Good day, and thank you for standing by. Welcome to the Scandinavian Tobacco Group Q2 2023 Results webcast. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one and one on your telephone, and you will then hear an automated message advising your hand is raised. To withdraw your question, please press star one and one again. Alternatively, you may submit your question via the webcast. Please be advised, today's conference is being recorded. I'd now like to hand the conference over to your first speaker today, Torben Sand. Please go ahead.
Thank you. Welcome to Scandinavian Tobacco Group webcast for the second quarter results of 2023. My name is, as said, Torben Sand. I'm Director of Investor Relations and Group Communication, and I am, as usual, joined by our CEO, Niels Frederiksen, and CFO, Marianne Rørslev Bock. Please turn to slide number 3 for the agenda for today's webcast. The agenda is as follows: First, highlights of the second quarter, followed by comments on our revised outlook for 2023. Then we'll go into a business update. We'll focus on developments that feed into the wider rolling towards 2025 strategy, and these insights will be followed by an overview of the performance in our three commercial divisions.
Key financial developments for the group, including an update on net debts and leverage, and then we will conclude the webcast with a Q&A session, where we will be pleased to take any questions you might have. Before we start, I ask that you pay attention to our disclaimer on forward-looking statements at the end of this presentation. With this, please turn to slide number 4, and I'll leave the word to Niels.
Thank you, Torben, and welcome and good morning to everyone on the call. We've seen a more volatile environment than we expected in 2023, and we have had to make an adjustment of our full year outlook to reflect this. Net sales are trending lower than expected, as some of our handmade cigar customers are cutting down on inventories. The recovery of our market share in machine-rolled cigars in Europe is taking more time than we anticipated, and the plan to open new retail stores in the U.S. is somewhat delayed. We don't expect net sales to fully recover during the rest of the year, which is why we have revised our net sales guidance for the full year. We still aim to report sales growth for the year.
Before going into detail with the guidance and the progress of our strategic agenda, I would like to give you a few key financial highlights from the second quarter results announcement. Net sales decreased by 2.3% to DKK 2.2 billion. The EBITDA margin declined to 23.1% versus 23.9% last year. Free cash flow before acquisitions was DKK 159 million versus DKK 143 million last year, and adjusted EPS came in at DKK 3.5 versus DKK 3.6 last year. In organic terms, net sales declined by 1.8%, and EBITDA declined by 2.9%. For the six-month period, net sales were negative by 0.7%.
The EBITDA margin was 23.6%, compared with 25.5% last year, and free cash flow before acquisitions was negative DKK 20 million versus DKK 272 million last year. Marianne will give you more details on the financial performance in a moment. I will now turn to the revised expectations for 2023, and please turn to slide number 5. As mentioned before, the main reason for net sales trending lower than expected is primarily that some of our handmade cigar customers have been cutting down on inventories, and the volume recovery and regain of market share in machine-rolled cigars in Europe is taking more time than anticipated.
The delay in our plans to open new retail stores in the U.S. and changes in exchange rates have also had some impact, as has the overall normalization of consumption of handmade cigars after COVID. As a result of these developments, we revised our expectation for net sales to DKK 8.7 billion-DKK 9 billion, from previously DKK 9 billion-DKK 9.3 billion. With changes in the product and with the ... Sorry. With changes in the product and market mix, the revision of net sales also impacts EBITDA margin negatively.
France and the U.K., which are two of the machine-rolled cigar markets where market share has not recovered, are high-margin markets, and combined with a scale effect from lower volumes, as customers have adjusted inventory, means that we have revised the expectations for the full-year EBITDA margin to 23.5%-24.5%, from previously 24%-25%. The revision of both the free cash flow before acquisition and earnings per share follow the revisions of the expectation for net sales and the EBITDA margin. Now, whereas the decline in machine-rolled cigars followed the structural decline rate of 2%-3%, the consumption of handmade cigars in the U.S. declined by more than its structural decline rate of 2%.
