Carlsberg A/S (OTCPK:CABGY) Q2 2022 Earnings Conference Call August 17, 2022 3:30 AM ET
Company Participants
Cees ‘t Hart – Chief Executive Officer
Heine Dalsgaard – Chief Financial Officer
Peter Kondrup – Vice President, Investor Relations
Conference Call Participants
Andrea Pistacchi – Bank of America
Laurence Whyatt – Barclays
Trevor Stirling – Bernstein
Nik Oliver – UBS
Mitch Collett – Deutsche Bank
Simon Hales – Citi
André Thormann – Danske Bank
Sanjeet Aujla – Credit Suisse
Operator
Ladies and gentlemen, welcome to the Carlsberg H1 2022 Financial Statement. For the first part of this call, all participants are in a listen-only mode. Afterwards’ there will be a question-and-answer session. [Operator Instructions]
This conference call is being recorded. I will now hand it over to the speakers. Please begin. Speakers, please begin.
Cees ‘t Hart
Are we ready?
Operator
Speakers, please begin.
Cees ‘t Hart
We will wait for one moment because we seem to have a technical problem. Operator can you confirm that you hear me?
Operator
I can confirm, I can hear you loud and clear.
Cees ‘t Hart
Excellent. Good. Let me start. Good morning, everybody. And welcome to Carlsberg’s H1 2022 conference call. I am Cees ‘t Hart, and I have with me, CFO, Heine Dalsgaard; and Vice President of Investor Relations, Peter Kondrup.
Let me begin by summarizing the headlines for H1. It was a challenging half year due to the war in Ukraine, significantly rising input costs and COVID-19. Nevertheless, Carlsberg delivered a strong set of results and we are now significantly ahead of the pre-pandemic levels of H1 of 2019 on basically all parameters.
Our Ukrainian colleagues have shown incredible strength and resilience, navigating both the humanitarian crisis and the enormous business challenges since the outbreak of the war, by which we have been able to reopen our breweries in Ukraine. We have announced our intention to dispose the business in Russia, hence the preparations to allow for this are progressing well.
Despite continued challenges ahead of us, we are very satisfied that we are able to upgrade our full year earnings outlook last week. And thanks to strong cash generation, we have made DKK5.4 billion cash returns to shareholders in H1 and we have launched another DKK1 billion share buyback program this morning.
I will now go through the key headlines for the first half year, our new ESG program, which we are launching today and the regions. And after that, Heine will take you through the financials and the outlook for 2022.
Please turn to slide three. The Group delivered very strong numbers for H1, albeit helped by easy comparables due to the more extensive COVID-19 restrictions last year. Total volumes grew organically by 8.9%, supported by the strong rebound of the on-trade, particularly in Western Europe, where on-trade volumes doubled compared with 2021. Total on-trade volumes increased by 27% compared to last year and is now back at 2019 levels.
Off-trade volumes grew by 2%, driven by strong growth in Asia, mainly in India and Vietnam. In Western and Central and Eastern Europe, off-trade volumes were impacted by consumers returning to the on-trade outlets, and therefore, declined. However, compared with 2019, off-trade volumes were still very strong at 15%.
Revenue per hectoliter grew by 11%, mainly due to a positive channel mix from the on-trade recovery and positive brand mix and price increases, and consequently, organic revenue growth was 20.7%.
Operating profit was DKK6.4 billion, with strong organic growth of 31.8%. A solid testimony to the strength of our business and our strategic priorities is the fact that our H1 2022 reported figures were well ahead of those in H1 2019.
Excluding Russia, volumes were 11% above 2019, revenue was 21% ahead and operating profit was 42% higher than in 2019. Looking at adjusted EPS, which is based on reported figures, and therefore, including Russia, it was up by 89% in H1 2022 compared with H1 2019.
Slide four and some of our strategic growth drivers. We saw good progress for our premium portfolio and alcohol-free brews. 1664 Blanc grew strongly in many markets in all three regions, but this was offset by a decline in a few markets, including Ukraine. Consequently, volume declined by 1%. Excluding Ukraine, volumes were up by 5%.
Tuborg volumes grew by 14%. In Asia, Tuborg grew by 18%, with India being a strong growth driver.
Carlsberg delivered very strong growth at 20% in Asia. Carlsberg volumes were up by 25%, achieved by very impressive results across the region, with particularly strong growth in India, Vietnam and Malaysia.
