Good day and thank you for standing by. Welcome to the Scandinavian Tobacco Group third quarter results 2022 conference call. At this time, all participants are in listen only mode. After the speaker presentation, there will be the question-and-answer session. To ask a question during the session, you need to press star one one on your telephone keypad. You will then hear an automated message advising your hand is raised. If you wish to ask a question via the webcast, please use the Q&A box available on the webcast link at any time during the conference. Please be advised that today's conference is being recorded. I would now like to hand the conference over to a speaker today, Torben Sand. Please go ahead.
Thank you. Yes, welcome to Scandinavian Tobacco Group's third quarter 2022 webcasted conference call. My name is, as you heard, Torben Sand. I'm Director of Investor Relations and Communications. As usual, I'm joined by our CEO, Niels Frederiksen, and our CFO, Marianne Rørslev Bock. The agenda for this webcasted conference call is the highlights for the third quarter of the year, then a business update on some of the many interesting projects we're working on, followed by an overview of the performance in our three commercial divisions. Then we'll have key financial developments for the group, including an update on capital allocation. Before concluding with an update on the guidance for the full year, we will have a Q&A session where we will be very pleased to take any questions you might have.
Before we start, I also, as usual, will ask you to pay attention to our disclaimer on forward-looking statements in the end of this presentation. With this, please turn to slide number three, and I will leave the word to Niels.
Thank you, Torben, and welcome and good morning to everyone on the call. After two exceptional years in 2020 and 2021, where Scandinavian Tobacco Group delivered very strong financial performance, this year has turned out to be a more challenging one for the group. Consumer behavior is changing, cost inflation is moving to levels not seen for many years, and the level of visibility for just the coming quarters is lower than what we would normally expect. All this results in increasing pressure on many parts of society, including our company, our employees, our business partners, as well as our consumers.
I mention this because I want to emphasize that despite our financial performance for the third quarter being in line with our expectations, and we maintain our full year expectations, we have to be mindful that the level of uncertainty is unusually high, and any forward-looking statements must be seen in this perspective. One such uncertainty we are facing is the ongoing supply issue. Resolving this remains our highest short-term priority. The plan to improve productivity in the supply chain is being executed, and we are seeing good progress. However, progress is slower than originally anticipated, and we expect part of these issues to persist into the next year. Now, before going into details of the most recent business developments, I would like to give you a few key financial highlights from the third quarter results announcement.
Net sales came in at DKK 2.4 billion, with an organic decrease of 1.4% versus last year. EBITDA before special items was DKK 631 million, with a 6.2% negative organic growth. Free cash flow before acquisitions was DKK 462 million versus DKK 564 million last year. Adjusted earnings per share came in at DKK 4.4 versus DKK 4.2 in the third quarter of last year. These results are in line with our financial expectations for the full year, which is why we maintain the guidance for 2022. Now, please turn to slide four.
Before Marianne provides you with more insights to the development in the quarter, I would like to give you an update on some of the many interesting projects we are currently working on, each of them with the potential to enable growth and to strengthen the long-term opportunities for our company. First, let me start with STRÖM, which is our first own brand within the growing white nicotine pouch segment. We have launched the brand in Sweden, and the initial results have been very positive, both from consumers and the trade. It is still early days, and for now, our main ambition is to learn more about the category and its consumers so that we can decide what role is meaningful for our group to play.
The brand has also been launched in Manchester, in the U.K., in a test launch where we, in a controlled environment, can assess the potential in the U.K., where the white pouch category is also gaining momentum. Secondly, in 2021, we acquired the controlling interest in MOSI, a small but growing challenger in the very profitable Italian segment for cigars of more than 3 gram. Also here, we've got off to a good start, and we continue to see healthy growth while we invest in solving the traditional problems of a small and cash-constrained business. We are confident that MOSI will be a value-creating acquisition for Scandinavian Tobacco Group, and it also strengthens our overall position in the important Italian cigar market.
Further, we continue to work with Versa, our hemp-based smoking alternative, and we also continue to expand our retail presence in the U.S., where our latest store in San Antonio, Texas, is off to a very strong start. We are also moving ahead with our preparations for the launch of our new SAP S/4HANA ERP solution that will go live in the first countries towards the end of Q1 2023. This is a very challenging but also very important project for the group, as it will help us drive a much more simplified and more process-driven organization. The project remains on track. Finally, let me say a few words about the progress we're making on the implementation of our ambitious and comprehensive sustainability strategy, which we call Rolling Responsibly.
