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October, 2006

BMJ

Altadis’ Metamorphosis Begins Taking Shape
Deal with Philip Morris Pioneers New Areas

By Joseph Finora

The popularity of Altadis’ brands and strong logistics has helped forge the company’s international expansion, a strategy introduced in the mid-1990s.

Last year, Altadis Group, formerly an almost exclusively Spanish-French concern, unveiled a plan to begin branching out across many borders. This year, the plan’s early results are beginning to take shape. Its cigarettes and cigars are now available in 80 countries, enjoying a substantial presence in Morocco, Germany, Russia and across the Middle East. Being well balanced has its rewards as highly regarded brands plus a logistics business, as well as acquisitions and restructuring/modernization moves have kept Altadis’ fortunes steady in an erratic market for tobacco companies.

Today Altadis describes itself as an “integrated tobacco company, focused on profitability and sustainable growth, as well [as] continuous creation of shareholder value.” Altadis management is aiming to build its future based on the strength of its three business units, each of which now helps provide synergy on a worldwide scale. Its brand portfolio, which is its key asset, continues to flourish while supported by adroit fiscal management, clever alliances and an ability to create opportunities — even sometimes with rivals.

Among other things, Europe’s third-largest cigarette manufacturer produces and sells blond and dark cigarettes. The blond segment — the market’s fastest growing — has become by far the leading contributor to revenue, accounting for 64% of its cigarette division’s sales. Altadis’ cigarette brands include such names as Fortuna, Brooklyn and Gaoloises Blonds. Cigarettes account for 52% of total Altadis’ sales and 58% of its operating cash flow. They should enable the company to continue solidifying its position in the international market as each brand is fairly profitable, bringing cash into the company and helping it keep pace with the growing trend for quality rather than quantity among smokers. Although this segment is also getting crowded and many companies are subscribing to this plan, moves such as Altadis’ can be interpreted as a sign of things to come as the force of change continues to lock itself around the cigarette industry.

The popularity of its brands and strong logistics has helped forge Altadis’ international expansion, a strategy introduced in the mid-1990s. Roughly one-third of Altadis’ cigarette sales are now generated outside France and Spain. Gauloises Blondes generates 75% of its sales outside of France while sales of Fortuna are steadily rising in France and Italy. Gitanes Blondes are doing well in the Middle East, as are Fine in Africa, Smart in Finland, Fox in Poland and Marquise in Morocco according to company statements. Production is concentrated in Spain and France but growing in Poland, Morocco and Russia. Nevertheless, cigarette division sales were €819 mn, down €179 mn from 2005’s €998 mn. The drop has been largely attributed to increased excise taxes in Spain and lower inventory levels compared to the previous year.

Over the next three years Altadis aims to achieve average annual sales growth of between 2-4% within its cigarette business, between 4-6% in its cigar business and between 3-5% in its logistics unit. Operating profit margins are expected to increase by more than one percentage point in cigarettes and one percentage point in cigars. Logistics is expected to remain steady. Since 2004, Altadis has returned a total of €1.8 billion to shareholders.

In the first half of 2006, Altadis basically finished in line with its 2005 results for the same period. Sales came in at €1,934 mn compared to €1,947 mn in H1 2005. Focusing down to the second quarter, it posted economic sales of €1,004 mn vs. €1,061 mn in 2005. Group Ebitda (Earnings before interest, taxes, depreciation and amortization) was also stable at €550 mn vs. €556 mn in 2005. During the second quarter, the Group posted an Ebitda of €299 mn vs. €314 mn in 2005.

Cigar sales reached €450 mn — up €36 mn (8.7%) from €414 mn in 2005. Cigar brands include Cohiba, Don Diego, H. Upmann, Partagas, Montecristo and Hoya de Monterrey among many others. A generally favourable exchange rate also helped bolster worldwide cigar sales. On the road, the Logistic Division posted a sales gain of €581 mn, up €19 mn (3.3%) from €562 mn in 2005.

