Carlsberg AS ADR B (CABGY) CEO Cees 't Hart on Q4 2018 Results - Earnings Call Transcript

Carlsberg AS ADR B (OTCPK:CABGY) Q4 2018 Results Earnings Conference Call February 6, 2019 3:00 AM ET

Company Participants

Cees 't Hart - President, Chief Executive Officer

Heine Dalsgaard - Chief Financial Officer

Conference Call Participants

Simon Hales - Citi

Jonas Guldborg - Danske Bank

Ed Mundy - Jefferies

Mitch Collett - Goldman Sachs

Hans Gregersen - Nordea

Søren Samsøe - SEB

Andrea Pistacchi - Deutsche Bank

Richard Withagen - Kepler Cheuvreux

Trevor Stirling - Bernstein

Fernando Ferreira - Bank of America Merrill Lynch

Operator

Ladies and gentlemen, welcome to the Carlsberg 2018 financial statement call. Today, I am pleased to present CEO, Cees 't Hart and CFO, Heine Dalsgaard. For the first part of this call, all participants will be in a listen-only and afterwards there will be a question-and-answer session. And just a reminder, this conference call is being recorded and a transcript of the call will be made available online.

Speakers, please begin.

Cees 't Hart

Good morning everybody and welcome to Carlsberg's full-year 2018 conference call. My name is Cees 't Hart and I have with me CFO, Heine Dalsgaard and Vice President of Investor Relations, Peter Kondrup.

Let me first briefly summarize the key highlights for the year. We delivered strong financial performance both on top and bottom line. We see good growth coming from our SAIL'22 priorities. We are significantly increasing the cash returns to shareholders and we are well prepared for continued growth in 2019. I will go through the highlights of the year, our strategic progress and the regions and Heine will take you through the financials and 2019 outlook.

Please turn to slide two. Before I go through the numbers, let me spend a few minutes evaluating the financial, strategic and organizational health of our company. Financially, we continued the positive trajectory that we have been on since 2016. For 2018, we delivered strong topline growth, margin and ROIC improvement and a very healthy cash flow. We have also been able to invest significant funds in support of our SAIL'22 priorities in order to strengthen our growth profile. In 2016 and 2017, our focus was on delivering the Funding the Journey benefits.

In 2018, our focus was to shift gears to growth, to deliver topline growth, enabled by the significant SAIL'22 investments. We are therefore very pleased with the results, albeit we were helped by a very warm summer. Strategically, we made excellent progress on our growth priorities and saw strong numbers for craft and specialty and alcohol-free brews as well as in Asia. We continued building stronger capabilities within areas such as sales, marketing and digital and we continued the rollout of DraughtMaster.

Looking at the organizational health of the business, we are also moving in the right direction. It is a continuous and never-ending journey and we see our winning culture becoming increasingly embedded across the group. Our competencies in areas such as commercial, finance, supply chain, digital and data have strengthened. We also see very good traction of bringing to life our purpose of brewing for a better today and tomorrow, including our sustainability program Together Towards ZERO. We are convinced that being a purpose-driven company will become increasingly important for our people, customers and consumers and for attracting new talents. At the end of the day, having a better purpose will help us to deliver sustainable long-term value for our shareholders.

Back to the numbers now. As you can see from the slide, net revenue grew organically by 6.5% and operating profit by 11%. The gross cash generation remained strong at DKK6.2 billion. And we reduced net debt further ending the year with a leverage of 1.29 times. As a result of the strong financial performance, the Board will propose to the AGM an increase in dividends of 13%. In addition, we have today initiated for DKK4.5 billion share buyback program. Heine will come back to the details.

Slide three and a few words on our golden triangle which serves as a key KPI in our performance management. It helps us to continuously aim at balancing growth and profits but at the same time delivering a strong free cash flow. For 2018, we delivered a well-balanced golden triangle of topline growth, margin improvements and operating profit growth while at the same time achieving a strong free cash flow. The organic volume growth was driven by all three regions.

In parts of Western Europe and Russia, we were also helped by warm weather during the summer. GPaL margin strengthened by 100 basis points, due to a solid 2% price mix, volume leverage and efficiency improvements. The 11% organic operating profit growth was the result of improved GPaL and cost efficiencies, which were positively impacted by Funding the Journey. And all these more than offset the significant increase in marketing investments.

Please turn to slide four. I have a few comments on our international premium brands which also very good growth. 1664 Blanc continued its strong performance crossing the in the one million hectoliter mark in 2018. The brand grew by 49% even after having achieved 46% growth in 2017. We saw growth in most markets with particularly strong growth in Russia, China, Ukraine, France and some export markets.

Grimbergen also continued its double digit growth pattern and grew by 14%, driven by Western and Eastern Europe and with particularly strong results achieved in markets such as France, Denmark and Russia. Tuborg, our largest brand, grew by 10%, mainly driven by continued strong growth in India and China together adding another million hectoliter to our Asian volumes. The brand also grew in several markets in Western Europe such as Denmark, Norway, Serbia and Bulgaria as well as in the Turkey license market.

Volumes of the Carlsberg brand grew by 5%. We saw solid growth in all three regions. On the slide, you can see the brand new design which was launched in September. The new looks and the number of sustainability improvements that we launched in Norway, Finland, Sweden, Denmark and U.K. and will be rolled out across other Carlsberg markets such as China, India, Malaysia and many more during 2019.

Please turn to slide five and a brief update on some of our strategic priorities which are receiving support from our SAIL'22 investments. The strong growth of the craft and specialty category continued and we grew our portfolio by 26%. Russia, France, China and Poland were important drivers of this growth. During the year, we launched Brooklyn in Poland and established a microbrewery in Lithuania taking the number of craft breweries in Western Europe to 10.

Our extensive portfolio of local alcohol-free brews includes brands such as Carlsberg Nordic in Denmark, Munkholm in Norway, Feldschlösschen Alkoholfrei in Switzerland and Baltika #0 in Russia. Alcohol-free brews grew by 33% in Western Europe. And in Russia, Baltika #0 grew by 35%. In May, we launched Birell, which is our first global standalone alcohol-free brew. Birell was launched in Bulgaria and Poland with positive initial consumer response. The rollout of the DraughtMaster system continues, supporting the availability of our craft and specialty portfolio in the off-trade. The system is available in all Western European countries and the process of converting all steel keg installations in the Nordic markets is well underway and expected to be finalized within the next two to three years.

