CAC XI
Item Q : Acaiysis of =logic Imes
INTRODUCTIM
1. The purpose of this session is to identify the main strategic
issues which will reed to be resolved if we are to be successful
in achieving the cbjectwes we have set ourselves.
The ground that I interd to cover is sum=-ised on t@w first
sl:.de.
(a i I wil' star-, by recalling our objectives and the
strategies that ',-Ave previously been agreed.
b I wil' then go cn to review the prospects fc-- the Lus s
envircrmient and t!ie implications for the Grcup
Follcwnq cr. frzm. this. i will pick up on scre of the key
points made ty :avid Allvey in his review of =he
Financial Fczecast.
(A@ Finally: I w:.' I suggest the issues which I te, ieve to be
most _Tportant and on ;-mich I think we need -_@ concentrate
over --he rewa;.rder of the conference.
3. Let us star: by cur agreed objectives and
st-rategies. -
B.A.T UIDUSTRIESTWECTMES
1. Our central objective :.s to provide our shareholders with an
abcve-average retL:t-- cn their investment in B.A.T Trxiustrigs
through dividends =_=wth and through increases in the capital
value of the= shareholding (SLIDE 11).
2. We believe that to d., this we need to aim for earnings per share
-z-
,-swth of at least 15% p.a.
guideline objec=ves for the individual businesses are
Ot=
deri,-red fr:r,. this cent-ral Grcup objective and our aim is for
each business writ!= the Group to achieve a ret=.-, such that it
generates s-,.i!f;.c,-ent --ash both to cover the cost :z; servicing
t@e funds emploWd in the business Ithrough dividend and
interest ;ayments) and tc achieve self-funded prc!--;;.ts gr--4th at
rates in lline with the target for the Group overa'1.
4. Provided that a business is achieving an acceptable level of
return, the cash generated can either be invested :.n supporting
its own grcwth or it can support-growth elsewhere in the Group,
either dire-c-ly cr ttzough acquisition. However, it is
cbviously -.we satisfactory to be supporting organic grcwt:h and
for this reason %,* leave an objective for a high ;:roportion of
cur businesses to be positioned in such a way that they have a
good potential for g-.=wth.
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5. An important qualitative objective is that our businesses should
seek to be in leadership positions in their markets with
strengths based an defined competitive advantages since it is
only mrough this that we can have reasonable confidence of our
ability La meet our quantitative objectives.
ij. To present 'die dissipation of financial and management
resources. we also aim to foctis on a limited range of activities
in Tobacco, Retailing, Paper/Pulp and Financial Sex-.-ices.
T. Finall-:. we have zin jbjective to control "he risk profile of the
business arid LIUS is taken into account both in determining the
_tnd feour-aphical split of the Group's. activitlei and
also in the ob.iective to aim for a Debt.Equivy ratio limited -a
rr,
AGREM) :31T-_%TM I M
1. @'Xir @-urrent strateeies wei-i rarely set in place as a result of
the Strategy Review- carried out in 1982 and have evolved -
consi-r.enL11, -31zice then. -hese strategies can be :.ummarttied as
follo--,cs (SLIDE I:I):-
(.t) To mu; titairt or imprcve the veturns- frt)m T,.;ba- cco and Lo
conLinue to pursue profits growth in this activity -
However Lhat tells will not be enough tit;.lise
all the cash generated.
(b) To impr@.,%-e Uie returns in Retail arid Paper/Pulp .ind ',L)
seek to position these businesses for sustained long term
profitable growth.
(C) To enter Financial Services uid to establish this Ls a
major GV--@Ilp ;tVtiVLt:,--
(di To withdraw Progressively from actJvi-Les outside the
mainstream of GrOUP develotmient.
we tl-sa hi%ve a strategy to concentrate our development in North
-\merica and in Europe. In doing this, we have not made a
decision La withdraw from our involvement in the rest of the
world. However. taking into account the reiative prospects and
the ris'ks involved, new investment in the developed countries in
We North Atlantic region is conssidert4.1 La offer be#-Ler
prospects than investment elsewhere. It could be argued, of
course, that taking into account the relative prospects Vor
growth, combined with reasonable political stability. the
Pacific Basin would offer even better prospects than the North
Atlantic but we have taken the view that we have a stronger base
an which w bdid closer Lo home mid Until this is firmly
established, we do not have a sufficient capability for an
aggressive Emirsuit, of expansion in the Pacific Basin area. This
does not mean that we should ignore these markets and the
success achieved with the e.-,port of cigarettes to Japan, Korea
and Taiwan is an illustration of what can be achieved. However,
for the Lime being at least. these countries are likely to have NJ
more significance as export markets rather than as markets in C>
which to invest.
