Imperial Brands PLC
Q2 2013 Earnings Call Transcript

Published: 30 Apr 2013

[Executives:]

Alison Cooper – CEO Bob Dyrbus – Finance Director Matt Phillips – Corporate Affairs Director Arthur van Benthem – Group Sales Director

[Analysts:]

Chris Wickham – Oriel Securities James Bushnell – Exane Henry Davies – Merrill Lynch Martin Deboo – Investec Erik Bloomquist – Berenberg Rogerio Fujimori – Credit Suisse Doug Wendell – Jefferies Adam Spielman – Citi Chas Manso – Société Générale Jon Fell – Deutsche Bank

[Alison Cooper:]

Well, good morning. I’m Alison Cooper, Chief Executive. I’m here with the Finance Director, Bob Dyrbus, and other members of the senior management team. Earlier in the year, we said this wouldn’t be a pretty set of results. And as you’ve seen from the R&S, these numbers are well below our usual standard. We flagged the profits will be second half-weighted and we expect to grow full year earnings per share in line with our earnings model, albeit at the lower end given the difficult operating environment. We’re going to talk you through the main factors that had affected our results, give you some color around how we’re managing them to deliver the full year and position ourselves for growth in 2014. In the first half, we delivered on our strategy with some good performances across our total tobacco portfolio, achieving further growth from our key strategic brands, fine cut tobaccos, cigars, and smokeless products. And from a footprint perspective, we delivered some good EU results in the UK and Germany and made further progress in a number of emerging markets and our rest of the world region, particularly across Asia Pacific and Africa and Middle East. This has been offset by the following factors. First, weakness in the EU was materially impacting the market sizes and there are no signs that this is ameliorating. Outside the EU, Russia and the USA have clouded good results in Asia Pacific and Africa and the Middle East compounded by reduced trade stocks in some markets. And following recent excise changes in Russia, the market is declining and the value segment is shrinking which is impacting our share. And in the US, we continue to transition to our new cigarette pricing strategy. Investment was higher during the first half of last year across the group, and a large chunk of this was in Russia and the US. These are the main headwinds in the first half. We’re taking a number of actions in line with our strategy to address them and strengthen the sustainability of the business. In the EU, that’s about building on a robust performance. Our total tobacco focus meant that EU profits were down just 2%, an encouraging result given the deteriorating conditions. Portfolio initiatives, pricing and cost optimization will support profit delivery in the second half and into 2014. In Russia, the focus continues to be on driving quality growth from our key strategic brands, supported by investments in portfolio initiatives to address current trends. In the US, we are focused on strengthening our acquisition with our sales growth drivers, embedding the new pricing strategy and progressing portfolio and customer engagement initiatives. The actions we’re taking in Russia and the US should deliver improved performance in the second half. And we see many opportunities for growth outside the EU including in Asia Pacific and Africa and the Middle East where we’ll be building on group’s first half performances. The second half will also benefit from mapping the higher investment levels that began in the second half of 2012, as well as an initial £30 million savings from our cost optimization program. So that’s some context for today’s presentation. I will now hand over to Bob to go through the financials.

[Bob Dyrbus:]

