Scandinavian Tob Grp Ord

Good day, and thank you for standing by. Welcome to the Scandinavian Tobacco Group Q1 2024 results conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. If you wish to ask a question via the webcast, please use the Q&A box available on the webcast link anytime during the webcast. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Torben Sand. Please go ahead.

Thank you and good morning and welcome to our webcast for the first quarter results for 2024. My name is Seth Torben Sand, and I'm Director of Investor Relations and Group Communications. And I am, as usual, joined by our CEO, Niels Frederiksen, and CFO, Marianne Hrøstrup-Bock. Please turn two slides to number three for the agenda for today's webcast. The agenda is as follows. Highlights of the first quarter, followed by an update on our strategy and other key events. This to be followed on an update on the performance in our three commercial divisions. And then we'll turn to key financial developments for the group, including an update on net debt and leverage. And finally, we will give you an update on our outlook and guidance for 2024. We will conclude the webcast with a Q&A session where we will be more than pleased to take any questions you might have. But before we start, I ask you, to pay attention to our disclaimer and forward-looking statements at the end of this slide presentation. With this, please turn to slide number four, and I'll leave the word to NOS.

Thank you, Torben, and welcome and good morning to everyone on the call. The financial performance in the first quarter of the year was weak, with net sales being slightly down and the EBITDA margin declining to pre-COVID level. A positive net sales performance by Next Generation Oil and handmade cigars could not offset lower volumes in our machine world cigar business and profitability was negatively impacted by mixed changes as well as the impact from lower volumes. Part of our strategy is to invest more in our growth enablers to secure long-term sustainable growth for Scandinavian Tobacco Group and the investments have started to deliver good results with our Next Generation Oil portfolio now accounting for about 5% of group net sales and with double-digit net sales growth rates for both our U.S. retail stores and international sales of handmade cigars. Combined, the growth enabler share of group net sales increased to 11% in the first quarter. Trends for the product categories, handmade cigars and smoking tobacco remained broadly unchanged, whereas first quarter volume data for machine-rolled cigars in Europe was below the structural development. In a moment, I'll give a little more insight into these overall trends, but let me first conclude my introduction by giving you a few key financial highlights for the first quarter. Reported net sales decreased by 0.7% to 1.9 billion kroner. Adjusting for acquisitions and exchange rates developments, organic net sales were negative by 2%. The EBITDA margin declined to 17.2% compared to 24.1%. in the first quarter last year. Pre-cash flow before acquisitions was negative by 126 million versus minus 179 million last year. And adjusted earnings per share came in at 1.8 Danish kroner versus 3.2 last year. Marianne will go into more details on the first quarter financial performance later. I will now turn to an update on our strategy, so please turn two slides to slide number six. Less than two months ago, I gave a detailed update on our strategy and the conclusion is that we have made significant progress in achieving our ambitions as laid out in the rolling towards 2025 strategy and that STG is today a stronger company well positioned for the future. Today, I will supplement it with a few additional updates. And let me start by saying that in March, we announced that we are creating one commercial organization. with a stronger focus on our core product categories, namely first, handmade cigars, second, machine-rolled cigars and smoking tobacco, and finally, next-generation oral. In this slide, we have illustrated the share of GroupNet sales for each of these product categories, including other, which comprises accessories, bar sales in our retail stores, and third-party contract manufacturing. Now handmade cigars, which include all markets, both the U.S. and international markets, online and retail sales increased by 4% organically, driven by international markets and retail. Pricing across all channels was positive, and in total handmade cigars accounted for 37% of group net sales in the first quarter. Machine rolled cigars and smoking tobacco, which is pipe tobacco and fine cut, experienced relatively high volume decreases. In a moment, I'll give you more detail to these drivers. But for now, let's say category comprise 46% of group net sales, following a 12% organic decline compared with the first quarter of last year. Next Generation Oil, comprising both our own brands like Strøm, XQS, as well as third-party distribution, more than doubled net sales and accounted for about 5% of group net sales in the quarter. We expect this share will increase going forward. Please turn to slide number seven. Here I want to give you a little more color on our plans to maintain the momentum for our growth enablers, which are, again, Next Generation Oil, retail stores in the U.S., and international sales for handmade cigars. Since we acquired the nicotine pouch brand XQS in May last year, the sales performance has consistently exceeded our expectations. By rolling out the brand through our existing distribution network in Sweden, we increased the number of selling points considerably, and through a dedicated strategy of launching new products to the market, the brand has almost doubled its market share and most recently reached more than 7% of the Swedish nicotine pouch market. Our strategy, as we've expressed before, is to launch XQS in more new markets in 2024, and two days ago, on May 1st, we