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3. Taking an overall view, we have boon reasonably successful in
-i een
,plementing cur agreed strategies and this has b reflected
bor-h in tle composition of the Group and also in the financial
results that have been achieved.
4. '-I-,ille thms :.s encouraging, however, we also need to look at the
Xtential for maintaining progress in rZe future, measurmg
=selves against the objectives to ach-,eve -r-stitive
'leadership and to be positioned for growth. I shall return to
t:-zs later wher I =Lsider each of the major activities in =re
detail.
5. Befcre doing this, however, _1 want to spend some time in
c=ider,-r.g the influence of the business envir=nent on the
6. :n assess=g cur past success, a significant factor which must
te taken into ac--%=t is that we hAvp t-r, _,n 1
fa-Axxablle en,,ircnment with sustained ec--ncnmc growth and price
.=ties ir the cigarette market influenced by the desire of R.J.
=zynclds and Ph-,',,p @brzr:.s to maintain a strong cash flow in
:---4er t7 _4:.nance their diversification
7. ::-. _c--)x=.g to the future, we must start by considering wmat kind
c-_ business envLronment we are likely -,:; experience fr= now
M BUz-:=S =-ry"LRCNMDM
1. Tlha period since 1983 has been charactiannsed in the developed
ovaries by sustained growth and, 160 1986 at least, by reducing
levels of inflation.
Z. The economies cf the developing countries have been less
successful with wide variations in growt-ft rates and, in many
czLzitzries. .,erl high rates of inflation. Despite thiss. the
develcpirg @:-_:untries have still benefited tOrM the high grcwLft
:----:es in t!,.e developed countries enabling them to boost exports
and to reez zcme at least of their debt servicing requirements.
w,-at are tlie prospects f or the futur-a ?
4. The next slUde slows the consensus forecast for econamc gra-wah
ir. scme of the major countries of interest to the Group. You
wz:1 see ;"net, this that there is a general expectation that
grzzwdi all be less in 1989 than in 1988 and that 1990 will be
again. Of course. these are only forecasts and recent
exq)erience has been that the actual performance of the economy
h:-.., exceeded the forecasters' expectations, with growth holding
uz much better than expected. Despite this, howiever. I think we
owst still be prepared for growth lower tum in the recent
past. This .all have particular imlicati-ons IC v.= Retail and
Zor
Paper/Pulp zusinesses; and these have already been reflected in
r2he forecasts and plans for these activities.
5. Tak=ig a reg;.onal view, the initzatize to mow towards a Single
EL---paan Mrket will iqn-ove the overall prospects in the EEC.
It ,all also be significant in creating opportunities as the r1-J
structure of the market changes and as restrictions on
cr-css-border trading are relaxed. This suggests that it may be
appropriate to 9'_VQ SPOCIAlemphasis to seeking opportunities -4
wit.6.,ui Eurc;e over the next few years. C7N
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6. Elsounere in the world, the pressures an the ecozummes in the
developed countries are likely to lead to reduced exports from
the developing countr,-es leading in turn to a worsening of the
economic and political climate, especially in Latin America and
in ct@er countries with a debt problem.
7. The next sl-,de (SLM_T 7) shows the the forecasts for inflation
demr-,strat:.nq the upward movement that has already occurred. In
this =ase, the forecasters may have erred on the side of
opt::r.iz,m and it would be wise to be prepared for so= further
incz=__z3e in in!laticn.
S. One c:'- the mearz used !Or ccmbatt2.-,g this trend has been an
increase in interest rates and apaxt from affec=.g the Group
dirract'y t1has will also act as a hrake on grow-"",,.
