British American Tobacco : HY 2018 Presentation transcript

British American Tobacco p.l.c.

Interim Results 2018

Presentation on July 26, 2018

CORPORATE PARTICIPANTS

Nicandro Durante

Chief ExecutiveBen StevensFinance Director

QUESTION AND ANSWER PARTICIPANTS

Jonathan Leinster,Berenberg- Analyst

Fulvio Cazzol,Goldman Sachs- AnalystMichael Lavery,Piper Jaffray - Analyst

Owen Bennett,Jefferies - Analyst

Adam Spielman,Citi - AnalystRey Wium,SBG Securities - Analyst

PRESENTATION

Nicandro Durante - British American Tobacco p.l.c. - Chief Executive

Hello, everyone, and welcome to British American Tobacco's 2018 Interim Results presentation. I'm Nicandro Durante, Chief Executive of British American Tobacco. And with me this morning is Ben Stevens, Finance Director. As always, a warm welcome to those of you who are listening on the conference call or listening via our website BAT.com. As usual, after taking you through the results presentation, there will be an opportunity for you to ask questions.

Before I start the presentation, I'll take it that you have all seen and read the disclaimer on page two and three. It's clear that these interim results have benefited significantly from the inclusion of Reynolds as a fully-owned subsidiary. Given this, volume of revenue and profit from operations will be presented as though the group had owned acquisitions made in 2017 for the whole of that year. We'll refer to comparison results on this basis as performance on a representative basis. This comparison will provide shareholders a better understanding of like for like performance.

Moving now to the interim results. Overall, we had another good start to the year in 2018 with the group performing well. Once again, we have delivered on our commitment to high single-figure earnings growth, with adjusted diluted EPS up over 10% at constant and 2% at current rates. Our strategic portfolio, which covers our key combustible, oral tobacco and NGP brands has grown strongly in the first half with revenue up over 8% on a representative constant currency basis.

You'll see over the next few slides that our combustible business which remains 94% of our business continues to perform strongly and industry fundamentals are robust. The US remains a great opportunity, and Reynolds is performing well. And finally, that we have a great opportunity in next-generation products, and it has been demonstrated that our multi-category strategy driven by consumer needs is the right strategy and we have the capabilities and products to win.

Turning now to the results highlights. Reported volume, revenue and profit from operations obviously benefited from the inclusion of Reynolds as a wholly-owned subsidiary, and were up 11%, 57% and 72% respectively. On a representative basis, volume was down 2.2%, again outperforming the industry. We expect the industry volume to be down around 3-4% this year. Constant currency adjusted revenue was up 1.9% on a representative basis. However, 2017 revenue in the US benefited from a number of one-off items recognised by Reynolds prior to acquisition. Principally, the sale of Natural American Spirit inventory to JT as part of the disposal of the international brand rights. Excluding this, adjusted revenue would have grown by 2.6% on a representative constant currency basis.

Tobacco price mix was a robust 4%, which reflects improved pricing held back by the negative mix effects of strong volume growth in Pakistan following the excise change in mid-2017 and down trading in the GCC. Excluding the one-off effect of NAS inventory sale, price mix would have been close to 5%. We continue to expect a stronger second half with full-year price mix ahead of last year. Despite the recent slowdown in the THP category in some markets, including Japan and South Korea, we remain confident of exceeding the NGP revenue of £1 billion in 2018 as we expect a range of new launches to re-energise NGP category growth in the second half.

As we said at the full year, we expect profit growth to be weighted to the second half driven by improving price mix, continued share growth and a strong growth in NGPs. Foreign exchange was a headwind of 8% EPS for the six months of the year and is estimated to be a headwind of 6% for the full year, assuming rates stay where they are today. I am very confident of another good year of adjusted earnings growth at constant currency, driven by strong underlying profit growth, with the benefit of the US tax reform enabling us to accelerate investment behind our NGP business.

Group market share grew 40 basis points driven by another strong performance from our strategic brands. Kent, Lucky Strike, Pall Mall and Rothmans all grew share globally. Dunhill held up very well in the premium segment and share was down only 10 basis points. Record share in South Africa and growth in Brazil were offset by declines in Malaysia, South Korea and the GCC due to excise driven market contraction and down trading. Kent grew 50 basis points. The brand had a strong performance in Japan driven by THP and grew share in Russia, Brazil and Turkey, where Kent is the fastest growing brand in the market.

