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Edited Transcript of STG.CO earnings conference call or presentation 14-Nov-19 9:00am GMT

Q3 2019 Scandinavian Tobacco Group A/S Earnings Call

Soborg Nov 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Scandinavian Tobacco Group A/S earnings conference call or presentation Thursday, November 14, 2019 at 9:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Marianne Rørslev Bock

Scandinavian Tobacco Group A/S - Executive VP & CFO

* Niels Frederiksen

Scandinavian Tobacco Group A/S - CEO, President & Member of Executive Board

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Conference Call Participants

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* Mathias Bjerrum Nielsen

Nordea Markets, Research Division - Analyst

* Niklas Ekman

Carnegie Investment Bank AB, Research Division - Head of Consumer Discretionary & Staples and Financial Analyst

* Simon David John Terrant Rowe

Janus Henderson Investors - Fund Manager of European Equities

* Søren Samsøe

SEB, Research Division - Country Head of Denmark and Analyst

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Presentation

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO, President & Member of Executive Board [1]

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Good morning, and welcome to Scandinavian Tobacco Group's Third Quarter 2019 Webcast Conference Call. My name is Niels Frederiksen, the CEO of the company. And with me today, I have Marianne Rorslev Bock, our CFO; and our Head of Investor Relations, Torben Sand. So please turn to Slide #2.

The agenda for this conference call basically covers the key highlights for the third quarter, including an update on fueling the growth, an update on the acquisition of Royal Agio Cigars and the closure of our factory in the U.S., an update on our performance in our 4 divisions with key financial developments before concluding with the Q&A session.

Before I start, I'd like to ask you to have attention to our disclaimer on forward-looking statements. The complete disclaimer you can find in the index to the presentation.

So please turn to Slide #3. Let me start by presenting the key highlights for Scandinavian Tobacco Group's third quarter, a quarter, we can all agree has been quite eventful. Financially, the overall message from our third quarter that I would like to leave you with is this: We deliver well on cost savings, organic business growth and cash flow. However, our net sales are under more pressure than previously expected, and that is obviously a concern.

I'll provide more details on our top line data in the presentation and for now focus on cost savings, organic EBITDA growth and cash flow. The group delivered an organic growth in EBITDA of 5.4% in the quarter and thus, supporting the full year expectations. The organic growth in EBITDA has been achieved despite a weaker-than-expected development in net sales. Our free cash flow increased in the quarter, resulted in an upwards revision of our cash flow guidance for the full year. Fueling the growth progresses well, and the program is actually delivering faster than anticipated. This means that net savings from fueling the growth in 2019 will be higher than previously expected.

Finally, another highlight in the quarter was our announcement of an agreement on the terms to acquire Royal Agio Cigars, a leading European machine-made cigars company. We are very excited about this acquisition that represents an important step towards our ambition of becoming the undisputed leader in cigar and pipe tobacco categories. I'll provide a bit more details about the acquisition in a moment.

Please turn to Slide #4. In the quarter, organic net sales was negative by 4.5% and year-to-date, the organic growth is negative by 2.4%. This is disappointing and below our original expectations for the year. The quarterly development was driven by negative organic growth in all 4 divisions. In the North America branded division, we remain impacted by decline in deliveries to the online distribution channel. The North America Online and Retail Division had negative growth, driven by a combination of Thompson and negative price mix impact. And the smoking tobacco and accessories division had negative growth, primarily driven by lower shipments of cigar to the Middle East, Africa and Russia. We consider part of the weak performance in net sales driven by temporary issues and expect a normalization of the top line development sometime during 2020.

Organic growth in EBITDA was positive by 5.4% for the third quarter and by 5.8% for the first 9 months of the year. This reflects improved operational performance and a strong progress in fueling the growth. The year-to-date results support our full year expectation of more than 5% organic growth in EBITDA.

The free cash flow before acquisitions was positive by DKK 503 million in the quarter and by DKK 819 million for the first 9 months. We thus exceeded our full year expectation for the free cash flow before acquisitions of more than DKK 750 million. The cash flow generation in the third quarter was unusually strong and will not be duplicated in the coming quarters. We do, however, expect a positive free cash flow before acquisitions in the fourth quarter. So we are now upgrading the expectations for the full year free cash flow before acquisitions to a level of about DKK 1 billion.