In 2018, we increased the number of the DraughtMaster installations by approximately 35%. Building the right capabilities in different functional areas is a vital part of SAIL'22. A very important area is digital. And in 2018, we set up a new team to drive momentum and progress within this area. One of the digital successes this year was the business-to-business platform, Carl's Shop, a platform that's currently available for customers in six European markets and it has just passed DKK1 billion in net revenue.

Slide six and a few comments on our sustainability efforts, which are driven by our sustainability program Together Towards ZERO. We have four ambitious sustainability targets being zero carbon footprint, zero water waste, zero irresponsible drinking and zero accidents culture. For each of these ambitions, we have defined clear, measurable and science-based targets for 2022 and 2030, all measured against the 2015 baseline. In 2018, we continued our efforts to achieve the targets. Our sustainability report will be released later today and it contains a wealth of information on our progress.

Let me briefly touch upon two of the areas. Our ambition for CO2 emissions is to reduce this at our breweries by 50% in 2022 and reach zero by 2030. Compared to the 2015 baseline, we have reduced emissions by 20%. Our breweries in Sweden became the first brewery in the group to run on 100% renewable energy and all our breweries in Western Europe now run on 100% renewable electricity.

Water usage is another important area for us. As we reduced our water usage by 9% per hectoliter compared to the 2015 baseline, taking us down to 3.1 hectoliter. We are among the most water efficient breweries in the world, but we still have some way to go to reach our target.

And now I will hand over to Heine who will take us through the financials and outlook.

Heine Dalsgaard

Thank you Cees and good morning everyone. Please turn to slide seven. So net revenue grew organically by 6.5%. This was driven by volume growth of 4.8% and a positive price mix of 2%. In reported terms, net revenue grew by 3%, impacted by negative currency movements. Cost of goods sold per hectoliter grew organically by approximately 1%, mainly due to higher input costs and mix. The solid price mix and ongoing efficiency improvements led to a gross margin improvement of 20 basis points to 50%.

Operating expenses increased organically by 4%. This was driven by higher marketing expenses, supporting our SAIL'22 growth initiatives. Marketing expenses grew organically by more than 15% or around DKK700 million reaching 8.6% of net revenue compared to 7.8% last year. Excluding marketing expenses, reported operating expenses declined by 1% or 45 basis point reduction to net revenue as a result of Funding the Journey initiatives.

Depreciation was down from DKK4.7 billion to DKK4.1 billion, mainly due to an extraordinary depreciation charge in the first half 2017. In total, we delivered 11% organic growth in operating profits. In reported terms, operating profit grew by 5.1% due to a significant negative impact from currencies of DKK500 million.

Operating profit margin increased by 30 basis points to 14.9%. As expected and as we saw early in the year, the second half organic operating profit growth of 8.3% was lower than the 14.2% in first half. This was due to lower depreciation in first half 2018 versus first half 2017 and positive year-over-year impact in first half from selling to the festive season in Asia and higher spend in second half 2018 to support our SAIL'22 priorities.

Before turning to the next slide, a few comments on Funding the Journey, which as a program, has now been concluded. As we have talked about in the past, the benefits from the program exceeded our initial expectations. The benefits came from all four work streams. So that is value management, supply chain efficiency, operating expense efficiency and rightsizing of businesses. Taking all this together and compared to the 2015 baseline, we have improved the underlying profit organically by around DKK3 billion. As said previously, we have reinvested more than DKK1 billion back into the business into SAIL'22 growth initiatives. We will not announce a new efficiency program, but rather ensure that Funding the Journey as a mentality and way of living will stay in the optimization. By applying our disciplined approach, we will continue to take out costs and we will maintain discipline on cash.

Slide eight, please. Further down the P&L, net special items amounted to minus DKK88 million, primarily due to restructuring measures in Western Europe. Net financials improve to minus DKK722 million compared to minus DKK788 million last year. In line with our expectations, net financial expenses, excluding currency gains and losses, amounted to DKK758 million versus DKK980 million in 2017. The improvements versus 2017 was mainly due to a reduction in our net interest-bearing debt, including the repayment of the €1 billion bond in October 2017. Tax was DKK2.4 billion, corresponding to an effective tax rate of 28%, which was in line with our expectations. Non-controlling interests amounted to DKK824 million, slightly higher than last year. They primarily relate to our businesses in Malaysia, Chongqing in China and Laos. The Carlsberg Group's share of consolidated profit increased to DKK5.3 billion compared to the DKK1.3 billion in 2017, which was impacted by the impairment of the Baltika brand. Adjusted earnings per share were up 9% to DKK35.2 per share.

And now some comments on the cash flow on slide nine, please. We had another year of strong cash flow delivery and we will continue our strict cash discipline in the years to come. Free operating cash flow amounted to DKK8.1 billion which was slightly higher than last year. Trade working capital was very strong at plus DKK1.9 billion and better than we expected at the beginning of the year. All three regions improved on trade working capital and especially Asia delivered strong progress. As a consequence, trade working capital to net revenue improved to minus 16% or a 200 basis point improvement compared to 2017. We are very satisfied with our trade working capital performance.

Net interests paid were DKK863 million. This was higher than last year as last year's number was impacted by one-off income related to the settlement of a financial instrument. Tax paid amounted to DKK2.4 billion or approximately DKK400 million higher than last year. This was due to certain one-off tax payments and the consolidation of Cambrew in Cambodia. Total operational investments amounted to DKK4 billion, slightly below depreciations of DKK4.1 billion. This corresponds to CapEx revenue ratio of 6.3%.

Financial investments net were DKK1.9 billion, primarily due to the increased ownership in Cambrew in Cambodia and Super Bock in Portugal. As a consequence, free cash flow for the year amounted to DKK6.2 billion. We also increased our ownership in Olympic Brewery in Greece and Alivaria Brewery in Belarus. As these entities were already consolidated, the cash flow impact from these two acquisitions is accounted for in non-controlling interests below the free cash flow line.

