British American Tobacco p.l.c.
Q4 2019 Earnings Call Transcript

Published: 27 Nov 2019

[Operator:]

Hello, and welcome to the BAT 2019 Second Half Pre-Close Conference Call. Throughout the call, all participants will be in listen-only mode. And afterwards, there will be a question-and-answer session. Please note, this call is being recorded.I'll now hand over to Mike Nightingale, Head of Investor Relations. Please begin.

[Mike Nightingale:]

Good morning, everyone. Mike Nightingale here, Head of Investor Relations. And with me this morning is Tadeu Marroco, Finance Director.Welcome to our first pre-close conference call. This is the first time we’ve held a conference call for our pre-close trade update and we do hope that you will find it useful. Just before we begin, I'd like to draw your attention to the cautionary statement regarding forward-looking statements contained in the trading update.But I will now hand over to Tadeu who has a few short words on current trading before we open it up to questions. Unless otherwise stated, our comments will focus on consent currency adjusted measures.

[Tadeu Marroco:]

Thank you, Mike. Good morning everyone and welcome. I'm very pleased to have this opportunity to talk to you about how we are progressing 2019 and I want to thank you for joining us this morning.As you can see from today's announcement, the business continues to perform well. We are building on the progress we made in the first half and continuing our journey to transform the business. We are driving value growth in combustibles. We're investing to deliver step change in New Categories and we are transforming the business to create a stronger, simpler, more agile BAT.As a result, we are on track for one of our best financial performance for many years. We expect that adjusted revenue and adjusted profit from operations to be in the upper half of our guidance range of 3% to 5% for revenue and 5% to 7% for operating profit. This reflects a good performance in combustibles where we have seen share growth and strong price mix as well as good growth in New Categories.As you know, we have increased our focus on value growth in combustibles. We aim to deliver superior and winning product experience whilst driving efficiencies and reducing environmental impacts. We have rationalized and simplified the portfolio. We have focus on the global strategic brands and invested in key markets. This is driving value share, which is up 20 basis points with the strategic brands up 55 basis points.In addition, I'm pleased to say, we are back to growth in volume share, which is up over 10 basis points, having being down earlier in the year. We continue to expect this is going to be down around 3.5% this year. BAT full year volumes are expected to be broadly in line with the industry after adjusting for the continuing impact of Egypt and Venezuela and a 60 basis points impact from a one-off stock reduction in Russia. The good pricing environment has continued, and we expect full year combustible price mix to be in excess of 7%.In the U.S. we are really pleased with how the business is performing and we expect constant currency revenue growth to be within the 3% to 5% Group guidance range, with price and value share growth have more than offset the industry volume decline. U.S. value share is up 30 basis points. We have worked hard to position ourselves and are growing in all the right areas consolidating our leadership position in menthol and adult smokers under 30 and continue to grow our share of premium. We continue to expect the U.S. industry going to be down around 5.5% in 2019, with the timing and frequency of pricing during the year being one of the main drivers as well as the impact from the growth of vapour.Although the vapour market has slowed, we are not anticipating a significant throwback to cigarettes in 2019. We would expect the U.S. volumes