Please turn to Slide #5. On September 16, we announced the agreement on the terms for the acquisition of Royal Agio, a leading European cigar company based in the Netherlands that, with complementary brands and a great geographic fit, is a perfect supplement to our existing business. Royal Agio has a strong market position in the Netherlands, Belgium, France, Germany, Italy and Spain. The combined business will become the undisputed market leader in the Netherlands and France, while strengthening current market positions in other key European markets like Belgium, Germany and Spain. The transaction can only be completed when we have both a satisfactory conclusion of the statutory employee council consultation process in the Netherlands and the approvals from competition authorities in certain European jurisdictions. The consultation progress is progressing, and we still expect completion during the first half of 2020.

Please turn to Slide #6. The final information on the acquisition that we can share at this point is basically that on a debt and cash-free basis, the transaction is valued at EUR 210 million or close to DKK 1.5 billion. When the transaction is completed, our leverage ratio will temporarily exceed our target of 2x -- 2.5x debt but only shortly as Royal Agio is a cash-generative business while Agio had in 2018 net sales of approximately DKK 1 billion with an EBITDA margin of about 13%.

In comparison, in 2018, Scandinavian Tobacco Group delivered net sales of almost DKK 7 billion with an EBITDA margin of more than 19%. Including Royal Agio, net sales for the combined business will increase by about 15% to almost DKK 8 billion, and with a workforce at the takeover of more than 10,000 employees. The acquisition of Royal Agio is the biggest acquisition ever done by STG and it's our eighth acquisitions since 2010.

Over the past 9 years, our company has invested approximately DKK 3.5 billion in mergers and acquisitions. More details of the financial implication of the transaction will be communicated after completion of the consultation process and the relevant approval from the consultation authorities.

Please turn to Slide #7. Now let me give you a short update on the progress of our transformation program, which we call Fueling the Growth. We continue to make good progress on the various initiatives and still expect to deliver net savings from the program of about DKK 250 million by the end of 2021. However, we have progressed faster than originally expected, and now expect to realize more than 1/3 of total net savings in 2019, results versus previously slightly more than 1/4 of the total net savings.

The faster progress is driven by a combination of rapid improvements in some initiatives, for example, procurement as well as delayed recruitment propositions accounted for. These recruitments are planned to take place during 2020 and the scope for the total program is unchanged. The importance of fueling the growth increases with the lower volumes we have seen in the third quarter, and the program is a key initiative to protect our group earnings and cash flow. Optimization of our manufacturing footprint is another.

And with that, please turn to Slide #8. On October 17, we announced our plan to further optimize our manufacturing footprint by closing the STG Lane factory in Tucker, Georgia in the U.S. The factory produces pipe tobacco, fine-cut tobacco and small size cigar, primarily for the U.S., but also for exports. Combined with the closure of our factories in Nykobing in Denmark and Wuustwezel Belgium in 2016, we have now reduced the number of factories from 14 to 11 in the past 3 years.

We have taken the decision to reduce capacity further as a response to the continued volume decline in pipe tobacco and fine-cut as we have excess capacity in our other factories. The closure of STG Lane will adjust our capacity closure to current and projected volume levels. The production from STG Lane will be transferred to our existing factories in Denmark and the Dominican Republic. And the closure is expected to be completed by the end of 2020 with the transfer of production expected to incur investments of about DKK 30 million.

The cost savings will exceed DKK 20 million per year, with special costs being about DKK 120 million. Of these, about DKK 100 million relates to a noncash impairment charge, which has been expensed in the third quarter results and the remaining DKK 20 million relates primarily to severance costs, which will be -- which will have a cost, a cash flow effect in 2020. We have not included the potential proceeds from any sales of land or buildings due to uncertainties of amount and time.

Please turn to Slide #9. Before moving on to updates from our 4 commercial divisions, I will touch on the regulatory developments, which relates to Scandinavian Tobacco Group, just following on the comments I gave in relation in the second quarter results back in August.