Thanks, Alison, and good morning, everyone. As usual, my comments relate to constant currency performance. Our overall revenue and volume results have been impacted by the factors Alison highlighted, but we’re still driving momentum behind our total tobacco offerings. Our key strategic brands aren’t immune from the tough environment, but their equity strength and international reach resulted in net revenue growth of 5% and volume growth of 1%. Our fine cut tobacco performance was excellent with revenues up 10% and volumes up 9%. Adjusted operating profit declined 5%, reflecting reduced revenues and increased investment behind our sales growth strategy. Our tobacco adjusted operating margin was around 41%. Earnings per share declined 2%, also reflecting a lower interest cost and the benefits or our share buyback program. Including the impact of FX, EPS declined 3%, in part due to around £10 million as a negative FX on the leaf purchases. If current FX rates prevail, we estimate the negative impact of this at year-end to be in the region of £40 million. We’ve increased the interim dividend by 11% and bought back £295 million worth of shares as part of our annualized £500 million buyback program. I’ll now give you more detail around the factors affecting our results from the market perspective. EU markets have been impacted by market size declines due to austerity measures which have affected disposable incomes. Unemployment is rising, now at almost 11% across the EU and over 27% in Spain. We’ve also seen some marked increases in the illicit trade. In the 2012 calendar year, non-duty paid volumes increased in many EU markets and a significant proportion of this was illicit tobacco. Markets affected including the UK, Spain and France. And there was a material increase in non-duty paid volumes in these markets in the first quarter of our 2013 financial year. We’ve seen nothing to suggest this rise in illicit trade is easing and continue to work with authorities across the EU to tackle the supply of illegal tobacco. In the EU, we’ve continued to focus on balancing profit delivery and share performance. We’ve achieved good results in Germany, increasing our volumes, revenues, profits and market share. This is driven by growth in Gauloises Blondes, JPS and a number of fine cut tobacco brands. Profits were up in the UK, driven by strong price mix and our cigarette share was stable. In Spain and the rest of the EU, the impact of the macro factors was more pronounced and has significantly affected our performance. In the EU, continuously still searching for value and we continue to capitalize on growth in fine cut tobacco across the region. Volumes are up 9% and we grew share in a number of markets. We delivered some good performances in emerging markets, although overall non-EU net revenues and profits were impacted by Russia and the USA. We’ve also continued to invest across the region to support growth. Higher investment impacted our financial performance in USA. Investments are supporting a new pricing strategy as well as portfolio and customer engagement activities. And in mass market cigar, we’re further focusing on portfolio initiatives to drive growth. We delivered a good performance with our strategic brands in some Eastern European markets, particularly in the higher growth queen-sized segment. In Russia, we divested ahead of regulatory changes to support the development of our key strategic brands. The market has been impacted by recent excise changes. Market volumes are declining and the value segment, less 75% of our volume set, is declining faster which is impacting our share. In Africa and in the Middle East, we increased our net revenues and improved volumes of our key strategic brands by 10%. Gauloises Blondes continues to perform well, increasing regional volumes by 7% and we’re driving good growth from the team in our core African markets. Profit growth in Turkey and Saudi Arabia was strong and we delivered very good results in Asia Pacific, growing revenues and increasing volumes of our key strategic brands by 8%. West grew share in Taiwan, and JPS continues to perform well in Australia. These brand performances supported profit and share growth in both markets. It’s now five months since plain packaging has been in place in Australia. So far, we see no material impact on consumption and we’ve continued to grow share in both cigarette and fine cut tobacco. Our cash conversion rate over the 12-month period to March was 63%, impacted by a negative working capital swinging logistics to £400 million as excise flows were reduced following tobacco volume weakness in Spain, France, and Italy. Standalone tobacco cash conversion was in line with previous 12 months and around 75% and we expect 80% to 100% cash conversion for the full year with our usual caveat around any potential impact of any material excise or price increases. Our closing adjusted net debt for this half was £11 billion, up from £9.9 billion at the end of March last year. This was due to the negative working capital swing in logistics and tax paid which was some £300 million higher as we settled some outstanding tax matters which, last year, allowed us to write back some provisions we previously made. Foreign exchange in level was £200 million higher than last year. The net interest charge was £263 million. Our average all in cost of net debt was 5%, and that tax rate was in line with our expectations at 23%. In logistics, adjusted operating profit declined 1%, a good result given the current environment. Cost saving initiatives and price increases have offset market volume declines in tobacco logistics. And in non-tobacco, we’ve made further efficiency gains in our transport business. Thank you and I would like to hand back to Alison.

[Alison Cooper:]

Thanks, Bob. Total tobacco is a key strength in the current environment. Our consumer insights continue to drive investment priorities and a sustainable development of our brands and products. I now would like to give you an overview of our portfolio results and highlight the initiatives we’re implementing to build our growth record. I’ll start with the key strategic brands. Maximizing the potential of our key strategic brands remains a priority. Despite the difficult environment, we’ve again added to the track record of growth these brands have achieved in recent years, increasing revenues by 5% and volumes by 1%. These brands account for 32% of our total volumes. That’s more than 100 billion sticks on an annual basis and we’re focused on growing this further. Davidoff continues to perform well in a number of EU markets including Germany, Italy and Greece. Davidoff was impacted by reduced trade stocks in Eastern Europe but grew share in the core markets of Russia and the Ukraine and is generating very good results in Turkey where volumes were up by almost 30%. We increased volumes in Gauloises Blondes with good growth in Africa and the Middle East where regional volumes were up 7%. And Gauloises was also a key driver of our overall cigarette share growth in Germany. West made good share gains in Africa and the Middle East and Asia although the brand performed less well in Eastern Europe largely a result of increased competition in Azerbaijan. JPS grew as we strengthened the brand share in markets such as Australia, Germany and the UK. JPS is doing a great job of hitting the right consumer needs and trends in the current environment. It’s EU total tobacco brand moving a range of consumer needs to an extensive line of products and formats across cigarettes and fine cut tobacco. Our focus on generating sustainable growth has increased volumes over 25 billion stick equivalents on an annual basis. And JPS is now the fifth largest tobacco brand in its EU footprint. Innovation in key growth segments is underpinning the brands’ performance, and we’re building on this with the launch of the first expanded natural make your own product in Germany and Austria. We see plenty of opportunities for further growth in Western Europe and Australasia where consumers are seeking a high quality value for money smoking experience. JPS was integral to our excellent performance in fine cut tobacco. Revenues were up 10%, volumes were up 9%. And we outperformed in EU where our volumes increased 9% against the market being up 7%. This is again driven by gains in make your own, particularly in Spain with Ducados and Germany with JPS, Route 66 and Fairwind. Our fine cut success was complemented by further good growth in papers and tubes with volumes of both up by 3%. Our premium cigar division increased overall volumes by 3% and emerging market volumes by an excellent 18%. Growth is particularly strong in Africa and the Middle East and the success of Montecristo minis continue to support our growth across markets in Eastern Europe and Asia Pacific. Our US premium cigar portfolio is also performing well following a number of successful launches. And in Scandinavia, we’re driving further growth in our snus brands, increasing revenues by 31%, volumes by 30%, and profit by 28%. Our share performances were also strong, particularly in Sweden where we’re edging towards 9% of the market. On the strength of our snus portfolio, we see further opportunities for growth. We continue to develop our portfolio strategy, focused on building total tobacco brands that truly resonate with consumers, brands that will deliver quality, sustainable growth across our footprint. This slide will be familiar to those of you who’s on our Investor Day. It breaks down the core components of our portfolio and shows the quality of growth we’ve been delivering on a compound three-year basis. The volume in revenue growth we have achieved stands for total tobacco spectrum and we’ve added to this track record of growth in the first half. As we highlighted at the Investor Day, we’re taking steps to address the box at the top line. It’s not sustainable. It’s undermining the quality of our growth, and we’ve undertaken a strategic portfolio to review to drive clear portfolio priorities. I won’t dwell on the key strategic brands. They’ve been performing well versus market trends, and we continue to focus on generating growth across our footprint. We’ve highlighted four additional brands to focus at on our Investor Day. These focus brands have strong equity with consumers and will deliver volume and revenue growth on an aggregate basis. And then there’s the portfolio brands. These are brands with variable equity. Some are performing well. Others aren’t. And the good performance generate consistent returns, other things nurturing to boost performance, and a number would be migrated into key strategical focus brands to reduce complexity. We’ve assigned focus brand status to a number of other brands at the Investor Day including USA Gold as a new international value brand, Parker & Simpson or P&S. We’ve also confirmed three specialists fine tobacco focus brands, Golden Virginia, Drum, and Route 66. Our key strategic and focus brands generate high returns and represent nearly 50% of our total stick equivalent volumes. Collectively, these brands will drive sustainable volume and revenue growth. The contribution of each brand will vary, but on an aggregate basis, volumes and revenues will increase, and we’re investing in initiatives to support this growth. And you can see some of them on the next few slides. We’ve been active with all four key strategic brands. In May, we’ll start rolling out a global rejuvenation of Davidoff to reinforce the brand’s premium credentials. And we’ve also rejuvenated West. Again, this is a global brand initiative. The new look West was recently launched in Russia and Poland and more markets will follow in the second half. And we’re continuing to support our queen size formats in Eastern Europe. This is a high growth segment in which we have strong representation with Davidoff, Gauloises Blondes and West. Natural tobacco is another high growth segment where we’re performing well. Gauloises and JPS natural tobacco have added to our growth momentum in Germany and we’re building on this by making these products available in more markets, including France and Austria. We’ve also been investing in the development of our focus brands. And here you can see some examples