9. There is slightly better news for the Group on exchange rates
(0L:Zr_ VI) --nere a czmpariscr, z! t@e current exch-ange rates with
their -,ur=:.asir* power par--ties snows sterli--r, to be overvalued
in relation tcth to the US Dollar and the Deutschemark. 'Prince
the f-_iancial fcrecasst is constructed at constant exchange
rateS. this =tdervaluaticn of t@e profits fr--n. rhe US and
Germ"any represents an added potential for growzh over the longer
term wnen. as eq;ected. r-he currencies move =-wards --heir
purchasing power par--t--es.
1O. Despit's this positive factor, the overall prospect is for an
errv:z::-=.n-. 'Atich will be less favcurable than in the recent
past and this has been taken into account in t!:e discussion of
the pr--spects for eacn industry group.
I,. What Z would also like to emphasise @ere, howver, is that
althcugh we must take the general economic environment into
acc--urt in our planning, 4e must not be over-influenced by it.
Ach_,eving growth at tl,,e rates wtuch we have set ourselves as
targets depends on identifying specific oppMn:unities to grow
muc'@ f3ster than the average for the economy as a whole. This
depends on teing incovat2.ve and creative. on establishing
competiti-,-_ advantage and on pursuing aggressive strategies.
M,ass is items apprcac@h .a must follow w3.thin, each of our ,major
activities.
I Z. Befcre moving on to this, towever, lot us fire-r- consider the
prospects f= the Group as a whole as shown by the Group
Financ,-al Forecast.
GROUP MWICIAL FORECAST
I. In his paper, David Allvey showed that based on the forecasts in
the Cperating Group Plans, the Earnings Per Share for the period
to 1993 are forecast to increase at an average of 15% p.a. in
line with the Group's objectives.
2. Over the period, there is a forecast not cash generation of E1.5
billicn and assuming that the objective is to reach a
Debt:Equiti ratio of 501, the rescurce availability rises from a
negative sum in 1989 to around EX billion by 1993. NJ
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3. Another f eature of the forecast is the signif icance of the cash
contributions from Tobacco, with a cn=llative cash flow fr=
trading of over E4.3 billion over the next five years.
4. important -on from the Financial Forecast are:-
(a) The need to secure the profits which are included = the
forecasts for the exist=.g business.
(t) The Lm;crtance of the cash flow from Tobacco.
I
,c) Even taking rtis into ac=unt, the limited reso=es
available for major investments in expanding, developing
or repos3.ticr-ng the G-rcupls wb@a2smes.
5. These conclus:.ons have been taken into account when considertng
the issues for each --f the maDor industrial activities.
6. At the same ti;Ta, there is also a Group issue in considering
what mignt be done to increase the total resources available to
st:ppcr-- :he Group's development.
Cne way of increanng the resource avaiability is to realise
surplus assets and there is an exercise in progress at present
where the Centre is considerz.r.g -with the Operating Groups
whether scme asset realisat,-on might be appropriate.
S. As an ex,,ensicn of this, we a-so need to continue to consider
actively, the divest=t of businesses which are either not
capable of meeting the Group's performance criteria or which are
peripheral to the main dirrect:.ons of strategic thrust. Obvious
candidates for consideration in this respect are VG Inst-r.-rients;
and the Barotec busLness in Germany. In both cases, there is
implic= agreement that the longer tam future for these
businesses mLLa.-. lie outside the Group and the main issue is
e-1eter:.ni.n,--.,g the cpt,--= timing for divesmin't.
I? Let ,;3 -low consider the issues for each of the Group's ma3or
aczivities. szar-.3.rZ-,- with Tobacco.
TOBACCO
1. The Tobacco businesses are important as the major source of cash
which is available to support the dividend and to invest in
other act--,aties.
Z. However, -,r. is also an mpcnant source of profits and in
cons;.der---.g the strategies fcr these activities, we should lock
first at the ways in which we can grow these profits.
3. The consolidated Group forecast for 1989-1993 shows trading
profits fram Tobacco growing at 9% p. a. and levels of
profitabl-;.ty which are sufficient to generate a substantial
cash surplus.
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4. Key issues for di=,:ssicn in the session of Tobacco (SLIDE VII)
w@ " be: -
(a) Areas of sens:.=vity in these forecasts and in the
underlying assumptions
Lakely developments in the competitive env=oment with
particular ref erence to the extent to which the now
finan.cial pressures on R.J. Reynolds and Philip morris and
the comparatively poor showing of the other major Tobacco
companies represents an opportunity for B.A.T Industr,,es.
