Chocoladefabriken Lindt & Spruengli AG

SIX:LISN

Earnings Call Transcript 2018-Q2

[Dieter Weisskopf, Chief Executive Officer]

Ladies and gentlemen, it is my pleasure to welcome you to Lindt & Spruengli Telephone Conference we are holding on the occasion of Half Year Results 2018.

During the presentation, I'll give some additional comments to the charts that were uploaded this morning to our website. I'll guide you through the slides via webcast. The result presentation will take approximately 15 to 20 minutes. Following the presentation, I will hand over to the operator who will then organize question-and-answer session.

So let's go to the content of today's presentation. The point are the following; first, performance highlights of half year 2018; then more detailed P&L and balance Sheet details of this first half of 2018; then a quick outlook; and then as mentioned before, we go into the Q&A session.

So let's start with the performance highlights for 2018. First P&L statement of the Lindt & Spruengli Group. We go first into the overview of the results. Organic growth for the whole Group reached 5.1% as the Swiss franc weakened mainly against the euro and pound sterling, we got 7.7% growth in Swiss francs. Organic growth of 5% is in line with our 2018 full year guidance. Growth in NAFTA is at plus 4%, which is also in line with our expectations and is a positive trend after the slight decline in NAFTA last year, mainly driven by Russell Stover. Europe is growing by plus 5% and the Rest of the World between 8% and 9%.

We are pleased to deliver again good profit figures that are in line with our guidance. EBITDA, EBIT and net income all increased at higher rates and sales at levels between 10.8% at EBITDA and up to 12.7% at net income level.

The improved EBIT margin of 20 basis points in the Group has mainly been driven by the overall lower material expense ratio and lower personnel expenses, which will be explained in one of the next charts. EBITDA margin improved by a strong 30 basis points coming from the higher EBIT margin and depreciation.

As in previous periods, the EBIT figure shown is being charged by non-cash flow amortization of CHF 4 million for the half year, which is CHF 8 million for the full year, related Russell Stover transaction. The set of figures on sales and profitability shows the despite a challenging market trade and consumer environment to trend to premium chocolate is confirmed and continues.

Now moving to the balance sheet. Equity shown versus status at yearend 2017, the absolutely amount decreased by CHF 28 million, mainly driven by the share buyback program, which we initiated in April. Equity ratio is now at 63%. As you can see, we continue to have a very strong balance sheet. The net debt position is 50 million higher than at the year-end 2017 which is also coming from the share buyback program. We have already bought back around CHF 100 million worth of shares. Compared to half year 2017, net debt position has improved by around CHF 140 million, despite the share buyback program. I will talk about this a bit more in detail on one of the next slide.

So now going into details on profit and loss statement and balance sheet as well. Starting with sales analysis for five years in Swiss francs. We present again the sales growth over the last five years in Swiss francs, absolute and cross figures include Russell Stover for 2015. In many years in the past, Swiss franc growth has been negatively impacted by the strengthening of the home currency. In the first half of 2018, this has been different. Thanks to the strong euro and the stronger pound sterling. On the other hand, the U.S. dollar got bit weaker in the first half.

Moving to sales growth organic. And so in local currencies, which for sure is one of the big topics for you to show organic growth. The total Group reached 5.1% in the first half. This development has to be seen considering the following facts. Number one, chocolate markets on a worldwide basis still showed lower gross figure stand some years ago. Secondly, we had to tough trading environment considering the chocolate industry could benefit from lower raw material costs leading to price pressure in the markets. And thirdly, we are still cautious consumers in light of the volatile economic and political environment. Good news is that on a global basis, the premier chocolate category was again clearly outperforming the total market growth.

In the last years, the key topic in discussions with investors and brokers has been Russell Stover. The organic growth of 5.1% implies an improved performance of Russell Stover. Sales at Russell Stover were only slightly negative in the first six months and fully on track to achieve our full year expectations.

Moving to sales analysis, markets looking at by markets, I would like to highlight the progress made in Germany reaching 17.5%, United Kingdom getting to more than 6%, as well as Rest of the World now increasing to about 15%. Thanks to the excellent contributions mainly of the new markets, South Africa, Japan, China and Brazil. One other main pillar continues to be North America with around one third of our revenue.

