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

Welcome to the Haypp Group Q1 2024. [Operator Instructions] Now I will hand the conference over to the speakers: CEO, Gavin O'Dowd; and CFO, Peter Deli. Please go ahead.

Good morning, everybody, and welcome to our Q1 2024 interim results. Starting with the operational highlights. I would like to begin with our nicotine pouch's first quarter volume growth of 40%, which remains robust despite Easter falling in the first quarter. If we run our NP volume performance out to year-to-date end of April, i.e. reflecting the Easter effect in both years, you can see that our NP performance accelerated to 42% over that 4 months. NP accounted for 58% of our total volumes for the year, up 12 percentage points versus the first quarter of 2023. And the trend continues and our NP share was over 60% in March. We're particularly happy with the continued strong performance for NP and our growth [indiscernible], which has also moved into profitability for the first time. The snus category moved into overall decline -- overall market decline during 2023, and this is expected to continue for the foreseeable future. These changing dynamics have reduced the brand owner's appetite to invest in either new snus launches or snus promotions. Our consumers greatly value our ability to display new products and our competitive prices. The absence of both has resulted in a decline in our snus sales slightly faster than that of the overall market. While snus is not a strategically important long-term category for us, we have taken some actions to bring our decline back in line with the market. The increase in our EBIT margin from 2.3% to 3.5% reflects the benefits of scale throughout our business, particularly in our growth markets. This 3.5 percentage points includes an additional 0.8 percentage points, which has been reinvested into emerging opportunities. And our infrastructure transformation continues on track and will be key to our effective continued expansion. Moving to the next slide and taking a look at our emerging market segment. As we said on the Capital Markets Day, our nicotine pouches primarily is the fastest growing of the 3 produced product categories globally, and our existing markets currently account for faster [indiscernible] NP global volume but also recognize that only 4 million of the existing 100 million users of risk-reduced products are in our current target. This is why we plan to expand into adjacent RRP categories and new countries [indiscernible]. We have first expanded into vape in some of our existing European markets, which covers an additional 6 million risk-reduced product consumers. While our existing infrastructure and skill set gives us a material boost, our granular understanding of the vape category, and establishing organic search positions will require persistence over the coming years. We also appreciate the strong relationship between nicotine pouches and vape, with many NP consumers either previously been vapers or even still being dual users. Finally, we recognize that a wave of regulation regarding disposables is potentially on the horizon in Europe and may alter the landscape for the vape category. In general, we view this disruption as a long-term opportunity and shall dedicate our resources towards this opportunity with a clear appetite to have an economically sustainable slice of the market over the longer term. Moving along to our infrastructure improvements. We are building our total company infrastructure with the principles of sustaining growth in our current markets and ensuring efficient expansion into both adjacent categories and new geographies. We continue to make strong progress in this transformation. During Q1, we replaced our ERP and middleware in Sweden and Growth Europe, bringing all of our European operations onto the destination architecture. This facilitates the migration of our e-commerce stores to V3, our upgraded system. In addition to the new launch of Vapeglobe, the Vapeglobe store in Germany in late '23, we have also successfully migrated our first Norwegian store in recent weeks with minimal disruption. Moving onto our warehouse structure. We plan to automate our Texas warehouse in the latter part of 2024. This will harmonize our warehouse equipment and software, which is working efficiently in our European warehouses. In summary, the team are executing in line with our plans. Moving along to regulation. The new national regulatory initiatives in Sweden reinforces the principle of tobacco harm reduction. In addition, we support potential initiatives, which could deter use access, including restrictions on private persons, retailing products and reinforcing product standards, which we at Haypp Group have self-imposed many years ago. In Norway, there has been minimal movement on regulation and we remain confident that Haypp Group will not be negatively impacted by the potential regulation. In the U.S., the regulatory framework remains very stable despite some recent concerns from a prominent senator. Youth consumption remains extremely low for nicotine pouches. While the upcoming -- moving to the U.K., while the upcoming legislation is somewhat later than we initially expected, we generally welcome the legislation and believe that Haypp Group is well positioned to benefit from it. At an EU level, TPD 3 appears to be even further delayed. This has encouraged more member states to start to regulate NPs themselves. This continues to add even more weight towards appropriate category regulation at an EU level. With that, I will hand over to Peter for more depth on our commercial performance.

