Haypp Group AB (publ) (HAYPP) Earnings Call Transcript & Summary

Thank you very much. Good morning, and welcome, everybody, to Haypp Group's presentation of the interim report for the fourth quarter of 2022. Today, we will walk you through a brief overview of our business and comments on the operational and financial performance for the fourth quarter. The interim results and results presentation is available at the Investor Relations section of our corporate website. Presenting today in addition to myself is Svante Andersson, our CFO. Moving to Slide 3 in our results presentation. Here, we see a higher purpose of inspiring healthier enjoyment to millions, which is predominantly moving people from cigarettes to safer alternatives that traditionally was snus and in more recent years nicotine pouches. Moving to Slide 4. We have a chart presenting the spectrum of nicotine products and their relative harm versus cigarettes. Haypp Group's current focus on nicotine pouches and snus lies in the lower end of the spectrum. The scientific party of research around modern harm reduction alternatives to cigarettes has come a long way in recent years. In addition to nicotine pouches and snus, products such as tobacco heating devices and paper are widely accepted as carrying a significantly lower level of harm than traditional cigarettes and other smoking products. On Slide 5, we can see the smoking rates across a range of European countries -- in Slide 5, we can see where smoking rates are like across a range of European countries. Sweden with a strong tradition of oral nicotine is below 1/3 of the European average of smoking rates. In Norway, where oral nicotine products were introduced some 20 years ago, smoking rates are at similarly low levels to Sweden. On the right-hand side, we can see how smoking rates collapsed between 2005 and 2020 in Norway, especially among the younger part of the population. And there is no almost perfect correlation between that and the uptake of nicotine pouches and snus among the same age groups. It is this impact on public health, which we wish to bring to other countries. Turning to Slide 6. We can see the outlook for the market we laid out in 2021 in connection with our IPO, and we believe it is equally as valid today. We see a global market size for nicotine pouches and snus, which will increase from SEK 27 billion in 2020 to SEK 60 billion in 2025. All of this growth is going to be delivered by nicotine pouches, which will increase from share from 30% again in 2020 to 80% in 2025. Since the market outlook was prepared, nicotine pouches has been tracking in line with our expected CAGR of 41% per annum. And it is also worth noting that Haypp has been growing significantly faster. Due to the harm-reduced nature of this category, it carries lower excise taxes, and hence, there is quite a significant profit pool to be divided between manufacturers and retailers of circa SEK 48 billion. Furthermore, the category is very well suited for online, and we see online penetration increasing for every quarter that goes by, and we expect online to increase at healthy levels. Moving along to Slide 7. We laid out the key factors behind the growth in nicotine pouches. The primary driver is strong consumer demand for less harmful products, which is greatly supported by regulators in general, which are adopting a principle of harm reduction in their legislative approach to nicotine pouches. This, in turn, has led a significant investment from the category -- in the category from the industry players, both large tobacco companies and many credible new entries are driving innovation and -- are driving innovation. These are the drivers for the growth which we see on the right-hand side. On Slide 8, we have a picture of the competitive landscape for online in our category. While there is a significant number of players, many of whom come and go over time, they never reach the scale that we are at, and we are currently about 10x the size of our largest competitor online. On Slide 9, starting off with Sweden. We are -- starting off with Sweden, we're continuing to grow market share within nicotine pouches. And as nicotine pouches continues to grow its share in the total market, our share of the Swedish market has lifted from 10 percentage points that we stated in 2020 up to the early to mid-teens. As discussed in previous earnings calls, we have struggled in Norway since the border and the duty free channels reopened post-COVID and contracted the domestic market. However, we turned around the development in the fourth quarter. And in the fourth quarter, we saw strong growth in the nicotine pouch volume, which brought our total volume growth in Norway into positive low single digits. We estimate that our market share within the domestic market has been holding strong throughout 2022 and accelerated in the fourth quarter, especially within nicotine pouches. In our growth markets in Europe and the U.S., we have invested to grow market share, both within the online channel and within the total market during 2022, and we continue to do so in the fourth quarter. Moving along to Slide 10. You will see an overview of our logistics infrastructure. Convenience remains 1 of our key USPs and the ability to offer our customers across the markets fast and reliable delivery sets us apart. We completed the first phase of our warehouse expansion plan in Q2, and we are now operating 6 warehouse locations across our core and growth markets. We have managed this expansion while continuing to maintain healthy inventory turnover of 15x in the past 12 months. Furthermore, the warehouse expansion has led to improved consumer retention rates, which I will come back to in a moment. Having successfully completed the first phase during Q2, we have progressed to another phase where we are enhancing our infrastructure and back end. In addition to supporting scalable future growth in our current markets, it will also enable us to efficiently move into new markets. Moving along to the operational highlights of Q4 on Slide 12. And starting with our performance in nicotine pouches. The growth in consumer demand for significantly less harmful nicotine products remains unabated and continues to gain support from regulators. As I touched upon in the earlier slides, effectively all growth for the combined nicotine pouch and snus category is coming from nicotine pouches. With this in mind, the nicotine pouch volume is our primary measure of growth. In addition to the overall nicotine pouch category growth, Haypp continues to grow market share across all of our markets. Our nicotine pouch volume increased 42% year-on-year for the group driven by solid growth across all geographies. Our stellar performance in the category in recent years is the result of relentless efforts and focus from our team, who I would like to take the opportunity to thank. Despite a turbulent environment, with firstly COVID-19; and secondly, the terrible invasion in the Ukraine and the effects of the macroeconomic environment, we have grown our nicotine pouch volume by 574% since the fourth quarter of 2019. Nicotine pouches now accounts for 44% of the group volume, and this compares to 36% in the fourth quarter of last year. We continue to play a pivotal role in launching products in the nicotine pouch category, which in turn accelerates the migration from cigarettes. During Q4, 20% of our nicotine pouch volume relates to products which were launched in the past year. As I briefly mentioned earlier, our investment in 3 local fulfillment centers in the U.S. and the U.K. in the first half of 2022 have resulted in a material improvement in customer satisfaction and retention rates. While the relatively low volume in these warehouses initially means lower margins, the increase in volume is rapidly releasing benefits of scale and will support our EBITDA over time. With that, I'll pass the word over to Svante for comments on our financial performance.