Not much has changed since then, and the main topics remain the same. The deadline for submitting substantial equivalent applications is mentioned likely to be moved forward to May 2020. The deadline is being legally challenged so whether or not it will be enforced next year remains uncertain. Nevertheless, we are well prepared to comply and to deliver the necessary applications in time. The European Tobacco Products Directive is expected to be reviewed again in the beginning -- beginning sometime in 2021, but the exact timing remain uncertain. Other tobacco-related directives are also periodically updated. And industry is currently focused on the upcoming updates to the tobacco excise directive, which sets the definition and rates for how tobacco is taxed in Europe and initial EEU work on the excise directive revision has already begun with adaptation potentially sometime in 2021, although the timing is not finally confirmed.

Before moving on, let me emphasize that regulation is a permanent feature of the tobacco landscape and it offers both risks and opportunities for Scandinavian Tobacco Group. Regulation adds complexity and cost to our products, which means both scale and agility are important in mitigating regulatory risks. We believe we have both.

Now please turn to Slide #10. For the North America Online and Retail division, the organic growth in net sales was negative by 1.2% in the quarter, with the category handmade cigars delivering a decline by 2.2%. Year-to-date, the divisional organic growth in net sales is positive at 0.7%. As illustrated on the slide, the by far largest product category in this division, handmade cigars, delivered a 5.6% positive volume impact in the third quarter, but a 7.8% negative price/mix impact. The main explanation for this development is the impact from Thompson Cigar, where we have seen an increase in the sale of smaller cigars at the expense of larger cigar. This positively impacts volumes, while negatively impacting price/mix. Also negatively impacting price/mix is an intensive pipe competition environment amongst online distributors with a higher than usual amount of promotional expeditions.

The integration of Thompson Cigar is progressing as planned, and we will finalize it by the end of this year. The acquisition is on track to deliver the expected synergies and strengthen our position in the U.S. online market with full year EBITDA margins climbing to the anticipated level. So all in all, we are pleased with the acquisition and integration of Thompson Cigar.

The Super Store in The Colony in Texas shows continued good results with high customer activity and the promising performance supports our ambition to expand our retail footprint further. We're opening our second store in Texas and additional 2 stores in Florida are expected to take place in the second and third quarter of 2020. The EBITDA margin before specialized items improved by 110 basis points of which 80 basis points to date to accounting changes. And improved OpEx ratio driven by efficiency improvements contributed to the underlying margin expansion in the quarter.

With this, please turn to Slide #11. The North America Branded division had another quarter with high negative organic growth in net sales. For the third quarter, organic decline in net sales was 11.4% and year-to-date, the decline was 8.4%. This represents a steeper decline than expected and is up on the normal structural trend we see for this division. The decline for the product category handmade cigar was 7.1% in the quarter, and the total market for handmade cigars has, as mentioned before, throughout 2019, been impacted by temporary issues, such as weather conditions, the introduction of Internet sales tax and a prolonged inventory rebalancing in the online distribution channel. These issues have endured longer than anticipated. Nothing indicates though that the sales out to consumers are more challenged than expected and we have maintained consumer market share.

Furthermore, we still expect the overall handmade category to deliver positive organic value growth over time based on a slightly negative volume impact being more than compensated by price/mix improvements. And we continue to see 2019 as an exception to the long-term structural trend for the category.

The other product categories in the division, pipe tobacco, fine-cut and machine-made cigars all delivered negative organic growth in the third quarter. Pipe and fine-cut followed the long-term trends with steady declines. The negative growth in machine-made cigars was driven by preparations for plain packaging in Canada, which will take effect as we speak here in November. And this will only have a temporary effect, and we expect it to normalize during the beginning of 2020. The gross margin declined by 1 percentage point, driven by the lower volumes, where the EBITDA margin showed strong progress, even excluding the impact from the IFRS 16 accounting change. And this resulted in a DKK 14 million increase in EBITDA for the quarter and was primarily driven by good progress in fueling the growth and additional cost savings, given the volume performance.

Please turn to Slide #12. The region machine-made cigars division continues to deliver negative organic growth in net sales, but the signs of improvement that we have identified in the earlier quarters continues. The overall organic growth was negative by 2.3% in the third quarter and year-to-date, the organic growth in net sales was negative by 2.1% for the division. In the quarter, we saw a 2% decline in the machine-made cigar category, which was lower compared to the second quarter and is the result of a more stable volume development, especially in France. As usual, we have included our market share index in the appendix of this presentation. This consists of our top 5 European machine-made cigar markets, which improved slightly versus the second quarter, driven by improvements in France, the U.K., Netherlands and Belgium. The turnaround in France progresses as planned and we have been encouraged to see that both France and the U.K. actually delivered positive organic growth in net sales for the product category machine-made cigars.