Since its launch in May 2022, we have invested in and reinforced our sustainability organization in our strive to elevate our communities and to anchor climate into our corporate culture. We've also formally committed to the Science Based Targets initiative, setting targets to reduce emissions across our value chain. With that, we will turn to the performance by division, and I'll leave the word to Marianne. Please go to slide number six.
Thank you, Niels. I will start the overview with Europe Branded. Net sales for the third quarter increased by more than 3% to DKK 742 million. Organic growth was positive by 1%, and the acquisition of Moderno Opificio del Sigaro Italiano contributed with another 2% to reported growth. Pricing remains a key driver for all product categories. At the latest conference call in August, I mentioned that price mix impact for machine-rolled cigars was doing well, and for the third quarter, the price mix for the category has continued to be strong with an increase of more than 5%. Price increases are important for us to mitigate the combination of volume decline and cost inflation. Gross profit before special items was up by 3% to DKK 414 million, while the gross margin was almost unchanged at 55.8%.
EBITDA before special items was DKK 231 million, with an EBITDA margin of 31.1% versus 29.8% in the third quarter of 2021. The unchanged gross margin development reflects a combination of pricing being offset by lower supply chain productivity, whereas the improvement of the OpEx ratio reflects the year-on-year benefits from the Agio integration, as well as a continued focus on cost control throughout the division. For the quarter, the market share index stabilized at 30.4% versus 30.5% in the second quarter, implying the loss of market share in the previous quarters might have come to a stop. Having said this, currently it remains our priority to drive pricing rather than volume share gains.
The stabilized market share index reflects gains in markets like Italy, Spain, Benelux, and Germany, whereas the supply chain issue continued to impact performance in France and Benelux. Please turn to slide seven. Looking ahead, we continue to see the structural decline rate in machine-rolled cigars volumes at about 3%, with variations from year to year. Though we remain committed to regain market share long- term, driven by our strong brand portfolio, and as we improve supply chain productivity, we have higher priority to pricing in the near- term. One example is U.K., where we currently have more focus on value share than volume share. Long- term, the combination of market share improvements and a dedicated focus on price increases will pave the way for limiting the impact from structural volume declines in the category and to deliver positive long-term organic net sales growth.
In addition to price increases, simplification initiatives are expected to support long-term margin expansion. With this, now go to slide eight, where I will turn to the North America Branded and Rest of World division. For the third quarter of 2022, net sales in North America Branded and Rest of World increased by 11% to DKK 851 million, driven by the positive development in the U.S. dollar. Organic growth was flat versus the third quarter of last year and was driven by declining volumes across most categories. However, this has been balanced by strong pricing, both for handmade cigars and smoking tobacco products, the continued recovery in global travel retail, and the change in distribution model in Australia, going from own sales force to a distributor model.
Gross profit before special items increased by 7%, with the gross margin declining from 54.9% - 52.9%. The negative margin development continues to be driven by the return to pre-pandemic market and product mix following two years of mixed benefits during the COVID-19 pandemic. EBITDA before special items was DKK 326 million, with an EBITDA margin of 38.3% versus 43.7% in the same quarter last year. On top of the decline in gross margin, the decrease in EBITDA margin was a result of the refund of certain duties in the U.S. last year. Please turn to slide nine. For the full year, consumption of handmade cigars in U.S. is likely to decrease more than the long-term structural rate of about -2%.
This became apparent during the summer and is in line with our announcement from August. However, we would like to emphasize that we currently don't see any major changes to underlying consumer behavior compared to its long-term trend. Consumption for handmade cigars has now remained resilient following two years of exceptional growth in 2020 and in 2021. In case the challenging economic environment should begin to impact consumer behavior, for instance by more down trading, we believe we are well-positioned, anchored in our unrivaled brand portfolio, covering all price points in the market. Long- term, focused price management and strategic initiatives, like the launch of the Forged Cigar Company last year, and accelerating our international sales of handmade cigars, are expected to continue to support net sales for the handmade cigars.
