favorable exchange rates as sterling has softened against any of our key currencies.

Adjusted profit rose 14%.

However, the real story lies, as ever, in organic growth at constant rates of exchange. On this basis, we estimate that revenue grew approximately 2.5%. And organic constant profit from operations, after adjustments, was 8% higher after some good work on costs, leading to a marked improvement in operating margin.

The business has performed well during the first six months of the year, and this follows strong performances in 2009 and, indeed, 2008 despite the recession.

Adjusted diluted earnings per share was 13% higher, and 9% higher excluding the benefit of exchange.

The interim dividend, following our convention of paying one-third of the prior year's dividend, will rise 19% to 33.2p.

Looking at the remainder of the year, more economies in our key markets are returning to growth. But it is clear that unemployment levels continue to be high, and recovery is still fragile and uncertain. However, the pressure on volumes does appear to be moderating, and our volume trend is improving.

Organic volume decline was 3.9% in Q1 and 1.9% in Q2. We expect, at this point that, the second half of the year will be down less than 2%.

For the first half, our premium volume was down 2%, mid-priced, or value for money, was also 2% lower, while low price was down 4%. Despite down-trading seen in some markets, our premium volume has held up well.

Just to give you some idea of the impact of market declines on our business in the first half, our overall volume decline amounted to 10 billion StiX. The hit on our volume from industry declines alone in just four markets, Romania, Japan, Turkey, and Pakistan, amounted to 11 billion StiX.

From a market share point of view, we have continued to grow share in our top 40 markets, driven by share gains by our four global drive brands. In addition, we have achieved record shares in a number of markets, such as Brazil; Egypt; Romania; Spain; Nigeria; and Kazakhstan. With organic volume down 3% and organic revenue at constant rates up 2.5%, the pricing environment continues to be favorable.

Governments have continued to impose large excise increases, such as those in Turkey and Australia, and Japan later this year. Less dramatic, but also important, are VAT increases, which push up the prices of all goods, including tobacco. And we have seen VAT increases in Greece; and Spain; and Romania, while the UK follows next January.

However, as we said in today's announcement, the business is in very good shape. And while comparisons with 2009 will become tougher in the second half, shareholders should see another year of good growth in both earnings and dividends.

I'll now hand over to Nicandro.

Thank you, Paul. And good morning, everyone. I will start by looking at our global drive brands performance and then review our performance in the regions.

Collectively, global drive brands volume grew 6% to GBP97 billion. Dunhill volumes were 21% higher due to this brand's strong performance in the GCC, France, and Russia, and in migrations in Brazil and South Africa. Dunhill Reloc is being rolled out in key markets and in Malaysia, for instance, Reloc has added 0.6 percentage points to Dunhill's share. We have also launched Dunhill Nanocut into South Korea and Brazil.

Kent volumes were down 4%, mainly due to lower industry volumes in two of its key markets, Russia and Romania, despite the brand growing share in both markets.

Kent continues to perform well in most of its key markets. Innovations are a key driver of Kent's performance, and in 2010 we have launched Kent capsules in South Korea. The launch of Nanotek in a menthol thread variant has resulted in Kent returning to share growth in Japan.

Lucky Strike has also benefited from capsule technology with the launch of click-and-roll in the Americas and in France. Growth in the Americas and Africa/Middle East has offset an impact of down trading and price increases in some key Western European markets. Volumes were 1% higher.

Pall Mall volumes grew strongly, up 7%. It's now the world's fifth biggest brand outside of China having recorded increases in Germany, Uzbekistan, Italy, Spain, Pakistan, and Chile, partly offset by declines in Russia, Romania, and Turkey.

Turning now to the regions, in Asia Pacific, profit and revenue grew 17% as a result of strong performances in Australia, New Zealand, Bangladesh and Sri Lanka; favorable exchange rates; and the Bentoel acquisition.

At constant rates of exchange, organic revenue grew 2%, and organic profit 3%. Excluding Bentoel, volumes were slightly down as increases in Bangladesh, Vietnam were offset by declines in Australia; South Korea; Japan; Taiwan; and Pakistan.

Higher pricing, following a sharp increase -- excise increase in Australia, and continued cost savings, result in a strong profit growth, partially offset by competitor discounting. Market share was slightly down, despite good performance by Pall Mall and Winfield.

Malaysia is still experiencing industry volume decline, although the rate of decline has moderated. Dunhill and Kent's share are stable, and Pall Mall share grew strongly. The volumes result in marginally lower profit, partly offset by higher pricing and reduced costs. In Japan, market share rose, but industry volumes were 6% lower.