launched the product in the UK market. During 2023, We opened two new retail stores in Texas, bringing the total to nine by the end of 2023. This year we plan to open three more stores, which will add new opportunities for us to continue growing our retail sales in the U.S. in the years to come. We continue to investigate and search for new locations where the Superstore format can apply. However, it is not only new store sales that deliver growth for our retail business, During the first quarter, same-store sales, i.e., stores that have been open for more than 12 months, delivered a 4% increase in lit sales compared with the first quarter of last year. And finally, our international sales of handmade cigars outside the U.S. continue to deliver good growth, although with variations from market to market. We are convinced that we can improve our market share outside the U.S. from the current estimated about 5% market share. The opening of Club Macanudo concept stores, most recently in Jakarta, Indonesia, and Taipei, Taiwan, is one piece in the puzzle to increase the awareness and positioning of our international handmade cigar brands. Please turn to slide number eight. During the first quarter, our machine-rolled cigar business in Europe did not deliver as expected, with a double-digit decrease in organic knit sales despite sound price increases. The business has our very close attention, and we are committed to reverse the trend during the rest of the year and in 2025. Firstly, the total market volume in our seven core markets declined more than in previous quarters. Our preliminary data suggests that the decline rate was 5.1%, with the highest decline rates in markets like France, UK, and Belgium. The structural decline rate has been closer to minus 3%, for the past many years. At this point, we maintain the assumption that the total market decline will be close to the structural average also in 2024. And as the chart illustrates, there have been substantial variations from quarter to quarter in the past two years. From the first quarter of 2022 and until now, the decline rate has been in the range from minus 1.6% to minus 5.1%. One reason for these variations is that the data partly consists of sell-in data to the trade, for instance in France and Spain, and this implies that inventory changes in the trade might impact the data and might deviate from actual consumer trends. That is why it is important to look at the trend data and not only at the individual data points. Irrespective, there is no doubt that we are continuing to lose market share and something else needs to happen. This will include further investigations into whether our pricing strategy is appropriate given how competitors are pricing, not unsimilar to what we did in our U.S. online business in 2023 and where we can today see a more positive development. With this, I will now turn to a brief update of the performance by division. Please turn two slides ahead to slide number 10. I will start with Euro-branded. Reported net sales for the first quarter decreased by 4% to 617 million kroner, with organic net sales decreasing 8%. Acquisitions impacted reported net sales by 4%. The main driver behind the negative organic growth is lower volumes in machine-rolled cigars driven by key markets like France, Belgium, and the UK. Next Generation All and Handmade Cigars deliver double-digit net sales growth, and price remained a key contributor to offset volume declines in all core categories, but pricing cannot offset the level of volume decline we saw in Q1. The bid that before special items decreased by 61 million to 85 million kroner will then bid the margin of 13.8% versus 22.8% in the same quarter last year. The margin development is primarily driven by the scale impact of lower volumes, mixed changes, and to a lesser extent, the increased investments in supporting long-term growth for both next-generation oil and machine oil cigars. With this, please turn to slide number 11. For in the quarter, North America branded and rest of the world reported net sales decreased by 5% to 681 million kroner, and organic net sales were negative by 6%. The main drivers behind the organic development were a temporary volume impact in machine-rolled cigars in Canada following the implementation of plain packaging regulation in the market, as well as a decrease in smoking tobacco. We expect this trend to reverse in Q2. Handmade cigars in the U.S. continue to experience mid-single-digit volume declines, but this was mostly offset by price increases and international sales of handmade cigars increased as well, as previously mentioned. A bid that before special items decreased by 64 million kroner to 212 million kroner within a bid that margin of 31.2% versus 38.3% in the first quarter last year. The margin was negatively impacted by mixed changes like the net sales decrease in Canada and also a weak quarter for our lane business. We expect to see an improvement in the margin in Q2 as business mix normalizes. I'll now turn the attention to the performance of our North America online and retail division. Please turn to slide number 12. Reported net sales for the first quarter increased by 8% to 650 million kroner, with organic net sales growth of 9%. The positive development in organic net sales continues to be driven by new store openings in the retail business, a 4% increase in same-store sales, as well as an increase in third-party distribution of next-generation oil products. Online net sales of handmade cigars were positive, driven by a stabilization in volume sold and a positive price-mix impact. EBITDA before special items decreased slightly to 81 million kroner, with the EBITDA margin decreasing to 12.5 percent from 13.9 percent in the first quarter last year, and the decrease is driven by mixed changes and some timing effect of OPEX. I will now hand over the word to Marianne. Please turn two slides to slide number 14.