[Alison Cooper:]

Chris?

[Chris Wickham – Oriel Securities:]

Yes, hi. It’s Chris Wickham from Oriel Securities. I just wanted to follow up on your final point about total tobacco because clearly, in these eight markets that you highlight, you lost share in five of those in terms of fine cuts. And we’ve seen one of your competitors made quite a lot of positive comments about their progress in that area. I mean, clearly to some extent, fine cut is a route to survival in these very challenging times of illicits and sort of headwinds for FMCs. I was just wondering what you can do perhaps to sort of get your mojo back in that space and stop seeing share declines, and actually start seeing eight out of eight?

[Alison Cooper:]

I think your point around fine cut and its role in the current environment is a really important one in that consumers are clearly under pressure, the austerity measures the disposable incomes. And for us this is a really key aspect of the portfolio to keep consumers legal and also to support the trade as well. Because, as you’ve seen in a number of markets, we’re seeing non-duty pay growth and it’s quite significant. So clearly, it’s a very significant segment, a growing segment at the moment. And our fine cut portfolios largely sit within the markets where we clearly are balancing profit. It’s where we clearly are balancing profit and share in those markets. And we’ve made no secret of that. And we do that in a number of these key fine cut markets. So, our focus is very much on maintaining our position in fine cut tobacco, looking to grow where appropriate, but clearly making that margin consideration at times as well. And a classic example for me is the UK market. You can see we’re ceding share here. We’ve made a very clear call that there’s a profit opportunity here that we think we ought to pursue. And the easiest way of growing our UK share would be to dump the price of Golden Virginia. That would be the easiest way to do it. It’s a premium product with a very high margin. But that’s not the strategy we’ve chosen to take. We’ve chosen to say let’s look for opportunities in terms of the profit growth. Let’s also look to do things with our portfolio to address that share issue but not do the easy route in terms of adjusting it with the Golden Virginia premium product. So, that’s the sort of strategic decision we’re making around how we draw a fine cut. And I would point out that we come from a huge position in this segment. We’ve created it in a number of markets like Poland, like Spain, so when you start with 100% of the market, it’s tricky to go up from there. And therefore, that margin share tradeoff is quite significant for us. And we’re growing volumes. We grew 9% in the EU which I have to say is ahead of the market in total terms. So, overall, a good performance. So I think, considering our position in that product group. But we will continue to innovate. As you can see, expanded natural tobacco, huge growth segment in the EU currently, that should capture some new consumers for us too.

[Chris Wickham – Oriel Securities:]

And as a follow-up there, how would you see the outlook for fine cut products which are extensions of FMC brands relative to ones which are standalone fine cut brands?