Slide 10 please. As a result of the strong cash flow, we continued to reduce financial leverage. Net interest-bearing debt was reduced by DKK2.3 billion to DKK17.3 billion and the net debt to EBITDA ratio came down to 1.29 times. This is a continuation of recent years' progress and we now have reduced net interest-bearing debt by more than DKK19 billion since 2014 and over the same period reduced net debt to EBITDA from 2.7 times to now 1.29 times. Consequently, the group is now in a significantly stronger financial position than just a few years ago.

As mentioned, we increased our ownership in four businesses. The two biggest ones were in Cambodia and Portugal. In Cambodia, we acquired an additional 25% in Cambrew, bringing our ownership to 75% and giving us control. The acquisition was in line with our SAIL'22 priority of growing our business in Asia and we see interesting opportunities in Cambodia, both in terms of future market growth and our ability to strengthen the business through an enhanced portfolio and improved route to market.

In Portugal, we increased our total ownership of Super Bock from 44% to 60% through an acquisition of 28.5% of the holding company, Viacer, that controls the business. However, as our partner still controls Viacer, we don't the control of Super Bock and the business remains an associated company in our accounts. In Greece, we increased our ownership in Olympic Brewery to 100% and in Belarus, we increased our ownership in the Alivaria Brewery to 78%. In total, cash flow relating to investments in entities amounted to DKK2.8 billion in 2018.

Slide 11 please and a few words on the ROIC, dividend and payout ratio, which are clear shareholder value KPIs in SAIL'22. We managed to improve ROIC in all three regions. We increased group ROIC excluding goodwill by 520 basis points to 20.9% and including goodwill, which is our internal KPI, the increase was 120 basis points to 8.1%. The higher ROIC was a result of improved profits and lower effective tax rate and our strict focus on cash which reduced invested capital.

When it comes to capital allocation principles, we have been targeting an adjusted payout ratio of around 50%. We reached that last year and we maintained this level for 2018. Therefore, the Board will propose to the AGM on March 13 that dividends are increased by 13% to DKK18 per share. DKK18 per share represents a 100% increase in dividend compared to just three years ago, as you can see from the chart.

Slide 12, please and a few comments on capital allocation which we, on several occasions, the past year promised to come back to today. As a result of the healthy state of the business in terms of earnings growth, margin improvement returns and a significant reduction in leverage, the Supervisory Board has decided to significantly increase the cash returns to shareholders. In addition to the proposed DKK18 dividend per share, we are today initiating a share buyback of DKK4.5 billion. Combined, the total cash returns for the year will amount to DKK7.2 billion, corresponding to approximately 6.5% of the market cap of Carlsberg.

Let me go through the rationale behind our balance sheet and the decision to use buyback program to return cash. When we announced SAIL'22 in 2016, we set clear principles for capital allocation, as you can see from the slide. After having invested in the business, both organically and now also inorganically, reduced leverage to significantly below two times and reached the 50% payout ratio already, we have now come to point number four in our capital allocation principles, which is either high dividends or buybacks. Following discussions with a number of our largest shareholders, we concluded to maintain the 50% payout and use buybacks as a flexible tool to return additional cash to shareholders.

The amount of cash that we will return in any year will depend on the actual leverage in the year just past, so for this year, the 1.29 times leverage and the outlook for the coming year. We will at all times maintain a conservative balance sheet and we also want to have the firepower for potential M&A if the right opportunities arise. It is clearly not an exact science but will impact when balancing this, we concluded that DKK4.5 billion for this year would be appropriate.

To maintain the financial flexibility the current buyback program will be done in two tranches of approximately six months each with the first tranche amounting to DKK2.5 billion. The program starts today and will be done in accordance with the EU Safe Harbor regulation. The shares will be canceled at the AGM next year, except for those needed to cover share-based incentive schemes. The Carlsberg Foundation has notified us that they will participate in the share buyback pro rata corresponding to the 30% economic interest in Carlsberg. The details are described in the full year announcement on page 18.

And now please turn to slide 13 and the outlook for the year. We exit 2018 with good momentum. We delivered strong results and we have been able to invest significantly in the business. As a result, we feel well prepared for 2019, despite the well-known headwinds of high input cost and tough comps in Western Europe. The key focus for 2019 will be to further drive organic revenue growth while at the same time ensure that we maintain a strong focus on efficiencies, costs and cash. The strict cash discipline will focus on working capital as well as fixed assets.

Our regional priorities will be to increase net revenue and operational margin in Western Europe, drive growth in Asia through premiumization and strengthen market leadership in Eastern Europe. Based on this, we expect to deliver an organic operating profit growth of mid-single digit percentages. Based on the spot rates on February 5, we assume an insignificant translation impact on operating profit. Other relevant assumptions are finance costs, excluding FX of DKK700 million to DKK750 million and effective tax rate of below 28% and CapEx of around DKK4.5 billion. Our SAIL'22 financial priorities remain unchanged for 2019, meaning that we want to grow operating profits organically, increase ROIC and ensure an optimal capital allocation.

And now back to you, Cees.

Cees 't Hart

Thank you Heine. Please turn to slide 14 and Western Europe. Western Europe delivered strong results in 2018, partly supported by the warm summer in the northern part of the region, especially in Q3. Net revenue grew organically by 3% as a result of 3.6% organic total volume growth and minus 1% price mix. Reported net revenue grew by 1.2% due to the disposal of the German wholesaler Nordic Getranke in 2017 and a negative currency impact.

Price mix was positive in the majority of our Western European markets, supported by successful premiumization efforts and some price increases, partly countered by the higher growth of non-beer products. On the regional level, the positive price mix was more than offset by country mix due to growth in licensed markets such as Turkey and loss of volumes in high revenue export markets in the Middle East. Excluding export and license, price mix was around 0.5%.

Organic operating profit grew by 7% and operating margin improved by 60 basis points to 15%. The earnings progress was driven by volume growth, value management, premiumization, Funding the Journey benefits and lower depreciation. The organic operating profit growth in the second half of year was 6.3% and operating margin declined by 10 basis point year-on-year for the half year due to higher investments in SAIL'22 priorities, such as craft and specialties, alcohol-free brews and DraughtMaster roll-out.