The EBITDA margin was slightly down in the third quarter versus the same quarter last year when adjusting for the positive impact of accounting changes. This might look as a setback compared to the improvements we've delivered in recent quarters, but year-to-date, the improvement is more than 1 percentage point. But notice that the third quarter of 2018 was exceptionally strong as margins benefited from very good performance in the U.K. and Belgium. Underlying, we continue to see improvements driven by the progress of Fueling the Growth.

Please turn to Slide #13. For the third quarter of 2019, the Region Smoking Tobacco & Accessories delivered negative organic growth of 5.6%, but with an expansion of both the gross margin and the underlying EBITDA margin. Year-to-date, organic growth in net sales was negative by 3.7%. We expect the negative organic growth in net sales for the division to continue into the fourth quarter. The division was, during the quarter, negatively impacted by temporarily lower shipments of both machine-made cigars and fine-cut tobacco to Middle East and Africa and our machine-made cigars to Russia.

The EBITDA margin, excluding the impact of changes in accounting principles, was positive by more than 3 percentage points and was driven by a positive product category mix, leading to an improved gross margin as well as an improved OpEx ratio as the implementation of fueling the growth initiatives continues to increase cost efficiency.

In the quarter, we decided to divest our sales companies in Slovenia and Croatia to Swedish Match due to the loss of key management executives and a key third-party distribution contract -- sorry, and key third-party distribution contracts in these markets. Total loss net sales in these companies is about DKK 85 million in 2019 with an EBITDA margin above the group average.

With this, I will leave the word to Marianne. Please turn to Slide #14.

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Marianne Rørslev Bock, Scandinavian Tobacco Group A/S - Executive VP & CFO [2]

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Thank you, Niels. In the third quarter of 2019, we delivered a negative organic growth in net sales of 4.5%, with a positive organic growth in EBITDA of 5.4%. For the first 9 months of the year, organic growth in net sales was negative by 2.4% and organic growth in EBITDA was positive by 5.8%. The quarter net sales was DKK 1.8 billion, which represents a decrease of 2% compared to the third quarter of 2018. Thompson Cigar was consolidated into our accounts in the beginning of the second quarter 2018. So the only difference between the reported net sales growth and the organic net sales growth in the third quarter relates to exchange rate development, which had a positive impact of DKK 43 million. For the 9-month period, exchange rates impacted positively by DKK 161 million, whereas the Thomson acquisition had a positive net sales impact of DKK 130 million relating to the first quarter of the year. The organic development in the net sales was driven by negative contributions from all 4 divisions in the third quarter.

For the first 9 months of the year, the North America Online and Retail division delivered a small positive organic growth in net sales. Gross profit before special items decreased by 2% to DKK 899 million despite a DKK 14 million positive impact from exchange rate development. The decline was driven by development in net sales. The gross margin increased slightly to 48.7% from 48.5%. For the first 9 months, the gross margin declined from 48.1% to 47.9% due to the impact from lower volumes in the North America Branded division.

EBITDA before special items increased by 12%, driven by an 11% decrease in operating expenses. The decrease in operating expenses relates to the positive impact from IFRS 16 but more importantly, from the significant progress made in the Fueling the Growth as well as further cost initiatives taken to offset lower net sales, especially in North America Branded. The same explanations are applicable for the 15% increase in EBITDA for the first 9 months of 2019.

For the quarter, the net profit decreased by DKK 49 million to 170 -- DKK 172 million, and special cost before tax were DKK 95 million higher than in the third quarter of 2018. The impairment charge for the closure of our U.S. factory has been fully expensed in the third quarter. The free cash flow before acquisition was exceptionally strong by DKK 503 million versus the DKK 327 million in the third quarter of 2018. The strong improvement was driven by the operational performance as well as working capital improvement versus last year as well the positive contribution compared with last year from cash payments of taxes and financial items. More details can be found in the cash flow charts in the appendix.