(c! Likely technological trends in products and processes
within take industry and the adequacl of the current R&D
programme as a =arms ."zr enabli-na the Grouz to establish a
ccaipeti.t7,ve a&.rantage thrcugh have a capability to build
on tne recent good record 7Ln launching irixNative now
Products and in establishing facll-,ties for lowest cost
Pro&c-.-,cn.
'd) O;pcr--,;,-aties for strengthening the cirrent rather weak
market positic.11 --- Europe and the c=sts of doing this
relative t-- the benefits.
5. Finally, I thi-* us should also take the oppcr---uty to discuss
raw far the expanded Tobacco Strategy Review Tam meets the need
for coordinating Gr=ur, zoli-.,.es and strategies and to discuss
dhether ani further strengthening of c-c-operat;.on might be
desirable.
FINANCIAL SERVICES
I. Financial Ser-vices is now the second largest ccntributor to
Group prof-,ts and will soon overtake Tobacco as the Lugest.
2. An mnportw-t characteristic of the activity is that it can
expand at very fast rates wth=t needing additional injections
cf funds.
3. A key strategic issue (SLIDE 'MI) will be the extent to which
we are happy with the current spread of activities, taking into
account Lhe prospects for eacn class of activity.
4. We will also need to discuss whether there are any specific
weaknesses we need to eliminate or any spec7-fic opportunities we
wish to Pursue, taking :.nto account the Likely developwnts in
the market and especialli, these resulting fram changes in the
regulators environments and fran the European Single Market
initiative
5. An important issue will be the proposed priorities for
investment, which will need to be discussed Ja relat:.on to the
relative attractiveness of the opportunities open to the GroW
and to the resources required for the pursuit of those
opportunities which are considered to be most attractive.
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6. In view of the scale of invesvmnt that might be required to
become established in a now market, we may also need to consider
the implications of possible Joint Ventures as an alternative to
strught investment.
At present, Eagle Star and Allied Dunbar act separately and
although there is scme, co-ordir-aaon through the B.A.T Financial
Services 3oard, it may be appr---,--,-ate to consider whether there
might be some benefit in coris;.c Lng other structures for
pursuing development.
S. All of these are part of the wider quest,-on which was posed
yesterday, wh,-ch is to determns Ww we can best grow our
Financial Ser7ices activities.
MAIL
1. In Retailing, none of our busiresses except Argos meets the
Group's criteria for earning acceptable returns and having a
Proved potential for growth.
Argos has achieved a compound growth rate of 24% p.a. in sales
over the f _4ve years 1983-1988 and is projecting growth of 1.8%
P. a. to !993. The returns in this business are such that it is
also pro.,,ecting a cash surplus of E140 million over the period
and will generate a further E50 million of borrowing capacity
t!-Xcugh -ts retained profits.
sue for discussion (SLIDE IX) will be the ability to
.6
cLstain the growth rates and prof itabllzty, taking into &cccunt
market penetration and the emer-ging increase in competition.
4. A second issue will be the potential fcr developing new retail
businesses within B.A.T Stores, taking into account the
relatively poor record of success in past developments such as
C--untry Market and The Jewellers Guild.
0, BATUS retail has shown sales growth of 7.1% p. a. and profits
grown,. of cnly 2.1% P. a. over the past five years. The plans
for 1989-1993 show sales growth of 3.5% p. a. , profits grcwth of
V .7% P. a. and RONA rising from 15% in 1988 to 26.9% in 1993.
However, the not cash flow for 1989-1991 is minus $215 million
and, WM after takIM into account,sales of receivables and
addit=aal borrowing capacitor, is still positive Only to the
extent of $90 million up to 1991, before showing a surplus of
r-60 million in 1992-1993. The 1984-1988 annual rates of growth
for Saks at 7.5% and Marshall Fields at 8.5% compare with 34.21
for The Limited, 24.9% for NordStrom, 7-1.9% for The Gap and
3-2 for Dillard Department Stores
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8
6. A key issue for discussion wall be the nature of the now
initiatrres, enabling BATUS to forecast peetormance which is so
!=h oetter than has been achieved hist--zically.