Total volumes increased organically by 3.6% and beer volumes by 2.9%. Supported by the warm weather in Q3, we saw a significant improvement in the second half of the year after a difficult start to the year. Non-beer volumes grew by 5.5% due to good performance in the Nordics. We estimate that our regional market shares grew slightly.

Slide 15 please and a few country specific comments. The Nordic businesses all benefited from the warm weather in Q3. Total volumes for the year grew organically by 6%. In Denmark, the beer market grew slightly with our total volumes growing in line with the market. We saw good performance for the Carlsberg brand, specialty products and alcohol-free brews while Tuborg Green declined due to price increases.

Price mix improved by 5%. The non-beer business delivered strong growth. In Norway, we saw continued strong business performance. Our volumes grew slightly and price mix strengthened, supported by growth of premium brands. Within alcohol-free brews, we saw good traction of Munkholm and the alcohol-free variant of 1664 Blanc and Somersby.

In Sweden, total volumes grew driven by strong non-beer volume growth. Beer volumes declined slightly due to the loss of distribution rights for third-party brands. In Finland, the beer market declined slightly. Our volume growth was strong driven by relisting in Q1 at a major retailer for the winter campaign and growth of non-beer products.

The French market grew and our volumes were up by 5%. Price mix improved as a result of continued growth of our premium brands. Our craft and specialty and alcohol-free brands performed well while the Kronenbourg brand in the mainstream segment declined. The good performance was achieved despite some supply issues due to the French national rail strike.

The positive trend of our Swiss business continued. Volumes grew slightly and price mix improved driven by solid performance of our beer portfolio. Our power brand Feldschlösschen, our regional brands and our alcohol-free brews all delivered good growth.

Our Polish volumes grew slightly. After a slow start of the year, the business accelerated throughout the summer and towards the end of the year. We achieved price mix of high single digit percentages helped by the growth of upper mainstream and premium brands such as Okocim, Carlsberg, Zatec and Somersby as well as growth of alcohol-free brews.

In U.K., our volumes declined by 3%, mainly as a result of the declining mainstream segment. Our volumes in the premium category performed well. During the year, we completed our exit from porterage activities.

In the other Western European markets, we achieved particularly strong topline and margin improvement in the Balkan markets and the Baltics. And in Germany, our local power brands drove the growth. In our export and license business, license sales of Tuborg in Turkey increased significantly while sales in some Middle Eastern countries declined due to the higher duties and VAT.

Slide 16 and Asia, please. Our Asian region had another very good year delivering a strong set of results. Net revenue grew organically by 13.3%, driven by 8.6% organic volume growth and 4% price mix. Reported net revenue grew by 11.4% due to a negative currency impact in most countries in the region that more than offset the acquisition impact of Cambrew. The solid 4% price mix improvement was a result of our ongoing premiumization efforts, not least in China where the premium portfolio performed strongly.

The organic volume growth was broadly based with all major markets delivering solid numbers. Organic operating profit grew by 15.8%, mainly due to the strong revenue growth. The reported operating margin declined by 40 basis points to 20.4%. While the gross margin improved considerably, this was offset by a significant increase in marketing investments as a sizable proportion of our SAIL'22 investments were allocated to further strengthening our Asia business. As expected, the consolidation of Cambrew also impacted operating margin negatively.

Slide 17, please and a few country specific comments. Our Chinese business achieved very strong results. Net revenue grew organically by 50%, driven by 8% organic volume growth and 7% price mix. We outperformed the Chinese market that declined by estimated 1%. The market decline was driven by the mainstream segment whereas the premium segment continues to expand. Our premium portfolio grew by 13% and supported our price mix improvement along with price increases.

Our Indian business had an excellent year following a challenging 2017 that was impacted by the highway ban, GST and tax increases. Our volumes grew by 19% and price mix was 7% due to the strong growth of the Carlsberg brand and improved pricing. Profitability improved considerably due to the volume growth, positive price mix and supply chain efficiencies following the opening of the Karnataka brewery.

In Laos, our volumes grew by high single digit percentages, driven by growth of all three categories, beer, soft drinks and water. Price mix was slightly negative due to the profit mix. Our Beerlao brand strengthened its position as a result of improved communication.

Our Malaysian business delivered share gains, especially in the premium categories. Carlsberg Smooth Draught which was launched in 2017 grew strongly. Our premium international brands such as 1664 Blanc and Somersby also achieved very strong growth rates.

In Nepal, we saw good progress. Following a 30% excise tax increase in the first half year, retail beer prices grew by approximately 15% leading to a slightly declining price mix. In the second half of the year, we revitalized the communication platform for the Tuborg brand.

In Cambodia, we are currently in the process of rebuilding the business. Although it was a challenging year with double digit volume decline and operating loss, the first signs of the rebuild are encouraging. Our volumes in Vietnam declined slightly in a flat market. We saw strong growth of the Carlsberg brand.

Slide 18 and Eastern Europe. Our Eastern European business delivered 9.3% organic net revenue growth driven by 3.4% volume growth and 6% price mix. Reported net revenue declined by 1.3% due to the weak currencies in all markets in the region. Volumes grew in all markets. The drivers of the strong price mix improvement differs between markets with Russia price mix mainly being the result of higher prices but the other markets benefited from both price increases and mix improvements. Organic operating profit grew by 11.3%, driven by volume growth, the positive price mix and tight cost control. Operating margin improved by 30 basis points to 20.6%. H2 operating margin declined year-on-year as a result of higher packaging cost and adverse currency impact.

Slide 19, please. In 2018, the Russian beer market grew for the first time since 2007. The market growth was an estimated 3%, supported by favorable weather in Q2 and the World Cup impact in Q3. Our volumes grew organically by 2%. Price mix improved by 2% with an improving trend towards the end of the year, when we took price increases to offset input cost pressure. Product mix remained negative due to the continued growth of the economy segment. Operating margin remained in excess of 20%. Our market share was stable during the year, but declined slightly in Q4 as a result of our price increases which triggered some discussions with a large customer.

The Ukrainian market grew slightly and our volumes grew by mid single digit percentages, supported by growth of our strong local power brand Lvivske and our international brands. Brand mix developed very favorably due to price increases and the growth of premium products with particularly strong results for 1664 Blanc, Grimbergen, Somersby and Garage. Our businesses in Belarus, Kazakhstan and Azerbaijan all delivered solid revenue and earnings growth.