In conclusion, we have had very good first month of the year with regard to cash flow, resulting in an upward revision of our guidance from previously more than DKK 750 million to full year to now about DKK 1 billion.

Now please turn to Slide 15. On this slide, I will give a short update on our net debt and leverage ratio. By the end of the third quarter of 2019, the net interest-bearing debt was DKK 2,705,000,000, an increase of about DKK 120 million versus the end of 2018. The increase is driven by the balance sheet implication of the implementation of IFRS 16, dividends paid out in April 2019, partly offset by the year-to-date cash flow generation. The adjustment to net interest-bearing debt due to the IFRS 16 accounting change was DKK 192 million. The leverage ratio, defined as the net interest-bearing debt over 12 months rolling EBITDA before special items, was 1.9x at the end of the third quarter 2019 compared with our target ratio of 2.5x.

Please turn to Slide #16. Since our second quarter report released in August 2019, the guidance of 2019 has been changed with special costs. And today, we upgrade the guidance for free cash flow before acquisition. The guidance for organic growth in EBITDA is unchanged, and we expect to deliver more than 5% growth for the full year.

Based on the strong cash inflow for the third quarter and the outlook for the fourth quarter, we have revised our expectations for the free cash flow before acquisition up from previously more than DKK 750 million to now about DKK 1 billion.

For special items, we have with the announcement of the Agio acquisition and the closure of our factory in Tucker, made a number of changes to the previous expectation of about DKK 85 million. We are now including the transaction costs for the acquisition of Agio of about DKK 20 million as well as the cost for the closure of our factory in Tucker in the U.S. of about DKK 120 million for the full year expectation.

The previously announced special costs relating to Fueling the Growth of about DKK 60 million has been revised down to about DKK 35 million. All in all, that results in the new updated expectations of about DKK 200 million.

The main uncertainties to our 2019 guidance relates to the top line development and specifically to the total market development in France and the total cigar market in U.S. We believe we are well on track with our efficiency improvement to deliver our expected net savings for the year.

With this, I will leave the word back to the operator, and we are now ready to take any questions you might have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Soren Samsoe of SEB.

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Søren Samsøe, SEB, Research Division - Country Head of Denmark and Analyst [2]

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I was just wondering, you have strong growth in the handmade cigar business and online segment in volume. First of all, do you think this is in line with the market? Or are you gaining market share?

And secondly, what is the reason for the sort of very tough pricing environment? Is that the reason behind your strong volume growth or -- and has the market become more competitive?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO, President & Member of Executive Board [3]

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Yes. Good morning also to you, sir. And I think that when we look at the market share development in the U.S., it's important to remember that right now, our online business is composed of, let's call it, the original online engine with Cigars International and the newly integrated Thompson Cigars. And we have better performing -- better performance from our original engine than we have from Thompson.

And I think I explained during the second quarter that we are making changes to how we operate Thompson to make sure that when we, in 2019, we have a better margin picture. And that has had some impact on the net sales. So you can say that we are losing here, but I think we are losing here deliberately when it comes to Thompson, and we are on what we call a revised plan, which we are following towards the end of the year. So we do believe that, that the sales from Thompson will normalize over the course of the year. So -- but if you do it very mathematically, yes, I think we are losing slightly here on the online business.

The additional competition in the online business comes from a wide group of smaller companies that are driving quite aggressive pricing. So we can respond to this, and we do that to protect our volume. Some of it comes at the expense of margin but we still feel that it's not a problem we cannot deal with. But it is a fact that the promotion activity has gone up in the U.S. market. And we, of course, try to, let's say, discipline that and try to make sure that the suppliers do not deliver through these smaller players that are very aggressive on pricing.

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Søren Samsøe, SEB, Research Division - Country Head of Denmark and Analyst [4]

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Okay. My second question is, if you could just explain what's behind the strong working capital increase of DKK 130 million?

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Marianne Rørslev Bock, Scandinavian Tobacco Group A/S - Executive VP & CFO [5]

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So Sam, this is Marianne. So the main development in the working capital comes from a very focused view on inventory that we have decreased in the third quarter. So that is the main explanation. I will also say that we are talking about inventory that we do expect for the fourth quarter to see inventory increase slightly again amongst others due to the closure of the plant in Lane but also to continuously be ready for possible crisis in U.K. and other things. So that is the main explanation.