We are delighted with the acquisition of Bentoel Indonesia. Since the merger, with our existing business, our combined Group has increased volume, market share, and profit.

In Americas, revenue was 10% ahead of exchange -- at current rates and flat at constant rates of exchange. Profit was GBP115 million, or 20% higher at GBP694 million, mainly due to strong performances from Canada and Chile, as well as an improved mix and exchange rate benefits. At constant rates of exchange, profit have increased by GBP46 million or 8%.

Volumes were down 1% at GBP73 billion, due to industry declines in Brazil and Venezuela, almost offset by increases in Canada and Chile. Brazil's profit was slightly lower, due to unfavorable comparisons in the prior year, arising from higher margins from prices increases in anticipation of excise tax increases. Market share reached a record high.

Profit in Canada grew, benefiting from higher volumes and a strong currency. A significant reduction in illicit trades led to high volumes, while the Group gained leadership in all price segments.

In Mexico, volumes were slightly lower. But market share has been relatively stable since the mid-2009, with good performances from Pall Mall and Montana. Profit was in line with last year.

In Western Europe, revenue was impacted by loss of Gauloises blondes in Germany. On organic base, at constant rates, revenue was flat. Profit was GBP548 million, up by GBP39 million, as a result of strong performance in Germany, Belgium, and the Netherlands, partly offset by declines in Switzerland and Poland. At constant rates, profit would have increased by GBP51 million, or 10%. Volumes were 6% lower, or 4%, excluding the loss of the Gauloises brand.

In Italy, volumes increased on the back of a good performance of the global drive brands, largely offset by a decline in the local brands. December 2009, price increases improved revenue, but profit was slightly lower.

Germany's underlying volumes and market share were stable, driven by Pall Mall's excellent performance and Lucky Strike's strong position. Profit was higher, attributed to higher margins and lower costs.

Volumes in France were lower, though slightly better than for the rest of the industry. Vogue, Dunhill, and Pall Mall grew volumes and share, which were offset by Winfield and Lucky Strike. Higher profit and market share were achieved in Spain, as volume remained stable, despite industry declines.

Eastern Europe profit was down GBP59 million to GBP128 million (sic - see Press Release), principally due to lower volumes and adverse exchange rates. At constant rates, profit would have decreased by GBP14 million, or 8%. Volumes fell by 3%, mainly in Romania, where the significant increase in illicit rate has dramatically impacted industry volumes.

In Russia, volumes were in line with last year, although market share was slightly lower. The success of Kent resulted in continued growth of market share in the premium segment, as well as sequential growth in overall share for the last two quarters. Profit was down due to increased marketing investment.

Despite the market decline in Romania, Kent drove an increasing share with an impressive performance. However, profit was lower, reflecting the market decline.

In Ukraine, Kent and Dunhill's strong performance resulted in a market share increase. [Loading] by the threat ahead of an excise increase improved volumes, and coupled with higher margins, led to a rise in profit.

Africa and Middle East achieved an outstanding profit growth of GBP107 million to GBP443 million, mainly driven by good performances in Nigeria, South Africa, and the GCC. At constant rates, profit would have grown by GBP76 million, or 23%.

Volume declines Iran, Turkey, and South Africa led to an overall decline in the region of 2% at GBP63 billion, only partially offset by increases in the GCC, Egypt, and Nigeria.

A sharp increase in illicit trade in South Africa led to a significant drop in volumes. Market share was slightly down, but profit was higher due to improved pricing, cost savings, and a favorable exchange rate. Profit rose in Nigeria, a reflection of higher volumes, improved product mix, and cost saving initiatives. Volumes were higher, driven by growth in the premium segment, as well as Pall Mall. The level of illicit trade declined as a result of efforts by government enforcement agencies.

Turkey. Turkey experienced a sizeable drop in volumes due to a significant excise increase that resulted in increased illicit trades. Lower volumes more than offset the price increase and exchange rate benefit, leading to a fall in profit.

Ben will now take you through the financial statement.

Thank you, Nicandro. Let me first start with some comments on foreign exchange. A favorable foreign exchange tailwind during the first half of the year benefitted revenue by 4% and adjusted profit by 5%. However, since June 30, sterling has appreciated against a number of key currencies, and at today's spot rates the exchange benefit for this year is not going to be as favorable as the rates implied a month ago.

If we translate the first half's result at current spot rates, it would reduce EPS by approximately 2%. So, while we cannot predict exchange rates, and while we still expect exchange gains for the year, they are likely to be less than in the first half.

As you know, I report the cost savings program when we publish our full year results. However, I am pleased to say that we're making good progress towards our previously-announced target of an operating margin of 34% by 2012.

