Swedish Match : Transcript

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SWMA.ST - Q2 2021 Swedish Match AB Earnings Call

EVENT DATE/TIME: JULY 20, 2021 / 12:00PM GMT

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JULY 20, 2021 / 12:00PM, SWMA.ST - Q2 2021 Swedish Match AB Earnings Call

C O R P O R A T E P A R T I C I P A N T S

Anders Larsson Swedish Match AB (publ) - CFO & Senior VP of Group Finance

Emmett Harrison Swedish Match AB (publ) - SVP of IR & Corporate Sustainability

Lars Dahlgren Swedish Match AB (publ) - President & CEO

C O N F E R E N C E C A L L P A R T I C I P A N T S

Fredrik Ivarsson ABG Sundal Collier Holding ASA, Research Division - Research Analyst

Gaurav Jain Barclays Bank PLC, Research Division - Research Analyst

Jared T. Dinges JPMorgan Chase & Co, Research Division - Analyst

Mirco Badocco BofA Securities, Research Division - Research Analyst

Mirza Faham Ali Baig Crédit Suisse AG, Research Division - Research Analyst

Niklas Ekman Carnegie Investment Bank AB, Research Division - Head of Consumer Discretionary & Staples and Financial Analyst Sanath Sudarsan Morgan Stanley, Research Division - Research Associate

P R E S E N T A T I O N

Operator

Ladies and gentlemen, welcome to Swedish Match Second Quarter Report for 2021. (Operator Instructions)

Today, I'm pleased to present Emmett Harrison, Senior Vice President for Investor Relations. Please begin your meeting.

Emmett Harrison - Swedish Match AB (publ) - SVP of IR & Corporate Sustainability

This is the Swedish Match Q2 2021 Telephone Conference. And with me today are Lars Dahlgren, our President and CEO; and Anders Larsson, our CFO. In the Investors section of our swedishmatch.com website, you will find our Q2 investor presentation. We encourage you to have that presentation at hand as you listen to our prepared commentary for this call.

Several of the slides in the investor presentation repeat key messages from the interim report that we published this morning. We will focus our commentary on select slides only. And while doing so, we will refer to the applicable page number of the presentation.

After our prepared commentary, we will be taking questions. During today's call, there may be certain comments that constitute forward-looking statements and are subject to risks and uncertainties. Management believes that these statements are based on reasonable assumptions, but can give no assurance that expectations will be achieved.

Risk factors are outlined in today's interim report as well as the annual report, which are available on our website. Swedish Match assumes no obligation to update information concerning its expectations. A recording of this call will be made available on the Swedish Match website. I will now hand over the word to Lars.

Lars Dahlgren - Swedish Match AB (publ) - President & CEO

Thank you, Emmett, and good afternoon, everybody. With today's interim report, Swedish Match reported its eighth consecutive quarter of double-digityear-on-year operating profit growth in local currencies. For the quarter, both sales and operating profit in local currencies grew for

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JULY 20, 2021 / 12:00PM, SWMA.ST - Q2 2021 Swedish Match AB Earnings Call

all of our product segments. In absolute terms, the Smokefree product segment was the largest growth contributor, driven by an excellent performance from same nicotine pouches in the U.S. and a solid performance in Scandinavia.

Adjusted for acquisition effects and income on temporary character in the Light segment, the steepest local currency sales and operating profit growth in percentage terms was delivered by Cigars, where Q2 of prior year represented a relatively soft quarter. For Smokefree, both sales and operating profit grew by 18% in local currencies, resulting in an overall operating margin that was virtually unchanged. With significantly higher market investments relating to nicotine pouches in the U.S. and Scandinavia as well as in other markets, this demonstrates the operating leverage and growth potential in our largest product segment.

Strong volume growth for ZYN nicotine pouches across the U.S. market continued to be the key growth driver for the Smokefree segment, but also the more traditional smokefree products in the U.S. portfolio contributed with good year-on-year earnings development.

In Scandinavia, the local currency sales growth was driven by nicotine pouches and for earnings, relatively strong profit development for snus more than compensated for the increased market investments relating to nicotine pouches. In Q2 of the prior year, the COVID-19 situation resulted in an unusually low shipments of natural leaf cigars and some additional costs. In this year's Q2 very strong demand for natural leaf varieties, improved pricing and continuing progress in raising productivity at our Dominican facility, all contributed to the strong increase in sales and profitability for Cigars.

For Lights, underlying performance was solid and the reported numbers further benefited from the inclusion of a recent smaller acquisition as well as income from continued land sales and the recovery of indirect taxes in Brazil. Strategically, Swedish Match aims to actively invest and have a leadership presence in those categories and segments where we see the best growth potential. With a keen focus on consumer needs and societal trends, our targeted efforts have resulted in the portfolio of businesses with highly attractive prospects.

The second quarter is not only a good illustration of our ability to compete effectively but also the attractive prospects for several of the categories in which we operate. The U.S. nicotine pouch market close to doubled in size compared to 1 year ago, and relative to the first quarter, the sequential growth remained strong.