Lucky Strike was up 10 basis points, driven by Indonesia, Colombia and Japan. Pall Mall grew 30 basis points with strong results in Pakistan and the GCC where the brand was launched ahead of the significant excise increase last year to authorise the needs of down trading consumers. Rothmans continues strong performance and was up 80 basis points driven by good results in Russia together with an excellent performance in Malaysia, where the brand grew 260 basis points. The brand also benefited from migrations in Poland, Brazil and Colombia.

In the US, the strategic brands continue to perform well. Natural American Spirit and Newport shares were both up 10 basis points, while Camel declined by 10 basis points following the gains made last year. Pall Mall was down 10 basis points, reflecting someincreasing competitive discounting. Overall, the strategic brands had an outstanding performance growing shares by over 160 basis points.

In the US, industry volume decline remains within the historical range, and Reynolds is performing well. Looking at sales to retail, which are a good measure of consumer trends. First half industry volume was down 5%, mainly due to the impact of state excise increase in California in April 2017 and higher US gasoline prices. We expect US industry volume to be down around 4.5-5% for the full year.

Vapour category growth appears to be driven largely by new consumers and new behaviours, and we'll continue to see limited impact on US cigarette industry volume. Reynolds shipment volume to wholesale was down 5.5% broadly in line with the industry. Revenue was £4,525 million which was flat on a constant currency representative basis. However, this was against a comparator which benefited from a number of one-off items, principally related to the sale of NAS inventory to JT of approximately $100 million. Excluding this, revenue would have grown 1.8%.

Pricing in the US is robust and despite some increasing competitive discounting, the price environment remains good. Delivery of the cost synergies is ahead of plan with annualised cost savings now running at almost $140 million at the half year point. We are well on track to deliver the target of at least $400 million in cost synergies by the end of 2020.

We have submitted our comments to the FDA on its ANPRMs on nicotine and flavours. There is a large and diverse quantity of material, and this is likely to take some time for the FDA to digest given the complexity of the issues. As we have said, these are the first steps in a lengthy process as to whether the FDA issues a product standard on these issues.

Our new product applications for the FDA are also progressing well, and we are very pleased that clearance for the SE application for the improved Eclipse, our carbon tipped tobacco heating product has now been received. The scale of the opportunity for THP in the US remains uncertain and heated tobacco products will attract full cigarette excise. However, we'll be testing the potential of the improved Eclipse in the US during the next 12 months.

We filed the SE application for glo in February. The application is currently under scientific review with the FDA potentially completing its review by the end of 2019. We will also continue work on our plan to submit an MRTP application for glo.

The Camel snus MRTP application is also proceeding well and the TPSAC as it is meeting in September will review the application.

In oral tobacco, the business continued to grow strongly. Total first half revenue grew over 11% on a constant currency representative basis, driven by strong performance in the US, Sweden and Norway. In the US, oral tobacco industry volumes were broadly flat in the first half, with American Snuff Company volume in line on a representative basis. Grizzly saw strong first half revenue and profit growth driven by good pricing. Market share was down 30 basis points against a comparator which benefited from gains made during the USST product recall in Q1 2017.

Outside the US, the white pouch market is the fastest growing oral tobacco segment. In the first half, the category grew by more than 120% against same period last year and now accounts for 3.5% of European oral tobacco category, with margins up to two times that of premium cigarettes.

Across the north, where Epok is the fastest growing premium oral brand. BAT continues to grow share with a 12% share of the market in Sweden and an 8% share in Norway. In Switzerland, Epok has grown to 14% of the total oral tobacco category just 10 weeks after its launch. This is a profitable growing business with very attractive margins.

In tobacco heating, glo continues to perform well. In Japan, glo national share is 4.3%, up from 3.3% at the end of December having added a full share point over the year-to-date. Our share of the total tobacco market in Japan is now 16.2%, up 80 basis points since December, benefiting from share growth in both THP and cigarettes. We are the fastest-growing company in Japan across both categories. However, it is clear that the THP category has plateaued over the last four months as the category expands into more conservative consumers barriers to adoption are higher and growth naturally slows. We know that one of the greatest barriers to consumer adoption is the price of the device. We have been focusing on driving down the production cost of the current glo device and have been passing these onto the consumers through increased device discounting.

In the coming months, we will be launching different devices and consumables at different price points. For example, we have recently launched a new premium priced range of consumables with higher nicotine and different flavours. The second half will benefit from these initiatives and from new consumer activation plans, including a consumer hyper care conversion programme.