There are a number of timing factors that normally mean that the full year margin is lower than the first half, but we'll still make good progress this year.

As you know, we sold our wholesaling business in Belgium at the half-year. Lyfra contributed GBP215 million to turnover in the first half of 2010 and a negligible amount of profit, with an annual operating margin impact of 1 percentage point. As such, we're increasing our operating margin target to 35% by 2012, and the effect of selling Lyfra will be around 0.5 percentage point in 2010.

Turning to the income statement, adjusted profit from operations was GBP2,460 million; an increase of 14%. Restructuring costs were GBP158 million for the period, and mainly related to factory closures and reorganizations, together with costs relating to the restructurings following the Bentoel, Tekel, and ST acquisitions.

There was also an amortization charge of GBP31 million in relation to trademarks acquired with Tekel, ST, and Bentoel.

Last year's gain of GBP2 million arose on the disposals and trademarks in Scandinavia to meet competition issues.

Net finance costs were 5% higher, reflecting the reduced investment income due to lower interest rates.

Associates were 3% higher. But for the purposes of the adjusted earnings per share calculation, the adjusted contribution from Associates is GBP67 million higher at GBP306 million.

The reported profit before tax was 7% higher at GBP2,279 million.

The tax charge for the Group's subsidiaries rose from GBP534 million to GBP624 million, resulting in an underlying tax rate of 30%; in line with guidance. This year's higher tax rate was a result of a change in the mix of profits.

Profit for the period rose 4% to GBP1,655 million.

And the minorities charge was GBP9 million lower at GBP130 million, reflecting lower earnings in Malaysia and Brazil.

Here are the drivers of adjusted earnings per share growth. Profit from subsidiaries at constant rates of exchange drove earnings by 9%. Net finance costs, Associates, and Minorities together account for 2p, or 2.6%, of adjusted earnings growth. The higher tax rate had an unfavorable 2.2% impact on earnings, while favorable exchange accounted for 2.5p, or 3.2%, of the 12.7% increase in adjusted earnings per share to 87.1p.

Moving on to cash flow, operating cash flow rose GBP179 million to GBP1,902 million. This reflected the growth in underlying operating performance, partly offset by adverse working capital movements related to stock builds ahead of excise increases.

Free cash flow before dividends and investing activities was GBP145 million, or 17%, higher at GBP993 million, due to higher operating cash flow, as well as lower net interest, partly offset by higher restructuring and tax payments.

Dividends paid to shareholders rose 15% to GBP1,431 million.

Net cash flow after a final payment in respect of Bentoel and the proceeds of the sale of brands in Scandinavia and other net flows was reduced; net outflow of GBP509 million, down from a negative GBP666 million in the comparative period last year.

And finally, net debt at the start of the year was GBP8.8 billion and increased to almost GBP9 billion, the principal movement being the net cash outflow arising from the higher dividend pay out, partly offset by favorable exchange.

That's the end of the presentation, so I'll hand over to Paul, who'll start the Q&A session.

Okay, we'll kick off on the Q&A. Could I just remind everybody, if you could -- before asking your question, to state your name and the name of the firm that you represent? We're happy to take questions now. Yes, Jon.

Jon Fell from Deutsche Bank. Three things. First of all, on numbers stuff, I was a little bit puzzled by the FX impact in Eastern Europe where revenues were down, although negative FX impact was GBP18 million on revenues and GBP45 million on EBIT, and that was just like the ruble strengthening as well.

And then on Australia, a couple of things there. Firstly, I've read a report that one of the retailers has started to ship in some generic cigarettes from Germany; is that much of a threat on your radar screen? And what has happened to the plain packaging initiative of the former Prime Minister now that we have a new person in charge?

Okay, three questions, really, and I'll just repeat them quickly. Could we have some more detail on the FX impacts in Eastern Europe? Then a question on Australia; news that one retailer is importing generic cigarettes from Germany, what do we know about that? Not much I suspect. And plain packaging; whither plain packaging goest in Australia.

Ben, perhaps you want to take the FX; and Nicandro, I don't know if you can answer the generic cigarettes from Germany; and I'll pick up plain packaging.

Okay, well, the FX impact in Eastern Europe is affected by a one-off charge. As you say, the ruble strengthened; some of the other Eastern European currencies have weakened. But the main difference is we're finding it harder to get soms out of Uzbekistan, so we have an inter-company receivable that we've written down as a result of that, and that's pretty much the difference.

What's that in pounds?

It's about [GBP40 million], which is the difference between the current and the constant [hit] to profit.