Being exposed to the off-trade channel, category growth for alcohol-free brews was impacted by the declining off-trade channel in Western Europe. In addition, Ukraine was one of our larger markets for alcohol-free brews.
Consequently, total volumes for alcohol-free brews were down by 3%. Excluding Ukraine, volumes were up by 4%. In Western Europe, our alcohol-free brews grew by 7% despite the declining off-trade.
The growth was driven by both local brands and alcohol-free line extensions of our international brands. Our market share in the alcohol-free brew segment over indexed in most Western European markets and we were able to further strengthen our position during H1.
We saw good progress for our online B2B platform Carl’s Shop, which is now available in 11 markets. Volumes on the platform were up by 84% and revenue per hectoliter improved by 7%. We are optimistic about driving premiumization opportunities on Carl’s Shop and we expand the use of data-driven product recommendations. In H1, premium offerings sold on Carl’s Shop indexed 105 compared with off-line sales. In China, our largest B2C commerce market, our online market share was up by 170 basis points, reaching almost 12%.
And now a few slides on our new ESG program, Together Towards ZERO and Beyond, which we are launching today. Please go to slide five. Our new ESG program is an enhancement of our previous Together Towards ZERO program, addressing the environmental, social and governance topics that impact our company and our stakeholders most significantly.
As in the past, Together Towards ZERO and Beyond is embedded in the SAIL’27 strategy as a key mechanism for driving positive change, mitigating risks and demonstrating Carlsberg’s purpose of brewing for a better today and tomorrow.
Slide six, please. As part of Together Towards ZERO and Beyond, we will continue to deliver on our previous ambitions, namely zero carbon footprint, zero water waste, zero irresponsible drinking and the zero accidents culture.
We are building on the progress made thus far, including a 40% reduction in carbon emissions and a 21% reduction in water use per hectoliter since 2015. Going forward, we are stepping up to address intensifying world challenges, such as climate change and water scarcity, as well as health, well-being and diversity, equity and inclusion.
We have expanded the program to include a wider range of ESG topics to address the societal challenges impacting people and the communities where we operate. We have raised our ambition levels, sharpened our targets and introduced new focus areas to create a holistic and ambitious program with milestones for 2030 and 2040.
Slide seven as an overview of the updated and new targets and milestones. We maintain our target of zero carbon emissions at our breweries and a 30% reduction in our beer-in-hand carbon footprint by 2030. But we are now going to the next level, introducing the target of a net zero value chain by 2040.
Looking at water, we have updated our targets such that by 2030, we want to have a water usage efficiency of 1.7 hectoliter per hectoliter beer at our breweries in high risk areas and 2 hectoliter per hectoliter beer globally. In addition, we are targeting 100% replenishment of water consumption in high risk areas.
To support our ambitious net zero carbon target, we will take new actions within agriculture and packaging, which will drive critical emission reductions in our value chain. Firstly, looking at agriculture, where we can play an important role in reduction, reducing the carbon footprint for farming. Our 2030 target is to source 30% of our raw materials from regenerative agricultural practices. By 2040, our target is 100% of raw materials.
Secondly, packaging accounts for 41% of our Scope 1, 2 and 3 carbon emissions, and is therefore, very important to address. Our new packaging targets include the use of 100% recyclable, reusable or renewable packaging in 2030.
We also target 90% collection and recycling rates, 50% reduction of virgin fossil-based plastic and 50% recycled packaging content for bottles and cans. By reaching these targets, we will actively help drive a circular economy.
The last notable target evolution pertain to our raised ambitions for responsible drinking, where we now target 35% global portfolio share for no and low alcohol brews by 2030.
With our new targets, we support the industry transformation towards more sustainable business practices through, for example, shifts in farming practices, sourcing procedures and product design, as well as the scaling up of efficient deposit return schemes. We will continue to leverage partnerships to deliver on our ambitions together with suppliers, customers and partners to go towards zero and beyond.
And now the regions, please turn to slide eight and Western Europe, where volumes grew by 10.2%, supported by easy comps due to less on-trade restrictions this year and bad weather at the beginning of Q2 last year.
Revenue per hectoliter was up by 12% due to the positive channel and brand mix in addition to price increases. Revenue grew organically by 23.3%. Including the impact of currencies, reported revenue growth was 24.5%.
We took price increases across our markets in H1. Commodity prices and energy costs continue to go up and the favorable hedges from last year are rolling off. Therefore, we will take price increases across the region again in H2 in order to mitigate the higher costs, which will impact us in the second half of this year and the next year.