So sales analysis different drives. We can see this under following chart. As a whole Group, the volume went up by 4.9%. And on price mix, we had a positive impact by 0.2 percentage points, which of course led to this 5.1% organic growth performance. As I've already said before, Forex was positive by 2.6 percentage points reaching 7.7% overall growth in Swiss francs. In a market environment with pressure on prices due to lower raw material costs, it is a positive sign that our price mix remains positive.

Going into the very interesting segment information. Organic sales growth by geographical segment shows we continued good growth in Europe at plus 5.0% compared to 6% one year ago by the very good performance in important markets like Germany and the United Kingdom, but we also outperformed the markets in other important European markets such as Italy, Austria, Spain and Scandinavia. In the Eastern European markets, Russia, Czech Republic, Slovakia and Hungary we even grew double digit.

NAFTA is growing by 0.4% with Lindt USA and Lindt Canada both growing clearly above market and gaining market shares. Also Ghirardelli grew faster in the market in the U.S. What's more, the Mexican business is performing well and we are even putting more focus on that market going forward.

When looking at the performance in NAFTA region, it has to be taken into account that the U.S. chocolate market as a whole, slowed down over the last years. As mentioned before, in this difficult environment, the Lindt daily brands were outpacing the market.

We have seen in an earlier chart that sales across the store were only slightly negative in the first six months and fully on track to achieve our full year expectations. The management and financial integration of Russell Stover has been managed successfully in the first year post acquisition.

As always stated, the overall journey of strategic realignment takes between six and eight years. We have also seen that when acquiring and integrated your daily back in 1998. We are now in the middle of his journey, having acquired Russell Stover in 2014. In 2018, there was no negative impact from the product portfolio change across the store around two years ago. In addition, there was no negative impact with regards surprise increases done in 2015-216. And the drug channel which is very important for Russell Stover and Lindt and Ghirardelli in the U.S. did not make any further strategic shifts.

Furthermore, some of the product innovation we launched late 2017 such as the Russell Stover sugar free range are having a positive impact and are performing well.

Overall, we think we are taking the right strategic steps at Russell Stover to be set up for future success. This process has been taking longer than originally planned, but we are on the right track.

What's more, we have started various projects in the U.S. to gain further leverage from Russell Stover acquisition, mainly in the areas of merchandising, logistics and IT. We expect bottom line benefits from those projects in the next years, which in part can be reinvested in the brand.

In the Group Rest of the World, we also grew faster in the market and above Group average getting to 8.4% compared to 14% in the first half 2017. Growth is coming from basically all countries within the segment. It's great to see that the new markets South Africa, Japan, China and Brazil have grown double digit. Included in this segment as well the distributor business where we sell to a big number of third parties distributing our products in smaller countries.

Business in Australia was slightly slower than in the years before, as this is one of the markets where competition has been extremely aggressive with promotional pricing. In addition, Australia has had one of the hottest summers which did not help overall chocolate consumption. But overall, the segment of Rest of the World is on track to achieve the full year target of double digit growth. Basically a focus on this geographical segment and its core markets Brazil, Japan, China and South Africa and we will see positive results in the years to come.

Now moving from revenue to the different cost element. Starting with material costs. And this is justified change in inventory, it came down to 33.5%, which is 30 basis points lower than in the previous year and 140 basis points below 2016. The main reason for the decline, our benefits from decreases in the cocoa bean prices, partially offset by the whole high cocoa butter crisis and packaging material costs.

One big question for the next 12 months remains the development of the cocoa market. The market expects for the harvest season 2017-2018 a surplus of around 50,000 to 70,000 tons of no surplus in the 2018-2019 crop. That is also the main reason that we saw an increase in Cocoa future prices over the last few months. The future outlook heavily depends on the positioning of speculative market participants, we have quite a lot of influence on the cocoa market

So for those of you are interested in more details on cocoa bean and cocoa powder, we have prepared a chart. And we can see cocoa bean prices in London are currently trading between 1,700 and 1,800 pounds per ton and cocoa butter ratio has more or less stabilized at very high levels of 290. This compares when we go back one year in July 2017, we can see that one year ago, cocoa butter was 260 and cocoa bean prices were about 1,500 pounds per ton. So we have definitely seen a clear increase here in recent, in the last 12 months.