Thank you, Niels. Before moving into the details of the quarter, please let me once again mention the long-term perspective of the financial performance given the high volatility we can experience from quarter to quarter. In this slide, we have outlined the development of EBITDA margins in the first quarter over the past seven years since 2018. In the appendix, we have included the full year's trends. These long-term trends give a good insight into the underlying performance as well as the progress in our strategy and financial ambitions. Overall, the first quarter 2024 margin performance for the group for the group and in the three commercial divisions are more or less in line with the first quarter of 2020, but remain well above the level in 2018. The first quarter this year has, as we already have been mentioning, been impacted by mix changes and unusually low volumes in our machine-rode cigar business. With the expectation of an improvement in both mix and production volumes in the second quarter and onwards, We remain confident of a stronger EBITDA margin in the second quarter of the year, and that we will deliver on our expectations for a 22 to 24 percent EBITDA margin for the full year. Please turn to slide 15. We've already talked to the development in net sales and EBITDA margins for the first quarter, but let me add a few more comments to these. Reported net sales decreased by 0.7% to 1.9 billion. The effect from exchange rate development, primarily the U.S. dollar, was negative by 1%, whereas the positive impact from acquisitions, primarily Alec Bradley and XQS, was 2% or 39 million kroner. In total, this resulted in an organic net sales development of minus 2%. The EBITDA margin declined from 24.1% to 17.2%. The impact from lower volumes will always be stronger in a small quarter, like the first quarter of the year, due to the fixed cost base, and as volume in our machine rolls decline more than normal, the margin impact has been severe. Furthermore, the impact from business exchanges, like lower net sales in high-margin markets like Canada, and strong net sales growth in new categories like NGOs with lower margins, all added to the margin decline. We expect the year-on-year comparison to improve in the coming quarters with a more normal business mix. The special costs in total of 30 million relate to the ERP implementation called One Process, as well as the implementation of the new commercial organization. All in all, the net profit for the quarter was 125 million compared to 260 million in the first quarter of last year. The adjusted earnings per share was 1.8 kroner versus 3.2 kroner in the first quarter of 2023. The free cash flow before acquisitions was minus 126 million compared with minus 179 million last year. The development was impacted by the operational performance as well as changes in working capital. In the first quarter, these changes were negative by 252 million, driven by primarily tax stamps. The free cash flow before acquisitions are usually negative during the first quarter of the financial year before turning positive in the second quarter and onwards. With this, now please turn to slide number 16. Before moving to the outlook and guidance, I'll give you a brief update on our net debt and leverage position and the status on the current share buyback program, which was initiated in November last year. During the first quarter, the net interest-bearing debt increased by 0.4 billion kroner to slightly below 4.5 billion by the end of the quarter as a result of primarily changes in working capital and capital allocations. In the quarter, we have repurchased 1.3 billion shares at a total value of $164 million. By the end of March, our holding of Treasury shares was 2.8% of the outstanding share capital, and by the end of last week, the holding has increased to 3.7%. At the annual general meeting in April, it was approved to cancel 1 million shares implying that when fully implemented later in May, the outstanding number of shares will be 86 million. The leverage ratio increased to 2.3 times. It was 1.9 times at the end of 2023. We expect the leverage ratio to be about 2.2 times by the end of 2024. Please turn two slides