That was all for today. But before opening up for Q&A, a few concluding remarks on slide 20. 2018 was the year where we wanted to shift gears to growth, but at the same time, improving margins and stepping up investments in marketing and capabilities. This was a bold ambition and we are of course very pleased that we succeeded. The group has over the past three years taken important steps forward and we believe that we are well-positioned to target sustainable top and bottom line growth in the coming years.

So to summarize for 2018, we delivered strong financial results both on top and bottom line. We saw good growth coming from our SAIL'22 priorities. We are significantly increasing the cash returns to shareholders and we are well prepared for continued growth and expect mid single digit organic operating profit growth for 2019.

And with this, we now ready to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions]. The first question comes from the line of Simon Hales.

Simon Hales

Hello. Can you hear me?

Cees 't Hart

Yes. Simon. Good morning.

Simon Hales

Good morning Cees. Good morning Heine. Three questions, if I can, please. First, can I just go back to your comments around the buyback, clearly the decision to return DKK4.5 billion. And I just wondered given the outlook you have given for 2019, on my numbers your net debt to EBITDA at the end of the year will be broadly similar to where you ended 2018, still a long way short of the below two times level that you are targeting as being at the top end of that guidance. Is there something specific as you look into 2019 as to where you might see capital allocation going elsewhere? Is there M&A pipeline perhaps that you have got greater visibility on as we look forward? And how will you evolve the share buyback discussions? Is this is a once a year decision you will make or as you go through the year, will this be an ongoing discussion you will have with the Supervisory Board as to the right size of that buyback? And secondly, I wonder if I can just ask a little bit about input cost pressures. You mentioned this in the presentation. You have talked about it through the second half of 2018. What's the scale of input cost pressure you are facing do you think for 2019? And what have you been doing and what do you hope to continue to do to really mitigate that risk from the margin standpoint?

Cees 't Hart

Thank you Tom. Over to Heine.

Heine Dalsgaard

Yes. Good morning Simon. And so on the share buyback, so first of all, this is not an exact science as to what the amount is going to be. There are two key comments here. The first is that, we are a cautious company and we want to maintain a strong and conservative balance sheet and at the same time we also want to maintain our fire power for potential M&A going forward.

The overall principle for the deciding the size of cash return is that take a pragmatic view and look at our levers for the proceeding year and the outlook for the coming year. And this has been the basis for what we distribute to shareholders. That's not an exact science but that is sort of the principle we are using. And you are right, 1.5 is below two. And below two in terms of leverage is sort of what we are aiming for. And with these numbers, all else things being equal, we are looking something around 1.5 towards the year-end 2019.

Then, whether this is an ongoing thing with share buyback, that is definitely something that we will discuss with the Supervisory Board from time to time. Currently, the decision from the Supervisory Board is that we will continue with share buybacks. It can, of course, change in the future depending on our need for cash to expand the business and also depending on other sort of inorganic opportunities that may come up.

In terms of the input costs outlook for 2019, you are right that we do see a significant cost pressure coming into 2019. And we have discussed it before. We are well hedged for 2019. We don't discuss or disclose the exact hedging but we are well hedged. That's basically it. And we will sort of maintain our aim to ensure that the cost increase impact comes through pricing and mix.

Simon Hales

And can I just follow-up on the last one, Heine? Can you tell us what the actual input cost inflation is as you think you are seeing in 2019 versus 2018? And outside of what you mentioned in Eastern Europe, have you taken pricing elsewhere yet to offset that?

Heine Dalsgaard

So we expect COGS per hectoliter for across the group to increase by 2% to 3%. And as yet, we don't comment specifically on what we do in individual markets. But he plan is and that's what we are targeting and that's what we are planning for is to mitigate this through price and mix impacts. And then when we do it, it's something that is very specific market to market.

Simon Hales

Perfect. Thank you.

Cees 't Hart

Thank you.

Operator

Your next question comes from the line of Jonas Guldborg from Danske Bank. Please go ahead.

Jonas Guldborg

Yes. Good morning and thank you for taking my questions. First of all, on trade working capital, you have managed to outperform your own expectations once again. What have you put in for 2019 of expectations? Is there any one-offs in the later part of the year that will affect the development negatively in 2019? Or should we expect an improvement? Then you mentioned that you have seen a significant profitability improvement in India from volumes and other things. Could you update us on where your profitability is in India? And then my last question is on Russia. Is there any reason for not seeing any positive mix effects in Q4? Was that due to the interruptions you had with a customer? Or is it something to do with the Efes and ABI merger? Or what else could it be? Thank you.

Cees 't Hart

Okay. Thank you Jonas. The first question about trade working capital, Heine?

Heine Dalsgaard

Yes. Hi Jonas. So on trade working capital, I think we saw better performance on trade working capital at the end of the year than expected. And that is basically due to continued strong discipline and focus on cash across the entire group. We are with the minus 15% trade working capital amount for the year. It's always difficult to sustain world class, but we will maintain also for 2019 strict discipline. There are no sort of particular one-offs worth mentioning. We expect for 2019 sort of a total effect of around zero in terms of DKK and we are satisfied if we can stay within sort of a relative trade working capital of minus 14% to minus 16%.

Jonas Guldborg

Okay.

Cees 't Hart

With regard to India, we are really on a nice trajectory there. The price mix was 10%. So we did almost 90% volume and 27% value, which of course is very good. Our share is increasing. The market growth was 12%. So we lead the market. And obviously, at the moment the price mix is good. As we get the throughput of the volumes around breweries, the profitability improves. So where we were breakeven three years ago, we rally now are in double digit EBIT margin position in India. We are on the right track.

With regards to Russia, there we see, you were talking about pricing. Yes, Q4 had an impact of a big retailer in Russia that had some issues with our price increases. On the other hand, PET segment is still growing a bit and it had some negative impact on the total pricing of the beer category.

Jonas Guldborg

Okay. Very clear. Thank you very much.

Cees 't Hart

Thank you Jonas.

Operator

And the next question comes from the line of Ed Mundy from Jefferies. Please go ahead.