Good morning, everyone. Thank you, Gavin. Let me start with the financial overview on the group level and let me start with sales. So overall, we reported a 12% sales growth on a group level and achieved SEK 888 million sales. If we exclude unfavorable currency impact, the growth would have been 13%. But there are 3 key elements, which I would like to call out to give a bit of a color behind our sales performance. Gavin already mentioned Easter. So during holiday seasons, it's very typical for us to see a lower order intake. We experience this every time in the Christmas period every year, that's the usual thing and this year because Easter was in March in '23 -- in '23, Easter was in April. And now this year in March, we have to better look on year-to-date April performance. We already do have the preliminary sales numbers available. And looking at the year-to-date, April sales performance is already at 17%. So we can see the correction in the April month. Then the second important element to highlight here is the contribution -- the sustained contribution of our growth markets. We can see that those segments are contributing solidly to our overall growth. However, this quarter, the core markets contribution was lower than historically. And here comes the third part, which Gavin already mentioned, the decline in the snus segment. If we look at our sales drivers, net sales drivers, then the nicotine pouch remains solid. However, the snus declined but heavily into our overall growth. With this, let me move to the profitability because here, I think, we achieved a major step towards our long-term commitment of the targets we set down in our Capital Markets Day. So our gross margin for the quarter increased by 2.4%. This increase is predominantly driven by the annual commercial renegotiations and typically, such change happens only from Q4 to Q1 and throughout the year, it's relatively stable. The margin improvement was partly reinvested into overheads, into new capabilities and capacity, particularly behind the new emerging market segment. And overall, this resulted in adjusted EBIT of 3.5%, an increase of 1.2% from 2.3% in Q1 2023. Important to highlight here that the core and gross markets EBITDA was at 6.1%, 0.8% out of which was invested into the emerging markets. So the total group EBITDA was at 5.6% with the depreciation resulting the 3.5% adjusted EBIT. I would like to also highlight you the cash flow performance from operating activities because we achieved SEK 122 million positive cash flow. This is a combination of a better -- lower inventory levels after year-end, but also mainly driven by improved trading terms with our suppliers for the payables. We reported some exceptional cost in this quarter, and these are connected to the impairment of the retired equipment for the Stockholm warehouse where in previous year, we overhauled the entire infrastructure to improve capacity. Moving to the core market. Here, the net sales increased by 2% in Q1. In constant currency, the increase was 3%. Again, year-to-date April is an important figure here to bear in mind because that increase is already at an 8% level. We are happy with our nicotine pouch sales performance, which remains strong and grew 32% in the quarter and 34% year-to-date April. Based on our understanding, this growth is ahead of the market growth, so indicates that we are gaining share. The snus performance, which was on the weak end in Q1 has to be seen also from a long-term perspective. We do not see the category as part of our long-term strategy. There are not enough innovations, products coming through from the suppliers, and there is a very low level of appetite to invest into the category by the brand owners whose focus has clearly shifted towards nicotine pouches. However, we recognize that the snus category is not going to disappear completely. So we took actions to mitigate this decline as Gavin already indicated. The adjusted EBITDA grew 6.5% to almost SEK 54 million and reaching 8.6%, up by 0.4% versus last year. This is mainly attributable to a favorable mix impact between the categories. Moving to the Growth Markets. Let me start with the sales, which increased by 46%. Here, we saw strong performance across all markets, but especially in the U.S., the nicotine pouches grew by 59%. In the U.S., I would like to highlight California and the impact of California because as we talked about a year ago when we announced our Q1 report, we highlighted that due to the flavor ban, Haypp Group also benefited greatly from the increased consumer demand for products which were legally available by online retailers. However, we see that since then, many consumers reverted back using flavored nicotine pouches, which created a temporary headwind for Q1 for us. And this is what we evidently see in our sales in California. However, outside of California, we achieved 70% growth overall. EBITDA is another important element and a great milestone, what we reached in the growth markets this quarter. From being a clear profit drag for the group, this quarter, we resulted around the breakeven result very slight positive adjusted EBITDA, which is clearly driven by the economies of scale, very partly offset by commercial investment. And obviously, there is a key role here for annual commercial negotiations, which had our overall margin performance in this market segment. Last but not least, emerging markets. Here, financially speaking, there is not too much to say. These categories are in their infancy. So as you can see, we achieved an SEK 8 million sales. And in overall, we invested SEK 7 million on EBITDA level. This SEK 7 million investment mainly went into capacity and capability in specific part of the organization, mainly in commercial, search optimization and category management. At this stage, I believe that the success of this category is not to be seen through the financial KPIs, but more how we can be [indiscernible] positioning and progress in terms of customer acquisition within this segment. Let me move to the selected KPIs. I already told you about strong cash flow performance and strong EBITDA, what we had. The combination of these 2 is resulting a nice decrease in our net debt to adjusted EBITDA ratio, which is down to 0.8%. As I look ahead, I believe that our business model will allow us to maintain the capital-light structure and maintain our healthy balance sheet, so we are ready for the next phase of growth. With that, I give it back to you, Gavin. Thank you.