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Søren Samsøe, SEB, Research Division - Country Head of Denmark and Analyst [6]

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But since you're going to take inventories down, is that a -- because you are reducing the number of SKUs, so you don't have so many cigars types anymore? Or basically, how can you suddenly do this?

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Marianne Rørslev Bock, Scandinavian Tobacco Group A/S - Executive VP & CFO [7]

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It is mainly focused -- focused view both on our tobacco. We are taking down some of the SKUs, but that is not the main impact.

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO, President & Member of Executive Board [8]

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No, another explanation is also that when you look at combining the 2 online businesses, we have been able to basically run the combined business with a more efficient inventory level.

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Operator [9]

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And your next question comes from the line of Mathias Nielsen from Nordea.

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Mathias Bjerrum Nielsen, Nordea Markets, Research Division - Analyst [10]

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So if I heard it correctly, Niels, you were saying that you expect organic growth to normalize during 2020. And then my question is, what is a normalized level of organic growth for STG? Do you have any view on that? That's my first question.

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO, President & Member of Executive Board [11]

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Yes, thank you. I think that when we look at the handmade market in the U.S., and we've recently done quite some comprehensive studies of that, we still see that market to be at a 1% volume decline year-on-year, compensated by, let's say, 3% to 4% in pricing. So net, it should be a category that is slowly growing in value. When we look at 2019, the market has certainly been soft, and it's been particularly soft for our branded business, which has been affected by the, let's call it, the inventory rebalancing in the online channel, but also by one of our biggest customers having IT problems and hand-selling a lot less.

So when we look at 2020, we believe that it is natural to expect some normalization of levels. And we are also assuming that this company with IT problems will solve them and move back into normal operations. So that is for the handmade category.

Naturally, there's uncertainty related to that. But that's at least how we see the situation today because there are no obvious changes in consumer behavior that would indicate otherwise.

When it comes to the normalized level of net sales for Scandinavian Tobacco Group, I'm not going to give you a number. But it is typically -- and this is also still the case composed of the North American business that should be delivering growth and then more challenging mass market divisions.

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Mathias Bjerrum Nielsen, Nordea Markets, Research Division - Analyst [12]

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So net, you still see it as possible to deliver positive organic growth?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO, President & Member of Executive Board [13]

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We don't, let's say, give guidance or direction on the net sales. But obviously, our objective is to balance the categories where we do see growth versus those where -- which is under more pressure for decline. But you can see 2019 is an excellent example of when the categories that normally deliver growth, don't deliver growth, we do come under pressure.

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Mathias Bjerrum Nielsen, Nordea Markets, Research Division - Analyst [14]

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And then on to my second question. So now you see 1/3 of the Fueling the Growth savings coming in 2019, how should we expect the split going into the coming years? As you mentioned, as I think you mentioned something about that some hires have been delayed into 2020. Does that mean that the improvement should be less in 2020? Any thoughts about that?

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Marianne Rørslev Bock, Scandinavian Tobacco Group A/S - Executive VP & CFO [15]

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So thank you, Mathias. It's Marianne here. You heard absolutely right. What we have see -- what we have said originally is that we would normally see 1/4 of Fueling the Growth coming in each year. We have seen a higher impact in 2019, amongst others, because we have delayed some hiring, also as a consequence of our low net sales. So part of that will come back in 2020. So we do expect to see a lower impact of Fueling the Growth in 2020. And we will, of course, when we come with our guidance for 2020 in February, come with more detail.

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Operator [16]

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And your next question comes from the line of Niklas Ekman from Carnegie.

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Niklas Ekman, Carnegie Investment Bank AB, Research Division - Head of Consumer Discretionary & Staples and Financial Analyst [17]

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Yes. Firstly, if you look at North America Branded, this is the fourth consecutive quarter where you've seen a fairly sharp decline. I was wondering now that you're facing easy comparisons, you're talking about 2019 being a last year. But in reality, this started already in Q4 last year. So as you're facing easier comparisons, do you think you can start to see growth rates returning now in Q4? And I guess you should already partly know that as we are halfway through the quarter. That's my first question.