In South Korea, the THP category has grown to 12% of the tobacco market in June although this has plateaued over the last four months. Glo continues to grow national share and now has a share of 0.7% and a category share of 6%. Following the successful launch of two capsule variants in mid-April, we are now relaunching the brand with a revised marketing mix and upgraded device. Outside Japan and South Korea, category growth has been mixed. However, glo's presence has continued to grow with Italy joining the existing markets of Canada, Russia, Switzerland and Romania.

We are now unconstrained on device supply and have a strong pipeline of activity. We have a number of new market launches planned for glo in Q3 together with a significant uplift in activity in Japan. We maintain our view that the category could represent 30% of the Japanese market by 2020. We remain confident in glo's potential, and as new offers enter the category and products improve, growth should return. On this basis, we remain confident of exceeding £1 billion in NGP revenue in 2018.

In vapour, on a representative basis, volumes were up over 16%, and after excluding the impact of US Vibe product recall, revenue grew by 8%. In the UK, the market grew by almost 26% and BAT's vapour retail share grew by 20 basis points in value to 41.1%. We remain market leader in traditional retail in closed systems. Earlier this month, ePen3 was launched in the UK after an extensive pilot programme with excellent results. ePen3 represents the cutting edge of current vaping technology providing a more intense, satisfying vape experience. While it's still very early days, initial indications are very positive. In our VIP vapour stores, ePen3 has achieved the highest rate of sale for any VYPE device to date. With higher margins than ePen2 and refill purchase rates the highest achieved for any VYPE product to date, the early signs are encouraging.

In the US, the category has continued to grow rapidly and is up over 20% in the first half driven by a significant increase in the size of the consumer base. Vapour revenue was down 4%, but up 12% after adjusting for the impact of VUSE Vibe recall. The overall VUSE family which has featured nicotine salts technology since 2012 continued to grow volume and value. However, share was down 10 percentage points to 21% due to the growth in the vapour category. In Q2, VUSE vapour volumes were absorbed as negative sales. However, both VUSE Ciro and VUSO Solo have captured a significant proportion of the volume lost by the recall. Recall costs have not been material.

In August, we will be launching VUSE Alto in the US, our first pod-mod product. These will be available in four variants, and will feature an innovative ceramic wick. Like other VUSE products, Alto has a 5% nicotine concentration liquid and is a nicotine salt product. Our research shows that Alto rates significantly higher than any other nicotine salt pod-mod products on a number of key consumer attributes and purchase intent.

We continue to perform well in our other markets and remain a market leader in Poland and in Germany in closed systems. We also recently launched ePen3 in Canada and VYPE in Greece. The opportunity in the category remains significant. When you look at total nicotine consumption, we continue to see a growing market for nicotine with new consumers and behaviours driven by the growth in the vapour category. With a strong product pipeline, we are well-positioned with our multi-category approach to be a winner.

So, in summary, we are continuing to deliver on our commitment to high single-figure earnings growth. Our combustible business is outperforming the industry and we are generating strong revenue growth from the strategic portfolio. In the US, the business is performing well, and synergy delivery is ahead of plan. Our potentially reduced risk products continue to grow strongly. We have significant additional investments in NGPs planned as well for the second half, and expect to see the THP category grow again in Japan. Given this, I continue to believe we can deliver in excess of £1 billion in NGP revenue this year, more than doubling the size of our business over the course of 2018. We are on track for another good year of earnings growth at constant currency driven by strong underlying profit growth and with the benefit of the US tax reform allowing us to accelerate our NGP investments. Overall, the business is performing well.

I will now hand you over to Ben, who will take you through the details of the results.

Ben Stevens

Thank you, Nicandro, and good morning, everyone. As Nicandro said in his opening, reported volume, revenue and profit from operations were up 11%, 57% and 72% respectively, benefitting significantly from the inclusion of Reynolds as a wholly-owned subsidiary. As we said earlier, for clarity, I will now focus on the adjusted representative results which are all against a comparative base that assumes full ownership of Reynolds and other acquisitions throughout 2017. This doesn't affect comparisons made on an EPS basis.

Representative volume was down 2.2%. This was mainly driven by trade inventory movements in the GCC and industry volume decline, in particular in the Ukraine, Brazil and Russia, partially offset by growth in Pakistan and THP volume, which reached 3.3 billion sticks in the first half.

Adjusted revenue was down 6.4% at current rates but was up 1.9% on a constant basis. As higher pricing across the majority of our markets, was partially offset by negative geographic and portfolio mix of around 3%. Adjusted profit from operations was up 2.4%, excluding the impact of currency translation. On a current basis, it was down 5.4%. Adjusted diluted EPS was up more than 2% at current rates and over 10% on a constant basis, exceeding our high single-figure EPS growth objective.