[Alison Cooper:]

I think you can see growth in two areas at the moment. There are opportunities in roll your own, but more, I would say, in the cigarette tasting roll your own tobacco, so that can be within the fine cut brands, but also clearly, there’s an opportunity there for FMC brands too. There’s also growth in make your own and make your own does tend to be more cigarette-branded because clearly, people are looking for a replica smoking experience with the cigarette. So that’s being part of our focus and choice around the brands we’ve chose to focus on in the fine cut area, so you’ll see some pure fine cut brands. But also, we’re looking to leverage the total tobacco brands as well, like JPS, for example, in that category. Okay. Okay, next. The guy in the back here. Yes?

[James Bushnell – Exane:]

Hi, good morning. James Bushnell from Exane. Two questions, please. Firstly, you’ve mentioned you expect, say, a better H2, presumably that account refers to profits, how should we except the top line to develop in the second half? I know you said that conditions don’t seem to be getting any better. Is there a beneficial comparison effect and perhaps that will chime with what one of your competitors have said? And then my second question is on Russia. You said 75% of your volumes in the value segment and therefore, you’re losing share. What about profits? Should you still aim and are you still able to look at profit growth there given that your – I assume your profit growth will over-index to the moment priced brand you have? Thanks.

[Alison Cooper:]

So in terms of the second half, it’s going – the growth is going to come from various areas. First of all, if we look at volumes, I would see an improved volume performance underlying in the second half. But also there’s some further price coming through so that will help the overall top line position to improve through the second half. But the cost side of it is also important, I think, within that so I mentioned the cost savings coming through but also we’re lapping the higher investment level of last year, so that’s quite a key driver there too. Now, the two key markets that I’ve highlighted as being a drag on the first half aside from the EU, so USA and Russia. Russia, we did invest quite highly in the first half, as Bob mentioned, ahead of some of the regulation we see coming into the market and restructuring that’s going on in the market. And we do an improved profit performance and profit growth from Russia coming through in the second half of off the back of that. There’s a lot of portfolio activity going on. Clearly, the vulnerability we see currently in the value segment is going to persist for a while, so we got to try and address that, but prices will keep increasing in the market so that’s something that may not persist but we need to see how those dynamics play out. But we got a lot of portfolio initiatives to help that. And as we said, Davidoff share is growing in the market, so we’re getting some of that recognition at the top end too. We’re doing a lot of West also. So that should improve. And USA again, we’re lapping investments through into the second half and that will help the numbers. And again, this side?

[James Bushnell – Exane:]

Sorry, just...

[Alison Cooper:]

Yes.

[James Bushnell – Exane:]

A quick one, a clarification. So, in Russia, you would expect to actually grow profits given that prices are going up. Yes?

[Alison Cooper:]

Yes.

[Henry Davies – Merrill Lynch:]

Thanks. Hi. Henry Davies, Merrill Lynch. I’ve got three questions. First, can you just quantify the increase in investment costs in the first half or maybe what your EBIT would have done if they were held flat? Second, what are you expecting in terms of currency impact on your earnings per share this year? And third, just on your earnings growth model, you still have this 1% to 2% cost optimization, at the same time, you’ve said several times before, you don’t expect margin expansion due to negative geographical mix. So just which one of those is it – should we be working with? Thank you.

[Alison Cooper:]

Okay. Well, I’ll pass currency to Bob in a second. In H1, the increased investment was roughly £60 million and that’s a straightforward answer to that one. In terms of the margin expansion one, this is never the easy answer, is it, this one. We tried this one at the Investor Day as well. What we’re trying to demonstrate with our earnings model is we’ve got various levers to generate earnings. And with the cost saving program we have, my preference would be to invest that behind the business, in which case, you wouldn’t see much of an immediate margin expansion off the back of that from a group perspective. Where we’re sitting at the moment, though, is we’re potentially putting some of that clearly to help strengthen the business given the new headwinds and that may therefore help margins and obviously, that’s helping margins in the second half. But the key point you highlight is always being fungible for people which is with the geographic mix we’ve got, if we improve performance particularly in some of the lower margin regions, clearly when you mix that together from a group perspective, that tends to net out in terms of the growth in some of the higher margin markets. So I think our best guidance is still roughly where we are around that sort of 42-ish percent sort of margin and that sort of ballpark. But there will be swings and roundabouts behind that. You can see we’re slightly below that in the first half. The second half will be stronger from a margin performance perspective. Martin?

[Bob Dyrbus:]

So, currency...

[Alison Cooper:]

Outstanding currency once it...

[Bob Dyrbus:]

Currency...

[Alison Cooper:]

Is that currency reminder?

[Henry Davies – Merrill Lynch:]

Yes, yes.

[Alison Cooper:]

Okay. Sorry, Bob.

[Bob Dyrbus:]

Basically, in terms of currency, we’ve got about £40 million coming through in terms of the FX effect and it’s another probably £20 million in terms of the second half.

[Henry Davies – Merrill Lynch:]

So, £60 million negative, meaning the guidance for this year is higher than the 6% which is the low end of your guidance of EPS?

[Alison Cooper:]

Regarding...

[Bob Dyrbus:]

No. I think it’s £20 million positive after £40 million – sorry, in terms of the full year, currency will be at £20 million positive after the £40 million negative of leaf FX.

[Alison Cooper:]

There’s tariff on that. Clearly, where FX is for the full year slightly responsible.

[Bob Dyrbus:]

Yes, that’s...