to slide number 18. Before moving to the expectations for the financial year 2024, I would like to repeat a few of the insights for the longer-term outlook for Scandinavian Tobacco Group. In the coming years, we expect our core categories, cigars and smoking tobacco, to deliver flat to low single-digit annual net sales growth, while the growth enablers are expected to deliver double-digit annual net sales growth. Near-term, the financial results and especially the EBITDA margin will be impacted by our increasing investments in growth enablers, but these are important to support our ability to deliver stronger and sustainable financial performance over time. The adverse impact on the group EBITDA margin from the current level of investments in the growth enablers is temporary. and we still expect margins to reverse towards 24% by the end of the strategy period, so by the end of 2025. Beyond the strategy rolling towards 2025, we expect to continue to deliver annual top-line growth led by our investments in the growth enablers and with a like-for-like margin enhancements driven by the growth enablers as well as continuous cost efficiencies. We expect to update the market on our strategy plan beyond rolling towards 2025 in the first half of 2025. The largest uncertainties to deliver on our financial ambitions are major changes in the consumer trends and regulation, including acceleration of volume decline rates in our core categories, as well as the financial performance for our NGO portfolio. With this, now please turn to slide number 19. I'll now give you more details on the full year outlook, which is unchanged compared to the outlook we released in March. 2024 may be another year with consumption of alcohol products, cigars, and smoking tobacco declining more than the historical structural decline rates. The market for handmade cigar has not yet fully stabilized, although we have seen slight improvement in recent months. We expect price increases on our products, continued growth in our online and retail distribution channels, as well as in our international markets to more than offset the decrease in consumption. We expect organic net sales of handmade cigars to increase compared with last year. We assume that the consumption of machine-rolled cigars and smoking tobacco in our European markets would develop close to their structural decline rate. However, the development during the first quarter of the year might be an early indicator. This could be too optimistic. As said, the first quarter is a small quarter, and volume development has been volatile from quarter to quarter in the past, but we will monitor development closely to act if required. Net sales from our NGO portfolio are expected to increase by more than 50 percent driven by market share expansion and roll out to new markets. Based on the expectations for our different product categories, group reported net sales are expected in the range of 8.8 to 9.1 billion. The EBITDA margin before special items is expected in the range of 22 to 24 percent The margin is being impacted by increased investments in our growth enablers, cost inflation, and mixed changes. These impacts will only be partly offset by price increases and continued cost optimization. The largest uncertainties for net sales and EBITDA margins remain changes in consumer behavior and in market and product mix. Free cash flow is expected in the range of $800 million to $1 billion and will be impacted by special investments of up to $300 million. These special investments include the retail expansion in the U.S., track and trace implementation in the EU, and the continued rollout of our SAP solution. Working capital is expected to deliver a negative contribution primarily relating to the expected increase in sales, higher cost prices, and the expansion into new product groups. Adjusted EPS is expected in the range of 12.5 to 14.5 kroner, including an estimated impact from the current repurchase program of 0.5 kroner. As always, The expectations are based on current exchange rates. This concludes our presentation for today's call. I will now hand the word back to the operator and take any questions you may have. Thank you.