to be down around 4% to 6% next year, depending mainly on pricing and the regulatory environmentTurning now to New Categories. Our approach to multiple categories development is underpinned by robust price, product stewardship, age restricted assets and responsible marketing practice. We expect to deliver good full year New Categories revenue growth at the lower end of our 30% to 50% guidance reflecting the negative U.S. new flows. The vapour market has slowed in the last few months with industry vapour sales still staying the U.S. down around 5% and consumer offtake down 10%, although we have seen some signs of recovery in the most recent data. New Category growth excluding U.S. vapour is on track to deliver in the middle of the range in line with our guidance at the interims.In the U.S., Vuse Alto continues to grow and has reached a value share of 11.1% in October, driving a value share of 70.5% for the overall Vuse family which is now the number 2 in the market. At present, Alto is the only top five brand growing volume in declining market and has more than doubled its offtake share of replacement cartridge in the second half. I’m also pleased to say that we just received a confirmation from the FDA that our Vuse Solo PMTA application has been accepted for scientific review. Vype continues to do well in the two largest markets outside the U.S. Value share reached 11.8% in the UK and 19.2% in France in October with ePod now successfully launched in both markets. In Canada, Vype is the fastest growing brand reaching a value share of 27.6% in October, up 570 basis points since July.In THP, glo is holding share in Japan at 4.9% year-to-date. As you know we’ve recently launched our new glo device glo Pro, glo Nano and glo Sens together with a new range of consumables. We have yet to see the benefits of these in our share data as distribution for Nano and Pro is still building and we have only just launched the glo Sens. However, early indications are encouraging. For example, consumers have told us they really like the benefits of our induction heating technology. They like the fast ramp up time and the push button and appreciate the improved sensorial experience. This is a good performance in a very competitive market where we have seen a lot of new product launch from competition in the first half.Importantly, we continue to grow share in the overall nicotine market in Japan strongly and we have reached 18.4% year-to-date up from 16.2% last year. In Russia, glo has been demonstrating consistently through the performance with share of tobacco and nicotine now over 1% in key cities, including Moscow. In Modern Oral, Velo’s rollout in the U.S. has now expanded to 75,000 outlets. The brand has already reached a category volume share of 9.2% in October with shares in excess of 20% in nine states and more than 10% in the further nine states. LYFT and EPOK also continued to do well consolidating their leadership of the Modern Oral outside the U.S. In Russia, LYFT is the fastest growing Modern Oral brand in 2019.Moving on to the balance sheet, we are determined to reduce leverage. We remain committed to a full year reduction in currency-neutral adjusted net debt/EBITDA of 0.4 times and are on track to deliver full year free cash flow after dividends of £1.5 billion.To summarize, the business continues to perform well and we are on track to deliver on our commitments to high single figure EPS growth on a constant currency basis. If FX rates were to remain as at November 25, fully adjusted diluted EPS growth would benefit from a current translation tailwind of around 1.2% this year with this becoming a headwind of 2% in 2020. We are expecting a strong performance in 2019 driven by good revenue growth and continued share gains in combustibles together with good revenue growth across our New Categories.Thank you. And I will now open the call to questions.

