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Annabelle Degroot: Zambrew Finance Director

Africansens is pleased to publish the podcast and full transcript of the recent combined Zambian Breweries plc and National Breweries plc investor conference call below

Audio recording of the Combined Conference Call




Conference Call transcript 

26 November 2015

HALF YEAR RESULTS

Operator
Good afternoon ladies and gentlemen and welcome to the combined half year earnings call for Zambian Breweries Plc and National Breweries Plc hosted by Annabelle Degroot, the group Managing Director. All participants will be in listen-only mode. There will be an opportunity to ask questions at the end of the presentation. If you should require any assistance during the conference then please signal an operator by pressing star and then zero on your touchtone phone. Please also note that this conference is being recorded. I would now like to hand it over to Annabelle Degroot. Please go ahead, ma’am.

Annabelle Degroot
Good afternoon everybody and a warm welcome to our sixth investor conference call. The related earnings releases today by Zambrew and Natbrew and my presentation should have been emailed to you already. These documents are available on www.zambrew.com and are being released on the Lusaka Stock Exchange website today. If we lose our connection, as has happened in the past, please be patient as our service providers will reconnect us. I bring your attention to the usual forward-looking information disclaimer in my presentation.

I will now take you through the performance of Zambian Breweries and then National Breweries respectively. If I take you to page three of the presentation it sets out the agenda for today, whereby I will take you through an overview of our trading and business environment, our strategic review, our sustainable development, our financial highlights, capex expenditure and then ending with our prospects for the second half. The picture on the right on the agenda shows the good progress that we’ve made on our maltings plant in the Lusaka south MFEZ zone. And the maltings plant is due for commissioning in March 2016.

Turning to page four, and to take you through the trading and business environment, I will give you the highlights for the first six months of the year. Essentially we had good local currency results with operating profit up 57%. And that came on the back of a sharp decline last year, and so this is particularly pleasing for the group. These results came through despite a tough economic environment and trading conditions. We had significant power shortages with most of our breweries on eight hours of generator power a day. We had water restrictions coming through, and of course there was a sharp depreciation of the exchange rate in the period and now increasingly rising interest rates.

As a result of this, affordability for our consumers has become even more relevant in the period and our volume growth really came on the back of us actually dropping the price of our mainstream beer in 375ml packs from 6.5 kwacha to 6 kwacha. That really gave volumes a good kicker. To back that up we launched a 750ml pack in Mosi, Castle and more recently in Carling Black Label. That 750ml pack is an affordable offering and is priced at a discount per litre to the 375ml. That gave us good growth in the period.

Similarly Eagle Lager which is priced at 67% of mainstream grew by 72% in the period. That is priced at 4 kwacha versus the 6 kwacha and is our local sorghum/cassava blend beer. It is a great beer and it is a great price point, so we really drove that affordable offering up during the period. We have unfortunately had a continued lack of enforcement at the border, allowing Castle Lite smuggling to be rampant, quite frankly. We estimate approximately 55% of the Castle Lite sold in this period was actually sold by smugglers as opposed to Zambian Breweries. I’m pleased to report that towards the end of this first half and as a result of increased lobbying with government the border controls tightened and Castle Lite smuggling actually declined. Now with the weakened exchange rate it has made it even harder for smugglers to bring in Castle Lite.

The good news is that we entered the AFB category in a much stronger way. That is competing with ciders. And we came in with Flying Fish and Redds Vodka Lemon with good launches and really great progress in the market. So we have started to take good share in that category. Constrained disposable income for our soft drinks consumers led to a real decline in our 300ml RGB returnable glass bottle offering. And similarly there is a real change in consumer preferences in soft drinks whereby consumers are choosing to move towards the plastic PET offering.

So we took the price of our 300ml RGB soft drink offering up at the beginning of this year. It is the first increase we’ve had in five years. The price went from 2 kwacha to 2.50 kwacha and the consumer took that hit. That is really our consumer who has a little bit of money in their pocket, and they were unable to afford that drink. And we’ve seen a sharp decline in that RGB offering as a result. Similarly the consumers that did have money in their pocket have chosen the PET, and so we now see good growth in the PET offering. I’m pleased to report that CSD soft drink sales returned to year on year growth in the month of September and that momentum has continued in the current period.