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO, President & Member of Executive Board [18]

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Yes. Again, we don't express expectations through the fourth quarter. But I think that, as we've said already, when we look at the branded business and the trend that they've been running at for a number of quarters, we are not seeing that as an ongoing trend.

I think that it's important to remember also that the branded business is composed of 3 different business segments. There is a Canadian business, which this year have been somewhat affected by plain packaging, but in principle, have done well. We have a Lane, fine-cut, pipe tobacco and small cigar business, which has had a difficult year. I think we've explained that this business is looking at categories that are planning at relatively high rates. So pricing and discounts to customers are important, and we've gone through -- had some difficult negotiations with customers, which is also affecting the third quarter, which is beginning to bear fruit. So you can say that, that's just a difficult segment, which we try to manage it possible for pricing and for profit.

And then you've got the handmade business, which is the biggest segment in the division. And here, we are seeing a soft market in 2019 and we certainly expect that to continue for the full year, but we also expect to see normalization some time in 2020.

So it's a difficult question. I wish we had more certainty to express but it is -- a little more uncertainty.

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Niklas Ekman, Carnegie Investment Bank AB, Research Division - Head of Consumer Discretionary & Staples and Financial Analyst [19]

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Okay. That's good enough. And also, just to clarify, maybe I misunderstood here, but you said that one of the reasons here is that you see inventory rebalancing on the retail side. And obviously, if you look at your online retail business that has seen some very good improvements, and obviously, your working capital has also improved. So could it be that your online retail business is partly responsible for the weak growth in the branded business, that you literally send down some destocking that has affected your branded business negatively?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO, President & Member of Executive Board [20]

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Yes. So I think that when we look at the online category, we have seen a transfer of customers over many years from the physical retails to online. And in 2019, in connection with the additional work we've done to understand the category, we can see that, that transfer is stopping. So we basically have a relatively flat developing online category altogether.

This means that for many of our competition in the online category, they have been trending too high on inventory. And we could see it on our own inventory. In the beginning of the year, so many people have been rebalancing inventory. And that has affected our branding -- branded business in the course of the year.

But again, it's important to emphasize that the bulk of the negative development for our handmade branded business is caused by one customer, one big online customer who has not done well in 2019, almost facing similar problems that we had in 2017. And again, you can say that, of course, we have picked some of that volume up maybe elsewhere. But this is just one customer, where there's a very strong loyalty to our brand portfolio.

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Operator [21]

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(Operator Instructions) Your next question comes from the line of Simon Rowe from Janus Henderson.

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Simon David John Terrant Rowe, Janus Henderson Investors - Fund Manager of European Equities [22]

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Just on that last point. Could you give some kind of idea of how much this one customer cost in terms of the revenues in North America Branded? You call it out as being such a significant one-off.

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO, President & Member of Executive Board [23]

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Yes, we are not willing to disclose that, Simon. So I understand the interest. The closest we get is by saying that this is a significant part of the shortfall on the handmade part of that business.

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Simon David John Terrant Rowe, Janus Henderson Investors - Fund Manager of European Equities [24]

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Okay. And would it be fair to say that the impact of the change in sales tax has taken longer to fluster the system than you expected?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO, President & Member of Executive Board [25]

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I think it's one of those areas where it's very difficult to assess the exact impact. But when we look at the online category flattening in the course of 2019 versus the growth of the previous years, I think it's fair to assume that the fact that there's a little bit less price benefit has been part of the reason for that. So it's not that we see the online category declining. And I actually think we can do things to stimulate continued growth of the online business. But I think it's a little bit of a consumer adjustment that is being made because prices have gone up, let's say, by 5% more, 5%, 6% more than just price increases.

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Simon David John Terrant Rowe, Janus Henderson Investors - Fund Manager of European Equities [26]

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And so is your assumption for '20 and beyond that there will be a return to growth in online?

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO, President & Member of Executive Board [27]

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Again, I think that when we look at our online business over the past decade and also looking forward, we are still expecting the online business to deliver growth.

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Operator [28]

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(Operator Instructions) There are no further questions at this time. Please continue.

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Niels Frederiksen, Scandinavian Tobacco Group A/S - CEO, President & Member of Executive Board [29]

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Okay. Well, thank you very much for listening in and for asking questions. I wish you all a good day. Thank you very much.