Thank you, good morning, and welcome to this conference call for our third quarter results. Please turn to slide number two. As said, my name is Torben Sand, and I am Head of Investor Relations. With me today, I have, as usual, our CEO, Niels Frederiksen, and our CFO, Marianne Rørslev Bock. Today, we will present the highlights for the quarter. We will give you a business update on the impact of the COVID-19 pandemic on our business, and present a status of the Agio Cigars integration. Following this, we will give you an overview of the quarterly performance in our three commercial divisions and the group as a whole, including an update on our group funding structure and the share buyback program. Finally, we will take you through the outlook for 2020 and take your questions at the end.
Before we start, I will, as usual, ask you to pay attention to our disclaimer on forward-looking statements in the back of this presentation. Please turn to slide number three, and I will leave the word to Niels.
Thank you, Torben, a very warm welcome and good morning to everyone on the call. Overall, Scandinavian Tobacco Group delivered a strong third quarter of the year. On the backdrop of increased tobacco consumption across categories and markets, we delivered double-digit growth in net sales, earnings, and free cash flow before acquisitions. Net sales grew organically by 12% to DKK 2,231 million. EBITDA before special items was DKK 614 million versus DKK 446 million last year, displaying a 33% organic growth. Free cash flow before acquisitions improved to DKK 609 million, compared to DKK 503 million last year. The results continue to be driven by changes in consumer behavior following the outbreak of the COVID-19 pandemic and higher tobacco consumption across product categories and markets.
Specifically, we continue to see a positive development in the important U.S. market, with overall increased consumption of handmade cigars and strong volume growth in the online business. Additionally, sales of pipe tobacco and fine cut have performed better in several markets. Based on the strong Q3 numbers, our performance for the first nine months of 2020 is better than expected, with a 7.5% organic net sales growth to DKK 6,084 million versus DKK 5,020 million last year. We have 25.6% organic growth in the EBITDA before special items at DKK 1,429 million versus DKK 1,083 million last year. We have free cash flow before acquisitions of DKK 1,156 million versus DKK 819 million last year.
We are, however, maintaining the group's full year guidance as we expect a weaker fourth quarter, negatively impacted by loading on net sales of an estimated DKK 100 million in previous quarters, very strong comparison numbers for the fourth quarter of 2019, and a temporary increase in the OPEX ratio in the fourth quarter of 2020. All in all, for 2020, we continue to expect organic EBITDA growth of more than 9%. We also expect free cash flow before acquisitions of more than DKK 1 billion. Based on this overview of the third quarter, let's turn to the updates on the continued impact of COVID-19 pandemic to our business. Please move to the next slide. On the sales side, we see that restrictions and actions taken to counter the outbreak of COVID-19 has changed consumer patterns and behavior.
These changes persisted into the third quarter of 2020 with impact on most product categories and markets. In the handmade cigars and smoking tobacco categories, smoking opportunities for consumers increased as a large part of the workforce is still working remotely, while personal consumption has been supported by aid packages fueling increased demand. The overall trend toward online commerce also impacted our U.S. online business positively, where we continue to see increase in the number of active customers, in the average order size, and we also see improved customer retention rates. While we expect increased cigar consumption in the U.S. to continue in the near term, the long-term sustainability of these new consumer patterns remains uncertain.
If we turn to the supply side, we continue to have most of our factories up and running, and we have been able to increase capacity with more than 1 million premium cigars per week over the period. The overall supply of premium cigars has been under pressure as a result of the strong demand in recent months, and inventories throughout the supply chain have been reduced. However, with increased production output, inventory levels are expected to normalize early next year, assuming no material disruptions and lockdowns throughout the supply chain. With the recent worsening of the pandemic in several countries and regions, especially in Europe, preparations and precautions have been reintroduced to ensure the continued running of our business. Please go to slide number five. This brings me to an update on the integration of Agio Cigars. The integration is progressing well and as planned.