I don't have a lot of say. I'll have a look at that and come back to you, but at the end of the day we just see what's the price to the consumer of these generic imports because they [will have] to pay tax in Australia. So, we haven't seen this as a trend; maybe it's one isolated cases or not. But I don't have a lot to say on that one; I'll have a look at that and come back to you.

On plain packaging, I don't think the change in Prime Minister has made any difference. We'll have to wait to see the results of the election, although our assumption is that they will win. And our assumption is that they will try to proceed with the plain packaging legislation.

We are looking at that, and looking forward to presenting our arguments against that, and why we think that this is ill-conceived, and we'll be putting that to the government. And also, once we see the legislation, we haven't seen it yet, then we'll obviously look at that from a legal perspective.

Thanks.

Hi. David Hayes from Nomura. Two questions, if I can. Firstly, on Japan, I just wonder if you can update us on where you are in terms of your plans for price requests, etc.

And then just to clarify, PMI saw quite a big impact in the second quarter from shipping in, which I assume is to do with their potential increase earlier on price increases, but I just want to make sure that there was no impact for you guys in the second quarter related to that kind of shipment pattern?

And then secondly, in terms of the volumes, it feels like the back-end of the second quarter volumes got a lot better. Talking to you before the end of the close, it felt like you were maybe going to be a bit more cautious on the full-year volumes and now you're being a little bit more positive. Can you just talk about whether there was change in certain markets back-end of the second quarter, and where those big changes might have been? Thanks very much.

Okay, the question was Japan, what are our intentions, assuming we can say anything about our intentions on price increases in Japan. Secondly, PMI, and we don't talk about competition, PMI appeared to have loaded in anticipation of the October increase; have we done any of that, I think was the question. Nicandro, why don't you pick up those two?

And any change in volume to the back-end of the second quarter? Yes, perhaps you could pick up that one as well. Well, won't don't you all of it?

Let me start with Japan. In the case of Japan, as you know, it's public information; JT has submitted a price list to the Ministry of Finance, it has been approved. And [we] have done the same last week; it has not been approved yet so we have to wait and see. So we have a new price list, and we should have a price increase in October, if it's approved.

Regarding the loading, there is no loading in our numbers. The price increase in October is far away from October so there is no loading in our numbers.

Going back in terms of rate of decline, yes, I think that numbers are getting better. The first quarter, volume decline was 3.9%. In the second quarter we see 1.9%, so things are getting a little bit better. And you see the improvement in places like Eastern Europe, in places like Russia, so volumes are getting a little bit better.

Given our second quarter was down 1.9%, as we said, we see the second half declining by less than 2%, so there wasn't anything abnormal. Of course, there are lots of little ups and down in various markets, but overall there wasn't anything abnormal in the second quarter, and we expect that to continue through the balance of the year.

[But], Paul, there was nothing specific in those specific markets, Romania, [Lithuania], you mentioned earlier?

No, no, I think that's getting better in general. You see some good improvements in some parts of the world, as I said. You look at the rate of decline, for example in Eastern Europe, it was much higher at the end of last year. The rate of decline now is lower, and is getting better.

We have some loading, not only us but all the competitors, in Ukraine before the price increase that you are going through in July, but I don't think that is a big difference.

Of course, there are some good improvements in specific markets, like Canada, in which you see the illicit trade coming down quite remarkably. And you see industry volumes going up around 15%, it is here against last year. But I don't think that you change the whole trade environment in a global base, but we see some good improvements in some markets, yes.

It's Adam Spielman from Citigroup. Can I follow that question? You were saying that there's a gentle improvement in volume trends; are you also seeing a little bit of an improvement in mixed trends as well? So, I guess in places like Russia, are you seeing accelerating volumes of Kent, would be one question?

And a question also on the tax rate. Your tax rate has gone up as your mix of countries has changed; will it go up further as the mix continues on its trajectory?

Okay, let me just repeat the question; two really. Are we seeing any improvement in our mix trends, for example Russia? And then second -- which I think Nicandro you handle. And the tax rate, Ben; will it go up further? Do you want to handle those?

Yes, regarding the mix, and you were specific in the case of Russia, for example; the mix is getting better, yes. But let's take Russia as an example. The market is still declining, and I'm assuming that's around 4% to 5%. So it's better than the end of last year; remember that was declining 7% to 8, so it's declining less. And you see improved trends. I think the second quarter decline was better than the first quarter.

I think that, more importantly, if you look at the size of the segments for the share point of view, and you look at the premium segment in Russia, since I think November last year, the size of the premium segment for the share point of view has been stable. We have not seen any down trading from premium to mid-price or low-price, so the mix is getting better.