7. A second issue will be the potential for achieving accelerated
growth once acceptable levels of performance have been achieved.
S. in Germany, the separation of Horten into a Galeria chain of 39
stores and a residual Extra chaln of 13 stores has been
completed and 3 M G are formulating plans covering both the
development of t@e Galeria chain and the ultimate disposal of
the remaining stores.
9. Tissues for discussion will be the abil-=( of Horten to earn
=@-Orrxhla rp"Trnn and t-n arnw in A nv%r%d!Ar. sectment Which over
recent years '-as grcwn at only around 1% p.a.
10. For LTasco, tre issues for discussion ,all be the future of
Peoples Drug and the way in which Shoppers Drug, Hardees and UCS
are expected to ccntzribute to the overa-3-1 development of Imascc.
!I. Finally. taking a more general new and taking into accct--,t o=
rather limited success in retailing, it may be appropriate to
ask what value we are able to add to acti-,rltj,.
1-1. Mi-s shculd then lead on to a rather -ader discussion t=
determine whether we see realistic opt:.--rs for growing ttv-
Group's retail businesses in a way that -.culd meet our
object-,,49s.
PAPER/PULP
1. The Group's main Paper/Pulp activities are in Wiggins Teape and
Appleton and consist of Carbonless Paper including Thermals)
and Fine Papers. backed by Merchanting and j7y Eucalyptus Pulp
marndacture.
2. The market qr--4th rates for Carbonless are tending to tall off.
having been over 10% in the early 1980's but falling to 7 or 8%
for tte past t7wo years. The current fzrecast is for futux-9
growth at only 4-5% p.a. and this, combined with increased
competition, will make the market significantly mare
competitive.
3. The main strategic issue for Paper/Pul; is the need to formulate
a renewal strategy repositioning the business in markets with
prospects for long term sustained growth better than those
offered by Carbonless.
4. The development of the Thermals businesses can contribute to
this renewal but the scale of the actrrty IS Still SITMII In
relation to the Carbonless-business and even after 5 years of an
expected 20% growth rate, the total market for Thermal papers is
still expected to be only 101 of the market for Carbonless.
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5 in the discussion of the options for business renewal (SLIDE X),
key issues w,.ll be:-
(a) The identification of businesses of significant size which
are capable of provid=g the levels of returns and g=,mh
rates which are requ=ed to meet the Group's criteria.
ib) The investment required to establish the Group in a
leadership position in the chosen market sector.
x) Alternative strategies for repositioning the business
without increasing the Group's total investment in
Paper/Pulp.
Id) The options for accelerating growth in the Bra- I ian. paper
business.
T@@ -,!17,?nt t@., -tzi,7h I _Jn. 0--- /D.. 1,
an attractive opt--on !or that business.
1AJVW-=1@M '1rSSUF_S
1. Z@ far. : have concentrated on the evaluation of sensitivities,
c-n- :1. identification of now opportunities for investment ard on
the financial resources which would be required to pursue these.
I there is another resource which is even more impor-.wt
than t@e -Firiarcia! resource arA that is the management rese=s.
A disappointing feature of the Group's performance over the ;WI
few years has been the f allure to evolve viable strategies Z`cr
the longer term development of the Group's various activities.
4. Thus has shown up in particular in the Retailing and Paper/P,jlp
actraties where the need to identify new growth opportunities
ar4 renewal opticns is beccuumg increasingly urgent.
5. I think 1-1 is f a= to say that the failure-to develop these
strategies is evidence that we do Yrt yet have the quality af
management that is required either at company level or more
pan:cUarlly at I Group level where there needs to te
more attention to developing the capability to add value to the
c=nstituent businesses.
6. Key issues to be discussed must be whether the current
management resource has the capabilit'l to add value at Operating
Group level, whether we are organised to make the best use of
the management resource available to us and whether we have
systems in place to ensure that us recruit, develop, retain ard
moti,-rate the quality, of managers. required to develop our
k==esses
7. It is a measure of the importance placed on this subject that we
have scheduled it as the next item for discussion at this early
stage of the conference.
8. However, before inviting Tom loong to introduce the subject, are
there any questions or caments an the mare general subject of
the main strategic issues for the Group? r11J
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RS/rJA
24th April 1989
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BAT Industries document for Province of British Columbia 22 April 1999