[Alison Cooper:]

Our focus on the earnings model is on constant currency growth.

[Bob Dyrbus:]

Yes.

[Alison Cooper:]

Yes? Okay.

[Bob Dyrbus:]

That’s right. That’s absolutely right. That’s 100%

[Alison Cooper:]

So, Martin, I think, will be the next.

[Martin Deboo – Investec:]

Hello. Martin Deboo, Investec. Just trends on the top line decelerated in Q2 implicitly which we sort of knew they were from what you’ve been saying at the Q1 and afterwards. I suppose, just in interest trying to get a read on where the underlying trend is, is there anything you want to call out on Q2 that was unusual, like inventory loadings or anything that would explain the decelerating trend? What’s behind the question is just where does it seem to going?

[Alison Cooper:]

There were some destocking in Q2 which is if you look at it at a Q2 position on its own, clearly, distorts. But I think the bigger distort is actually if you look at the strength of the comparative periods, so we had a pretty favorable Q1 against the Q1 from 2012 and quite strong Q2 from 2012 to compare with so it’s the comparatives, I think, also you got to get your head around. Those are the two key factors, so if you look through it, I would say the overall H1 performance has a little bit of destocking impact in there, but it’s a fairly fair reflection of the performance in the period, understanding the factors that we highlighted around Russia, the US, and clearly how we’re dealing with the EU situation, albeit clearly say, robust in terms of the overall operating performance there at just 2% down given the headwinds. Erik – sorry, is that my first? Then Erik.

[Erik Bloomquist – Berenberg:]

Hi.

[Alison Cooper:]

Where are we going now? Let’s start with Erik then.

[Erik Bloomquist – Berenberg:]

Okay. I’ll fire away. Erik Bloomquist, Berenberg. Just a question on the US initiatives and you mentioned doing more work on the portfolio. They’re both in cigarette and in mass cigar. Can you expand on that because it looks like Sonoma’s now been added to the brands that may get some investment? USA Gold appears to be your cigarette brand of choice or the one you’re emphasizing in the US. How does that look given the very difficult competitive environment in the United States? And then secondly, can you expand on the mass cigar element of that in terms of the portfolio initiatives, what do you need to do in order to be more competitive and compete effectively with some of your perhaps more innovative competitors at this point? Thanks.

[Alison Cooper:]

Yes. I mean, the keyword here is focus, and we need to make sure that we are focusing on fewer brands and also we’ve made a choice to focus on fewer states as well. And I’m going to let Arthur comment in a bit more detail maybe on the portfolio, what we’re doing in the portfolio initiatives in the US. Do you want to – you might need a mic actually. Thanks Van

[Arthur van Benthem:]

Yes. In terms of portfolio initiatives in the US, what we’re focused on very much is the USA Gold brand as well as Sonoma in terms of pricing strategy. As you’ve seen in previous – in the Investor Day and previous presentations, we have implemented this strategy in four states. In late 2012, we then expanded this to 19 states and we see exactly the same development obviously stabilizing to then growing share, which is now having an effect on the national market share, in fact, which we expect to continue. We’ll layer on top of that specific innovation. You’ll be seeing innovation coming through in the US despite difficulty regulation-wise. To be able to do so, we found ways to be doing so. We’ll be doing that shortly. We’re cleaning up the portfolio in terms of really focusing on those brands that have the most merit for us to be able to invest behind. That is very much USA Gold. That is a focus brand for us. And nurtured brand is the Sonoma brand. And we’ll be looking to migrate other brands to these two in order to continue that focus that we have. Very specifically, also in the US just to expand on the question, is we’re getting our fair share in national key accounts. Key accounts is very much the majority of the market in the US. What we’re seeing is that we’re underrepresented there. And what we’re seeing is the benefit of having a mass market cigar business and a significant share in that mass market cigars in order to open the doors for also our cigarette portfolio to get to its fair share. We’re seeing that working with the top 40 key accounts and we’re expecting to see the benefits of that coming through in the coming quarters. In terms of mass market cigars, we’re very much focused on three brands. In the US, we’re much focused on Dutch Masters, on Phillies and on Backwoods. We are very – we have our significant share in larger, in thicker cigars and where all the growth is in the US as of more recent is very much in the smaller, thinner cigars. They are being called cigarillos, albeit, slightly different terminology to what we used to hear in Europe. And all of our innovation portfolio is ramping up to be able to innovate also in this cigarillo segment smaller, thinner cigars. And having a lot more, in fact, getting to our fair share in terms of promotional activities which has been lacking in the past. So, that’s on these.

[Alison Cooper:]

Thank you. Erik?

[Erik Bloomquist – Berenberg:]

Sorry, can you just expand on risk of FDA plan – in the US mass cigar, please?

[Alison Cooper:]

Yes, very briefly I might comment as well but this is something that’s been talked about for very long time. It’s something that we’ve been looking at in terms of adapting our business and moving and making changes effectively in preparation for it. And I think it’s still being debated. I don’t think we got any more clarity that’s happening. we have. No? Yes, let me finish off. Rogerio?

[Rogerio Fujimori – Credit Suisse:]

Rogerio Fujimori, Credit Suisse. Alison, could you talk a little bit more about the medium to long-term volume outlook for the group considering that you’ll be removing some of the support for the portfolio brands to deliver your cost savings targets. Thank you.