The good news is we’ve taken market share in both beer and soft drinks, actually in beer, soft drinks and AFBs in the period with good share progress. We have also embarked on a significant government and key stakeholder engagement. The last time I presented to you we spoke of the issues we had with our reputation in the market, not being visible enough and not engaging enough with government. We have spent an awful lot of time telling our story and listening to government in the last six months, and making some strong commitments to them. As a result they announced an excise break on clear beer from 60% to 40% effective 1st January 2016. And that was announced in early October. As we recall it was the increase in excise that really caused the decline in profitability last year as our volumes took a significant hit. So government has listened to our story, listening to our commitment and is now convinced that affordable beer pricing is the way to go and is the way to attract investment and long-term growth. So that has been a particularly pleasing development.

However, our local and particularly our US Dollar reported results have been significantly impacted by the depreciating kwacha. We have a good hedging strategy in place that minimised the transactional impact to date, but obviously as we translate our results into US Dollars our results are impacted. And we expect that to get worse in the second period.

If I move you on to page five and give you a strategic review of the business, essentially I took over the management of this business in December last year, and as you recall the business had been in real decline. As a leadership team we sat down and decided what the five key pillars were in terms of turning this business around. And they were competitiveness. We have had a real focus on regaining market share, and that has come through now in the volumes. We have had a big focus on developing sales-led organisation. Our organisation had become quite inwardly focused on resolving manufacturing and supply chain issues, and now that we had some of that sorted out we are looking far more outwards to try and push sales and increase in-market execution.

We have also focused on fostering a performance culture in the business. That’s a long-term vision, something that we keep working on in terms of driving performance and accountability in our staff. We spent significant amount of time improving our corporate reputation. We have done a lot with stakeholder engagement and then driving some big projects which I will take you through shortly. And then finally cost leadership. The reality is especially with the exchange rate and our affordability agenda we have to manage our costs and take real leadership in terms of doing things differently and driving costs down. The excise relief on 1st January will allow us to keep this affordability agenda going, but will then allow us to make long-term decisions for investment going forward. As we see some margin recovery the business case for investment has improved.

We will however next year continue to focus on dry area penetration and MDC models to capture new growth complemented by sustainable credit offering. Essentially what that is about is going to new areas of Zambia that have opened up in terms of our road network and accessing new consumers where we have never sold beer or soft drinks before. As I believe the economy is going to tighten up in the next six months or so it is essential that we go out and look for new areas of growth.

If I take you to page six it sets out our sustainability agenda which I have explained in previous presentations. Really just to explain in the last six months we have kick-started that in a big way. Under a thriving world we have the Mama Mpapa project now which has an aim to train 2,000 retailers in entrepreneurial skills. Then with respect to the next agenda, a sociable world, we have done significant alcohol training and responsible retailing training with those retailers. And we will access 2,000 in the short term. In terms of a resilient world we have now started work on securing the water source for our big Ndola brewery where we will be expanding in the future. That involves relocating households and some real restoration around those springs.

In terms of the clean world something I’m particularly proud of is Zambian Breweries and National Breweries have launched the Manja Pamodzi project, a big recycling project where we’re aiming at making an impact in Zambia in terms of collecting plastic bottles from any brand and Chibuku cartons. That has started really ramping up at the moment. Then finally in terms of a productive world we are pleased now particularly with the excise break we will be able to grow our barley crop further, and of course the maltings coming on line in March 2016 is a great development for the business.

I will now take you through the financial highlights. If you go to page eight as you can see lager volume was up 21% largely driven by the price reduction in January, the growth of the 750ml packs and then the 72% growth of the Eagle brand. Soft drinks, as I mentioned, volume growth was down 10%. That is a combination of growth in the PET offering but a significant 23% decline in our RGB glass bottle pack. As I said that has now started to return to month on month growth and soft drinks is back into year on year growth.