And of course, it's benefit our portfolio because if you look at Kent nowadays, Kent has a higher share now than we had before the economic crisis. Our share in the premium segment in Russia has grown 4%, four share points is almost 40%, so has benefitted our numbers as well.

Can I just build on that? Just on Russia, this may be obvious to everybody, but there are a number of numbers that I use to describe what's going on in Russia. There's the Nielsen numbers, and people are quoting that the market is down 11%, and that's coming from Nielsen. The thing about Nielsen though is that obviously it's a sample. It doesn't cover the whole of the country, and it tends to be weighted more towards west of the Urals, so it's a sample.

We tend to think that if you looked at the whole of the Russian market, that the market is down around about half that, so say 5%. So that's why you might be getting two different numbers on Russia.

And then when it -- the other thing just to bear in mind is that when you're being quoted sales, there are sales to distributors; there are sales from distributors to retailers; and there are sales from retailers to consumers. So, you just need to be careful as to what numbers you're being given.

Can I follow up on that? Now, you're obviously addressing a lot of talk in the market; what you said in your press release is your volumes are essentially flat in Russia this half, and yet presumably, because you're skewed to premium, you're also skewed to Western Russia, where you've suggested, actually, volumes are worse than they are in Eastern Russia, and that would suggest that you're gaining quite a lot of market share in Western Russia.

Well, as Nicandro was saying, we have grown our share of the premium segment in Russia quite significantly over the last two to three years, and continue to grow it, yes, which is what we've been trying to do, as you know. And Kent share has not only grown in the premium segment in Russia, but the Kent share has grown overall in Russia, so it is going some for a premium brand.

Just a comment on the tax rate. The unusual figure is of course the first half figure last year, which was 28%. That was because during the financial crisis we were charging higher rates on our loans to our subsidiaries from the UK. And as you know, we've got no tax to pay in the UK so we had an unusually low tax rate in the first half of last year.

The full-year tax rate for this year will be about 30%, which is a whisker down on last year, which was about 30.3%. So, tax rate will be much more evenly spread this year.

And if you bring that forward, will it stay at 30% for the foreseeable future?

That's as good a judgment I can give without knowing the mix of profits, yes.

Rogerio Fujimori from Credit Suisse. Two questions, please. Following Brazil last year, you basically guided us to around 2% volume decline in 2010, and about 0.5% to 1% volume growth in the medium term; is it still the case?

And my second question is to Ben. When I look at your interest cover and compare it to your target of 5 times to 9 times, could you please elaborate on basically your plan is to continue buying back bonds? Or any color would be appreciated. Thanks.

Okay, two questions here. One is what is our view on volume growth in Brazil overall?

It's basically what you said in Brazil.

Oh I see, when I was in Brazil; I'm sorry I missed that. What do we think volume growth -- okay, yes, I'll talk about that. And then interest cover at 9 times; what does this mean in terms of doing anything interesting with the cash?

I can't remember actually what I did say in Brazil now, but I'm sure it was very wise. I hope I didn't give anything definitive, because I've said on a number of occasions making predictions and what's going to happen in the future right in the middle of a recession, which is still very uncertain in terms of just about everything, in terms of duration depth, volatility, is probably not a good thing to do.

So, I don't know how long the recession is going to continue for and what the depth is going to be. Our view is that once we're out of the recession, we would see that our organic growth -- volume growth post-recession would be around 0.5 of a percentage point.

Now, interest cover, Ben?

Yes, just on the financials, cash flows remain strong; interest cover is going up. I guess the question is are we going to restart the buyback? That's something we look at with the full-year results.

And when we look at it, we look at how earnings accretive a buyback would be, and at current share price, it's not that earnings accretive, and then we look at what's out there in terms of potential acquisition targets and the relative benefits of retiring debt. So, we'll take that decision at the full-year.

Yes, Jon, I think you were next.

Jon Leinster, UBS. Yes, a couple of things. First of all, can you give a bit more color, particularly on the Africa/Middle East region; it's not an area that's described in detail? Constant currency sales seem to be up about 9% and profits up 23%, which seems a remarkably strong performance. What's driven that sort of margin growth in that region?

Okay, Africa/Middle East, a very good performance, particularly on revenue and profit, and obviously a margin improvement; what's driving that?

Yes, there are a lot to do with the mix of performance in Africa/Middle East from the profit perspective. For example, we had a strong performance in places like South Africa; that has a much higher margin than some other places in Africa/Middle East.

And the GCC had an outstanding performance. Share grew strongly in the first half of this year behind Dunhill, that, by the way, has hit an all-time record share in the GCC, and Nigeria.