[Alison Cooper:]

I think there’s various factors that clearly have an impact on the volume outlook for the business. But I think you highlight a very key point there which is we have driven a strategy to look at quality growth and strive quality growth in this business over the last couple of years. And you’ve seen now how the evolution’s now moving in terms of the strategy around how we’re looking at the portfolio, how we want to focus the portfolio and focus the investment to drive that quality growth even further. So, that’s going to be the focus of the business and I think I’ve spoken before around how we’re meaning to look at how we drive the metrics of that, particularly externally as well as to get people to understand what the different bits of the portfolio are for and how we’re driving them. So, going forward, yes, there may be some softness in certain areas because we’re not focusing on brands so much, but we should be making up for that with the quality of growth we’re looking at from other brands. So, I think the biggest dynamic on the volumes currently is more the macrodynamics in the markets rather than the impact of that portfolio strategy over the long term. But there may be some choices we’re making for efficiency of the portfolio to manage stock, to manage the portfolio, to make sure that we actually put the focus in the right places for the portfolio in the short term. But our longer-term focus – what you’re looking to do when you’re driving quality growth and you’re optimizing the portfolio is to realize growth in other brands not to abandon the growth. Back, next to Henry, sorry.

[Doug Wendell – Jefferies:]

Thanks. Hi. It’s Doug Wendell from Jefferies. I just wondered if you could maybe elaborate on some of the trends you are seeing in the illicit trade and whether you’ve seen that stabilize, and whether you’re seeing government to take action, maybe are you being proactive and trying to engage in that debate? That’s the first point on illicit trade.

[Alison Cooper:]

Yes.

[Doug Wendell – Jefferies:]

Secondly, maybe, just a word on next generation product, I saw some headlines on e-vapor. Maybe anything you could say on...

[Alison Cooper:]

On eBay.

[Doug Wendell – Jefferies:]

No. On eBay. No, e-vapor. And then, also, just in terms of marketing spend and support, are we at the level now after this year of where we need to be or given some more migrations, et cetera, does that need to come up a bit more? Thanks.

[Alison Cooper:]

Okay. Let’s take them in order. If I’ll start off on illicit trends, Matt can pick up on this one. Mic somewhere? Go ahead.

[Matt Phillips:]

Thanks. Illicit trade rates are still growing. I don’t know if you’ve seen the report KPMG produced the last few weeks. Basically, they estimate that the illicit trade in Europe has gone up from around 10% to now around 11% of the total European market. Now, it’s not in every single market. UK has been a particularly high spike last year. France as well and Netherlands has been big. Germany’s remained fairly static. But you’re getting up towards 30% non-duty paid of some of these big markets. So, France, back end of last year was up near 30% non-duty paid. UK over 25%. Netherlands over 25%. So, we’re seeing the trend still growing. Fine cut is also growing. But again, I mean, neither those things are a surprise where excise levels are at the level they are. So, we are working with governments, to answer your question. As you probably know, there’s – we got a partnership agreement with the EU to actually fight illicit trade, and there is – there are signs of the government to take it more seriously. They’re looking to bring in stricter penalties. They’re looking to bolster customs, a whole range of things. But the reality will remain that all the time that the excise levels are at the levels that they’re at, there will be always an incentive for people to bring product in. So, we are very, very focused on it, but they’re growing in simple terms.

[Alison Cooper:]

We’ve actually put an appendix in the pack. You’ll see some of the data that we had from the pack collection, activities we do with the rest of the industry, in the last quarter of last year. You can see some of the significant pickups in illicit trade through that quarter which is more current data than that KPMG report, I think. In terms of next generation product, we mentioned at the Investor Day we’ve set up a venture called Fountain which is based in the Netherlands. We are approaching it very much from the consumer experience perspective. So, we see opportunities to create new consumer experiences adjacent to the tobacco experience. So, this is a non-tobacco focused venture. We’ve got an interest in an e-cigarette business but we’re really looking at it more from an e-vapor perspective, so not just about nicotine, but opportunities in the e-vapor space and how we can create a new consumer experience in that space. But that’s the beginning of some other things we want to look at and add in to the mix in terms of opportunities in our next generation product space. And finally a bit on marketing spend, I think we flagged previously that we saw last year the step up, we saw some step up into this year. Really, I see going forward, it being a more normal level of increase on an ongoing basis. But it does depend at times on the nature of the initiatives and some of the innovation that we do as well as to whether or not that requires a little bit more investment than other activities. But currently, I would say it was taking more normalized trend in line with the revenue growth going forward. Adam?

[Adam Spielman – Citi:]

It’s Adam Spielman, Citi. Can I follow that up. I guess with sort of two interrelated questions. If marketing spend is essentially flattish in line with revenue which is flattish and you’re increasing your spend on focus brands, presumably you have to decrease your spend on the key strategic brands unless I’m wrong. And to the extent you do that, what does it mean for those brands? I guess that’s one question. The other question is what do you want to be judged on? Now, my understanding is that you would hope to move a dialog to the growth rate of the key strategic brands. In this half, you did 1% volume. And I guess the question in that is – or a couple of questions. One is, is that a good trend rate going forward? And secondly, given that you’ve just wacked up investment hugely, is that a good result also given the markets being very weak as we know?