Thank you. As a reminder, to ask a question, you will need to press star 1-1 on your telephone and wait for your name to be announced. Please stand by while we compile a Q&A roster. Our first question comes from the line of Nicholas Ekman of Carnegie. Please go ahead. Your line is open. Thank you.

Yes. The first question on the European machine made cigars. Can you tell us a little bit here? I mean, this is a business that has been in a decline for quite a few years now, and I think you have done many efforts in the past to reverse this. Can you elaborate a little bit on what you see as the core problem and, and, What makes it different this time? Why will the efforts that you're launching now be sufficient to reverse that trend? That's my first question.

Sorry, we just had to repeat. It was on mute.

Okay. Thank you, Niklas. It is true that machine-run cigars have been in decline for a while, and I think that if we think back a few years, we had the supply issues, and then we solved those, and we came back in the Q2 last year and realized that as we were fixing distribution and visibility in the stores, it still did not really help the market share turn around. Then we have made various efforts in the course of 2020 and we saw in the fourth quarter finally an uptick in market share, but as we can see in Q1 here, that market share was not sustainable and it was replaced by another decline. So the efforts we have made have clearly not been enough, and the analysis we've done is concluding that we have been too aggressive on some of our price increases and we need to take selected products down in price to be protecting volumes more. So these are the next steps we're looking at is primarily within the relative pricing of our brands versus competition. And you can say that we have been surprised not to see competition raising prices. And now we are taking the conclusion that we need to take a step back and get a better balance between pricing and volume. This is not unlike what we saw in the online business 12 months ago, and there you can say that the initiatives we have done have worked. So we're also hoping that that avenue will work for machine-rolled cigars. It's certainly one of our highest priorities for 2024. Thank you.

That's very clear. And on the same topic, I guess, or related, your margins, they rose from some 20% in the quarters before COVID to 27% at most. Now you're back to 22.5% if you look on a rolling 12-month basis. You mentioned here that 2024 is a year of investment and you expect margins to bounce back in 2025. How sure are you that that will be the run rate margin? Why wouldn't it be to go back to the margins where you were before COVID? What's different now compared to pre-COVID?

Thanks, Niklas, and let me try to answer that question. So you're absolutely right that during COVID our margins increased. First of all, pricing were a significant effect in those years, but also volumes, especially from our online business. When we look forward, there are several things that would imply that our margins would go up. First of all, the situation in general with cigars that Nils just talked about. We need to stabilize that and we need to regain our market shares. On the handmade part, we have our growth enables. We are expecting to grow in the handmade part of the business, which will improve our margins as we will add more volumes to our production network. And then, ongoingly, we are of course always looking at optimization. We are looking at optimization in our full network of production of around five to six percent annually, which is how you would normally also optimize as an industrial company. So we are targeting to revert end of 2025 to to if their margins of the 24%, as we have said, which of course also needs to come from improved gross margins.

Very clear. Thank you. And also, could you just clarify, because you are talking on the one hand, you're saying that you're confident that you're going to see a stronger development from Q2. And on the other hand, you acknowledge that the problems in Europe, it might be an early indicator that you might have been too optimistic. So just trying to merge those two comments into what we should expect, and particularly regarding the outlook for 2024. Are we looking at a clear risk that you're going to end up in the lower end of the guidance range, or how confident are you at this point that you can actually stabilize operations and come closer to at least the middle of the guidance range?

Well, let me start by saying that there's no doubt that with this quarter being also weaker than we anticipated and with the problems in Europe, we have, of course, taken a very close look at our year-to-go expectations. And it is based on that assessment or that analysis that we are maintaining our guidance. So it's not up for us to speculate where in the guidance range we are, but we are certainly confident that we will be in the guidance.

Okay, super. Fair enough. And thank you for taking my questions.

Thank you. We will now take our next question. Please stand by. Our next question comes from the line of Sebastian Grave of Nordi. Please go ahead. Your line is open.

Hi, Niels, my name is Torben. Thanks for the presentation and thank you for taking my questions as well. So first one here, I know that you started to report explicit on what you call next generation Oral, which previously was part of the next generation product portfolio. So is it fair to read this as a signal to the market that you are now committed to Oral pouch category going forward? And I mean, does it also mean that you're leaving out other categories or how should we think of these next generation products going forward?

Yes, thank you for the question, Sebastian. I think that we have, as part of the reorganization, established next generation oil as part of our regular organization. And in the past, it has been sitting in what we call our growth incubator. And I think you can... interpret the name Next Generation All is that our focus right now is on the white nicotine pouches and on the caffeine enriched non-nicotine white pouches. So that's where we are focusing. I think we are acknowledging that we are up against large competitors in these areas and that we need to focus and do well with what we have in the market. So this is what we are concentrating on and this is where we can But we've been starting with a focus on Sweden and we're now expanding to the UK.

Okay, thank you. I appreciate it. And also, yeah, I appreciate the new reporting structure here.