So I think that the mix of the profit takes the margins higher. But also, the region as a whole has performed extremely well. If you look at the other places, like Egypt for example, we had an outstanding performance. We have been growing volumes in Egypt I think that compounded 15% to 20% every year, so doing quite well.

Okay, yes. Hang on, Erik was -- sorry, Erik's been flagging me. Go ahead.

Yes, Erik Bloomquist. Just to follow-up on the raise in guidance for the margin in 2012, so effectively we're looking at 50 basis points of operating benefit; is that all? Is that something we should attribute entirely to an improved cost savings outlook? Or is that something that we can attribute to a mix of cost savings and [pricings] on?

Okay, the question is around the margin improvement, the increased guidance on the margins for 2012 and what's driving that; Ben?

Yes, it's more because having sold Lyfra, which has over GBP400 million turnover in a full year and very little profit, then that's the net effect in terms of the impact on our Group margins.

Prior to selling Lyfra, we were on target to hit our 34% by 2012. So, it's really just the impact of the adjustment of Lyfra, which should make 34% in 2012; 35% now.

Nico Lambrechts, Bank of America Merrill Lynch. Good morning. Just on pricing, the organic pricing 2009 was running around 8%, maybe 8.5%, for BAT and your peers. In the first half it moderated to 5%; what should we expect in the second half? Should there be a further decline of that level?

And maybe you could elaborate around is the shift in pricing that there's less MPI, Manufactures' Price Increase, and the governments are taking more, meaning that the consumers actually seeing the same retail price increase?

And maybe (inaudible), should we expect a moderation in the pricing to happen in the second half and maybe into 2011?

Okay, the question was around pricing. And given that there seems to have been a moderation of MPI from last year, from around 8% to around about 5% in the first half of this year, what's our view on where pricing may go in the second half of the year? And what's happening between manufacturers take and government take; that's how I read the question. Let me try and answer that.

Let me just give you some caveats. It's very difficult to say -- to forecast pricing in the future because -- and some of that is led by competition; it's also driven by governments increasing excise; and it's also around VAT increases, as I was alluding. So, very difficult to forecast what's going to be happening on prices from a consumer point of view.

But to try and give you an understanding as to how we see pricing, I think last year we had very good pricing for manufacturers last year. We were slightly surprised that, in fact, the overall pricing environment was relatively benign, in that governments did not increase excise as much as we thought they were going to do. But we did anticipate that this was going to get rectified in 2010, and that's certainly been the case.

So, from a consumer point of view, we see that prices have gone up in the first half of 2010, more than they did last year, but that the government take of that increase has increased. And you also have to be very careful that you don't over-crank pricing with the consumer. So, I think the industry take has slightly declined versus where it was last year so that you're not cranking prices too much.

Does that sort of -- now what that means for the next -- I couldn't tell you. I don't -- I still see manufacturers pricing momentum good. But from what everyone seems to be saying, including us, most of the increases on prices have been taken so far this year.

I would agree momentum's still good, but would you agree it's moderated from the prior year? And should we expect -- because if you're not taking further price this year, the MPI would moderate further in the second half compared to the first half of 5%.

Okay, the facts clearly show that there's been some moderation in terms of the Manufactures' Price Increase first half of this year versus last year. There are still some price increases to come; witness Japan. So there are still price increases to come, so it's not that 2011's going to be a desert in terms of price rollover. So, no, I don't see that.

I don't see any problems in the second half of the year. I'm just reflecting the fact that there has been some moderation, as you pointed out.

It's, therefore, quite interesting to see that volumes are actually recovering, despite faster retail price increases in the second quarter. Do you attribute that to better consumer confidence?

It could well be. You're asking me to divine -- I think disposal incomes are down in our top 40 markets. The issue is, when it comes to the recession, and given the organizations that you work for that you might be better able to talk about the recession than I am, we're not a large bank, what you're seeing is a sort of bipolar effect.

In the emerging markets, I think we're seeing some -- we are seeing pick-up, and it's quite clear. The emerging markets are going quite well. The US and Western Europe, they're still talking about whether there's going to be a double dip. So, you've got this sort of bipolar effect. And of course the thing to do is to bet with those that are exposed to the emerging markets.

Can I follow-up? Obviously, it's very interesting; you just said you mustn't over-crank pricing of the consumers. Now, in the past what I've associated with you on pricing as a comment is something like the amount of pricing we can take is more a function of the competitive environment than what the consumers will bear; that's roughly the message I've always got from you in the past.

Do you, therefore, think that your thoughts have perhaps slightly evolved? You've been through a period of pretty huge retail price increases with the combination of tax and [yield], and do you think that the fact that you've given a slightly different tone is important and we should be thinking about that pretty significantly?