For the division, the increased focus on growth enablers, like the product launches Niels earlier referred to from our growth incubator, are also expected to be part of our long-term organic growth. I will now turn the attention to the performance of North America Online and Retail division. Please turn to slide 10. Net sales for the third quarter increased by 11% to DKK 770 million, with a negative organic growth of -6% and a positive contribution from exchange rates development of 16%. The online channel continued to experience a decline in the active customer base versus the third quarter of 2021, driven by lower traffic across our various e-commerce platforms, as the shift back to online from retail takes longer than expected.
The retail channel delivered 18% growth in net sales, driven by our new stores gaining traction in the market. The retail segment accounts for about 8% of divisional net sales. Gross profit before special items increased by 10% with a gross margin stabilizing at 40.1% versus 40% last year. EBITDA before special items was almost unchanged at DKK 110 million from DKK 130 million last year, with an EBITDA margin of 14.3% versus 16.2% last year. The development in EBITDA margin relates to lower organic net sales, a continued high level of competition in the online channel, increased expenses for IT investments, and also increased expenses for the implementation of the automated warehouse system in U.S. Please turn to slide 11.
Caution among consumers on the back of the macroeconomic development continues to constitute a downside risk to the overall consumption of handmade cigars in the coming quarters. However, as I mentioned just a moment ago, at this point, we experience that consumption has stayed resilient. The temporary challenge for this division is the delayed shift back to online from retail after the retail channel peaked post-COVID-19. With the ongoing expansion of our retail network, this channel accounts for 8% of the divisional sales, with the current volume market split between close to 50/50 between online and retail channels. However, we remain confident that over time, consumers will return to pre-pandemic balance to purchase up to 60% of their cigars online. This, together with the continued expansion of our cigar superstores, does create a strong foundation for future growth for the division.
Following the opening of the new superstore in San Antonio, Texas in April, we still plan to open another five to seven cigar superstores in the U.S. in the coming two to three years. Now turn to slide number 13, please. Let me now give you a few more details to the financial performance from a group perspective. In the third quarter of 2022, reported net sales increased by 8% to DKK 2.4 billion. Gross profit before special items increased by 6% to DKK 1.2 billion, and EBITDA before special items increased by 1% to DKK 631 million. Organic growth in net sales was negative by 1.4%, a slight improvement versus the second quarter decline of 1.8%. Organic EBITDA growth was negative by 6.2%.
For the nine months of 2022, organic net sales growth was negative by 1.6%, and organic EBITDA growth was negative by 8%. The stronger U.S. exchange rate development had a significant positive impact on reported numbers also in this quarter. Reported net sales was impacted by DKK 196 million, or approximately 9%, and reported EBITDA before special items was impacted by DKK 43 million, equal to about 7% impact. As I mentioned in the divisional update, organic net sales growth was positive for Europe Branded, about 0% for North America Branded and Rest of World, and it was negative for North America Online and Retail.
For the group, the increase in reported gross profit was driven by the exchange rate development as the margin decreased about 1 percentage point to 49.6%. The margin decline was driven by a normalization of product and market mix in North America Branded and Rest of World, as both Europe Branded and North America Online and Retail experienced unchanged gross margins for the quarter. The group OpEx ratio decreased slightly from 23.2% in the third quarter of last year to 22.9% this year, driven by tight cost control and prioritization and despite increased cost inflation. Special items of DKK 27 million were almost unchanged versus last year. Special items were mainly driven by the ERP project One Process. The expectation of total special items for the year remains unchanged at about zero.
Net profit for the quarter was DKK 382 million, and adjusted earnings per share was DKK 4.4 per share compared to, compared with DKK 4.2 per share last year. The cash flow before acquisitions was DKK 462 million versus DKK 564 million in the third quarter of last year. The cash flow development is driven by operational performance. Working capital had a negative impact of DKK 29 million compared to the third quarter of 2021, where the impact from working capital was positive with DKK 136 million. With free cash flow before acquisition for the nine months at DKK 735 million, we remain on track to deliver a free cash flow before acquisitions for the full year in the range of DKK 1.1 billion-DKK 1.4 billion. With this, please turn to slide 14.
I will now briefly talk about our debt, net debt and leverage position. Since year-end 2021, the net interest-bearing debt has increased by DKK 872 million to slightly more than DKK 4.1 billion by the end of the third quarter. The increase is primarily driven by the appreciation of the U.S. dollar, an increase in these liabilities, and our capital distribution of DKK 564 million in share repurchases and DKK 692 million in dividend payments. In the third quarter, we repurchased shares in total of DKK 237 million, and by the end of October, we announced the holding of treasury shares exceeding 4.7 million shares or more than 5% of the outstanding number of shares of 93 million shares.