However, we have seen more consumers moving online, and the consumption of products in our category is still perceived as resilient, despite the impact on current performance of the recent adjustment of inventories with some customers and distributors. Now, given these considerations, the revised guidance for 2023 is now reported net sales in the range of DKK 8.7 billion-DKK 9 billion, down from DKK 9 billion-DKK 9.3 billion. EBITDA margin before special items in the range of 23.5%-24.5%, down from 24%-25%. And free cash flow before acquisitions in the range of DKK 1.1 billion-DKK 1.3 billion, down from DKK 1.2 billion-DKK 1.4 billion. Adjusted EPS is now in the range of DKK 14-DKK 16, down from DKK 14.5-DKK 16.5.
The guidance is based on current exchange rates. Please turn to the next slide. I'll now give you an update on our progress with the ongoing Rolling Towards 2025 strategy. Our ambition to grow the company through a combination of acquisitions, geographic expansion, and further experimentation in next generation products remains intact. During the second quarter, we have continued the integration of Alec Bradley. We've started the integration of XQS following its acquisition. We've opened another cigar store in Texas, and just a few weeks ago, we had the grand opening of a new Cohiba Cigar Lounge in California, the first of its kind. And we've made further progress in our sustainability strategy, Rolling Responsibly. Please turn to slide 7, where I'll give you more details to these milestones.
In this slide, we've outlined three important pillars for our road ahead: mergers and acquisitions, our growth enablers, and sustainability. Firstly, acquisitions have been and remain a key lever for Scandinavian Tobacco Group to grow the company and to create value for shareholders. With the acquisition of Alec Bradley and XQS, we have, during the H1 of the year, invested DKK 583 million in expanding our portfolio of handmade cigars in the U.S. and in our growth enablers. The integration of both companies is progressing well and will make important contributions to financial performance this year and in the years ahead.
The growth enablers, covering retail expansion as well as our experimentation in next generation products, accounted for slightly more than 3% of group net sales during the second quarter of the year, as compared to less than 2% in the same quarter last year. Our growth enablers are still not material to the group performance, but we believe they will, over time, become increasingly important to our financial performance, as well as the long-term development of our company. We are confident that these categories can complement our core categories and allow us to evolve with the changing demands and trends of our consumers. For STRÖM and XQS, the white pou-- the white pouch products, and AKT, the modern AKTies product containing no tobacco and no nicotine, the sales force continues... Sorry, the sales performance continues to progress as planned. XQS performed especially well with double-digit sales growth.
For all three brands, a rollout to new markets is being considered. In June, Cigars International opened its ninth retail store, retail cigar superstore in Katy, Texas, and the implementation of the strategy to expand the retail network in the U.S. continues. Although, as mentioned, the opening of additional stores during 2023 has been delayed into next year. Each of the seven cigar superstores opened before 2023 are developing well, and all stores are expected to deliver valuable contributions to net sales and profits during the coming years. Our sustainability agenda, Rolling Toward, Rolling Responsibly, continues to make good progress. Last quarter, I already mentioned our new data collection methods and reporting processes to be implemented, and our Center of Excellence is continuing to assist environmental, social, and governance initiatives for the communities in which we operate.
This quarter, we have initiated a more detailed work on Scope 3 emissions, and we've completed CDP disclosures for climate and water. We are proud of the way in which we support local businesses across a number of our operational areas. We strive to encourage and implement a circular economy wherever we can to improve our carbon footprint and our social license to operate. Please turn to slide number 8. It's a while since I last gave an update on regulatory developments, and let me start by mentioning the most important development, which is only a few weeks old. On August 10, the U.S. District Court for the District of Columbia has ruled in favor of the premium cigar industry to remove premium handmade cigars from the Tobacco Control Act.
This means premium cigars will no longer be regulated through the FDA's deeming regulation, which otherwise has been the case since 2016. The ruling can be appealed by FDA up until ninth October. In reality, and assuming the decision is not appealed, this implies that all non-flavored premium cigars will be exempt from applying for substantial equivalence, and there will be no predicate requirements for the launch of new products. We believe that the decision supports our view that premium cigars are a unique product category with both different product characteristics and consumer profiles than other tobacco products. Now, the potential ban of characteriZyn flavors in the U.S. remains in process with no material news. The FDA has already released its proposal for a ban on flavored tobacco products, including flavored cigars.
