Scandinavian Tobacco Group A/S (STG) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the Scandinavian Tobacco Group Q1 2024 Results Conference Call. [Operator Instructions] 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 [ as said ] 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 Rorslev Bock. Please turn 2 slides to #3 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 3 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 on forward-looking statements at the end of this slide presentation. With this, please turn to Slide #4, and I will leave the word to Niels.

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. Positive net sales performance by next-generation oral and handmade cigars could not offset lower volumes in our machine-rolled cigar business and profitability was negatively impacted by mix 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 oral 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 enablers share of group net sales increased to 11% in the first quarter. Trends for the product categories, handmade cigars and smoking tobacco remain 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 DKK 1.9 billion. Adjusting for acquisitions and exchange rate 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. Free cash flow before acquisitions was negative by DKK 126 million versus minus DKK 179 million last year. And adjusted earnings per share came in at DKK 1.8 versus DKK 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 2 slides to Slide #6. Less than 2 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 1 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 group net sales for each of these product categories, including other, which comprises accessories, bar sales in our retail stores and third-party contract manufacturing. Our 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 comprised 46% of group net sales following a 12% organic decline compared with the first quarter of last year. Next-generation oral comprising both our own brands like STROM, 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 #7. 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 oral, retail stores in the U.S. and international sales [ or ] 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 have expressed before, is to launch XQS in more new markets in 2024, and 2 days ago, on May 1st, we launched the product in the U.K. market. During 2023, we opened 2 new retail stores in Texas, bringing the total to 9 by the end of 2023. This year, we plan to open 3 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., also have been open for more than 12 months, delivered a 4% increase in net sales compared with the first quarter of last year. And finally, our international sales of handmade cigars outside the U.S. continued 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. on the current estimated about 5% market share. The opening of Club Macanudo concept stores, most recently in Jakarta, Indonesia and Taipei, Taiwan is 1 piece in the puzzle to increase the awareness and positioning of our international handmade cigar brands. Please turn to Slide #8. During the first quarter, our machine-rolled cigar business in Europe did not deliver as expected with a double-digit decrease in organic net 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 7 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, U.K. and Belgium. The structural decline rate has been closer to 3% -- 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 2 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 also 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 2 slides ahead to Slide #10. I'll start with Europe branded. Reported net sales for the first quarter decreased by 4% to DKK 617 million, 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 U.K. Next-generation oral and handmade cigars delivered double-digit net sales growth and pricing 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. EBITDA before special items decreased by DKK 61 million to DKK 85 million with an EBITDA 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, mix changes and to a lesser extent, the increased investments in supporting long-term growth for both next-generation oral and machine-rolled cigars. With this, please turn to Slide #11. For -- in the quarter, North America Branded and Rest of the World reported net sales decreased by 5% to DKK 681 million, 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 regulations 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 well -- as well as previously mentioned. EBITDA before special items decreased by DKK 64 million to DKK 212 million with an EBITDA margin of 31.2% versus 38.3% in the first quarter last year. The margin was negatively impacted by mix 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 & Retail division. Please turn to Slide #12. Reported net sales for the first quarter increased by 8% to DKK 650 million 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 oral products. Online net sales of handmade cigars were positive, driven by a stabilization in volumes sold and a positive price/mix impact. EBITDA before special items decreased slightly to DKK 81 million with the EBITDA margin decreasing to 12.5% from 13.9% in the first quarter last year, and the decrease is driven by mix changes and some timing effect of OpEx. I will now hand over the word to Marianne. Please turn 2 slides to Slide #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. On this slide, we have outlined the development of EBITDA margins in the first quarter over the past 7 years since 2018. In the appendix, we have included the full years 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 in the 3 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 impacted by mix changes and unusually low volumes in our machine-rolled 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% 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 this. Reported net sales decreased by 0.7% to DKK 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 DKK 39 million. 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-rolled cigars declined more than normal, the margin impact has been severe. Furthermore, the impact from business mix changes, 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 cost in total of DKK 30 million related 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 DKK 125 million compared to DKK 260 million in the first quarter of last year. The adjusted earnings per share was DKK 1.8 versus DKK 3.2 in the first quarter of 2023. The free cash flow before acquisitions was minus DKK 126 million compared with minus DKK 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 DKK 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 #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 DKK 0.4 billion to slightly below DKK 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 DKK 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 2.3x. It was 1.9x at the end of 2023. We expect the leverage ratio to be about 2.2x by the end of 2024. Please turn 2 slides to Slide #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 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 revert 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 the 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 #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 our core products, cigars and smoking tobacco, declining more than the historical structural decline rates. The market for handmade cigars 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 to the last year. We have shown that the consumption of machine-rolled cigars and smoking tobacco in our European markets would develop close to their structural decline rates. 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, where we will monitor our development closely to act if required. Net sales from our NGO portfolio are expected to increase by more than 50%, 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 DKK 8.8 billion to DKK 9.1 billion. The EBITDA margin before special items is expected in the range of 22% to 24%. The margin is being impacted by increased investments in our growth enablers, cost inflation and mix changes. This impact will only be partly offset by price increases and continued cost optimization. The largest uncertainties for net sales and EBITDA margin remain changes in consumer behavior and in market and product mix. Free cash flow is expected in the range of DKK 800 million to DKK 1 billion and will be impacted by a special investment of up to DKK 300 million. These special investments include the retail expansion in U.S., track and trace implementation in 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 net sales, higher cost prices and the expansion into new product groups. Adjusted EPS is expected in the range of DKK 12.5 to DKK 14.5, including an estimated impact from the current repurchase program of [ DKK 0.5 ]. 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. [Operator Instructions] Our first question comes from the line of Niklas Ekman of Carnegie.

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 what makes you different this time? Why will the efforts that you're launching now be sufficient to reverse that trend? That's my first question.

Yes. Sorry, [ we just have ] to repeat, it was unmuted so.

Okay. Sorry. Thank you, Niklas. So it is true that machine-rolled 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 visibilities in the stores, it still did not really help the market share turnaround. Then we have made various efforts in the course of 2023, 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 are 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 has 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.

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. So 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 machine-rolled cigars that Niels just talked about, we need to stabilize that, and we need to regain our market shares. On the handmade part, we have our growth enablers. 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 5% to 6% annually, which is how you would normally also optimize as an industrial company. So we are targeting to revert end of 2025 to EBITDA margins of 24%, as we have said, which of course, also needs to come from improved gross margins.

Very clear. 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 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 2 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 weaker, 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.

We will now take our next question. Please stand by. Our next question comes from the line of Sebastian Grave of Nordea.

Hi, Niels, Marianne, and Torben, thanks for the presentation. So first one here, I note 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 our 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?