Thank you, Gavin. With that, let's flip to Page 13 and the financial overview for the group. So we reported a net sales increase of 19% for the group in the fourth quarter. In constant currency, the net sales increased by 15%. Effectively, all of the growth is attributable to our progress with the nicotine pouches, and we're recording solid growth rates for nicotine pouches across all markets, including Norway. The underlying trend of gradually increasing gross margin that we've seen throughout 2022 is driven by our performance with the nicotine pouches and the strength of our value chain position within the category. Our volume performance in the fourth quarter further amplified this trend, and we increased the gross margin by 3.1 percentage points to a higher-than-normal 13.9% gross margin. Adjusted EBIT for the quarter grew by 36% versus last year and amounted to SEK 16 million, corresponding to an adjusted EBIT margin of 2.3%, up by 0.3 percentage points versus last year. The drivers behind the EBIT margin uplift is higher volume and gross margin, partially offset by higher adjusted OpEx from investments in the organization to support further growth. Our cash flow from operating activities during the period was negative SEK 32 million due to the planned temporary inventory buildup in Sweden ahead of the excise tax increase on snus on the 1st of January. Adjusting for the inventory buildup, underlying cash generation remains strong. Now turning to Page 14 and zooming in on our core markets. Reported net sales for the segment grew by 12% during the quarter and amounted to SEK 565 million. Our nicotine pouch volume grew substantially more at 41% with both Sweden and Norway showing strong performance. In Sweden, net sales for the quarter increased by 19%, driven by continued strong performance in the nicotine pouch category. In Norway, we saw results from our efforts to turn around the previous negative trend and net sales increased by 1% versus last year. On a sequential basis versus Q3, net sales increased by 20% in Norway after having seen declines sequentially in earlier quarters of 2022. The profitability for our core markets continues to increase. And on a full year basis, we generated SEK 174 million of EBITDA in the core market. The EBITDA margin increased in the fourth quarter to 8.4%, up by 1.2 percentage points against last year. This is showing the scalability in our business model and evidencing our ability to reach our long-term financial targets. The EBITDA margin increase in the quarter is mainly attributable to a higher gross margin, partially offset by OpEx investments. Now moving on to our growth markets on Page 15. Net sales increased here by 56% to SEK 136 million for the quarter on the back of strong performance across both the U.S. and Europe. EBITDA amounted to negative SEK 18 million versus negative SEK 15 million during the same period of last year as a result of continued commercial investments for growth. And we continue to invest substantial resources into building strong market positions in these very significant consumer markets, and we have been gaining market shares throughout 2022. We remain confident that with our current trajectory and market share gains, we will over time be able to deliver healthy profitability from the growth markets, which will support our trajectory towards the long-term financial targets. Lastly, here on Page 16, we have the selected KPIs, and I would like to focus on the balance sheet, in particular. In this uncertain macroeconomic environment, we are particularly pleased that our financial position continues to remain strong. We closed the year with a net working capital position of SEK 230 million, of which our inventory accounted for SEK 223 million as we built up stock before the anticipated excise tax increase in Sweden. The fast-moving nature of our products naturally implies high inventory turnover rates, and we are already well on the way to have cleared out most of this excess inventory. On the back of the inventory book, net debt increased at year-end to SEK 185 million corresponding to a net debt to adjusted EBITDA ratio of 1.8, which we expect to reverse down as the inventories cleared during Q1. And with that, I'll hand the word back to Gavin.