Sales for other operations, however, were significantly higher at €100 mn vs. €51 mn in 2005. This jump represents earnings from consolidation efforts, most of which took place in 2005. Restructuring generated €35 mn of cost savings while other efficiency moves generated €44 mn. Pressure to remain competitive and to continue delivering shareholder value were behind the reorganization and consolidation decisions.

According to Antonio Vázquez, chairman of the Executive Committee and c.e.o., earlier moves have borne fruit but more are expected. The Altadis model, based on three business units allows for “diversification and risk reduction, resource optimization, synergy creation in costs and economies of scale, and improved tax management. Likewise, from a strategic point of view, it is a strong base for geographic and product expansion. From a human resource standpoint, we can benefit from a much broader talent base.”

In 2006 central headquarters in France and Spain were reorganized to obtain greater production efficiency. Corporate functions were reorganized in Madrid and Paris and involved the closing of operations at its center in Tres Cantos (Madrid), which develops tobacco blends and manages the quality policy for the Cigarette Division, in cooperation with the Orléans – Les Aubrais center. As it did in Spain, Altadis also plans to restructure its logistics organization in France by closing the Paris North Regional distribution facility. Operations would be transferred to the Paris East Regional Distribution and Le Mans centers. However, keeping in line with commitments made to employee organizations, Altadis is making support measures available to affected employees and includes early retirement measures, geographic mobility assistance for transfers to other sites and external reassignments. The implementation of the plan costs some 94 mn euros but should provide recurring annual savings of 55 mn euros as 472 positions, 239 in France and 233 in Spain respectively are permanently eliminated and come on top of the industrial restructuring plan which already led to the elimination of 1,167 positions. Other positions may however be added in Spain by the end of 2007.

Last year, Altadis was considered a “company in flux.” Strengths such as strong cash flow, which it has maintained, a foundation of reliable brands and a reliable logistics business made the company a steady player. Many changes at the top levels of management and a changing international tobacco business caused others to be concerned about what Altadis would encounter in this new universe. Strategic acquisitions and savvy management, however, is moving Altadis into the industry’s upper echelons.

“We are totally convinced that we can maintain the excellent results as well as a favourable rate of development through healthy growth in operations, increased sales and constant optimization of our corporate and cost structures,” said Vázquez. “All of this will allow us to continue to provide our shareholders with an attractive remuneration policy.”

Aligning with PMI
In October 2006, Altadis and Philip Morris International (PMI) announced a strategic alliance to develop a market for Gauloises and Gitanes brands in Asian countries. Under the terms of a framework agreement, PMI will be entitled to enter into long-term license agreements for the manufacturing, marketing, distribution and sale of Gauloises and Gitanes in selected countries. PMI would use its extensive infrastructure in Asia in order to contribute to the success of these two brands in the region, a relative weak spot for Altadis.

“Due to the complementary brands portfolio, this agreement will benefit both companies. It will allow Altadis to expand the global reach of its key brands in the region and to reinforce their notoriety,” said Vazquez. “It is fully coherent with the strategy of alliances the Group has already successfully developed in countries where our critical mass does not allow us to grow fast enough.”

“This framework agreement between Philip Morris International (PMI) and Altadis will benefit both companies, allowing PMI to add Gauloises and Gitanes to the portfolio it offers consumers and expanding the global reach of Altadis’ key brands through PMI’s extensive manufacturing, marketing, and distribution infrastructure in Asia,” said André Calantzopoulos, president and c.e.o. of PMI.

Altadis acknowledges that this agreement will not have a serious impact on its immediate financial results. However, moves such as these indicate that it is developing a greater international scope for its brands in the future. Like its international competitors, a rapidly changing landscape at home and abroad is forcing tobacco companies to rethink themselves, even if it means forming a strategic alliance with a competitor. In Altadis’ home country of Spain, earlier this year it was greeted with three tax increases in less than six months, a price war and the introduction of a new law restricting the consumption, sale and promotion of tobacco. Changes like these would have once been considered monumental, today they are becoming commonplace and companies are forced to react to them.