The commercial integration is expected to be finalized in the fourth quarter, and it is encouraging that the combined like-for-like market shares improves quarter by quarter. The expectations to deliver total net synergies of an estimated DKK 225 million by the end of 2022, and cost savings of about DKK 70 million to DKK 80 million in 2020 remain unchanged. Special costs in relation to the integration of Agio Cigars of DKK 61 million have been expensed in the third quarter, as well as DKK 13 million impairment costs. The expectation is maintained that total special costs until the end of 2022 will be at the level of DKK 450 million with cash impact and DKK 122 million with non-cash impairments. The latter were primarily expensed in the first quarter of the year.
Now please turn to the next slide and the overview of the three commercial divisions, which Marianne will take you through.
Thank you, Niels. For the division North America Online and Retail, the reported net sales increased by 21% to DKK 746 million during the quarter, composed by a 27% positive organic net sales growth and a negative exchange rate effect of 6%. Driven by the overall demand increase in handmade cigars and the shift of consumers to online platforms, our North American online channel experienced a solid increase in the number of active customers, an increase in average order size, as well as improved customer retention rates compared to the third quarter of last year. EBITDA before special items increased by 41% to DKK 151 million, with an EBITDA margin before special items of 20.2% versus 17.3% last year. The margin improvement was driven by an improved gross margin reflecting lower competitive pressure and scale benefits, as well as continued efficiency improvements lowered the OPEX ratio compared to last year.
The EBITDA margin declined, however, slightly versus the same quarter of 2019, where marketing expenses and other costs were exceptional and unsustainably low, as well as the second quarter is the largest quarter for North America online and retail. We successfully finalized the first phase of the U.S. retail expansion under the Cigars International brand. In July 2020, we opened the second Texas store in Fort Worth, and in September 2020, the first store in Florida opened in Tampa. A second store in Florida was opened in October 2020. This brings the total number of Cigars International operated stores in the U.S. up to seven. With this, please turn to slide seven.
The division North America Branded and Rest of World, the reported growth in net sales was 12% to DKK 734 million, composed by a 12% organic net sales growth, a 5% positive impact from acquisitions and divestments, and a negative exchange rate effect of 5%. The development was driven by a strong demand in handmade cigars and smoking tobacco, including fine cut tobacco. The combination of personal consumption being supported by the governmental aid packages and the consumers working from home and having more smoking occasions has positively impacted total consumption of several product categories. While demand for handmade cigars from the online channels continues to be strong, the reopening of the brick-and-mortar retail channel in the U.S. also impacted total sales volumes positively. EBITDA before special items increased by 30% to DKK 279 million, with an EBITDA margin before special items of 38% versus 32.7% last year.
The margin improvement was realized with an improved gross margin driven by product mix and general price increases and an improved OpEx ratio, which decreased due to lower sales and marketing spend and a general efficiency improvement. This brings us to the update of the last division, Europe Branded. Please turn to slide eight. For the division Europe Branded, the reported net sales increased by 40% to DKK 752 million during the quarter, composed by 0.4% negative organic net sales growth and a 40% positive impact from the acquisition of Agio Cigars. During the quarter, the overall market for machine-made cigars returned to pre-COVID-19 declining trends, while minor market segments such as border trade and sales in regions with a traditionally strong tourist economy continued to be profoundly negatively impacted by the pandemic.
Organic growth in net sales was stable, with market shares in machine-made cigars slightly down and smoking tobacco delivering positive growth. EBITDA before special items increased by 56% to DKK 213 million, with an EBITDA margin before special items of 28.3%, from 25.4% last year. The integration of Agio Cigars progresses according to plan, with the commercial integration expected to finalize during the fourth quarter. Overall, the combined market shares of machine-made cigars in the key markets have been maintained or improved since the acquisition. The combined market shares in the largest European markets, which are France, Belgium, the Netherlands, U.K., Germany, Spain, and Italy, was 33% versus 33.3% in the second quarter of 2020, and 32.9% in the fourth quarter of 2019, with especially France delivering good progress, but with market mix lowering the weighted market share. Please turn to the next slide.