Thank you, Svante. Moving on to Slide 18. We reiterate our long-term targets of SEK 5 billion in net sales by 2025, predominantly through organic growth. We also reiterate our profit target of high single-digit adjusted EBIT over the medium to long term. As you have seen from Svante's material, we are already rapidly closing on this target in our core markets. Due to the growth potential of the category, the Board does not intend to issue any dividend in the foreseeable future and instead utilize our strong cash generation and robust balance sheet to accelerate growth. On Slide 19, we highlight the potential which we see for the overall category growth and also the potential for online to take a larger share of that category, given how suitable the characteristics of the category are for online. We also reiterate our market-leading position in all of our key markets. Moving along to Slide 20 and our current trading. Overall, market trends for the oral nicotine category remains favorable, and we continue the transition of our business into the nicotine pouch category. On top of that, the online channel continues to grow relevant within the category. In terms of inflationary pressure on inbound costs, we reiterate our previous guidance that inflationary pressure on our cost base remains limited. Given the noncyclical characteristics of the category, we remain confident that any additional inflationary pressure can be passed on. Looking ahead, we continue to see a solid performance in our nicotine pouch growth, the successful turnaround in Norway creates a solid platform for profitable growth in core markets. And performance has remained strong despite challenging comparables from the final COVID lockdown during the first weeks of 2022. The strong momentum we have in our growth markets is sustained as we continue to gain share in the total market. Following the flavor ban in California, we have seen an initial uplift in our performance but we remain conscious that it is still early days and consumers are still settling into the new environment. Given the continued strong performance of both the category and the channel, we have further strengthened our capabilities in key strategic areas. We believe this is broadly sufficient to achieve our medium-term growth ambitions. Our capability is to attract new customers and retain them with our offer hinge around convenience, assortment and price continues to perform well in the current macroeconomic environment. We are on track with our plans to enhance our digital infrastructure including our back end, enabling further growth opportunities and releasing benefits of scale. Lastly, we are very well positioned for the current complex environment for consumers with a strong balance sheet and noncyclical product, and a capital-light business model, we are able to remain flexible and strengthen our market position. As I wrap up, I would like to guide you to Slide 21. In summary, there is over 1 billion smokers in the world, the majority of whom are looking for healthier alternatives and nicotine pouches is the fastest-growing category. The category is perfect for online, and we are the undisputed global online market leader, where we're over 10x the size of our nearest competitor. We have a symbiotic relationship with our suppliers, where in addition to be a partner of choice for new launches, we are also 1 of the largest providers for consumer insights. We continue to welcome proportionate regulation and we often benefit from it. Our unit economics continue to improve as we scale, and this is already evident in our core markets, and we have a highly engaged team with core competencies across both nicotine industry and e-commerce. With that, operator, I would now like to open up the line for questions.

[Operator Instructions] The first question comes from Niklas Ekman from Carnegie.

I have a couple of questions. Firstly, if you can elaborate a bit on this excise tax hike. You talked about a significant stock build. Is that something that also had a positive impact to your sales in Q4? Or is it mainly that you built inventory that you're using to boost your profitability? That's my first question.

This is Svante speaking. Yes, you're correct. We did build a lot of inventory as we talked about. We have not seen that much hoarding effect on our sales from the tax increase. I think there was a bit of that in the last couple of days of the year. So it obviously has a very limited impact on the quarterly figures here. But as I say the big effect from the excise increases that you -- as we have highlighted here that we build good inventories but limited on the sales side.

Okay. Super. And are you using this inventory here to boost your profitability or to gain market share by having lower prices than your store-based competitors?

Yes. So I think we -- I mean, we built this inventory with the aim to have the flexibility. I think we're a little bit -- as we are sort of in the middle of the first quarter now, we won't come into detail on it at this point. I think we'll [indiscernible] the exact results and we released our Q1 reports, right? Pricing always kind of depend on competitive activity as well and so on. So we won't say too much about that at this point.