[Operator:]

[Operator Instructions]. Our first question comes from the line of Adam Spielman at Citi. Please go ahead. Your line is now open.

[Adam Spielman:]

Thank you very and good morning. And thank you also for such a detailed press release. My question concerns sort of definition of market share in particular I guess in glo in Moscow and also for Velo in the U.S. So you talked about over 1% market share for glo in Moscow and about 9% in the U.S. Is that a sort of shipment share or is that Nielsen share across the whole of Moscow and the U.S.? Or is it share within the stores that you are selling? Because obviously sometimes these definitions can change. That’s my simple question or my first simple question.

[Tadeu Marroco:]

Okay. Adam, look, this is shipment share of the whole country. It’s not where we just stated the shipment share of the place where we are talking about.

[Adam Spielman:]

Fine. Perfect. Very simple, very clear. Am I correct that I think about the whole shape of this set of report, I think on the one hand clearly volume in Russia or shipment volume because of the destocking is getting weaker in Egypt and Venezuela. But on the other hand, sales growth overall, constant currency is fine. And that suggests to me that perhaps if anything the U.S. is getting a little bit stronger as we come to the year end. Is that a fair point, does the U.S. if anything is getting a little bit better for you and that offsets -- is offset by slight weakness in other markets?

[Tadeu Marroco:]

Yes. The U.S. market specifically, we are keeping our guidance of 5.5% for the industry decline. We have seen recently a small uptake in terms of volume of cigarette. We're not making any change to the guidance still but this will be -- well be a consequence of timing of pricing. So we are yet to see a major relevant impact coming, for example, from the news flows from vaping. We haven’t seen that yet. That’s why we're keeping our guidance 5.5%. Now saying that, we're very pleased with the results we're getting from revenue in our U.S. business within our range of 3% to 5% as we stated in this statement this morning. And this coupled with pricing and share environment across the world is giving us the upper end of the -- our guidance for this year.In terms of volumes, I quoted in the interims about Egypt and Venezuela. Just as a reminder, Venezuela I think that we all know what's happening there and we basically have a ownership -- or we control the market. We are leaders in the market and we suffer most part of deterioration of economic situation there.In Egypt, we had a health tax that's impacted the lower end of the portfolio where we are more present. And I mentioned those two points there. In Russia, the reduction in distribution inventories has to do with the fact that we are looking as I said before as well to all the same opportunities we had in terms of cash management initiatives. One of that is we do improvement in supply chain. We saw an opportunity happening from Russia as a consequence of the closure of the BAT factory in Saratov and this will translate in some impact this year. That's why we are flagging that.

[Operator:]

Thank you. Our next question comes from the line of Gaurav Jain of Barclays. Please go ahead. Your line is open.

[Gaurav Jain:]

Thanks for the detailed press release as well as the conference call. So I have a few questions. Number one is on the 2020 U.S. volume outlook. Does this include any impact from minimum age 21 regulation?

[Tadeu Marroco:]

Well, the idea behind the range of 4% to 6% is exactly to cope with those uncertainties and the reason why we have mentioned the drivers of uncertainties that are on the regulatory front. You’re absolutely right, 21 age, minimum age is present as we speak, by general, would be about 40% of the sales in the U.S. So we don't know if there will be a federal legislation that will increase this percentage and by when. And so we want to try to flag this possibility. That's the reason on the range. The other regulatory front that can impact positively the market is on the vaping side depending on how more the enforcement will be in terms of the PMTA coming in May. The guidance that we expect from FDA as an entering into the PMTA, we still don't -- we are uncertain about that. So I think that on the regulatory front these are the major swings and hence the range. The other element of the range has to do with the timing of pricing, as you can imagine, as well, and then all the macroeconomics like gas price and the macro itself.

[Gaurav Jain:]

Second is the guidance for New Categories revenue for 2020 and longer term. Your guidance says 30% to 50% for the next few years and we yet find that every few months it's very hard to forecast what's going to happen in the U.S. vapour market. So is there an opportunity for you to reframe the way you communicate the New Category guidance to the market?

[Tadeu Marroco:]

Yes, look, I think that more important is the ambition that we have set of £5 billion revenue by 2023, 2024 and this we are sticking to that. For sure, that to get to that position this will require between 30% to 50% growth on average. But you're right. One thing that we have learned is that isn’t predictable. The U.S. is just showing that for us. It’s hard to forecast on the short-term. You're absolutely right on that. It depends on regulatory framework, it depends on consumer acceptance. But our ambition is completely unchanged and we are confident that we are doing the right investments in consumer insights. We are doing the right investments in terms of planning the building and we have a lot of plans coming through in 2020 in terms of new launches and we can provide a bit more detail in 2020 if necessary. But the bigger picture is the ambition to deliver £5 billion and we are very, very happy with the performance that we have underlying in terms of vaping. You saw the statement that we released today. We have more than doubled our share in Vuse Alto over the last three months in the U.S. We are doing extremely well with equivalent of Alto which is ePod in Canada, in France where we are now market leaders, in the UK, which are the biggest markets in vaping. We have making very good inroads in terms of Modern Oral, not just anywhere, but outside the U.S. as well. And we are increasing our competitive position in THP with the new launches. So, that's what matters. Our ambition continues, our commitment, our levels of investments and we want to get to the £5 billion in 2023, 2024.

[Gaurav Jain:]

And if I can ask one last question. I believe you haven't really shared your capacity for Velo so far and what the capacity and distribution plans can be going forward. So, can you shed some light on those?