Personal expenditure, we see an improvement by 30 basis points. We had efficiency gains driven by our Global Lindt program in the factories combined with benefits from the combined merchandising force in the U.S. one of the strategic projects which I mentioned before, which have tackled after the acquisition of Russell Stover. This was partly offset by the very successful rollout of our retail concept and double digit growth in this segment. The retail concept is labor intensive means pressure on these cost element. On the other side of course cross margins are higher.

So going on to operating expenses big part here is marketing. And this goes slightly up and there are two main drivers of it. On the one hand, we have seen again efficiencies reducing costs. On the other hand, increased market investments. As previously announced, our goal is to invest additional funds in brand building activities such as advertising. The lower cocoa bean price is coupled with a slightly positive price mix impact have allowed us to do that.

Then the next one is depreciation, amortization and impairment. As a result of our high CapEx program, over the last years to satisfy our volume growth depreciation, amortization in absolute terms increased in the first half by 8 million to 87 million. The main investments were made in the factories of Lindt German, but as well in Switzerland, Italy and France. The expense ratio increased by 10 basis points to 5.2%.

So what does that all mean for the operating profit, EBIT figure increased by an excellent 11.5% versus previous year, reaching CHF 117 million or 7% of sales which is an improvement of 20 basis points compared to one year ago. The EBIT figure includes a recurring amortization charge of CHF 4 million for the half here as I mentioned before, which is of course CHF 8 million for the full year related with the amortization of activated customer relations of Russell Stover under the rule of IFRS 3.

And moving to net income, the two lines between EBIT and net income had the following developments. The net financial expenses came in at CHF 6.1 million, which is an increase versus last year, main driver higher hedge costs for the subsidy financing, as well as negative interest environment. The higher hedge cost is coming from the bigger interest rate differential between Swiss francs and other currencies.

The tax rate decreased versus last year by 1.7 points to 22.5%, thanks to further tax optimization. Based on the current outlook consider this rate as sustainable on this major changes in local taxes ruling or curve. So I would expect a tax rate of between 22.0% and 22.5%.

The absolute level of net income is CHF 86 million, an increase of 12.7% versus prior year and a 30 basis points margin increase over last year.

Our next key figure CapEx, you probably remember the CapEx last year for the full year at lower level than usual. They are now for first six months about 190 million which is in line with expectations but higher than last year. We still expect CapEx to reach around 250 million for the full year, which is about seventy million above 2017.

As always communicated, due to timing of the projects, 2017 was unusually low on CapEx and we expect the number close to 300 million in the years to come, mainly driven by the build out of our production facility in the U.S. We have seen this as part of the announcement that we are investing around 200 million, which will help of course the capacity, we have planned volume growth in the U.S. and the capacity to be able to manage that.

So net financial position development, the bridge shown on this chart is giving the details of the main cash flow relevant developments. Given our net better position, we pay surely high tension to the cash generation to reduce the absolute debt level. Net debt increased by around 50 million due to the share buyback program where we spent around CHF 100 million. On the other hand, we had a positive free cash flow of CHF 214 million. Depending on the share buyback program and given today's outlook, net debt will be at around 250 at the yearend.

So with that, I am now moving to the next chapter which is the outlook for 2018 and beyond. So premium chocolate market continues the positive trend. Lindt & Spruengli have strong growth over brands and strategic business actions to result, which will result in continued market share. We are further initiating projects to improve efficiency, to have better costs, cost improvement programs, some of them are all in place and we will even accelerate some of them like procurement in North America where we still see potential to get efficiency gains between the three subsidiaries. Product [ph] is cost savings and efficiently gains we plan to reinvesting and reinvest in marketing and the idea of course with this brand building activities, we will be able to get back to 8% eight on the mid-term growth, organic growth. So our mid-term guidance is still 6% to 8% and EBIT between 20 and 40 basis points.

For 2018, we always communicated that our plan on organic growth around 5% and an improvement of EBIT margin in range of the mid long term goal. Now I think it's probably going to be rather on the lower end of the 20 to 40 basis points for 2018, but the guidance is for 2018, so 5% organic cause and EBIT margin in line with the mid-term guidance probably closer to the lower end of the range.