In the third quarter, net sales increased by DKK 423 million compared with the same quarter last year. Gross profit before special items increased by DKK 217 million, and EBITDA before special items by DKK 168 million. During the comparable quarter last year, Agio Cigars, which was acquired in the beginning of the year, delivered DKK 273 million in net sales, and the sales activity in Slovenia and Croatia, which were divested in the third quarter, delivered DKK 23 million in net sales. Adjusted for these transactions and a negative ForEx effect of DKK 74 million, the organic growth in net sales was DKK 247 million or 12%. The increase in gross profit was driven by the acquisition of Agio Cigars, the organic growth in net sales, and margin improvements. The gross margin was 50.4% versus 47.2% last year, and was impacted by the volume increase and a favorable product mix.
The improvement was driven by all three divisions. The EBITDA margin before special items, 27.5% versus 24.7% in the third quarter of last year. The margin expansion was driven by gross profit improvements. Underlying cost efficiencies across our operations continued to improve the OpEx, but was in the quarter offset by the integration of Agio Cigars running at a higher cost level. Special items was negative by DKK 80 million, with a majority of the cost, DKK 61 million, expensed in relation to the Agio integration. Another DKK 13 million is expensed as an impairment, and the remaining DKK 6 million being expensed in relation to Fuelling the Growth and the closure of our factory in Tucker, U.S. We now expect special costs to be in the level of DKK 375 million-DKK 400 million for the full year.
This is about DKK 40 million lower than previously anticipated, due to timing of certain costs from mainly in relation to Agio Cigars integration, but also in relation to Fuelling the Growth . The expectations for special costs in relation to both Agio Cigars integration and Fuelling the Growth remain unchanged. Adjusted earnings per share was DKK 4.2 per share, compared with DKK 2.6 per share for the third quarter of last year. Finally, the free cash flow before acquisitions increased by DKK 106 million to DKK 609 million for the quarter, leaving the cash generation for the first nine months at DKK 1,156 million. Working capital contributed positively to the cash flow by DKK 237 million in the quarter, with inventories declining throughout the supply chain, as well as continued positive timing of payables.
It is expected that a normalization of working capital will take place by year-end 2020, implying a cash outflow during the fourth quarter. With this, please turn to the next slide. During the third quarter, the net interest-bearing debt decreased by DKK 595 million to DKK 3.4 billion. The reduction was driven by the operating results and a DKK 237 million positive contribution from working capital. Compared with the second quarter, the leverage ratio declined by 0.6 times to 1.8 times. However, given our cash flow projection for the fourth quarter, we expect a slightly higher leverage ratio by the end of the year, but still well below our financial leverage target of 2.5 times. In September, we refinanced our funding structure by the issuance of a EUR 300 million unsecured corporate bond. The issuance was well received by the market with more than 2 times oversubscription.
The bond will mature in 2025 and holds a coupon of 1.375%, unlisted on the Copenhagen Stock Exchange. In relation to the bond issuing, both Scandinavian Tobacco Group and corporate bonds were assigned with an investment grade rating, Baa3 by Moody's Investors Service with a stable outlook. We are very pleased by having finalized our funding plan following the acquisition of Agio Cigars earlier in the year, but also by having secured our long-term and strong funding structure for the next five years. Now, please turn to slide 11. As part of our financial policy, we have stated that any excess capital, taking into account potential acquisitions and other liquidity needs, will be returned to shareholders. As part of this commitment, we initiated a share buyback program on the 31st of August.
The size of the program amounts to a total value of up to DKK 300 million with a purpose to adjust the capital structure and to meet obligations in the share-based incentive program. Shares not used for the incentive program are intended to be canceled. As of the third quarter 2020, we had repurchased about 550,000 shares at a total value of DKK 53 million. As of October 13th, we have repurchased 1,029,000 shares at a total value of DKK 98 million. Including the ordinary dividend we paid in April of DKK 6.10 per share, we have returned DKK 706 million to our shareholders in 2020, corresponding to 8.7% of the market capitalization by the end of 2019. With the listing in 2016, we have now returned almost DKK 3.3 billion to our shareholders. Please turn now to slide number 12, and I will leave the word back to Niels.
Thank you, Marianne. I will now give you a short update on the regulatory developments in our key markets. As we mentioned in relation to the second quarter results announcement, the filing date for substantial equivalence applications for premium cigars was lifted and therefore not implemented as implemented in September. Premium cigars remain regulated by FDA, with manufacturers still subject to inspections, ingredient and other reports, and other FDA requirements. For Europe, the topics to mention are more or less the same as previously discussed. First, the Tobacco Excise Directive, which is set to undergo a statutory review. The process has started, a formal proposal is not expected before at earliest the end of next year. The timing of completion of the review and the effective dates for potential changes remain uncertain.