[Tadeu Marroco:]

Yes. We don't have any constraint in terms of Velo capacity. We have -- as I said now we’re present in 75,000 stores. By the end of the year we want to be above 100,000 stores in Velo. We have been setting our capacity to be able to cope with all this demand and in terms of minimum cans and we are not expecting any type of restrictions on that side.

[Operator:]

Thank you. Our next question comes from the line on Alan Erskine of Credit Suisse. Please go ahead. Your line is open.

[Alan Erskine:]

Yes. Just two questions from me. One is on the net debt to EBITDA guidance. You are saying that you still expect it to be down approximately 0.4 times, excluding the impact of FX. If the exchange rates stay as they are, if sterling stays 1.28, 1.29, would that also be the case in reported terms or might it be even be more favorable? My second question is just on the price mix benefit of -- in excess of 7%. Can you give us some idea of what the geographical mix component is within that? Thank you.

[Tadeu Marroco:]

Yes. Okay, Alan, good morning. Net debt/EBITDA is 0.4x FX. You are right, if the currency stays -- is a big if, no? It’s a very unpredictable and you know that this needs to happen on 31st of December. But if it stays around the 1.5, we are in the range between 0.4 to 0.5, so we probably be seeing some uptick in the 0.4 guidance ex-FX. And in terms of the price mix, we are facing a positive geographic price mix. We are basically seeing a bit short than 1%, something close to 0.65% on the geographic mix, and it’s basically a consequence of us making a big inroads in the likes of Japan for example and which is something that has changed over the previous years where we used to have drags on geographic mix and we are very pleased now that we have upsides coming from that.

[Operator:]

[Operator Instructions]. Our next question comes from the line of Alicia Forrey of Investec. Please go ahead. Your line is open.

[Alicia Forrey:]

Just a few questions from me. One, you mentioned some recent improvement in the U.S. vaping market. Just wondering if you could sort of flesh out a bit what you’re seeing there, what your current assessment is of that market? And do you think vapour products in U.S. can see positive volume growth in 2020 assuming approval from the FDA come through with one of the disruptions in business? And then secondly, I was wondering if you could discuss in the heated tobacco, what you’ve seen as far as pricing development in markets where glo and ePods are competing against each other that would be helpful? Thank you.

[Tadeu Marroco:]

Okay. So, just coming to your first question, yes, we saw a reduction in terms of sales to retail. But the problem that we saw in vaping in U.S. had basically driven by both consumer offtake and retail confidence. In terms of sales to retail, I mentioned volumes in terms of cartridge comparing the position that we had in mid of the year that was before all this new flows coming through the market, we had a decline around 20% to 25%. And we are seeing recently a recovering around 7% when you compare the first positions of November compared with October. So, we are seeing some recovery from that. For sure that we are performing better than that because we are gaining share in that depressed industry.In terms of your question around the FDA, yes, it’s still very uncertain, the positioning of FDA. We are still to be seeing what will probably materialize from that. We are trying to engage as much as we can with FDA and -- but one thing that we are very confident with is the fact that we have received the approval from the FDA for our first submission of Vuse Solo for scientific review. This is quite important for us in terms of our portfolio of vapours in the U.S. And we have to bear in mind that all types of guidelines that the FDA will be issuing to address the -- mainly the youth epidemic which we fully support and endorse, this would be entering steps until we get to the May 2020 with PMTA coming through. So that’s the major impact on that.Now, your second question, could you remind me, Alicia on the second question, was related to?

[Alicia Forrey:]

Sure, I was just wondering about in heated tobacco in markets where glo and ePods are competing against each other. If you could update us on how pricing has evolved on heated tobacco in your experience thus far?

[Tadeu Marroco:]

Yes. This depends -- this varies a lot and depends on the markets. If you take Japan for example, we have more than one price position in the market. We have some of those products positioned in the premium of the markets, some more in the WAP of the market, in the weighted average price of the market. And if you see outside Japan has been below -- a bit below premium, more on the average of the price. We are trying to compete in those price positions with [IQOS]. We are not seeing much of the similar pricing between us and them, and I think that this has been very stable over the last few months I would say.