Well, okay, the question is that have we moderated our view in terms of the price opportunities? In the past, we've said that it's more to do with competitive behavior than it is the consumers' ability to pay, and now here I am talking about not over-cranking the consumer. I think those two positions are entirely compatible, by the way. Let me explain.

Where you have markets where excise has gone up by 25%/30% -- sorry, prices have gone up as a result of excise increases by 25%/30% in a short period of time, and I think Nicandro was saying that in Romania prices have doubled in the last 12 months, just to give you some idea, for us to go in and say it's purely down to competitive behavior here as to whether we can take a price increase, we clearly do in those markets. We need to be careful that we don't ask the consumer to bear too much price in a relatively short period of time; that's the point I'm making.

As you know, we have often said that the consumers can bear more excise; the consumers can bear more pricing. What you have to do is you have to go for -- to even that over time. And in a period of time when they're suddenly hit with substantial price increases driven by excise, you obviously have to be a little bit careful around that.

But over time I think consumers will get used to those prices, and I think there are markets which haven't had huge increases in excise where there are still opportunities. So, I'm not -- I just think that we have to be -- we can't be blind to where the consumers are in a particular market, and that's all I'm saying.

Right, Nico are we still on this?

No, we're moving on.

Oh good.

Two lines down, on the cost of goods sold, could you give us an indication what is happening to leaf costs and other variable costs in the light of, will your gross margins be under pressure [and they fall] as pricing moderates?

Okay, asked a question on what's happening on cost of goods sold, variable costs, and particularly leaf; Ben, do you want to --?

Yes, our variable costs are up in line with inflation, plus a little bit, which reflects the extra value we're putting into the product mix with the innovation strategy. We're making savings on product cost. Leaf's up about 7%. We don't see that galloping head during the course of next year. So, I think we're in a pretty good position on the inflation in the cost base.

Do your comments refer to the first half or the full year?

That's the annualized effect we're expecting this year.

So, overall cost of goods sold in line with inflation and the leaf 7%?

Yes, leaf's slightly higher; some of the other bits are slightly lower; and we're making savings of course as part of the cost saving program anyway. So, by and large, 5% to 7% inflation in the cost base would be, yes, a good guess; more nearer 5%, I would say.

All right. So your rate of inflation across your different markets are running low [on funds]?

Yes. It'll be more in local currency, of course. You've got local inflation of 15% and local salaries are going to go up by 15%. But if you look in sterling at our costs base, you'll see it's up in line with inflation, plus a little bit, which reflects the slightly higher cost of leaf and the slightly more marketing investment we're putting into the product, rather than to marketing spend.

Hi, just two follow-ups. Obviously, South Africa's doing very well, which you mentioned, but you also mentioned, I think, a little bit of share reduction. I just wondered whether you're seeing anything different from PMI following the pipes business. Obviously, they've been pretty open -- ?

Sorry, say that again?

Sorry, I just wondered whether you'd seen anything different from PMI in that market. Obviously, they've been pretty open that one of the reasons for the pipes acquisition was to also put cigarettes through the country more aggressively.

And then secondly, just to pick you up on a comment I think you made on the interviews this morning, Nicandro, I think you mentioned one of your key focuses, which might be slightly different to before, is the focus on roll-your-own. Just wondered whether you can elaborate on that, n terms of whether you're doing anything in that in the moment; what you might do differently there now; and what the targets might be on that particular category. Thanks very much.

Okay, two questions; one was on South Africa. We have been asked to comment on whether we're seeing anything different from PMI in South Africa. And also, what our intentions might be on RYO, picking up the comment that we see that as an area of increased focus going forward.

In the case of South Africa, we are doing quite well, I have to say. We have lost 0.4% share, but we are coming to quite a strong share in South Africa, 85.4%, so it's still extremely strong.

And the biggest issue that we are facing in South Africa nowadays is the size of illicit. So, it's coming back to the issue that we had in 2006, in which illicit came to around 20%/25%. And the government did an outstanding job at that time and brought it back to a very low rate of illicit.

Now, it's coming back. The illicit now in South Africa, I think that is around in 20%s, something like that; 18%, 20%, 21%. So, I think that the government -- we have been in touch with the government and they are doing a lot of work on that one. So, I think that our share loss has come a lot about the size of illicit and some slippage from low price brands to illicit volume.

But our share in the duty-paid market is extremely strong in South Africa. I wouldn't say that we are facing any big issues there, apart from illicit, to answer your question. Profit-wise, we had an outstanding half year. And the volume is suffering a little bit because of illicit.