[Alison Cooper:]

Okay.

[Adam Spielman – Citi:]

Thank you.

[Alison Cooper:]

First of all, as a context point, my answer to the previous question was around our trends in spending going forward, so I think you’re talking flat revenue and therefore, no investment growth. That’s more of a short term investing currently as you’ve seen in the first half. So let me step back on the portfolio. We’re looking to deal with the portfolio. We started off – took you to the journey a bit at the Investor Day. We started off looking at the consumers and then applying those understandings, the KSBs where we saw strong equity, strong international equity and the potential for those brands. And we’ve been investing behind those brands by, yes, partly marketing but clearly, by the innovation initiatives, the investment, and the products costs, and all those other aspects as well behind those brands which has been generating a good quality of growth versus if you look at those three-year CAGR track record that was on the chart earlier. In the first half, yes, that growth rate is ameliorated although given the overall growth rates of the group, clearly, those brands are still doing a lot better than the rest of our portfolio. So, that focus is still important. And the step of the investment is not for a one-year benefit. Clearly, it’s for an ongoing benefit for those brands going forward. What we’re doing now, though, is we’re expanding that focus so it’s on the KSBs. That’s working for us and we’re now extending that focus to a broader portfolio brands. And that includes the focus brands. And when you include fine cut brands in that, as I highlighted, that’s 50% of our portfolio. You still got 50% left which are the portfolio brands. And when I’m looking at optimizing investments, it’s not from the KSBs into the focus, it’s optimizing the investment for the focus and the KSBs so what you’re looking to do is make some other choices around what you’re doing with the balance of that portfolio, the portfolio brands. Are you following?

[Adam Spielman – Citi:]

I think so. But basically...

[Alison Cooper:]

But you’re missing one bit of the portfolio in your question. You’ve got the focus brands and KSBs which is 50%, then you’ve got the portfolio brands which are the other 50%. Yes.

[Adam Spielman – Citi:]

So, just to make sure I got this right, the KSBs investment isn’t being cut off.

[Alison Cooper:]

No.

[Adam Spielman – Citi:]

And they should grow, at least, as well in future as they have done in the recent past.

[Alison Cooper:]

They should continue growing back in the industry trends. And we’re looking at an aggregate of growth in volume and value from that 50% and the focus on that going forward, and we will be optimizing what we’re doing in that other 50%. And that will be about either nurturing some of the brands so they will get some investments. Some of the brands would be more about profit. And some of the brands we will actually migrate into the focus brands so that 50% increases over time, back to the slide from the Investor Day. Yes. So, there’s no intention here to take away focus from the key strategic brands. The intention is to expand the focus to a broader selection of brands where we see equity, where we see potential for growth.

[Adam Spielman – Citi:]

And coming back to how, I guess, we should judge the success of the whole scheme, is it keeping KSBs growing or is it sort of keeping the EPS greatly...

[Alison Cooper:]

It’s driving quality growth in those focus in key strategic brands, which will therefore drive into – back into the earnings model, the top line growth, the cost optimization, the cash management to deliver within the earnings model.

[Adam Spielman – Citi:]

And do you think you’ve achieved that in the last 12 months, quality growth?

[Alison Cooper:]

The quality growth, you can see it coming through from the key strategic brands, the fine cut tobacco, all those aspects have come through in terms of the portfolio growth. And it’s still there as well in the half year even though we’ve had the tough headwinds we’ve had in terms of the KSB performance is outperforming the market, the fine cut tobacco, the premium cigars and that little bit of snus have added profit in there now so people can see that we’re not destroying the market. Also growing very profitably for us as well is that total tobacco quality growth coming through despite the headwinds of the markets.

[Adam Spielman – Citi:]

Thank you.

[Alison Cooper:]

Chas.

[Chas Manso – Société Générale:]

You have Chas Manso from SocGen. Can we come back to the headwinds of the markets? You’re saying on the second half you’re expecting the volume momentum to improve for the group. If the EU continues to decline up to 10%, have you sort of stress tested that? I mean how long can Imperial withstand that kind of negative backdrop both in terms of earnings and, I guess, therefore dividends? And on the price mix quite dependent on the UK this time around X, the strong UK price mix at rest was sort of 3-ish, I think, which is less than peers. And I guess between price and mix, you’re suffering from greater negative mix. So, could you take us through your thoughts on how you manage that negative mix and is that negative mix going to be there whilst the EU continues to give you that headwind?