The Tobacco Products Directive, where a first draft proposal might see the light during the first half of 2021, approval and implementation still is some years ahead. I would also like to comment shortly on plain packaging, where the recent updates are that in Denmark, plain packaging is likely to be introduced on cigarettes and fine cut during the first half of 2021, and in the Netherlands, it seem increasingly likely that the existing plain packaging legislation also will include cigars earlier than previously anticipated. Please turn to slide number 13. While the numbers for the third quarter are strong and our performance for the first nine months of 2020 is better than expected, we expect a weaker fourth quarter, negatively impacted by the loading on net sales in previous quarters, very strong comparison numbers in Q4 2019, and a temporary increase in the OpEx cost base.
We estimated that about DKK 100 million of net sales have been loaded in the previous quarters with an anticipated negative impact in the fourth quarter. The temporary increase in cost is mainly related to higher marketing spend, positively impacting next year's sales. Cost for expanded retail footprint and increased cost in online following the higher activity. We expect a negative cash flow in Q4 due to a significant increase in inventories to support the growth in North America and for preparations ahead of Brexit, just as timing effects in payables also will impact working capital negatively. Higher CapEx related to the Agio Cigars integration and retail expansion will also impact the cash flow negatively in the fourth quarter. The financial guidance remains unchanged with expectations of organic EBITDA growth of more than 9% and free cash flow before acquisitions of more than DKK 1 billion.
The guidance is based on assumptions that the change in consumer behavior in the U.S. will continue for the rest of the year and no material disruptions to the supply chain will occur. The group expects a contribution from cost savings in relation to the integration of Agio Cigars of around DKK 70 million-DKK 80 million in 2020, as well as further benefits from fueling the growth restructuring program. EBITDA before special items in the fourth quarter is expected to be below the same quarter last year. This concludes the presentation of all. I'll hand back the word to the operator and we're ready to take questions. Thank you.
Thank you. As a reminder, if you do wish to ask a question, please press star one on your telephone and wait for your name to be taken by an operator. Once again, it's star one if you have any questions or comments. You have the first questions coming from the line of Magnus Jensen from SEB. Please ask your question.
Thank you very much. Magnus here. Thank you for taking my questions. My questions mainly go to the guidance or actually to Q4, where you have a couple of elements that makes you think that Q4 will be a weak quarter. First of all, on the phasing around the DKK 100 million that you mentioned, a couple of questions to that. First of all, you've been saying all along, both in Q1 and Q2, that there is phasing and that it will be impacting the coming quarter. It has not been the case, it seems, on either Q2 or Q3. Why are you so certain that now you will see a loss of around DKK 100 million? That's one question. Then the other question is, what divisions is it related to? The final one to that is why do you see this behavior from, I guess, your retail customers?
That's my first question.
Magnus, thank you for that question. Let me start with the DKK 100 million. What we have seen in several markets, some of the markets are Russia, Norway, Middle East, that they have been loading orders during the year. The main reason for that is the closure of our Lane factory, and also for Russia, the implementation of Track & Trace. What we have seen during Q3 is that the loading has, over the previous quarters and also in the quarter of 2019, been so high that for that segment, there are more or less no orders in Q4. The division that is mainly impacted by this is the North America Branded division.
Thank you. Then, two questions more to the Q4. You said that, excuse me if it's a weird question, but I haven't been following this year that long. You said that Q4 last year was a very strong quarter. Looking at the numbers, I can see that you had negative organic growth in basically all divisions. Why is the Q4 a strong comparison?
Yeah. I think that when you look at the fourth quarter last year, it's important to remember that first of all, we had the one-time positive impact from the French excise. That's a significant number that raises 2019. Secondly, there was a number of orders in the fourth quarter, which was related to excise increases in various geographies. This also makes the placing of orders stronger in that quarter. Finally, I think that what we did last year was that as we were progressing towards the end of the year, we also managed our cost base very tightly to make sure we could deliver the guidance. We did that most of the quarter without knowing that a few weeks before Christmas, we got this French excise one-time benefit. I think that's the main reasons why we are saying this is a difficult quarter comparison.