Ed Mundy

Hi. Good morning. I only have three questions, please. On your guidance of mid single digit EBIT growth, are you able to provide any color by region? And also do you expect to continue to invest behind SAIL'22 initiatives within that guidance? Second question is on China. You are seeing a very good trajectory here on both volumes and price mix. Could you provide a bit more color as to how many cities you are in now and how we should think about the opportunity for China over the next few years? And then the third question is on the tax rate which fell about 100 bips in 2018. Should we expect a similar step-down for 2019?

Cees 't Hart

Thank you Ed. With regard to the guidance, Heine?

Heine Dalsgaard

Yes. Hi Ed. So our guidance on organic operating profit is mid single digit. We don't split it per region.

And to your question as to whether we will continue with our SAIL'22 investments, that is definitely a yes. We have seen hat Funding the Journey worked very well and we have seen that the investments that we put into the topline into growth initiatives working very well also in year. So yes, definitely we will continue with SAIL investments also going forward.

And if I just take the tax rate, on the tax rate, you are right. We are 100 basis points below where we were and we guided with below 29% and we hit 28%. This year, we guide with below 28% and that is basically our guidance. Where we specifically is something we will come back to. But for 2017 and 2018, we guided with below 29% and we hit 28%.

Cees 't Hart

And Ed, regarding your question about the cities where we are in. By the end of 2018, we were more than 20 cities. At the end of 2019, we expect to be in between 30 and 40 cities, which is very important for our international premium brand portfolio that grew in 2018 by 13%. Just give you some details on that. Carlsberg is 11%, Tuborg 12% and 1664 Blanc is 15%. So the further rollout in the big cities is quite important for us.

Ed Mundy

Okay. Thank you very much.

Cees 't Hart

Thank you.

Operator

And the next question comes from the line of Mitch Collett from Goldman Sachs. Please go ahead.

Mitch Collett

Hi there. Can you comment on organic sales growth for F2019? Do you think you would be within the 2% to 4% medium term range you guided to, I think at your Investor Seminar back in 2017? And then secondly, now that Funding the Journey has ended, I just wondered whether you could comment on where you would expect margin expansion to come from going forward? If I look at what you have delivered in terms of Funding the Journey and then net of the reinvestment, it's roughly the same as the organic EBIT growth you have achieved across that period. Do you expect there to be other drivers of margin expansion going forward? And then a final one on CapEx versus depreciation, which are broadly equal. I noticed that your CapEx is running head of depreciation in Western Europe and then below in both Asia and Eastern Europe. Is that the impact of DraughtMaster and should we expect that shape to continue? Thank you.

Cees 't Hart

Thank you Mitch and good morning. Let me take the first question and Heine the other two. What we said already is, we don't guide on the topline. However, we want to continue to grow the topline. But of course, it will be a bit more challenging this year due to last year's strong performance. But we, in general, commit over the period of 2017 to 2022 to grow the topline by 2% to 4% organic.

Heine?

Heine Dalsgaard

Yes. Hi Mitch. And on the Funding the Journey going forward and how we see the margin progression, so we said before that, well, for this year, we are guiding with mid single digit. We have said that we will continue the journey also after 2019 in terms of improving our operating profit organically. So that remains the key priority for 2019 and also for 2020 and afterwards. Where is the margin improving going to come from, well, basically more or less the same levers as we have used in the past which is sort of value management.

So that's pricing and mix. It is supply chain efficiencies. And then it's strict discipline in general on our costs, our SG&A cost and our OpEx costs in general, so across the line. Then on top of this, the more than DKK1 billion that we have invested in particular in 2017 and 2018 in SAIL investments also give us benefits in terms of margin progression. So even though Funding the Journey program will close, Funding the Journey as a mentality, way of living and as the focus will definitely continue.

In terms of CapEx versus depreciations, you are right that there is a regional difference and that will probably continue. What we can say is that what we have done over the last few years in terms of CapEx is not to under-invest, definitely not. But we have implemented a strict discipline on where we allocate our CapEx and that is what you see come through now that it follows that our priorities and our SAIL sort of projects.

Mitch Collett

Got it. And one unrelated follow-up which is just a clarification. The guidance you have given for finance costs in 2019, I assume that's post the impact of your buyback?

Heine Dalsgaard

That is including impact of our buyback, yes.

Mitch Collett

Okay. Thank you.

Cees 't Hart

Thank you Mitch.

Operator

The question comes from the line of Hans Gregersen from Nordea. Please go ahead.

Hans Gregersen

Good morning. First question on Russia. We have seen during 2017 and 2018, there has been quite hefty promotional activity level from one of your competitors. Have you seen any sign of that easening in the beginning of 2019? Or do we still need further time before you can make a call on that? That's the first question. Second question, a little bit accounting. When you made the big investments in your IT supply chain systems, you had a significant investment that would undergo depreciation charges. Are they coming to an end? And how should we assume depreciation continuing going forward? Thirdly, on the U.K. Can you give an update on when we should expect the negative revenue turn to stabilize? And then finally, just one quick accounting question. If you look on the estimates and assumptions you are applying into the accounting principles, are there any change in the 2018 accounts versus the 2017 accounts? Thank you.

Cees 't Hart

Thank you Hans and good morning. With regard to Russia and let's say the investments of our competitors, main competitor, if you like, there was the World Cup and our main competitor was the sponsor of that. So you can imagine that there was extra support money. We have not seen an effect directly in our market share. Our market share did not really suffer from that. So in that respect, we answered that challenge well. It's a sizable number two player but we don' know yet how they really will behave in the market and whether they will continue with this kind of high-level support promotions. We don't think that because after the World Cup, we show a reduced level of promotions, but of course other activities.

Heine, over to you.

Heine Dalsgaard

Yes. Good morning Hans. You are right that we have reduced to our depreciations over the last year. And you are also right that a part that comes from the lower depreciations relating to the investments we made a few years ago into our setup in Western Europe, what we call the BSP1 structure. For 2019, you can expect depreciations around DKK4 billion.

Then, if I take the last one on accounting. U.K., Cees?