Regarding the OTP --

Anything different from PMI in South Africa?

No, I don't think so. I think that if you see the share of the competition, it has not moved a lot. So, I wouldn't like to elaborate on the competition but it has not moved a lot.

Regarding OTP, the point that I raise is that our share in the OTP business is lower than our share in the cigarettes so there is an opportunity there. Our share in the OTP is around 16.5% to 17%. We grew share in the first half of the year.

We slightly grew share in the OTP segment in fine cut, but I think that we can do better. And we are going to do better looking at focusing on the four or five big markets in Western Europe. So, we are doing a lot of work on that one. You'll probably see some launches in the market in the next 12 months or so. So, we think that we needed to have our fair share in the fine cut as we have in the cigarettes, at least.

Just a follow-up -- it's Toby McCullagh from Morgan Stanley. Just following on on the comments on illicit, specifically in Canada, we've seen an improvement in the illicit controls; what's really changed there? And do you think it's structural and giving you confidence, perhaps, that this will endure into the second half and beyond?

And are you finding that when people are trading back into the legal market, that they're just coming in at the lowest price points? Or is it more balanced than that?

Then I suppose the follow-on from that, you just referenced South Africa; are there any lessons or practices that you can take into other markets that have taken -- or that suffered recent spikes in illicit?

Okay, all right, the question was around Canada and the reduction in the illicit trade in Canada. Do we perceive that whatever has caused those changes to illicit trade, are they structural and, therefore, are they likely to endure?

And when consumers return from illicit back into cigarettes, are they going into the lowest price point, or are they mixing it more?

And thirdly, given that we have markets where illicit trade has been reduced, can we take those learnings and transfer them to other markets? Do you want to give that a go?

Yes. First of all, let's start from the last point, in terms of learnings from one market to another. And I think that, first of all, let's try to -- let me explain that illicit comes from three sources.

You can have contraband, and you can even have contraband of legitimate products, from places that you pay low tax in places that you pay high tax, so there is an economic advantage for the channel; then you can have as well tax evasion, products that are produced in the country and don't pay tax or don't pay fully as legal industry pays; and you have the counterfeiting. So, you attack the problem in different manners.

So, yes, we take learning from one country to another. We have a global team here that tries to benchmark what you do well or what you don't do well in some parts of the world. And they try to work as much as possible together from a global point of view to see what you can take from one society to another.

So, we've had a good experience in Brazil in the past because illicit trade in Brazil has been a problem for many, many years. So they have done a good piece of work there, so we always take the learnings that we had in Brazil, pass to South Africa, and so on and so forth.

In 2006, when I was the African/Middle East vision -- Director, the first thing that I did, I went for -- I asked for a workshop of illicit trades. We took the learnings from different parts of the world; we took the learnings from what we had in the center as well, in terms of knowledge; and we tried to engage with the governments to pass the knowledge that we have in terms of fighting illicit trade. So, we are quite active on that one.

Because in some markets, illicit trade, such as in South Africa nowadays, is our biggest competitor in terms of share so we have to be very strong on that one. And as you saw, for example in Romania in the last couple of months, we saw illicit trade coming down, and you see the impact in our numbers.

Going to Canada, you see that overall industry in Canada is relatively stable from the consumption point of view. But from the duty paid point of view, is going up the second quarter 17%; this is mainly due to the decline in illicit trades. So, it's quite important for us to, as I said, engage with the government.

And in Canada, most of the illicit -- or probably 100% of the illicit comes from the Indian reservation. There is a completely different issue that we face in places like Brazil, South Africa, Romania, and so on. But what I can say is that the government is active on that.

And we try to engage with the governments, not BAT but the industry in general, in order to support with the knowledge that we have in the industry, the knowledge that we have about the channels, because our trader reps are on a daily basis meeting our customers so they know where the problem is. So, we try to engage with the government and explain the situation in order to have the government with the right information to act on that.

And the Canadian Government has done a good job, I have to say. You see the illicit trade is coming down; volumes are up in the second quarter we reckon something like 17%. Considering that, our market share position in Canada, we are a great beneficiary of the reduction of illicit.

I think we'll see that decline remain. Border control is really down to the will of the government. And if they focus on it, they can do something; the question is will they continue to focus on it. I think they will, but whether they'll do it to the same extent as they've done it because these tend to go in pulses. But I think the reduction in illicit trade will be broadly -- I don't see that -- the reduction in illicit trade reducing, if you see what I mean. It'll still remain good.

And they do -- consumers do tend to go back into low price.

I think that's it. Thanks very much, everyone. Thanks for coming. And we'll see you again soon.