A pleasing result is that despite taking prices down on beers we have net producer’s revenue growth of 10% clearly because of the growth in beers but also the mix towards beers from soft drinks. Our gross profit grew 17% in local currency. We really managed to leverage the gross profit margin up from the 10% revenue growth by driving costs down in our total cost of distribution and total cost of manufacturing. Those were two initiatives that SABMiller is pursuing in terms of really looking at distribution and manufacturing across the supply chain and driving those costs down. We have made good progress on that in the six months.

As a result of that and managing our fixed costs, almost flat on prior year, we have had operating profit growth of 57% which compared to the decline in prior years is a great result. As I mentioned we have had a good hedging strategy in place. While the exchange rate is hovering around 13 kwacha at the moment we are currently hedged between 8 kwacha and 9 kwacha to the US Dollar for the next six months which has helped minimise the transactional exchange impact on our P&L. but it will start to unwind in the second half.

We have had good margin growth due to the mix towards beer and the cost savings. Our finance costs are up 9%. We have been on a deliberate drive to drop our debt levels down, but this 9% reflects the increased borrowing rates in the country. The good news for Zambian Breweries is that all of our debt is Kwacha denominated so we are not exposed to exchange risks on our finance costs. This flows down nicely to a profit after tax growth of 87%, and as a result of the good performance the board declared a 75% interim dividend at the half year.

I won’t take you through the details of the financial performance slides on pages ten and 11 other than to point out particularly on page 11 the impact of the US Dollar translation on our results. While we had operating profit increase of 57% in Kwacha that has only been 23% in Dollars and similarly that flows through to the bottom line. We do expect the exchange impact to worsen in the second half, so these results will not look as good in the second half.

Moving on now to page 12, there are a lot of ratios there. Just to point out in terms of margin recovery that is something that we’ve been focusing on significantly. Operating profit margin is back up to 23% compared to the 17% last year. And then gross profit margin despite the transactional exchange issues holding there at 50.2%. Our effective tax rate is still below the 35% because of our investment benefit coming through on the big investment. And the debt ratios are looking much better now compared to a few years ago.

If I move to page 13 what this shows is that as Zambian Breweries we have invested $358 million in this economy over the last seven years. That is a significant investment. And as you can see the capex is starting to slow down now because there is a real drive for us to start sweating the assets, minimise our capital investment over the next few years and limit it to essential capacity upgrades. There will be a general pullback on capex investment for the future.

Our prospects for the second half on slide 14, despite the good news we are anticipating a real slowdown in quarter four. We believe the inflation rate which was reported today at 19%, the interest rates that are up as high as 30% for borrowers and the exchange rate to really start to impact on disposable income. There have also been some announcements yesterday of 4,000 job losses in the mining sector. And the currency impact remains uncertain in the second half at the moment. We are currently experiencing a peak season but we do anticipate a real slowdown in quarter four. Power and water restrictions remain a major concern and will add significant cost in the second half to the business as we continue to run on generators on a daily basis and put water backup plans in place.

We will continue to focus on the affordability agenda. And one thing that the excise rate does allow us is to at least hold price or take minimal price increases compared to what we would have had to take previously. The good news is Castle Lite smuggling is almost over. There are a couple of key distributors still bringing in products, but when the excise rate adjusts then our beer will be very comparable to the regional prices and Castle Lite smuggling will come to an end. That gives us a significant kicker as we take that 55% of smuggled beer back into our business. As a result we have just recently announced that we will move back to local Castle Lite production after investing $2 million in labelling capability for next year.