I would like to repeat that our exposure to flavored tobacco products in the U.S. is limited, and with pipe tobacco not being included, the exposure will be well below the 5% impact we have previously mentioned. In Europe, the two major pieces of legislation related to Scandinavian Tobacco Group are, as you might recall, the Excise Tax Directive and the Tobacco Products Directive. Both remain in process. A proposal for the Excise Tax Directive is now expected during the H2 of the year, and the Excise Tax Directive relates to potential revisions on the tax differential between the tobacco categories, potentially renewed minimum excise duty rates, and taxation of new product categories, and now seem to be postponed slightly. An impact from the directive is at the earliest expected at the end of 2026. For the Tobacco Products Directive, there are no new updates.
The Tobacco Products Directive could relate to characteriZyn flavors and ingredients, product labeling, and next generation products. The formal proposal for changes is expected by the end of 2024 or early 2025, with an impact expected at the earliest in 2027. We'll now turn to the focus, turn to focus on the performance by division, and I'll leave the word to Marianne. Please turn 2 slides to slide number 10.
Thank you, Niels. I will start with the overview with Euro Branded. Net sales for the second quarter decreased by 1% to DKK 712 million, reflecting the organic development in net sales. The negative organic growth was driven by machine-rolled cigars and pipe tobacco within the category smoking tobacco. Handmade cigars and fine cut tobacco delivered growth, and for all product categories, pricing remained a key contributor to offset volume declines. As an example, within the largest product category, machine-rolled cigars, the price mix impact was positive by almost 8%. The overall market continues to decline by 2%-3%, but as markets like France, the U.K., and Benelux decrease more than the European average, and as these markets are our largest markets, we currently experience a larger volume decline than the market average.
In addition, as flavored cigars perform better than unflavored cigars, where we have the strongest market positions, and as our market share takes time to recover following our out-of-stock issues last year, we have experienced a somewhat stronger volume decline than in previous quarters. This is particularly the case for markets like France and the U.K. EBITDA before special items decreased to DKK 164 million, with an EBITDA margin of 23.1% versus 24% in the second quarter of 2022. The margin development was driven by changes in market and product mix, especially the declining net sales in France did impact the overall margin, but also the scale impact of lower volumes did reduce margins in the quarter. The OpEx ratio increased slightly, driven by cost inflation and the investment in Next Generation Products.
Our aim remains to regain market share over time, driven by our strong brand portfolio, although it does take longer time than we originally anticipated. Having said so, pricing is a key priority to grow our value share of the market, thereby offset the structural decline in volumes and any inflationary effects. Additional levers for Euro Branded to deliver margin improvement over time is our simplification initiative to reduce the number of stock keeping units and brands within the portfolio. This initiative continued during the quarter, and we aim to simplify our portfolio further. With this, please turn to slide 11, where I'll speak to the North America Branded and Rest of the World.
For the second quarter report, both reported and organic net sales in North America Branded and Rest of the World decreased by 6% to DKK 773 million as a result of inventory adjustments across handmade cigar customers, including contract manufacturing customers, as well as comparison is impacted by the change in distribution model in Australia, which impacted net sales positively in the same period last year. The acquisition of Alec Bradley and general price increase did partly offset this. EBITDA before special items decreased to DKK 265 million, with an EBITDA margin of 34.2% versus 37.2% in the same quarter last year. The decrease in profitability is driven by an increase in the OpEx ratio. The gross margin was slightly up compared to the second quarter of 2022.
Increase in the OpEx ratio relates to cost inflation and the lower sales from contract manufacturing, which carry limited operating expenses. Consumer demand for cigars is still considered resilient, although volumes of handmade cigars in the U.S. continue to decline by more than the expected structural decline rate. However, an improvement might be on its way, with signs of a stabilization of the online sales channels taking place in recent weeks. I will now turn the attention to the performance of our North America Online and Retail division. Please turn to slide number 12. Net sales for the second quarter increased marginally to DKK 740 million, compared to the second quarter of 2022, and the EBITDA margin improved to 16.4%, compared with 13.7% in the same quarter last year.