Turning now to the regions, revenue in the US was in line with the prior year on a constant currency representative basis. Good pricing in both the cigarette and oral tobacco categories and higher VUSE consumable volume was offset by the reduction in cigarette volume and the impact of the Vibe recall. Excluding the one-off items in the revenue comparator, which principally related to the NAS inventory sale in 2017, revenue grew 1.8%. Operating margin of 41.4%, or 46.2% on an adjusted basis, benefiting from synergies achieved since acquisition and the timing of expenditure. As a result, adjusted profit from operations was up 5.6% on a constant currency representative basis.

In APME, adjusted revenue on a constant rate representative basis grew strongly and was up 5.6%. This was driven by pricing, volume growth and the benefits of higher revenue THP volume, which more than offset the negative mix effect of downtrading in GCC and the growth of illicit in Malaysia. Volume was up 3.5% with strong growth in Pakistan, Bangladesh and THP outperforming the industry, which was down around 3%. Market share in the region grew strongly and was up 110 basis points. On a representative constant currency basis, adjusted profit from operations was down 5% driven mainly by the impact of inventory movements and down trading in the GCC and increased investment behind THP.

Australia continued its good performance. Profit was up, and share grew driven by Rothmans. In Japan, revenue grew, but profit was down due to decline in industry cigarette volume and investment in NGPs. In Malaysia, the duty paid industry declined by 5.5% and illicit trade increased to reach 67% of total consumption. This impacted both profit and revenue. The strategic brands had an excellent performance with volume up over 15%. Share was up 90 basis points, mainly driven by Pall Mall in Pakistan and Saudi Arabia as well as a good performance from Lucky Strike in Indonesia.

Revenue in AMSSA was down 9% to £1,951 million due to a significant translational foreign exchange headwind of 12%. However, on a constant currency representative basis, adjusted revenue grew by 2.9% to £2,206 million. Good pricing across the region, notably in Canada, Chile and Nigeria, more than offset lower volume. Volume in the region was down 5.9% mainly driven by industry decline in Brazil, South Africa and Mexico. Adjusted profit from operations on a representative constant currency basis grew by 4.1% driven by Canada, Nigeria and Chile, partly offset by the continued difficult trading conditions in South Africa.

In Brazil, although there are signs of improvement and no new excise increases are currently planned, the weak economy continues to affect industry performance and drive further growth in illicit trade. While pricing was good and premium share was up aided by a good performance from Dunhill, revenue and profit declined impacted by lower volume. In South Africa, revenue and profit were also lower as volume was down due to the continued growth of illicit trade and VAT and petrol price increases. Strategic brands performed well, driven by share gains for Rothmans and Dunhill, which reached a record share of 15.7%. Canada posted another strong performance with revenue and profit growth driven by continued good pricing. Strategic brand volume was up nearly 30% driven by growth in Mexico as well as migrations in Brazil, Colombia and Nicaragua.

In ENA, adjusted revenue on a constant representative basis was up 1.3% driven by improved pricing and mix in Germany, Romania and Russia, partly offset by the impact of lower volume and continued excise absorption in France. Volume was down 3.9% driven by Russia, Ukraine, France and Italy, which offset good performances in Turkey and North Africa. Adjusted profit from operations at constant rates on a representative basis was up 2.2%, with good performances from Germany, Ukraine and Romania.

In Russia, volume declines were offset by good pricing and cost savings. Rothmans and Kent both grew share and Kent remains the number one premium brand in the market. In Germany, BAT is the fastest growing total tobacco company. Volume was down, but constant currency revenue and profit grew driven by pricing and improved mix.

A good performance in the Ukraine saw revenue and profit increase driven by improved pricing and share growth. Rothmans is the number one brand in the market with a 17.3% share. In France, share was stable despite aggressive competitor pricing activity.

Strategic brand volume was up 11% with strong performances from Rothmans in Russia, Ukraine and Poland, Pall Mall in Egypt and Kent in Turkey and Russia. The first half also saw a great performance from our oral tobacco business in the region. Volume grew 29.6% driven by Epok, outperforming the industry which was up 6%.

Turning now to operating margin, on a reported basis, margins were up 340 basis points, benefiting from the inclusion of Reynolds as a fully-owned subsidiary. Underlying margin improved by 180 basis points. This was driven by pricing, cost savings and synergies with Reynolds. This was offset by higher NGP investments which represented a headwind of 130 basis points. Adjusted operating margin