As announced, when the current DKK 1 billion program was launched, the intention is to adjust the company's capital structure and to cancel excess shares, assuming approval by the AGM next year. The leverage ratio decreased slightly versus the end of second quarter to a 1.9 x, whereas the leverage ratio increased versus the end of 2021. We expect the leverage ratio to decrease further by the end of the fourth quarter. We consider our financial position as strong and supported by our strong annual cash flow generation. Consequently, we remain committed to a disciplined capital allocation policy. We will now turn to the full year guidance, and I will hand it back to Niels. Please turn to slide number 15.
Thank you, Marianne. Based on the development in the first nine months of the year and the outlook for the coming months, the financial expectations for 2022 are maintained. Adjusted EBITDA, we expect organic growth in the range of -4% to 0%, free cash flow before acquisitions in the range of DKK 1.1 billion-DKK 1.4 billion and adjusted earnings per share increase at more than 5%. Currently, the bias in the outlook is to the lower end of the guidance range for both organic EBITDA growth and free cash flow. For organic EBITDA growth, we have to and do expect to deliver a return to positive growth in the fourth quarter of 2022, driven by a combination of stable top line, tight cost control, and as the balance between cost inflation and price increases improve.
The free cash flow remains solid, and we are on track to deliver more than DKK 1.1 billion for the full year, even though the expectation is that working capital will be impacted negatively by about DKK 500 million kroner versus our previous expectation of DKK 300 million. Before concluding on the presentation, I must, however, again emphasize that visibility remains lower than normal, with the largest uncertainties being changes in consumer behavior, the progress we make in improving productivity in our supply chain, and additional unexpected cost inflation. Now that concludes today's presentation, and we are ready for questions.
Thank you. Dear participants, as a reminder, if you wish to ask a question over the phone, please press star one one on your telephone keypad and wait for your name to be announced. Alternatively, if you wish to ask a question via the webcast, please use the Q&A box available on the webcast link. Now we're going to take our first question. The first question comes to the line of Niklas Ekman from Carnegie. Your line is open. Please ask your question.
Thank you. Yes, a couple of questions. I'll take them one at a time. First one, just if you could elaborate a little bit more on the market outlook here, because on the one hand you talk about consumption being resilient and indicating that this is very defensive. On the other hand, you're warning a little bit about a return to the pre-pandemic mix. You're talking about cost inflation, promotional pressure in online, and that will likely persist into 2023. So I'm just trying to get a grip on here. What is your view on the level of cyclicality and on the level of COVID-19 boost reversing or not? Could you elaborate a little bit more on that topic? That would be very interesting. Thanks.
Yes. Thank you for the question, Niklas. I think that when we made our profit warning back when we reported Q2, we did see concern, or we did express concern around the decline of the U.S. handmade cigar market. I think that what we can see today, three months later, is that demand remains fairly resilient. That is a positive development, but at the same time, we remain concerned around, let's say, the consumer behavior in the light of increasing inflation, food prices, energy, you know the drill. We monitor the situation very carefully. Similarly, you can say across many of our other categories, we do see good resilience, and remember that some of our top line is affected negatively by the supply issues.
The reference to product mix is really around some of the categories and market mix that have been extraordinarily strong in 2021, and our best example is always Norway, where when the mix returns to, you know, a combination of domestic order and global travel retail, the net margin of that deteriorates a little bit. So overall, you can say that I think demand is staying fairly resilient, but we are really concerned about the impact as we look forward, like any other consumer products company, in terms of exactly how consumer will behave.
Thanks. Thanks for that answer. That helps a lot and clears out a lot. Another clarification maybe. Your organic earnings are down 8% in the first nine months. Even the lower end of the guidance basically requires at least 7% earnings growth in Q4. I know you've always said that earnings would be back-end loaded, but could you elaborate a bit more on your confidence here over returning to fairly strong earnings growth in Q4? Is this all about comparisons or is there any other main drivers here?