[Operator:]

Thank you. Our next question comes from the line of Sanath Sudarsan of Morgan Stanley. Please go ahead. Your line is now open.

[Sanath Sudarsan:]

Just two questions from me. One, on the -- coming back on the U.S. volumes and your expectations for 2020, and your range of minus 4% to minus 6%, Tadeu can you just walk us through why do you see the top end of the range being favorably impacted by PMTA please? And the second one is on your NGP guidance that you have longer term of about £5 billion by 2023, 2024, how much of do you see coming from the U.S overall? Thanks.

[Tadeu Marroco:]

Sanath, look the -- we always said that the PMTA will create a contestable space between 1 billion to 1.5 billion in the U.S. We saw by our own experience that how cumbersome can be the process of generating all the scientific material to get through the line. And it's not -- as you know, it’s not just a science that will be important here but also marketing practice. So we believe given the time and resource, physical resource in terms of knowledge and also financial resource, that a number of the current players will probably not be continuing the market after this guideline is established. So that’s why depends on lot of enforcement in our perspective and also depends on what will be done until there in terms of the guidelines that the FDA is supposed to be releasing. That’s the level of uncertainty that we -- that could have an implication in the FMC market and that’s the reason why we're putting this range. That’s basically the reason of the range.In terms of the £5 billion, this will be a combination not just about the geography but would be a combination of the categories. And as you can imagine this evolves in a very frequent basis. As we launch new products, you will see attractiveness to consumers and it’s very hard to predict necessarily by market and by category where you’re going to land. For sure that we keep saying that we have invested a lot in terms of consumer insight, that’s the most important thing to be able to navigate into these most categories strategy that BAT has. There is a lot of insight and foresights that we're generating, that we have invested heavily over the last 12 months. So we have very good information of each category and that’s what defines us in terms of resource allocation where we deploy our investment. But for sure, if you see, after we are in the market with one category, a bit more traction than we would expect, we're going to invest more and this necessarily probably will make this as a kind of a change in targeting within the £5 billion. But overall indication is, it shows that that’s the number that we’d probably be -- relate -- able to achieve which will mean for us a number above 20% of revenues coming from New Categories.

[Sanath Sudarsan:]

Thank you very much. Just going back to the first question on the numbers and volume, does that mean that you expect from the PMTA process a migration of consumers back into the cigarette fold from NGP?

[Tadeu Marroco:]

Well in the U.S. 40% of consumers are dual users between vaping and cigarettes. I think that what we could say depend on how hard the offers are in the market for vaping that you’ll probably be seeing less outflow of consumers from cigarettes to vaping. I think that that's the issue might happen depending how we -- the regulatory environment will impact the market.

[Operator:]

Thank you. Our next question comes from the line of Nico Von Stackelberg of Liberum. Please go ahead. Your line is open.

[Nico Von Stackelberg:]

Just my first question, please, on the illicit trade. Do you have any call up by market on where the illicit trade in particular is severe? And then secondly, just trying to back into your free cash flow before the dividend. So, could you give me a rough steer on where you hope the dividend growth to come out for the full year or vice versa, if could you give me a rough indication of where you see perhaps free cash flow ending up before the dividend?