As a result we will continue to closely manage our cost to cope with the reality of the depreciated Kwacha and the impact on our margins. Strategic infrastructure investment will go ahead. We do continue to invest, but we will not be investing the large sums that have been invested in the past until those assets have really started to pay for themselves. So we expect to have some packaging investment in the next year and we have already ordered a soft drinks PET plastic packaging line for the mill. Our maltings plant, as I mentioned, will come on stream in March 2016 and there will be more focus in the second half on developing the cassava value chain for our Eagle brand. We have now introduced cassava into our Eagle so it is now a sorghum cassava blend. The aim is to grow this brand so that those sorghum and cassava volumes increase from small-scale farmers but also to [break in audio]. So we will be working through that supply chain all the way down to the small-scale farmers.

Finally an issue that often comes up is that we continue to engage with the stock exchange and LUSE to address the 75% shareholding requirement. We are not compliant, but we do have a plan in place that has been approved by LUSE at the moment, and so we continue to work towards compliance. That is all I have for Zambian Breweries. If we could move on to questions about Zambian Breweries.

Operator
Thank you. At this time if you would like to ask a question regarding Zambian Breweries Plc results please press star and then one now. If however you decide to withdraw your question from the queue please press star and then two. I repeat, at this time if you would like to ask a question regarding the Zambian Breweries Plc results please press star and then one. Right, we have a question from John Munge from Kingsway Capital. Please go ahead, John.

John Munge
Hello. My question is with regards to the hedging strategy that you talked about in slide four. I just wanted to know exactly what is being hedged, which instruments are you using, and to what extent? How large are these hedges?

Annabelle Degroot
John, thank you for your question. SABMiller has the same way of hedging that we apply throughout Africa. In Zambia we hedge forward six months and we use normal forward contracts. We don’t use any other types of instruments. And we hedge our capex and more material import flows out six months within certain guardrails. So the prior year we had some losses as a result of that hedging strategy, but as you know hedging is meant to even out over time. We have had gains in this period that have helped us with some of our costs.

John Munge 
Thanks.

Operator 
Our next question comes from John Leopold from SQM. Please go ahead, John.

John Leopold
Hi. Just to follow up on that last question. So you’ve got hedges in place. Presumably that has helped you not have to raise prices very quickly with the exchange rate dropping. How do you think that’s going to play out next year as the hedges wear off? You have some savings on the tax side, but will you be able to raise prices along with the devaluation of the currency enough that margins will stay the same, or do you think the margins will contract?

Annabelle Degroot 
John, I think it is a difficult one to answer. The drop in excise from 60% to 40% gives us some margin relief which does allow us to hold prices as a result and not take margin decline. However, as you say those hedge will unwind and the rate of the appreciation of cost in the market I think will mean that we will be forced to take price next year at some point. We will try and hold it for as long as possible, but we are getting suppliers coming to us requesting 17% and 25% increases. As those costs start to take hold then we will have to take price at some point.

John Leopold 
I mean it is very impressive that you have done as well as you have. I would have thought that the consumers would be really squeezed and that this is going to get worse. Do you think that spending will hang in there, or do you think that consumers are going to really suffer going forward?

Annabelle Degroot
No, I think we have hugely benefitted from the fact that we have kept clear beer affordable. But that reacted with other offerings like the value 750ml pack, like Eagle, and then of course we have our Chibuku business to back that up. So I anticipate that demand will start to fall back in quarter four. What we’re seeing is that the inflation, the exchange rate etc. hasn’t fully taken hold yet. But I fully anticipate it will, and obviously there is quite a lot of talk about government raising fuel prices by 50% and electricity by 300%. Then I think we would be naïve to assume our consumers are going to be able to cope with that. The only benefit we have as a group is we have variable offerings downwards through the ladder in terms of price such as Eagle and Chibuku in our business.

John Leopold
You have got to talk about two separate companies but there is a middle ground here. On the clear beer side you are kind of moving down the chain and creating cassava beer etc. And on the Chibuku side you’re kind of moving up into Chibuku Super. Where do you think the demand will shift? Will it shift all the way down towards the Chibuku or will it go more towards the more affordable clear beer brands?