According to company statements, its growth strategy will bank on alliances with other tobacco companies in targeted markets where Altadis’ has a minor presence. Partners will be selected on their ability to introduce Altadis brand portfolio members into new markets, obtain new customers and take market share from competitors. Emerging markets, particularly Morocco, represent fertile territory for the mature company as they often have growing, younger populations hungry for new brands. Consider that in Morocco, the government passed a law in mid-2006 extending the monopoly on the import and wholesale of tobacco products until December 31, 2010. Altadis has an 80% stake in the state-owned Regie des Tabacs du Maroc (RTM). The extension was based on demand for blond as opposed to dark cigarettes, which has been causing local tobacco farmers to switch to growing blond tobacco. The transition will take some time as RTM will provide technical support to Moroccan tobacco farmers until December 31, 2010, with the goal of developing a variety of blond tobaccos there. Altadis has the option to purchase the remaining 20% of the contract from the Moroccan government. In 2005, RTM sales rose to €237 mn and Altadis’ unit sales in Morocco were 11.7 billion, in a total market of 13.4 billion units.

In the more established markets, such as those of Western Europe, price increases hold the key for future cash flow as brands and distribution are established. This is especially true for Altadis in its home countries of France and Spain.

Cigars Keep Smoking
If cigarettes are expected to position Altadis’ in emerging markets for the future, it’s its cigar unit that enjoys a position of undisputable world leadership. According to company figures, Altadis’ cigar stable boasts an astounding 25% international market share. Consumption is highly concentrated in the USA and Europe and is bolstered by a solid distribution network that delivers quality products well known around the world. Cigars account for 23% of Altadis sales and 19% of cash flow.

The global cigar market, estimated at roughly 15 bn units, is highly concentrated geographically. More than 96% of all sales are recorded in Western Europe as Germany, France, Spain, and The United Kingdom account for 55% of the market. The United States accounts for 41%. Since the mid-1990s, these markets have registered slow volume growth and higher value growth, except in the United Kingdom which has been hampered with very steep taxes and retail prices.

Altadis manufactures cigars in the United States, the Caribbean (Cuba, the Dominican Republic and Puerto Rico), Honduras and Europe (Spain and France) with some 7,500 employees. It exports cigars from the United States, Europe and Cuba.

However, many world markets remain promising territories for both hand- and machine-made cigars as well as “little” and flavored cigars. Its Fleur de Savane brand is a leader in Spain, Portugal, the Middle East and Africa, while the Backwoods brand is present in some 30 countries. Exports from Europe and Cuba are increasing. Exports of Cuban Minis to Europe are expected to have strong growth prospects in Germany, Belgium, Luxembourg, Italy, Portugal and Greece. Altadis is also exporting cigars to big emerging markets such as Lebanon, Turkey and a number of West African countries.

Logistics Moves Forward
Altadis’ Logistic Business Unit is the distribution leader for tobacco products in Southern Europe and North Africa, with over 140,000 clients in Spain, France, Italy, Morocco and Portugal It moves a wide variety of products by truck, rail and plane serving some 221,000 retail outlets. It has 877,000 square meters of storage space and nearly 3,600 vehicles. Tobacco currently accounts for 40% of the Logistic Division’s economic sales as it delivers books, magazines, newspapers, stamps and prepaid cell phone cards to newspaper kiosks, gas stations, convenience stores, office supply outlets and other small retailers. It also has a specialty pharmaceutical distribution business and is a leading carrier of industrial packages that need to be shipped at controlled temperatures. It also distributes. As barriers between nations continue to fall, prospects for Altadis’ logistics division should remain robust.

By keeping cigarette brands out of the US, Altadis has so far, managed to stay away from the dangerous legal climate engulfing many of the other internationals who do business there. This is another reason to like the company. That could one day, however change should lawsuits increase in other countries. Smoking bans are also growing and one will soon go into effect in France — Altadis co-home base, where its brands are well positioned.

Altadis is fairly well diversified for an international tobacco company thanks to its interest in cigars and logistics. This philosophy, plus a renewed commitment towards managerial and production efficiency should keep the company steadily moving forward.


Tobacco International - October, 2006

Essentra


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