Organic net sales increased for the second quarter in a row, driven by good performance in the online business, continued growth in the retail business, and the distribution of Zyn. The performance of the division has started to improve, as the dynamics between retail and online sales channels have started to move back towards pre-pandemic levels. An example to the benefit of the online sales channels, to which we have a higher exposure. We expect the rebalancing between the sales channels to continue in the coming quarters, and we also expect the number of active customers on file finally have stabilized. Retail accounts for an increasing share of net sales in the division, and delivered double-digit organic net sales growth versus last year, driven by new store openings. This resulted in retail accounting for close to 9% in the quarter.
EBITDA before special items decreased to DKK 122 million from DKK 101 million, with an EBITDA margin before special items of 16.4%, last year, 13.7%. The margin development is primarily driven by the scale impact from higher net sales, but also as a result of efficiency improvements, most notably through the investment in our AutoStore facility in our Bethlehem warehouse last year. Now please turn to slide, to slide number 14. Before I turn to the details to the financial performance from a group perspective, I would like to update you on the long-term trends in the EBITDA margins by group and by division. Each quarter, we deliver many details to the development for the actual quarter by division, and to the development compared with the same quarter the previous years.
In this slide, we have outlined the development in the second quarter EBITDA margins over the past six years, since 2018. These trends give a different and better insight to the underlying progress in our strategy and financial ambitions. It appears from the long-term trend that 2021 and 2022 were exceptions to the underlying growth traction, which we have illustrated with arrows. Our financial ambition of increasing the EBITDA margin over time, subject to changes in business mix as well as acquisitions, is anchored in our strategy, Rolling Towards 2025, and the ambition is based in the past performance, and gives us comfort we will continue to deliver on the ambition in the years ahead. With this, now turn to slide number 15, please.
As Niels addressed in his opening remarks, overall, we deliver financial performance during the quarter, which is impacted by a weaker-than-expected net sales development, which turned out to be increasingly difficult to recover in the H2 of the year. The weaker net sales primarily relate to temporary issues like the inventory adjustments with some customers, and the delay in opening of retail stores. The change in the exchange rate did also have a minor impact on our revised expectations for the full year. As we don't expect to catch up on issues during the H2 of the year, the expectation for the full year net sales has been revised down accordingly, which also has impacted the outlook for our other guidance metrics.
For the second quarter of 2023, reported net sales decreased by 2.3% to DKK 2.2 billion, while organic net sales growth was negative by 1.8%. Acquisitions impacted net sales positively by DKK 35 million, or 1.5%, while exchange rate developments impacted net sales negatively by DKK 45 million, or 2%. The decrease in organic net sales of 1.8% was composed by 3% growth in North America Online and Retail, a 1% decrease in Europe Branded, and a 6% decrease in North America Branded and Rest of the World. The EBITDA margin decreased by 0.8 percentage points to 23.1%, primarily as a result of the lower gross margin in Europe Branded, and a higher OpEx ratio in North America Branded and Rest of the World.
For the H1 of the year, net sales decreased by 0.7%, with organic growth being -1.3%, and the EBITDA margin was 23.6%, compared with 25.5% last year. The free cash flow before acquisitions was DKK 16 million higher than last year, with DKK 159 million for the quarter. The development is driven by the operational performance, higher financial costs and taxes paid, as well as an increase in working capital. The continued negative contribution from working capital was primarily driven by the increased trade receivables and lower payables. Inventory was reduced in the quarter, although I expect the levels to reduce further in the H2 of the year.
For the H1 of the year, the free cash flow before acquisitions was negative DKK 20 million, compared with positive DKK 272 million in the same period last year. The cash flow is normally much stronger in the H2 of the year, which will also be the case this year. Therefore, we remain on track to deliver significant improvement on the free cash flow before acquisitions in the H2 of the year, based on our expectations for operational performance in Q3 and Q4, and a material reduction of our working capital. With this, now please turn to the next slide. Before concluding the presentation, I will give you a brief update on our net debt and leverage position.
During the second quarter, the net debt, the net interest-bearing debt increased by DKK 643 million to almost DKK 5.1 billion by the end of June 2023. The increase is driven by the dividend payment in April of DKK 715 million, whereas the combined cash flow from operation and investing activities, including acquisition of XQS, was positive by DKK 90 million. The leverage ratio increased to 2.3x versus 2.0x by the end of the first quarter. The leverage ratio is expected to approach 2x by the end of the year. Please turn to slide number 17. Finally, I'm pleased to announce the date for our next Capital Markets Day. The last time we hosted a Capital Markets Day was almost two years ago.