Next one. Sorry, Sebastian. I was just thinking it's really sad to add that I think it's important to remember that although we've made this change, it's still early days for us. This is not a significant part of our business today, but it is something which we believe can play a role in the future, and that's why we're focusing on it as well.

That makes perfect sense to me. Thank you, Nils. Next final question, and I know you touched a bit upon it already, but it's around the guidance, and I recognize that Q1 is a seasonal small quarter, and and obviously lumpiness and orders therefore have a severe impact on profitability. However, it's hard to ignore the fact that this was a soft start to the year, which obviously sets the bar high for the coming quarters. So, I mean, something likely within your reach, but I guess is it fair to say that you also rely on a little of, you can call it market tailwinds, or am I wrong here? And maybe could you expand again on your visibility going forward? What do you expect exactly to play out here over the coming quarters, which gives you confidence in the guidance?

Yes, Sebastian, let me answer that question. Then I can also come back to Niklas' question, which I don't think we answered on the Q2 performance. There's no doubt that this has been a weak and also disappointing 2-1. And the main reasons for maintaining our guidance is that if we take them by category, if we take the, or by division, if we take the online division, they are performing really well. They are growing. We see a significant growth also in new products, and we see the growth in the retail expansion. So we do expect them to continue their growth during the year, and that will also help margins. If you go to North America branded rest of the world, They have in the first quarter been impacted by low volumes in high margin countries like both U.S. and Canada. Canada is a timing issue simply because of the plain packaging implementation or plain packaging regulation being implemented in Canada and we expect that to fully revert and with the high margins there that would again impact the remaining year. And also on the U.S. handmade cigars, we are seeing some stabilization in the market trends here. It is still an uncertainty, and that is where the visibility kind of is a little dizzy when we look into the rest of the year. If you look at Eurobranded, no doubt that we need to reverse the market share development in Eurobranded. The market development, as Nils also alluded to in his speech, was a minus 5% decline in the first quarter. That's a very high decline compared to what we have seen, so we do expect that these will improve during the year, but that is also one of the largest uncertainties. I hope that gave some clarification.

Oh, that was very helpful. Thank you. Thank you so much, Marianne. Yeah, that was all for me.

Thank you. Just as a reminder, if you'd like to ask a question, you will need to press star 1-1 on your telephone and wait for your name to be announced. Please stand by.

And meanwhile, I can take one question from the web, and that is basically also relating to the performance of our machine world cigar business in Europe. So basically the question is whether we think the volume declines are exclusively linked to the price positioning of our brands, or is there something else impacting results? And to that, can you clarify whether we have already taken price actions in the UK, France, and Belgium to address competitive issues as the first question?

Yes. So thank you for the question. The volume declines in Europe are not exclusively linked to relative pricing. I think we've explained in the past that SDG has a relatively stronger market position in the segments that are declining the most. So we have a structural challenge in our machine world cigar business. We are gaining market share in some of the segments that are growing, but it's still not material in the overall context. And we also have an element of market mix where some of our really strong markets like France and the UK are seeing a relatively higher market decline. So these are all three things contributing to our challenges in the European machine-rolled cigar business. Now, have we already taken price actions? Yes, we have taken price actions in certain markets, but we have tried to be selective about it in the sense that we understand that pricing is also one of the areas which is the most expensive to touch. And what we are saying now is that we will probably need to take more initiatives on pricing, and we are looking at that at the moment.

And then there's a question on the EBITDA margin contribution from these next generation oral products, how that is playing out.

Yeah, thank you. So the question also is related to Europe. I would say the EBITDA contribution into one is about zero for this product. category and if we look for the remaining year we do expect the contribution to be negative because we are going into the UK market and we are investing also with additional sales force. So that is part of our clarification on this category, how we should compete and whether we can compete. We will invest and then over the next 18 to 24 months We need to establish whether we believe we can be competitive in the longer run.

And I hope that addresses the questions from the web for now. So back to the operator.

Thank you. There are no further questions via the phone. Speakers, please continue.

Okay. But then I think we will conclude the webcast for now. And thank you for listening in, everybody. And have a continued good day. Thank you.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.