Cees 't Hart

With regard to the U.K., you are right that if we look across all markets globally, the U.K. business is probably the one where we are most disappointed on performance and we are focused on improving the profitability. The market share loss is mainly driven by a decline in banking segments as consumers are trading up and we over index, as you know, in the mainstream. The Carlsberg brand continues to lose their share and we will have our relaunch announced more or less as we speak. Then in 2018, we saw a further decline of our net revenue because of the planned close of the porterage business. So in total, we are good plans for U.K. It's a difficult market. And it's for us, very important that the relaunch of Carlsberg will be successful.

Heine Dalsgaard

And now the accounting. Hans, you asked a question about the accounting changes from 2017 into 2018. So there are a few changes. They are described in detail. It's relating to IFRS 15 --

Hans Gregersen

Heine, sorry, the question was, when you prepare the accounts, you as a management make assumptions and estimates going into the accounting principles? That was what I was asking about, if there is any changes in those in 2018 versus the 2017's?

Heine Dalsgaard

No. I can tell you that is not the case. We apply the same logic and rationale behind our estimates as in 2018 as we did in 2017.

Hans Gregersen

Thank you.

Cees 't Hart

Good, Hans.

Operator

And the question comes from the line of Søren Samsøe from SEB. Please go ahead.

Søren Samsøe

Yes. Good morning. First question on your margin and profitability. Given your higher topline, you would expect a higher underlying at least productivity and maybe margins, but I understand why your EBIT margin is down given your higher marketing costs, et cetera. But why is your gross margin down? If you could give some flavor and details to this? In second half, sorry, I mean.

Heine Dalsgaard

Hi Søren. So you are right. So revenue is strong and also our profit is strong and we also have a good progress on our overall group margin of 30 basis points. So we are very satisfied with that. If you look into the second half in particular, there are some one-offs benefits that some of them hits OpEx, some of them hits in COGS and it is relating to acceleration of SAIL reinvestment. And then in particular, in Eastern Europe, we in the second half and you can see that in the numbers as well, we were hit by negative FX and we were hit by higher commodities, in particular packaging.

Søren Samsøe

Okay. And then the higher OpEx level you apply for the second half versus sales, is that also similar OpEx level you have assumed behind your 2019 guidance?

Heine Dalsgaard

No. So when we look at our 2019 guidance, we take out seasonality within the year and we look at the full-year. So what you can expect is that the baseline for 2019 in terms of OpEx is full year 2019.

Søren Samsøe

Okay. So we should expect these sort of high our investment levels that you are seeing in second half that you will continue to sort of invest at that level for the full year 2019? Is that what you are saying?

Heine Dalsgaard

No. We can't really see that and say that. What you can expect is that the full-year net effect, so you should look at the full-year OpEx and compare for 2018 and compare that to our assumptions for then 2019. In 2018, for many, many reasons we skewed, in particular, our SAIL investments towards the second half part of the year. This year, we are starting our SAIL investments up earlier in the year. So we expect to invest more in SAIL in first half versus second half in comparison with 2018.

Søren Samsøe

Okay. That's helpful. And then on Asia, you had 14% growth in Q4 organic. Of course, I understand there are some easy comparables especially in India but could you give us the growth in China and India and the rest of Asia in Q4?

Cees 't Hart

Well, we will come back on that one. I don't that on hand now. Peter will give you a call.

Søren Samsøe

Thank you. And then final question on your free cash flow. It seems to be about flattish for the year. Maybe you could give some flavor of what is your ambition going forward to 2022 in terms of your development of your free cash flow? Thank you.

Cees 't Hart

Heine?

Heine Dalsgaard

Yes. So when you look into the free cash flow, you have take into account that we invested quite dramatically in the second half of the year, particularly in Cambrew and in Super Bock. If you look at the operating cash flow, it's actually quite strong and slightly up versus last year. Going forward, we will maintain the strict discipline we have on cash and that goes to both trade working capital and it goes as well for our CapEx investments. For 2019, you can expect a working capital of around zero, depending on the country mix and CapEx of around DKK4.5 billion, as said and tax and interest in the cash flow statement assume they consume around DKK2.5 billion to DKK3 billion. So cash is a way of living in Carlsberg. It will remain a way of living for 2019 and also going forward. And we don't comment specifically on numbers. You know that, Søren, beyond 2019.

Søren Samsøe

Okay. Thank you. It was just more sort of your thoughts and ambitions. So thank you for that.

Cees 't Hart

Thank you.

Operator

And your next question comes from the line of Andrea Pistacchi from Deutsche Bank. Please go ahead.

Andrea Pistacchi

Yes. Good morning. I have three questions, please. The first one on Europe. You had a strong Q4, I think about 6.5% organic sales growth. Now Q2 and Q3 had been very strong in Europe but then you had some one-off benefits from the weather. My understanding is that Q4 is a sort of clean quarter with no specific one-offs. And obviously 6.5% growth is a lot better than you were delivering a couple of years ago. So could you just comment on that, whether there were any maybe factors helping Q4 or not? Secondly, on Russia, you talked a bit about the pricing environment still maybe uncertain but you sound cautiously optimistic. What do you think about the market in Russia in 2019, given no World Cup and comps? And then finally, just a question on the buyback. I understand the rationale of splitting the buyback into two tranches of DKK2.5 billion and DKK2 billion. Is that because you generate typically more cash in H1? And whether theoretically, it would be possible, for example, to seek approval from the Board at the half year potentially to raise the buyback should you be comfortable with the cash you are generating?

Cees 't Hart

Very good. Thank you and good morning Andrea. With regard to Europe, no specific factors for Q4. The Nordics were up. England had a good quarter, France had a good quarter. The Balkans had a good quarter. We see the revenues of DraughtMaster growing. So it was just a good quarter. We were satisfied with that. Q4 2017 was not the strongest in that respect. It was a good and forecasted strong quarter.

Then with regard to Russia and as you know, the market declined by 4% to 5% in 2017. And then in 2018, it grew by an estimated 3% and we think that is due to a good weather in June and the World Cup in the Q3 and we plan for a flattish market with a slight negative bias. We remain cautious on the Russian market and don't want to make too precise predictions. So let's say the market is around flattish.

Then over to you, Heine.