[Tadeu Marroco:]

Nico, [indiscernible] trade market has actually increased. We have seen increase overall in 2019. And it is driven by markets like for example that has a big wave in the markets like here for example Ukraine, the likes of Russia and the likes of Pakistan and -- but we are seeing that. We are always seeing decline in markets where for us we are overexposed like South Africa which is a good news for the first time after many, many years, we have seen improvements in [vigilant] trade in South Africa in particular. As a consequence of that we will be growing share, we will be growing name too, we will be growing profits in South Africa and which we are very pleased with. The other markets, which is very relevant for BAT is Brazil as you know, and Brazil [indiscernible] trade has been growing as fast over the last few years and even a new government in a new direction in terms of enforcement for the first time after many, many years we have seen that we are growing in the low, low end, low-single figures with a good expectation for the next year that the economy in Brazil starts to picking up again. So overall it’s a story of increasing densities but where we are most overexposed is a good story for us.In terms of the free cash flow, yes, we said dividend to -- that will be £1.5 billion. Our dividend is around £4.8 billion, £5 billion and you can have from that the numbers are before dividends. And this is part of our strategy to delever the company. As you know we are putting a lot of focus in terms of CapEx that I mentioned before, working capital conversion, operating cash conversion rates we expect to be north of 95% moving forward. So these are the strengths of the balance sheet. As you know it is a very cash generative company. And the other thing is that we have a very good match between the currency breakdown of our tax and currently earnings today. And because the company today is very different than what it used to be few years ago after the acquisition of Reynolds but our exposure to emerging markets financially in terms of earnings is much less than it used to be, which puts some more strength in terms of our balance sheet.

[Operator:]

Thank you. And our final question comes from the line of Rey Wium of SBG Securities. Please go ahead. Your line is open.

[Rey Wium:]

Hi, Tadeu and Mike. I'm just curious if you can maybe just elaborate a little bit more about the change in Russia. I mean, first thing, I just want to clarify, I mean this 60 basis points of reduction that you are talking of, so my calc sort of indicate it’s around about 4 billion sticks hits in the second half. And then, related to that, I mean obviously it looks like tobacco eating products are back in good growth in Europe as well as in Russia. So, I just want to know if you can share a bit on your plans specifically in Russia? I mean, if you look at the trend in Japan, obviously first-move advantage is important. So, do you have any capacity issues or will you be able to confirm the margin in that market, so that's I just want to get a few on the Russian tobacco eating market? Thank you.

[Tadeu Marroco:]

Okay. The Russian -- as part of the cash exercise we discussed before, we have made a full assessment of our supply chain in a number of key markets for us, and we saw an opportunity in Russia to reduce the level of investments that we had there. But we had a factory -- closed one of the factories there in Russia happening during the year and as a consequence of that we adjusted our inventories by 4 billion, you're absolutely right and that reflects in the 0.6 one-off. This is generating more cash and helps with cash generation and in working capital that I have always said that will be a priority for us to manage. We have done this year, a bit here and there but that's the most relevant market. We are growing share in Russia. Everything is going well in Russia. We have a strong portfolio of combustibles there. In THP we are very pleased that we have seen consistently growth since January till now with the new launch and reaching the markets and we haven't seen for example glo Pro in the market yet. We just launched glo Nano there and we have reached more than 1% share in the key cities of the country, not just in Moscow. And the same is happening in reality in Ukraine and Kazakhstan as well. So, we are getting more and more traction in glo across Eastern Europe. There is no issue at all in terms of capacity for THP or either for everything that we are doing in terms of reviewing supply chain in Russia.

[Operator:]

Thank you. And as there are no further questions at this time, I'll hand back to Tadeu to close the call.

[Tadeu Marroco:]

Okay. So, thank you very much. So in summary, delivering a strong financial performance in line of our guidance, we are very pleased with constant currency revenue, operating profit and upper half of our guidance range. High single-digit with constant EPS growth versus 1.2% currency tailwind for EPS at current rate this year. Our deleveraging on track. Our combustibles business performing very well with strong pricing and share gains. Our U.S. business expected to deliver strong revenue and profit performance, good growth in New Categories in the second half as we gained share and creating a stronger, simpler and more agile BAT which is in line with the priorities that Jack set at the very early beginning of the year. And our restructuring project is completely on track and we will update you more on those points and more of that in February when we’ll have our year end release. Okay? So thank you very much for joining us today. And we look forward to seeing you in February at our prelims.