Thank you. Moving to our financial targets. We target SEK 5 billion in revenue for 2025 from our core and growth markets. While we recognize that our Q1 overall revenue growth was well below what's required, we would also like to guide you to our overall nicotine pouch growth of over 40% despite some one-off impacts and that nicotine pouches now accounts for over 60% of our sales. Continued strong performance in NP will continue to lift the overall revenue growth. Regarding profitability, we guide investors towards an adjusted EBIT for core and growth segments in the range of 5% to 7% in 2025. During Q1, our adjusted EBIT for these segments was 4.3%, an increase of 2 percentage points versus Q1 '23. We would like to remind you that our operating model tends to reflect the benefits of scale as we transition from one calendar year into the next. As such, I expect early 2025 to be the next time when we experience a material uptick in our EBIT margin. Moving to our final slide. I would like to reflect the dynamics underpinning our continued performance. Our operating model is a substantial moat for our business, which, in turn, is built on robust processes and systems. However, our overall progress is a result of an excellent team and culture that they have fostered and their connection to our higher purpose of inspiring healthier enjoyment moments. I would like to take this opportunity to thank the team for their commitment, dedication and overall performance. And with that, I will hand over to the operator for questions.

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

Just a couple of questions from my end. Firstly, if I could start maybe with the growth target here of SEK 5 billion by 2025. Given the slowdown you're seeing, how confident are you? Because I think this requires a sales CAGR of 28% over the next 7 quarters. How confident are you that you can see that level of acceleration and that the slowdown you saw here in Q1 was really very temporary?

Niklas, yes, I think there's a couple of dynamics in this one. I think the first dynamic running through this, I think we very much have to view it towards probably 3 different layers sitting within it. And the way I would lay the layers out would be at the bottom level is snus, at what level of decline will be manifesting through that. At the next level of nicotine pouches within our core markets. And then at the top level, nicotine pouches within our growth markets. And what we can see is that now roughly 1/3 of our sales is coming in each of those segments or just we call it statistically 1/3 of our sales coming in each of those segments. What we can see is accelerating growth in that top layer of nicotine pouches in our growth markets, continued robust growth, operating well above that 25% to 28% level that you're referring to for nicotine pouches in our core markets. And of course, we have been experiencing that headwind on snus. Now regarding snus, we always expected that there was going to be a decline. I think what has been sort of interesting to us over the last maybe 5 or 6 quarters is realizing that it's not constant. It does come in ebbs and flows a little bit as it comes through here. So we still remain confident for the overall numbers, but we recognize that we are going to have to navigate what the snus dynamic within it would be. We also recognize, Niklas, on this one, that we're maintaining our primary focus on nicotine pouches because that is where not just the growth is coming from, but it's also where all of our margin comes from. I think as Peter alluded to in some of his slides, part of the reason why we've been seeing the margin expansion in our core markets has been the mix change away from nicotine pouches towards snus. So we remain confident for those sort of key factors going to it.

That's very clear. And a second question, if you can elaborate a bit on the margin development here. Is it right to understand that because of renegotiated contracts, we can now expect basically a plus 1 percentage point margin improvement throughout 2024. And you believe this could accelerate even more to more than 1 percentage point margin expansion in 2025. Is that the right way to understand this?

Directionally, absolutely. The calendar, as you sort of alluded to, the negotiations are done on an annual basis, and we've taken more than 2 percentage points out of core and growth with the uptick in it. And this is why we felt that as we knew this was coming as we went through 2023, we thought it was an opportunity to be able to utilize some of that to invest into our emerging opportunities. Hence, where you can see that 80 basis points of margin reinvested into there. So we do expect that to continue during the year. Like I said, I don't expect to see that level of uptick that we've seen from Q4 to Q1 occurring in other quarters during '24. But again, I would expect that, that type of step change would be anticipated again in early 2025. That wouldn't come across as a great surprise.