Okay. Thank you. I guess it answers my last question why, because you see an uptick of around 3% on your OPEX ratio, mainly driven by marketing. I guess this is part of the explanation, and I guess the other one is that you've not been using that much marketing for the last two quarters. Do you have further comments to that?
Maybe just a quick comment on that, because you're absolutely right, that in the last quarter of 2019, we took down the spend of marketing. In this quarter, on the fourth quarter, we are going back to a more normalized level, which we believe is needed to invest in the revenue for 2021. Also that we do see some strategic projects, also as part of executing our strategy. As an example, an evaluation of our portfolio that we will also have a cost expense on in the fourth quarter.
Okay. Thank you very much for answering my questions.
The next questions come from the line of Niklas Ekman from Carnegie. Please ask your question.
Thank you. Yes, a couple of questions. Firstly, I'm curious about the COVID-19 impact here. It seems you've had a very positive impact to North America and both the online retail and the branded business. Whereas in Europe you're talking about a slightly negative impact, I'm just curious why there are such big differences in consumption.
Yes. I think that if you look at the third quarter from a U.S. perspective, there's kind of two important points. One is that we've seen continued strong demand in handmade cigars where the online obviously is benefiting from more customer traffic and good sales growth. When you look at the branded business in the U.S., it's also benefited from, let's call it the recovery and reopening of stores that have taken place during the third quarter of 2020. The branded business has a strong quarter simply by retailers reengaging and actually placing higher orders than anticipated. When we look to Europe, sorry, all of that in the U.S. is driven by this, call it this underlying consumption increase driven by working from home. In Europe, we do not see the same trends.
I think when we look at our mass market business across Europe, we lost some volume in the second quarter, which was really driven by lower consumption inventory changes. Although the total market has bounced back in the third quarter, we really lost some sales in the second quarter that is not coming back. That is where we see a little bit of different dynamics between the two geographies.
Okay. Generally, you're not seeing significantly increased tobacco consumption in Europe, is that also the case?
Yes. That's our assessment of the situation right now.
Okay. Excellent. The second question, just on the outcome here in the U.S. election, it's obviously uncertain, but if we do see a shift from Republicans to Democrats, do you see that that could lead to any tangible shift in the regulatory environment from your behalf?
I think it's a little early to say, but I think what we have said before is that clearly it is in our best interest that there is not a one-sided Democratic control of both the White House, the Senate, and the House. At least with the latest update I received, the Senate seems to stay fairly balanced, which in my book would provide for a relatively neutral situation for us. Time will show. That is the current reading.
Okay, thanks. Also on the cost reductions, both from Agio and fueling the growth, how much of these DKK 70 million-DKK 80 million have you achieved in the first nine months? The same question here on fueling the growth, how much of the, what was it, DKK 225 million has now been achieved?
On fueling the growth, what we are looking at is around a run rate of 80% we have achieved or we will achieve during 2020 out of the DKK 225 million. On the DKK 70-DKK 80 of Agio, we have for the third quarter approximately realized two-thirds of that.
Okay. Excellent. Thank you very much for taking my questions.
Welcome.
Once again, ladies and gentlemen, if you do have any questions or comment, please press star followed by one on your telephone. You have the next questions coming from the line of Gaurav Jain from Barclays. Please ask your question.
Good morning. It's Mandeep Singh from Barclays. I'm dialing in on behalf of Gaurav Jain. A couple of questions if I could, I'll obviously start with my first one. You mentioned in your presentation that the phase 1 of your retail expansion is completed. Could you please, looking forward, help us understand the next phases of your retail expansion, and is there any timeline around this? I also noticed that you lowered your FY 2020 CapEx assumption from DKK 300 million to DKK 250 million. Does this suggest that the store openings that have now been completed have acquired less capital than you previously expected?