Heine Dalsgaard

Yes. Andrea, so on buybacks split in two tranches, you are right. The intention definitely is to initiate also the second tranche following our first half announcement in August this year. The reason to split the buyback in two is basically to give more flexibility to adjust for potential M&A and overall business needs. Can the second half tranche of DKK2 billion increase? Yes, it can but it is not the plan. The plan is the DKK2 billion.

Andrea Pistacchi

Okay. Thank you.

Cees 't Hart

Thank you.

Operator

And the next question comes from the line of Richard Withagen from Kepler Cheuvreux. Please go ahead.

Richard Withagen

Yes. Good morning all. Two questions, please. First of all, on marketing spending. Perhaps can you give some background on how marketing spending has changed as part of Funding the Journey? And have you developed any internal tools to improve the marketing function? And also, how will marketing spending develop in the future? Will it continue to go up? Second question is on the regional priorities. Heine, you mentioned it there briefly, but especially on Western Europe, will them be more focus on topline growth and less on margins than in 2018? And probably related to that, will it be specialty beers, crafts, alcohol-free beers, will that be the main focus of generating topline growth in Western Europe?

Cees 't Hart

Good. You take the second part and I will the first, Heine. And so with regard to first one, the marketing expenditures. Well, we think that our marketing team or better to say, the commercial team, group commercial has seen quite a lot of changes over the last few years. It's based on the activities we wanted to develop for the SAIL'22 roll-out and they have prepared the programs crafts, specialties, alcohol-free beer but as well on the local power brands because we see a lot of commonalities between these brands and of course the international power brands we have as well supported quite well. So we have first of all, strengthened our group commercial. Then, based on our strategy, we allocate the resources across the markets. We do that on the basis of investment cases and we see this, for example, coming back now in the strong growth of the craft, specialties. You saw more than 30% in Western Europe on alcohol-free beer. The big cities, the DraughtMaster and probably see is that allocations based on business cases are now giving the returns. The way forward is that we continue to see that we want, of course, to invest in the markets. The P&L needs to be balanced. But for next year, we have as well an increase versus well, more or less the same kind of the level of investments like this year and 2018 as you know was already an increased of DKK700 million. We see good returns as we continue with investing in our brands.

Heine?

Heine Dalsgaard

Yes. Hi Richard. And then to your question on the prices for Western Europe. There is no change in our priorities for Western Europe. The journey basically continues that started a few years ago. There will be strong focus on margin progression in Western Europe. Also going forward, Western Europe will be a significant part of the group's continued margin progression journey. In terms of Western Europe, focus will continue both on topline and bottomline, on bottomline specifically. The cost discipline that we have had in Western Europe over the last years will continue also going forward. And then you will see that the SAIL'22 at the topline that are focused, we have had in particular in 2018 will continue also in yeas to come. So both topline focus and cost discipline will make us continue the margin progression journey looking ahead. And that's the same as we have seen in 2018.

In terms of the SIL'22 priorities, the way it has been that we are investing our money in Western Europe. It is, you are right, in craft and specialty. It is also in alcohol-free. We see a very significant increase in alcohol-free across Western Europe and we are putting a lot of money behind that also going forward. Then it is DraughtMaster, as you know, being rolled out now in a lot of European markets and the journey will continue. And then it is our local power brands.

Richard Withagen

That's very good. Thank you.

Cees 't Hart

Thank you Richard.

Operator

And the next question comes from the line of Trevor Stirling from Bernstein. Please go ahead.

Trevor Stirling

Good morning Cees and Heine. So a lot of my questions have been answered already, but two quick ones, please. The first one relating to Eastern Europe. Regional price mix was 6% but Russia was only 2%. So does it imply that Ukrainian price mix is very strong? And if that's so, could you maybe just give the split between price and mix in the Ukraine? And the second question, I guess the internal discussions around Habeco. Do you have any update on the Habeco negotiations case?

Cees 't Hart

Thank you Trevor and very good morning, Yes, you are right. In Eastern Europe, we have mainly the Ukraine that is driving the topline, if you like. And just looking at the main figures now, in Ukraine we made 5.1% volume and 25.2% in value. So in that respect, that's the real driver. I don't have the difference between the mix and price but I know that the majority is price.

With regards to Habeco, no new update. We continue our conversations. It has been said that the Vietnamese government would like to finish the privatization project by the end of 2020. And Habeco is part of that, that's of course what we take into consideration into our own planning.

Trevor Stirling

Thank you very much.

Cees 't Hart

Thank you Trevor. Can I have the last question please?

Operator

And the last question comes from the line of Fernando Ferreira from Bank of America Merrill Lynch. Please go ahead.

Fernando Ferreira

Good morning Cees and Heine. Thanks for the questions. I have three, please. First one is still on marketing. Despite the strong growth we saw, they still appear to be a bit below some of your peers in terms of a percentage of revenues. So just wondering if you have a target level in your mind going forward for what's the appropriate level of marketing investments in your business? Second question, if you can comment on how relevant are the alcohol-free beers and craft and specialty as a percentage of group revenues today? And lastly, there is a Bloomberg headlines saying that in China, the year started well for Carlsberg. So if you can please discuss the expectations for 2019 in China, please, given the stronger year you had last year? Thank you.

Cees 't Hart

Thank you. With regard to the marketing investment, basically we don't look so much on the percentage. We look at what market needs and as depending on the strengths of our plants. But because of the Funding the Journey, we have the money to invest in these markets and these brands.

With regard to the share of craft, specialties and AFB in our market, it's 7% volume and 30% revenue in total. So it becomes to be a real significant part of our total portfolio.

And the third question was, Fernando? Sorry, I didn't get it.

Fernando Ferreira

Sure. China expectations for 2019 because a headline of the year started well, yes?

Cees 't Hart

Yes, that's it. That was the headline. The year started well. It's only February now. That is, more or less, as we speak in China and it's very important for us, of course, to have the right trade loading before that period starts and we were satisfied, very satisfied with that part. But as you know, the year is still long, but it's always good to have a good start.

Fernando Ferreira

Right. Thank you.

Cees 't Hart

Thank you. This now brings us to the end of the call and thank you for listening in and thank you for your questions. We are looking forward to meeting some of you during the coming days and weeks. Have a nice day. Thank you.

Operator

This now concludes our conference call. Thank you all for attending. You may now disconnect your lines.