Annabelle Degroot 
I guess we don’t necessarily see it so much as going down and going up. What we see it as providing price points all the way along the ladder, which allows people to choose. In Zambia people will choose depending on location and depending on the time of the week. They may dip in and out of Chibuku and up to clear beer or up to Eagle. For us it has been very much about providing and offering at different price points and different pack offerings, for example like a shared pack offering, so that we can mitigate this reduction in disposable income. Do I see a down-trade more towards Eagle and Chibuku? Yes I do. But the strategy is to make sure that we have all price points and pack offering available.

John Leopold
And just to give us some kind of general idea, now that Castle Lite is not getting smuggled, how big was that?

Annabelle Degroot
We estimate that the smugglers were selling between 80,000 and 100,000 hectolitres of Castle Lite.

John Leopold
So of your total volume what would that be roughly that you were missing out on?

Annabelle Degroot
We were missing out on all of that. We were selling approximately 66,000 hectolitres. We anticipate that Castle Lite will more than double.

John Leopold 
Okay. Thanks very much.

Operator 
Our next question comes from Jonathan from African Life Financial Services. Please go ahead, Jonathan.

Jonathan
Thanks Annabelle for the presentation. I just had a few questions, the first being what were some of the commitments that you had made with the government to have the excise duty reduced, if you’re able to share on that? Then also could you shed more light on the impact of the load shedding on the business? And then thirdly, we know that the excise duty will be reduced effective 1st January. But with increasing cost can we actually expect a price reduction on the prices of lager, or are we going to see the [unclear]? Thank you.

Annabelle Degroot
Thanks Jonathan. The commitment we made with government was actually to give government the history of how things have played out between dropping excise and raising excise, and what we as Zambian Breweries or SABMiller would do if we were able to grow volumes in the future. The key message we have been able to get across is that if beer remains affordable beer will grow, and you will pull people not necessarily into alcohol but you will pull people from illegal, more illicit non-taxed categories such as spirits and bulk opaque into a more regulated and taxed sector. So painting the total alcohol landscape has very much helped.

But the commitments we have made are really growing barely volumes through growing beer volumes. We have committed to investing in local Castle Lite production. We have committed to growing the cassava value chain such that our Eagle brand grows. And we have committed to affordable beer prices. The important thing to note if I listen to your third question is that we already dropped the price of beer, so we will not be dropping the price of beer with this excise hit. We dropped the price of mainstream beer already on 1st January and that is partly why our engagement with government has been successful.

Their view was that we didn’t sit around and mope for too long. We actually decided on our own to pull back prices to try and kick-start the volume. And we took the margin hit as a result. But we also then proceeded with affordable packs like 750ml which succeeded with Eagle to try and mitigate this impact of excise. That is why it has been a positive engagement. I think government can see that we are following true with our commitments and we are a trusted investor. They understand that with volume growth and decent margin we can then commit to invest in the future particularly in our Ndola plant.

To your second question, the impact of load shedding is both beer and soft drinks in the north and south run on eight hours of generators, particularly in the south every single day. That is now increasing to ten hours. The hit on our P&L is expected to be in the region of $2 million just from diesel and generator costs. We were just discussing this morning that the other impact that is harder to measure is the real damage these voltage fluctuations and irregular timing has on our plant. So we have had to spend quite a lot of money replacing parts that have been damaged as a result. So it is a significant amount. I think Zambian Breweries is better placed to cope with this than other companies. We have invested in large generator capacity over the long term for several years now, and as a result we do have back-up generator capacity at all our plants. And we are obviously a bigger entity who can manage the cost of diesel better than maybe some of the other smaller companies.

Jonathan
Thanks.

Operator 
As a reminder, at this time if you would like to ask any question regarding the Zambian Breweries Plc results please press star then one. Right, Annabelle, that closes the session for Zambian Breweries Q&A.


Annabelle Degroot
Thank you. I will now take you through the National Breweries results for the first half of the year. The agenda is very similar to that of Zambian Breweries. That is on page 18. The photo there shows you the Chibuku Super, our innovative premium product in Chibuku that is now being manufactured on a large scale in our new Lusaka brewery that came up in the year.