Okay. Fair enough. Secondly, on Norway, this is a business where you've had a fairly sharp decline in the past 4 quarters. Now it's flat. And this is still a quarter where I think that you are still negatively impacted year-over-year by the shift back to border trade. So is there any way to kind of pick up, what is the underlying growth in Norway? Do you have any estimate of what the underlying growth is when you kind of adjust for the COVID impact and what it's done to border trade?

Maybe just to give a little bit of context around this one, Niklas. So when COVID curfew, we had a robustly growing business quarter-on-quarter up until COVID hit. When COVID hit, we can close shifting our business in Norway quite rapidly. And then we saw the unwind of that as we're going through the early stages of 2022, all we can see now is that our business in Norway has shown robust quarter-on-quarter growth during Q3 and continued the robust quarter-on-quarter growth during Q4 and particularly driven by nicotine pouches where we are seeing material year-on-year growth during -- quite substantial year-on-year growth during Q4. So -- and bearing in mind that for Q4 in '21, there was a lockdown in Norway for the last circa 5, 6 weeks of the year. So we did see some high comparables for that period in Norway as we are facing for the first 4 weeks in January '23, where we also have a lockdown in all of that period. And we are showing -- we continue to show strong performance within Norway. So we view it very much as though not only have we turned the corner in Norway, but we're showing material growth, and we are doing it now for a couple of quarters consistently.

And would that -- in your best estimates, is the growth in Norway, is that stronger than what you're delivering in Sweden or even the growth market? Is that the kind of magnitude you're looking at? Or what kind of underlying growth are we talking about?

No. So it's not at the magnitude of -- it's not a quarter-on-quarter growth here. It's not on the magnitude of what we're seeing in growth markets for the reasons of -- it's already a core market, we have a material market share already within Norway. So it is a much higher base to be working from. But we are dealing with quite healthy and robust quarter-on-quarter strong mid-single-digit sort of quarter-on-quarter growth rates within Norway, if that gives you some too guidance on the construct around the growth rates that we're experiencing there at the moment.

Yes. Yes. Sure. Sure. Thirdly, just on your margin progression. You're -- and I'm talking EBIT margins now, up 40 basis points now in 2022. Do you have any best guess for what we can expect in 2023? And then particularly considering your margin -- your medium-term margin targets are for mid- to high single-digit operating margin. So that would require an acceleration from what we've seen in 2022. Is it -- is it reasonable to assume that this margin expansion will accelerate in '23 and in particular now with Norway maybe coming back to good growth?

Yes. I think -- I mean, on that one, our guidance hasn't changed very much, Niklas. I mean, we -- I think, first of all, we see 2023 as quite a good year as well to continue to really grow market share and advance our market positions in the current economic environment. And I mean we have been sort of guiding, I guess, that our -- if you look at our margin in relation to the financial targets, it will be somewhat backloaded. And I don't think we should expect any sort of material uplifting the EBIT margin throughout 2023, but more sort of continued focus on advancing our positions within the market we are in.

Okay. And you talked about -- in the press release here, you talked about a favorable regulatory development. Are you referring to any specific recent events? Or is that more a general reflection of the year that has passed?

I think it's a general reflection of the year. And I know in some of the prior calls, we talked a little bit about what had happened during some of the earlier quarters in '22 particularly the positive outlook that we were getting from Germany around this space. So I think it's more of a general sentiment rather than any specific event which has occurred within Q4.

Okay. Fair. Fair enough. And the final question, just you mentioned here that your warehouse expansion enables expansion to new markets. Can you elaborate a little bit on what kind of markets you're looking at for future expansion?

Yes. So maybe just to give a little bit more context around that one, Niklas. What we talked about was the warehouse expansion was the first phase, which we wrapped up by the middle of last year. We now recognized that in order to be able to utilize our capabilities across new markets and new opportunities as they emerge. We're going to be dedicating a little bit. We are currently in the process of dedicating a lot more of our energy towards building other aspects of our back-end infrastructure around both warehouse management systems, transfer administration, ERP, et cetera, in order to prepare us to launch across more markets. Our intent is that these markets are likely to remain within Europe and North America. We don't envisage that there will be much outside of that.

Okay. But are you looking at -- are you looking at several new markets in Europe in the next 1 or 2 years? Or is it further down the line?

No, I think it's -- we're looking at a range of new markets, and that is the time line that we're considering as well.