[Alison Cooper:]

I think I’ve got all of that but if I haven’t covered off the chart, I’ll come back. First of all, EU and the stress test on the EU, you quote the cigarette number on a stick equivalent basis, we see the market down around 7% currently. And when we’re looking at it and looking at going forward into the second half, I’m not expecting that to get any better. So, I’m not expecting any hockey stick in terms of the EU markets. You can hypothesize over the next year or two whether or not you end up getting some sort of plateau on illicit trade. I think that’s worth playing with. We’re clearly looking at it in terms of our scenarios internally. But there are some examples where markets got up to that sort of 30 percentage penetration where there’s been more action taken because of the impact on extrapolating things. So, I’m not saying that’s watertight in terms of use, but I think it’s one of the constraints that’s maybe sitting there in terms of where market is ultimately developed going forward. But if I’m panning out over 2014 and into 2015, if we assume that we still continue to see higher rates of the decline in EU, clearly, we’ve got to strengthen than by the portfolio and what we continue to do with the portfolio. But also, clearly, we have got some levers in terms of cost piece therefore because you’re seeing those with the decline rates. We’ve got to be taking even further actions probably on cost over that sort of time period if that’s really the case in those markets. So, we’ve got the levers on the EU to manage it. I mean even in the first half when we haven’t really kicked in, in terms of some of the cost savings linked to the portfolio strategy, we’re only down 2% in the EU, and yet there’s been quite some significant declines in market sizes. So, I think we’ve got the levers to manage that and we have stress tested it against the earnings model and the dividend intentions of the business too. In terms of price mix, I think we achieved pretty similar price mix in the EU in the first half to our competition. So, we’re not seeing any different dynamics in our business through that once you strip out some of the higher price opportunities they’ve had in other markets. And yes, I think there is clearly a mixed piece handle and we continue to do that with our portfolio to give consumers reasons to stay in higher-priced products which we’ve done very successfully in Germany, for example. We’ve got West and Davidoff both growing in the first half, and even in Greece with Davidoff still growing in terms of market share which is probably slightly unexpected for some people.

[Chas Manso – Société Générale:]

(Inaudible)?

[Alison Cooper:]

Yes. Yes. Anymore?

[Jon Fell – Deutsche Bank:]

Hi. It’s Jon Fell from Deutsche Bank. Two quick things. First of all, could you update us on what’s going on with pricing in Germany and has there been any movement? And secondly, the new brand, Parker & Simpson, can you just tell us a bit what that’s about? Is it chiefly going to be aimed at markets where you don’t own JPS?

[Alison Cooper:]

Germany, in terms of pricing and Arthur will correct me if I haven’t got the latest update. We’ve recently announced the price increase which will be implemented 1st of July which – and that’s where we’re sitting currently with our pricing in the market. It’s an interesting point now, just to link off the back of it and that you maybe see our German price mix, and our German pricing not coming through as strongly, profits coming through strongly in the first half as you might have anticipated given the fact that we’re growing volumes and growing share in that market. And that’s because we effectively been absorbing excise since the 1st of January to some degree because we really didn’t see an opportunity to take price at that time, but some currently, we’re increasing prices on the 1st of July. So, that’s related on Germany. And then, on Parker & Simpson, we’ve been looking really for an opportunity to really develop a further international value brand for the business and Parker & Simpson is a trademark we’ve owned for a very, very long time, a very, very long time. So, we’ve seen some opportunities now move that brand forward and take it forward an international value brand as we’re seeing some of our inspectors do as well as in certain areas around. Our brand has got more international heritage feel to it rather than a local heritage feel. So, we started launching it in a few markets. It seems to be getting some traction. We have a certain consumer need model around it that works quite well which we call the equity transfer model. And yes, we think it got some opportunities.

[Alison Cooper:]

Chas.

[Chas Manso – Société Générale:]

Sorry, could you just give a bit more color on your initiatives for Davidoff and West in the second half, these new global renovation projects?

[Alison Cooper:]

Davidoff is really a rejuvenation of the pack. We’ve done a lot of work on looking at what we need to do to really lift and energize the brand going forward at the premium end. And West similarly, I mean it’s been a huge amount of what we did on quality and what it means to the consumer. And then we did some deep dives into sort of aspects of quality and what I means to consumer and how you communicate that not only by the product but by the pact. So, these are two quite exciting rejuvenations for the business. Did you want to comment maybe briefly, Neal on what is on with those two? Yes? Just a little bit of more color on both of them because they look like just a pack change but the work has gone behind it has been very significant. Yes.

[Bob Dyrbus:]

Yes, thank you. Davidoff, first all, the new proposition, it is fundamentally a pack change but it is about upgrading certainly the quality perception at the premium end. So, Davidoff has always been renowned for quality, of course. But with the new proposition, this has been through quite extensive research over the last few months. We think we found something which gives it that extra edge. So, we’re rolling that out to a number of countries in the second half. On West, West is a total brand proposition change. We’ve repositioned the brand effectively in the consumer mind. So, we’re meeting new consumer needs with West. It’s not only a packaging change. In some cases, there are some product changes as well. And so far, we’ve rolled that out in around about five or six markets, but again, in the second half, we expect that, I think, to go to around about another 10. So, that’s very much accelerating over the second half and into FY 2014 as well.

[Alison Cooper:]

Thank you. In addition, there’s quite a lot going on with different formats. We’ve talked about our success queen size currently. And also, in natural products as well which are proving very successful for us too. So, it’s a number of things. In addition with Davidoff, I should mention – I think Neal showed you at the Investor Day, the Boudoir product which is the first, it’s slimmer than a super-slim. It’s an ultra-slim cigarette and a longer length and that’s some – it’s gone down quite well in Russia. We’re putting it into other markets. We’re seeing opportunities for that as well. So, we’re going to be a huge volume brand. That’s important for the equity and for certain consumer needs in the markets. Okay. Do we have more questions? Thank you very much. Thank you for coming.