Thank you, Niklas. Let me try to answer that question. You're absolutely right. We need in Q4 to return to positive EBITDA growth, but also positive top line growth. It's also correct that you're saying with that we have all year long said that we were back-end loaded. The assumptions that needs to be realized during Q4 is top line growth, and that needs to come from price increases that we have done during the year that will have full impact in Q4. There will also have to be an impact from our retail expansion, so the stores opened in U.S. We need to be able to offset inflation by our cost control, which I think we have shown good evidence of during Q3.
I hope this helps you.
Perfect. Thank you. Third question on these recent product launches. You have nicotine pouches and hemp cigarettes. Can you tell us a little bit more about your initial experience? I know these are relatively new categories, but I assume that they're already fairly crowded as well. How do your products stand out relative to the competition?
Yes. Let me start with Versa, which is the hemp-based product we launched in the U.S. I think already when we launched it, we explained that this would be a slow burn, and it is also a slow burn, but we are continuing to build distribution, and we are continuing to focus on product rotation in the outlets where we are. When you think about our product performance, I think that we have been able to develop a smoking experience which we think is differentiated from what is available from some of the competition. We've done so based on actually some of our pipe tobacco blending experience, and we do believe that over time, you know, smoking experience is what the consumer will prefer. So for that particular category, it's still a slow burn.
You know, it's not gonna affect our business, you know, in the near- term at all, but it is one of the small ships we put into the sea. When you look at the launch we've done in the third quarter of STRÖM, which is our first own brand within the white nicotine pouch, here we are talking about a segment that is still being developed and growing dramatically. As we've explained, we've been looking at these various categories for quite a while now, trying to determine whether there is a meaningful role for us to play. You know, even in direct competition with what we consider to be the larger cigarette companies, and we do think there is so.
In STRÖM, we again try to stay core to our expertise, which is to develop a product with superior consumer experience and different consumer experience than some of the existing products also from a packaging side. What we have seen at least, and we are only six, seven weeks into the launch, is that both consumers and retailers have found this to be a, I call it a fresh breath into the category. It's still way too early to call STRÖM a success or not, but it does signify our commitment to try to build a, let's say, a new income stream based on some of these emerging categories and the role we can play.
That's very interesting. I assume the impact on earnings, and I mean maybe losses short term is relatively limited unless these products really start to take off then losses could temporarily increase. Is that a correct assumption?
Yeah. You can say that for all of these categories we have been trying to approach them in an asset-light way. We are not investing in own production capabilities and we are of course, as I also think we wrote in the announcement, we are testing and learning here as much as we are making the full commitment. As we get wiser, we will of course decide whether more investments are needed.
Perfect.
Maybe an addition from my side. I think it's also important with this category to say the category moves very fast. It also means that we need to be fast decision makers in how we approach the market.
Super. Thank you. Final question, just if you could elaborate a bit on M&A as well. What do you see here going forward? Is the M&A strategy more relevant or is it more hesitant right now? Maybe if you could talk about your priorities, is it mainly machine-made cigars in Germany, Spain, Italy? Are those kind of the key target areas or what do you see in terms of M&A?
Yeah. We remain, you know, fully committed to our M&A strategy. I think that the way we currently think about the M&A strategy is that we prefer to look for assets in the handmade side of the business. This is where we would like to boost further the strengths of our portfolio. I think everyone is aware that outside of the U.S., the Cuban supply of cigars, handmade cigars into the market has been somewhat damaged by COVID-19 and some harvesting problems, and they've also implemented a very aggressive price increase strategy, and we feel that we've got a nice opportunity going into 2023 to actually expand that international handmade cigar business. So that's our preference. On the overall pipeline, I would say that it is, you know, more encouraging.
As we've also said before, that doesn't mean that we can actually close transactions and we keep being, you know, disciplined about, you know, paying the appropriate price and ensuring that we create value with these transactions.
Very clear. Thank you so much.
Thank you. Dear participants, as a reminder, if you wish to ask a question over the phone, please press star one one on your telephone keypad. Alternatively, you are welcome to use the Q&A box available on the webcast. There are no further questions. I would now like to hand the conference over to our speaker today, Torben Sand, for closing remarks.
Okay. Thank you. I would say to all of you that has been listening in, thank you very much for doing so. Yeah, wish you all a continued good day. Thank you.
That does conclude our conference for today. Thank you for participating. You may now all disconnect. Have a nice day.