We are excited about the opportunity to give all our stakeholders an opportunity to gain further insights into Scandinavian Tobacco Group, our strategy, and how we intend to create value for our shareholders, our many partners, our consumers, as well as our employees. The event will take place on the twenty-first of November in London. It will be possible to follow the event, both in person in London or through a live stream. The agenda and registration for the Capital Markets Day is expected to be ready by mid-September. This concludes our presentation for today's call. I'll now hand the word back to the operator, and we're ready to take any questions you may have. Thank you.
Thank you. If you would like to ask a question, you'll need to press star one and one on your telephone and wait for your name to be announced, and to withdraw your question, you can press star one and one again. If you wish to ask a question via the webcast, please type it into the box and click Submit. Thank you. We'll now take our first question. Please stand by. First question is from the line of Niklas Ekman from Carnegie. Please go ahead.
Thank you. Yes, a couple of questions from my end. Firstly, on the full year guidance, maybe if you could just clarify where - you talk about the, the sales guidance. I think even the low end of the sales guidance requires at least 2%-3% organic growth in H2. And you talked about how, you did not expect sales growth to be strong enough in the H2 to, to kind of meet your, your expectations. So, can you just elaborate a little bit here? Are you expecting recovery in H2 or, or not, or are you expecting growth in H2 or not? And, and the same question, I guess, on the margins, because you seem to, or rather the opposite question on the margins.
You seem to expect a continued much lower margin in H2, and if you could again elaborate a little bit on these trends.
Yeah. Thank you, Niklas. So, yes, we do expect growth in the second quarter, sorry, in the H2 of the year, and it is composed of a number of factors. First of all, you can say that our online business has been turned around and is continuing to grow year-on-year. Secondly, we expect Europe Branded also to deliver growth, not least driven by the price increases already taken, and which will have a higher impact in the H2 of the year. So, we are seeing growth. We are just seeing less growth than we originally anticipated, and we no longer feel comfortable that we can recover fully, and that's also why the guidance has gone down.
That's very clear. And the same on the margins, because on the margins, it's kind of the opposite. You expect—you seem to be guiding for a lower margin in or margins continuing much lower in H2.
Yeah, and it's Marianne here. Hi, Niklas, and that's correct. So, we do anticipate to have some mix effect between markets and products also during the H2. And then we are also seeing some catch up on on some additional costs in the in the H2.
And also on top of that, we also have the impact, diluting impact from the full consolidation of the acquisitions we take on.
Fair point. Thank you. And on the topic of margins, I'm trying to see where you are and where you're heading, because you're now guiding for margins in the range of 24%. Margins before COVID were, or were in, at least in 2018, they were around 20%, then they rose to 27%. Now you are back around 24%. So what is the long-term trend? I know you showed this slide here with the rising margins, but there has been quite a lot of volatility in recent years. So what do you see as kind of a long-term sustainable margin?
... Yeah, so let me try to answer that, Nicholas. Let me start with where we focus our energy on margins right now. It is primarily a focus on our Europe Branded division, where the sliding volume and market share has kind of a double impact, because it erodes our gross profit. But also, as our volumes decline in our factories, it gives us less efficiencies. We are very aware of that. Currently, we are occupied about keeping the stability in our factories that we have finally established.
And as we are also implementing the Track and Trace to be ready in mid-2024, and we are also running towards second implementation of our ERP system, we are currently reluctant to we are cautious of taking costs out of the factories currently, but that will be the case when we come a little further down the road. I think also when we talk margins, we saw as you're also mentioning, an uplift of margins during COVID, simply the very higher net sales was leveraging our margins. So it is still our ambition to grow margins over time. And we have several initiatives to be part of of growing those margins.
One thing is, as I just mentioned, our ERP system is that when that is globally implemented, we will see some efficiencies coming from that.
Super. That's very clear. And finally, on the same topic here, when you talk about current trading, you talk about July and August, you say that that supports the revised outlook. Does that mean that you've seen strong sales, but a weaker margin in the start of Q3?
Correct.