Yes. Let me say, we were very pleased that we finally got all what we call our four test stores up and running and open for business. As we've said before, this is an investment in trying to create a retail format that is attractive to the consumers of tomorrow. If we do this well, we believe that we will have both a strong business case for the individual outlets, but we'll also have a vehicle that we can help stimulate overall category interest. What we will do now is that we will look at the performance of the test stores, and depending on what we interpret from that, we will decide what to do in the next phase, whether we will open more stores or whether we will allow the current stores to run for a longer period before deciding.
I think we've already said before that we really need to see proof of concept. That's important. I can say the store that has run the longest in The Colony, Texas, which has run for about almost two years, we are very satisfied with the performance of that store. It's also clear that the impact of COVID-19 is still not 100% clear, and we are going to watch that closely also in the context of the retail environment. I can just say that, or maybe I'll just Can I say, Marianne, I don't think that the CapEx in the fourth quarter or the full year has anything to do with retail.
Absolutely. That is absolutely correct. It's more bits and pieces all around where it's been an extremely busy year, and I think engineers are always at the beginning of the year, very positive of what they can achieve during the year. It's simply that we haven't achieved all our smaller projects around the world.
That's very useful. Thank you. I suppose, is it fair to say then that further store openings aren't really planned into 2021 at the moment? You're obviously going to look back and see the performance of your test stores before working out what you want to do in 2021. Is that fair to say?
I think what we will do is that we will continue to look for new opportunities for stores if we end up with a particular store location that is very attractive, I don't think it can be ruled out that we will try to do one more. Really the focus of what we're doing right now is running the four stores that we have opened.
Thank you. One more question, if I could, please. The Agio integration looks to be very much running on track, and obviously you maintain your guidance of a 2% EBITDA margin improvement by FY 2022. Do you sort of see any upside to that at all? Do you think that you would have realized all your synergies at that point? Do you think there's a bit more upside that could potentially be realized?
I think it's too early to say anything about a possible upside to that number. The synergies is related both to people leaving, and that is the main part for 2020, including procurement opportunities and then the operations footprint. The operations footprint will not be realized until later in the integration. I think it's too early for now to say anything about a potential uptick on the DKK 225 million.
Okay. Thank you very much. That's all the questions from me.
We have another follow-up question coming from the line of Magnus Jensen. Please ask your question.
Thank you very much. Two smaller questions from me. The first one is, you talked about that you had reduced inventories during Q3 that you're ramping up. Has that had any impact on your sales, on either your wholesale or your retail business?
We do not really see inventory in the third quarter affecting our sales in any material way. I think what we have realized is that the, let's say, the building of inventory to the level we would like to have in the U.S. of handmade cigars has turned out to be more difficult than we anticipated, also because demand has been so strong.
Yeah. Okay. The final one, I'm not sure you want to answer that, but I'll try anyways. You guide for more than 9% organic growth, EBITDA. What does more than 9% mean for you? It's an open-end guidance, difficult for us to know exactly what kind of number you're looking for internally. How high should it be before you would be willing to raise your guidance?
Yeah. Let me try to answer this, then Niels can supplement. You're absolutely right, I can't give you a specific number on that. When we say above 9%, of course, if we see a significant uptick versus that, we will go to the market. When we evaluate whether this will have any impact on our share price, if we have an upgrade of our guidance, we will go to the market. Maybe I can talk a little into sort of the uncertainties around the guidance. One of the first questions we have been talking about the decrease in revenue in our branded business, which we are very comfortable around. Revenue in the rest of the world are orders that come in well before, and we have a very, very good overview of that.
Where the uncertainties lie are both in the handmade market, how does that development look over the coming quarter, where we have projected what we have seen until now. It's also on the COVID-19 development in Europe, where we do see additional lockdowns around the world, how would that impact our sales numbers. Hopefully that gives a little flavor on where we see the uncertainties in the guidance. Maybe, Niels, you have a few comments, too.
I think the only comment I'll make is still that, I've said it before, I think it's dangerous with us to focus too much on the individual quarters. When you look at the overall performance in both 2019 and projections for 2020, even backing out the impact from the Agio, we are, in my opinion, performing well in comparison to what we call our financial ambition. I think that should be the focus area.
That's very helpful. Thank you.
We have no further questions at this time. Sir, please continue.
I think we will thank everyone for participating and for the questions, wish you all a continued good day.