On page 19 I will take you through the trading and business environment for this business. Again we had good local currency results, not as good as Zambian Breweries, but much better local currency results on the back of the significant decline last year. This has again been despite the tough economic climate and challenging trading conditions. The business has really experienced a real turnaround particularly in the second quarter of the first half, and we now are continuing that momentum throughout. The principal problem in this business last year and at the beginning of this year was the design and commissioning problems we had with the new Lusaka brewery. It was really very challenging, but I’m pleased to report that these technical issues have been resolved and we are getting great volumes out of that plant.

The other real benefit that we’ve had, as we talked about on previous calls we have integrated the operating functions of Zambian Breweries and National Breweries, so a lot of the technical and S&D expertise that we’ve been able to develop over time in Zambian Breweries is now being shared with our sister company. So the technical focus we have from our combined team meant that we have greatly increased production reliability in that business, and most importantly quality has improved across all five plants. So when we took it over we really had some serious quality issues that meant that we had lost some market share. Similarly the combined sales and distribution team have placed significant focus on our route to market strategy in that business. They really focus on consistently supplying good-quality products day after day to our consumers and customers, but also increasing our geographic footprint for our deliveries.

The good news is that with real focus and the right pricing and quality our new product, Super, has really taken off and our volumes have grown by 75% over prior year including our margin mix. You may recall from previous calls this is a higher-margin product. Carton volumes were in decline last year as a result of our loss of market share and our technical issues and quality issues. I’m pleased to report that carton volumes were back into growth in quarter two and that momentum has continued. Similarly we have taken good market share from our competitors in this category.

While we have also managed to gain efficiencies through cost control our profitability and margins in this business are under significant pressure as a result of the foreign currency impact on the cost of importing raw materials associated with packaging. Again we are hedged forward in this business, but the increase in the packaging cost has really hurt this business. 70% of the cost of putting a carton of Chibuku on the market is actually the packaging that it comes in. It is Euro-based and that contribution to cost has been [unclear] and as a result you can see that our margins in this business have not grown well enough yet.

In terms of the strategic view on page 20 again I will take you through the key pillars. I said five key pillars there, but actually for this business we had six key pillars very similar to Zambian Breweries in terms of driving competitiveness, driving our market share and fighting against the bulk opaque in the market. For this business we had a real business turnaround strategy to get Chibuku back on track and looking forward. Again we focus on the sales-led organisation, fostering a performance culture in Chibuku which hasn’t been there in the past, and then again improving our corporate reputation and managing our cost. All of that combined together has given us the good volume growth that you see today.

We are going to remain focused on growing Chibuku Super PET particularly in the regional and dry areas. We are re-thinking our returnable bottle category to compete against the increasing number of HDPE Chibuku offerings that are coming through in the market now. We will do this while we are turning our core carton business to growth, because that still remains such a big part of our business.

Unfortunately the playing field for opaque beer still remains very unlevel. Many competitors now are trading in bulk opaque beer despite the regulations against that. Because of the tightening economic times and the cheapness of that beer it is really gaining momentum. We do continue to lobby both on this and cheap spirits coming through, partly because of the tax revenue loss to government, but it is really more about the social impact that these dangerous alcohol levels have and hygiene impacts.

If I take you to page 21, which again is our five shared imperatives for sustainable development, we essentially share our projects across National Breweries and Zambian Breweries now and pool that money to really make an impact on these projects. The most important project for our Chibuku business has been the Manja Pamodzi recycling campaign which has really started with the collection of Chibuku cartons and Super PET plastic which has greatly increased on the streets and quite frankly something has to be done about to. So we are pleased to be moving forward.

Taking you to the financial highlights for Chibuku, as I mentioned carton volumes declines in the first half 5% but month on month that decline has decreased and we are now back into positive territory on the Chibuku volumes. Super has grown by 75% partly because of us really understanding that product, getting the pricing right, getting the execution right, but obviously also because of the capacity that has come on stream with the new Lusaka brewery. We have net producer’s revenue growth of 8%. Unfortunately however we have had a gross profit decline of 2% primarily driven by that high increase in the carton Euro price coming through.