In Scandinavia, over the past few years, the Smokefree category has become more and more Unifix with accelerated category growth as a result. In the U.S. market, despite the easing of COVID-19-related restrictions, the category growth for cigars in Q2 held up well with more and more consumers transitioning to the natural leaf segment, which represents the majority of Swedish Match's portfolio mix.

While the generally improved COVID-19 situation during the second quarter -- with the generally improved COVID-19 situation during the quarter, we were able to accelerate our marketing and consumer engagement activities in several markets and thereby better match investments to the growth prospects of our businesses. For ZYN in the U.S., we attended more events and expanded our loyalty building programs to both consumers and retailers. Encouraged by the consumer traction in initial geographies, during the quarter, we rolled out ZYN Menthol and Chill products nationally. In Sweden, we introduced a new modern range of nicotine pouches under the VOLT brand family, along with an ambitious activity plan.

Swedish Match will continue to invest in brand building awareness and loyalty with consumers and retailers and not the least for ZYN in the U.S., our marketing calendar for the upcoming quarters ambition.

By that, we will now turn to some more detailed commentary and continuing with ZYN. And starting on Page 8 -- Slide 8 of the presentation. This chart illustrates the impressive trajectory of ZYN shipment volumes on a 12-month rolling basis. During the second quarter, we delivered an all-time high volume of 42.5 million cans, which brought the 12-month rolling shipment volume to close to 143 million cans, of which close to 80 million cans were sourced from the first 6 months of this year.

Our staff in the Owensboro, Kentucky facility has done an outstanding job in coping with the elevated demand, while at the same time delivering on the capacity expansion projects in line with or better than original plans. And at this point, we do not anticipate that our manufacturing capacity will be a constraint in our ability to meet further growth in demand.

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JULY 20, 2021 / 12:00PM, SWMA.ST - Q2 2021 Swedish Match AB Earnings Call

Moving to Slide 9. This graph illustrates the volume development for all the brands included in the nicotine pouch category in the U.S., as measured by MSA data, which captures deliveries from distributors to retail. The MSA data is helpful in understanding market trends, especially when viewed over longer periods. The 13-week period largely representative of calendar quarters are somewhat volatile as they are susceptible to waves of distribution expansion and promotional offerings that cause retailers to stock up. Viewed over several quarters, however, the chart clearly depicts the impressive growth trend of the nicotine pouch category.

And in annualized terms, with the 13-week MSA data as a basis, we estimate the Q2 category size to exceed 250 million cans. While the data indicates a close to 20% category growth in Q2, it is important to view this against the background of heavy distribution builds and aggressive price promotional activity by competition. In that respect, it's very encouraging to note that the steady volume trajectory for ZYN has continued despite relatively modest store distribution expansion for ZYN. On a sequential basis, the MSA data shows a slight market share decline for ZYN in Q2. However, this decline is not necessarily fully representative of market share based on consumer purchases and particularly in terms of market share measures based on dollar share.

Moving to Slide 10, which provides some further details on the trajectory for ZYN based on the same MSA data. The graph to the left illustrates the store distribution for ZYN based on isolated 13- and 26-week period. The graph to the right shows the velocity for ZYN measured as cans per store per week on a 13-week trended basis. The strong volume performance for ZYN during the quarter was partly enhanced by the national rollout of Chill and Menthol varieties, but also when adjusting for this, ZYN continued to grow its velocities on a sequential basis. With the store count for ZYN being up only marginally from Q1, we are pleased to note that the sequential velocity growth for ZYN was the strongest across all brands captured in the MSA database.

Turning to Slide 11. The nicotine pouch category continues to demonstrate its premier position among next-generation products, and not the least with its appeal among cigarette smokers that seek better alternatives. Based on MSA data, our estimate is that annualized year-to-date volumes for nicotine pouches measured by cans correspond to close to 7% of 2020 cigarette volume measured by packs in the Western region.

Despite being present in the rest of the U.S. for only 2 years, the corresponding number on a national basis now exceeds 2%. Consumer research confirms that nicotine pouch consumers gradually increase their weekly consumption as they transition from other tobacco products, and that current weekly consumption levels remain well below those of cigarettes. Our estimate is that the number of nicotine pouch consumers correspond to about 10% of the number of cigarette consumers in the Western region. And that on a national level, that number has already reached 5%. With the superior function and emotive benefits, there is significant potential for further increased penetration as well as average consumption for nicotine pouches. With that, I'll hand over to Anders.

Anders Larsson - Swedish Match AB (publ) - CFO & Senior VP of Group Finance

Thank you, Lars. Turning to Smokefree in Scandinavia and Slide 12 with continued COVID-19-related restrictions and timing effects on shipments, it remains a challenge to determine the underlying growth of the Scandinavian smokefree market. However, as Lars pointed out, we are encouraged by the strong market dynamics and our estimate is that the Scandinavian smokefree market reached double-digit consumption growth in volume terms for the 6-month period ending June 30.