Very clear. Thank you. And also, can you just update us on your view on buybacks, or rather the board's view on buybacks at the moment?
Yeah. So, as we have said all along, we evaluate ongoing buybacks, and we are committed to returning excess cash to shareholders by the ordinary dividend and buybacks. Currently, our leverage is 2.3 after acquiring two companies this year, and we expect it to be around 2% at the end of the year. So around year-end, we will evaluate potential further share buybacks at that point of time.
Super. Thank you. Thank you for taking my questions.
Thank you. We'll now take the next question. Please stand by. This is from the line of Sebastian Grave from Nordea. Please go ahead.
Thank you. Just a couple questions from my side as well here. So just to come back to your net sales guidance, just to clarify here, as I hear it, the updated guidance does not assume any improvement in European branded market shares or tobacconist inventories coming more in balance in H2. Is that correct?
It is correct that when we look at the inventory rebalancing, in the U.S., then we think it will take the full 2023 before we see a normalized situation. With respect to Europe Branded, yes, we are not putting in market share improvements, but we are, of course, having this as one of the main focus areas for the remainder of the year to regain market share momentum. So, but no, we have not included a market share improvement in the expectations.
Okay, thank you. That's very clear. And on the latter topic here, you stated in the report that flavored products are gaining ground in key markets in Europe. And as such, I mean, to me, it sounds like these market share issues could be more sticky in nature. Do you share that perception? And maybe could you give some insights as to how do you work on improving this market situation? Is it simply a question of pricing, or are you thinking about adding flavored products to the shelves as well, or could you give some insight here?
So let me say, first of all, even though the traditional non-flavored products are losing ground to flavored, we are also looking forward to a potential flavor regulation in the future. So we are actually quite pleased with our strong position in the non-flavored segment, and we need to continue to strengthen that. But we also need to build market share momentum in the flavored segment. And we are trying to focus that both by introducing new products and by strengthening distribution and rotation of our existing flavored products in the market. So we do want to improve our position in the flavored segment, but we also want to maintain that stronghold we've got in the non-flavored.
I mean, now, I mean, this market share challenges has been persisted for a while. Have you changed your approach to solving these issues over the past quarters, or what is the approach really? Could you maybe elaborate?
... Yeah. So the first focus we've had has of course been to, let's say, regain distribution and visibility in the stores after a period where we have had very erratic supplies. And that we believe we have secured today. Then the second push is around raising rotation. And given also the many restrictions we have in this market, it's not that easy to raise rotation. And what we have been, let's say, surprised by, is the level of effort required for us to regain the momentum. So we are increasing, let's say, the resources behind these key markets like the U.K. and France because we need our market here to get back on a more positive trend.
Okay, that's clear. Thank you. And then the last from my side here on your inorganic growth activity. So you had only a modest DKK 35 million revenue impact from acquisitions in Q2, which I assume primarily relate to Alec Bradley. However, compared to the reported Alec Bradley full year 2022 performance of +$25 million, which corresponds to around DKK 170 million at current exchange rates, I think the 35 million sounds a bit soft here. So is that a result of Alec Bradley also being impacted by this destocking? Or maybe that the 2022 figures are elevated from selling effects or what is the reason here?
Yeah, there, there's no doubt that Alec Bradley is also impacted by the inventory readjustment. And, there's also. When we took over Alec Bradley, we took over a brand that was performing well, but also one that, to be honest, during the acquisition, had not been maintaining an innovation pipeline. So we have had to invest more resources in, let's say, reestablishing an assortment of innovation required to compete in the market. So we're not super nervous about this, although it's always, you know, not what you would optimally want to find. What we do and what we have been encouraged by is when you look at our Alec Bradley's performance in our online channel, where we have, then we are delivering growth year on year on Alec Bradley.
Okay. Thank you, Niels. That's very clear. That was all from my side. Thank you for taking my questions.
Thank you. As a reminder, if you would like to ask a question over the phone lines, you can press star one and one on your keypad, or you can submit your questions via the webcast. There are no further questions coming through at the moment.
Okay. But then thank you very much to everyone for participating, and we wish you all a good day. Thank you.
Thank you. This does conclude the conference for today. Thank you for participating, and you may now disconnect.