It is also important to note in this business that depreciation is now a major cost following the Lusaka investment. The depreciation is something this business has not really had to cope with in the past. But because of the policy of paying out 100% dividend in the past and very low levels of investment this business is now paying the price for that as we have to invest in new capacity. So depreciation has a much bigger impact on this P&L going forward. The good news is we’ve had operating profit growth of 11% on the back of that significant decline last year. And I look forward to an improved performance in the second half.

As I mentioned we have a good hedging strategy in place. You can see some good gains coming through in the bottom half of the P&L which have helped mitigate the extra cost of packaging in the top half of the P&L. We have had some minor margin growth of 40 basis points. I anticipate that that should improve in the second half as Super really takes hold. Our profit after tax of 11%, we put the Dollar number in there to show you that unfortunately in Dollar terms this is going back due to the currency depreciation. Despite that because of the good results of the business turnaround the board declared a 75% interim dividend.

The summary of the financial performance in local currency and US Dollars is set out on page 25, 26 and 27 of the pack. I will not take you through the detail of all of those slides, but I’m very happy to answer questions at the end of the presentation on it. I think the important thing to note is operating profit margin recovery in F16 versus F15 on page 27. We need to continue to focus on driving that margin up in the future.

I take you to page 28. That sets out the capex for this business. And you will see the sharp acceleration in capex spend over the last couple of years. That very much talks about the history of paying 100% dividends in this business in the past and very low levels of investments. Unfortunately the production has taken a toll on these plants and we now need to invest in this business going forward, which we have started in Lusaka. And so this business will have higher levels of investment into the future.

In terms of our prospects on page 29, unfortunately with the weakening economic fundamentals and customers and consumers having less disposable income we expect them to become increasingly constrained as a result of inflationary price increases on commodities and utilities. Unfortunately that will mean some of our consumers will continue to down-trade into illegal bulk and illicit spirits. As a business we are very much looking at different pack offerings that we can start to offer to prevent people down-trading into that sector.

Power and water restrictions will remain a major concern. We have five breweries at National Breweries. They are all running on eight hours of generators a day. The cost of diesel will come through, and there are additional costs of having back-up water plans in place particularly for the Lusaka brewery. We expect a bigger impact on our results from currency in the second half, but we will continue to take advantage of the shelf life on Super to enhance our sales and grow volumes in the remote areas of Zambia. We will continue to engage with government on the non-enforcement of bulk opaque trading, and we are dialling up our lobby in this quarter around taking some significant action against this.

The business has gained real momentum in quarter two, something that we’re proud of in terms of turning this business around, and we will continue to drive it in the second half. That is all that I have for National Breweries and would be very happy to take any questions that you have now.

Operator 
Thank you very much. At this time if you would like to ask a question regarding the National Breweries Plc results please press star and then one. If you however decide to withdraw the question from the queue please press star and then two.  I will repeat for convenience. At this time if you would like to ask a question regarding the National Breweries Plc results please press star and then one. We have a question from Bevin Ngara from Imara Zambia.

Bevin Ngara
Thank you so much. Good presentation. I would like to ask a few questions. First of all to do with illicit beer, what is your estimated loss in terms of market share to illicit beer and prospects improving? Secondly I see that you have really managed to contain your costs through hedging for raw materials. You said you did a forward basis. But now there is a higher prospect of [inaudible]. How are you going to contain that seeing as you seem a bit reluctant to increase the retail price of Chibuku beer? Can you explain how much that is going to come down going forward? And lastly I think you will take some bit of pressure from employees wanting to hedge themselves against inflation by asking for higher pay rises. How are you going to tackle that? Pass on that to consumers, or is that going to put pressure again on margins? Thank you.