While the growth has been driven by nicotine pouches, it is positive to note the resilient trajectory for more traditional products. One contributing factor to the growth development, we believe, is the lowered Norwegian excise taxes at the beginning of the year, which have resulted in a notable decrease in retail prices.

Slide 13 provides more details of the Scandinavian category trend development on a 12-month rolling basis. As the picture depicts, nicotine pouches have provided incremental growth to the category with the broadening of the consumer base as the range and types of products cater to more diverse preferences and needs. Of particular note, more females have now found a viable alternative to the combustible cigarettes. And as cigarette consumption historically has been higher for females, we view this as a very positive development from both a harm reduction and a commercial perspective.

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JULY 20, 2021 / 12:00PM, SWMA.ST - Q2 2021 Swedish Match AB Earnings Call

On Page 14, we look at snus isolated. According to Nielsen, our share within the snus category in Scandinavia has been relatively stable, and we remain the clear #1 player, more than twice the size of the next largest competitor. While the declining percentage of snus relative to the entire smokefree category is apparent, as illustrated to the right on the slide, this needs to be considered in the light of the very strong overall category growth.

Moving on to Page 15 and nicotine pouches in Scandinavia. The category for nicotine pouches remains highly competitive. And over the past year, the level of activity from competition has been extremely high in terms of both new brands and variants and promotional offerings. This high level of activity has helped to support category growth. And according to Nielsen, nicotine pouches now represent close to 21% of the Scandinavian smokefree market. While our volumes of nicotine pouches have been very strong, they have yet to match the growth of the overall category. The introduction of the VOLT series is one initiative that we believe has prospects to make the Swedish Match assortment even more relevant for consumers, and apart from consumer activations at physical venues, the digital engagement has been extensive.

Turning to moist snuff in the U.S. on Page 16. Our moist snuff positioning in the value segment is serving us well as we note the growing share within the total moist snuff market. As for a number of products within the U.S., volume development was unusually strong in the third quarter of 2020, implying tough comparisons for the coming quarter, which was also the case for our chewing tobacco business. With sustained momentum for our Longhorn brand, our moist snuff volumes have grown year-on-year despite the discontinuance of certain products within our range. We also note that recently a large competitor repositioned a brand to seemingly match Longhorn EDLP price positioning.

Turning to cigars on Page 18, which illustrates several interesting aspects of the cigar category based on data from the MSA set, measuring shipments from distributors to retail. As the bars in the middle show, the total category continued to exhibit good growth in the second quarter when considering that across several parts of the U.S. COVID-19-related restrictions have been eased. The natural leaf segment stands out as the key driver of the category growth, which is in line with long-term trends. With close to 60% of our portfolio in the natural leaf segment, Swedish Match is very well positioned to capture growth opportunities as consumer and segment dynamics play out.

We manufacture our natural leaf varieties in our facility in the Dominican Republic. And over the past 15 months, keeping up with market demand has been a challenge. Production of natural leaf cigars at our Dominican factory reached an all-time record in the second quarter. But with the strong growth trends within the cigar category, we need to balance our resources and fully meeting demand remains a challenge. Year-on-year, our cigar market share increased as we have been able to compensate for production constraints on the natural leaf side with increased HTL production.

In the second quarter, with the improved production situation, shipment volumes grow for natural leaf cigars, and we also noted a sequential improvement in our market share within the natural leaf segment. Within HTL, we noted a sequential share decline in the quarter, but it should be noted that this was partly attributable to very limited shipments of our low-price offering Jackpot, which was one of the contributing factors to the improved price mix in our cigar segment.

On Slide 20, we have summarized relevant metrics from our interim report relating to finance costs, our financial position and earnings per share. Net finance costs during the quarter were substantially flat versus prior year on somewhat higher interest rates and lower returns on surplus cash, which was partly offset by lower average debt. The weighted average interest rate of our loan portfolio at June 30 was 2.07%, virtually unchanged compared to the end of 2020. Our net debt to EBITDA for the 12-month period ending June 30 was 1.9%. During the first 6 months, new bond loans of SEK 1.6 billion were issued, repayments of maturing bond loans amounted to SEK 750 million and early repayment of short-term bond loans amounted to SEK 716 million.

During the remainder of 2021, SEK 803 million of bond debt falls due for payment. As of June 30, 2021, Swedish Match had SEK 15.347 billion of interest-bearing debt, excluding retirement benefit obligations, but including the recognition of lease liabilities of SEK 283 million. The capital duration was 3.9 years, with 98% of the portfolio subject to fixed interest rates. The EPS bridge illustrates the components of our 26% year-to-date growth in adjusted EPS. And apart from the after-tax effect of our increased operating profit, the reduced number of shares had a meaningfully positive impact. The adjustments highlighted in the EPS bridge refers to the after-tax effect of settlement income related to a previously ongoing arbitration.

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