Annabelle Degroot
Thank you for the question. I may have missed the first one, but I will answer the others and then please tell me if there is something that I’ve missed. They are all related in some respects in terms of margins going forward. We secure our maize crops in advance, so in terms of the drought we have secured maize crops and that at the moment doesn’t appear to be a problem. The maize crop in Zambia is so significant and our proportion of it is relatively small. At the moment we have secured our maize crop for the next year and we will be cautious as we go into the next season. On the question of taking price we have actually taken price already on Chibuku cartons. That is our biggest pack. And in quarter three we have raised prices from 3 kwacha to 3.50 kwacha following our competitors actually raising prices. We have done that to protect margins. Wage negotiations and increases this year are 10%, but we do expect that to increase next year. So we are just going through the budgeting process at the moment, but I have no doubt that margins will be under pressure going forward. I think your first question was about the share of illicit opaque. Approximately 50% of the Chibuku market is actually in illicit bulk. So it is significant. It is over 2 million hectolitres of bulk. In some respects that has always existed in terms of traditional home brews. That is not really where our bone of contention is. Our bone of contention is with the really poor quality illicit and dangerous brews which quite frankly do not represent the traditional opaque beer that we have come to get used to.

Operator 
Just a reminder, if you would like to ask a question regarding the National Breweries Plc results please press star and then one now. We seem to have a follow-up question from Jonathan from African Life Financial Services. Please go ahead, Jonathan.

Jonathan
Annabelle, just a clarification on the drop in the cartons that we saw. Can you just explain what actually happened? And then in Q2 you have mentioned that there is some improvement. Could you explain what was being done differently in Q2 over Q1 or whether conditions just changed?

Annabelle Degroot
We had a combination of issues last year in terms of poor quality, poor in-market execution, and then we had some real production issues with the new plant coming on line in November and December. So it was a combination of issues. When we took this business over more or less in November in terms of real integrated operating practises we focused very much on getting that new plant up and running, which has helped, then also very much on quality and consistent delivery and in-market execution. So essentially the recovery that you’re seeing now is a result of the capacity coming on line, but also a result of taking back market share which we had lost as a result of poor quality product and in-trade execution.

Operator 
We don’t seem to have any further questions from the conference.

Annabelle Degroot
If you would like I will move to the email questions now. I have a question from Adriana from African Alliance. The question is for National Breweries could you comment on margins for Chibuku standard versus Chibuku Super? Also given that Super has a longer shelf life to what extent is the product being exported either legally or illegally? In terms of margin the general guidance is that Chibuku Super gross margins are approximately double that of Chibuku standard. But it is important to note that the technology, manpower and the skill that goes with Chibuku Super means that the operating margins are less than double of Chibuku. They are definitely margin-enhancing. In terms of the shelf life and being exported we have an agent at Kasumbalesa border in Congo and there is volume that we are aware of that is going over the border from that agent to the DRC Congo.

The next question is from Bevin Ngara at Imara Asset Management Zimbabwe. He says please explain the sharp increase in profit from ordinary activities before exchange of 44% on prior year at a time when gross margins decline by 2%. How do you manage to contain costs going below inflation? Can you share your depreciation charge, distribution cost, admin and general and selling expenses for both half years? I’m assuming that this question relates to Chibuku. A couple of things have taken place in terms of our fixed cost management has been much stronger in this business. As I have explained we have now integrated these businesses and we have applied the same focus and cost structures as we have in Zambian Breweries in the past. The other thing to note is there was a reallocation of storage costs out of fixed costs into gross margin. So really the way that we’ve been able to grow that bottom line is by containing fixed cost, not adding any more fixed costs to this business, but really growing volume on the top half. In terms of sharing the detailed costs I’m not able to do that at this time.

I think that is the end of the questions. Once again I very much appreciate the time people take to attend this call and wish you a good evening. Thank you very much.

Operator 
Thank you. On behalf of Zambian Breweries and National Breweries that concludes this afternoon’s conference. Thank you for joining us. You may now disconnect your lines.


END OF TRANSCRIPT


Related Links:
View Zambian annual reports
View Zambian Breweries plc section
View National Breweries plc section
 
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