The organic growth in operating profit of 46.8% was significantly ahead of revenue growth, benefiting from the strong topline growth and cost reductions that more than offset the significantly higher cost of sales and sales and marketing investments. The operating margin improved by 240 basis points to 15%.
Denmark, Sweden and Finland delivered good volume growth, although with a soft June due to tough comparables. Volumes in Norway were impacted by the reopening of the borders, which enabled the Norwegians to resume their border trade and travel. There was a strong on-trade recovery in all markets.
In France and Switzerland, volume growth was double-digit, supported by very good progress for premium products and growth of alcohol-free brews.
In Poland, the beer market improved in Q2 following a tough start to the year. Our volumes in the first half year were flat, is good momentum in market share.
Volume growth in the U.K. was 20%. On-trade volumes recovered strongly, but were partly offset by mid-teen volume decline in the off-trade.
Slide nine and Asia where we achieved very good results. Volumes grew by 13.2%, with accelerating growth in Q2 in all markets but China.
Revenue per hectoliter improved by 6% as a result of a positive channel mix, premiumization and price increases. Organic revenue growth was 20.5% and reported revenue growth was 25.8%. The higher reported growth was because of a positive currency impact, partly offset by the deconsolidation of Gorkha Brewery in Nepal. Due to higher cost of sales, logistic costs and sales and marketing investments, operating profit grew in line with revenue, being up organically by 20.1%.
A few comments on the individual markets. In China, volumes grew by 6%, thanks to successful New Year activities and continued good progress for our growth priorities, including expanded distribution, our international and local premium portfolio and big cities strategy. Thanks to the premium growth, revenue increased by 11%.
In Q2, volume growth was more muted at 2% as some of our big cities were impacted by COVID-19 restrictions. It is still early days, but we are very pleased with the progress of Somersby, for which volumes are exceeding our expectations.
Our Indian business saw a very strong recovery in Q2, following a slow start to the year as January and February were impacted by the outbreak of the Omicron variant. Volumes grew by 50% for the half year, this volumes in Q2 being almost 7% above Q2 2019, a proof point of the resilience of our business.
We saw very good volume growth in Laos, Vietnam and Cambodia. In Laos, we benefited from fewer restrictions and achieved strong growth for beer, water and soft drinks. The performance was very good, but the Laotian economy is struggling and we have seen a very high inflation in the country and the weakening of the currency.
In Vietnam, volume growth was in the mid-teens, driven by our local Huda brand and very strong growth for the international premium brands. We are increasing our investments in Vietnam considerably both behind breadth and through investments in route to market.
In Cambodia, we continue to see impressive results for the Sting energy drink. Beer volumes were also up strongly, albeit on easy comps.
Malaysia posted very good volume growth on the back of easy comps. We saw a very strong growth for the Carlsberg brand at the premium portfolio.
On slide 10 and Central and Eastern Europe, where overall results were impacted by the war in Ukraine. Due to the very significant volume decline in Ukraine, regional volumes were flat. Excluding Ukraine, volumes grew by around 7%.
Revenue per hectoliter was strong at 14%, driven by a positive channel mix due to the on-trade recovery in the Southeastern part of the region, brand and country mix and price increases. Revenue was up organically by 14% and 16.6% in reported terms due to a positive currency impact. Operating profit increased by 7.9%, and both gross profit and operating profit per hectoliter improved.
In Ukraine, we have reinstated production at all three breweries. The reopening happened at the request of our local colleagues, whose stamina and courage have affected us deeply. For the half year, volumes declined by 27%. In late April, we announced that the operating profit in Ukraine will be included in special items due to the volatile situation and the inconsistent level of operations.
However, due to the reopening of the breweries and as a consistent level of operations has been achieved much faster than expected we will include the full year profit from Ukraine in the operating profit for the region.
The Balkan markets saw good growth of premium brands, including Carlsberg, Tuborg, Blanc and Somersby. On-trade rebounded strongly after last year’s lockdown.
In Italy, the beer market began to recover, thanks to the reopening of on-trade. We increased our market share and volumes were up double digits, with growth in both on- and off-trade. Carlsberg, Tuborg, Grimbergen and Poretti, all delivered high growth rates.
In Greece, volume growth accelerated in Q2 following the reopening of on-trade and the increase in tourism. Carlsberg, Mythos, Somersby and the local alcohol-free brew delivered strong growth. Inflation in Greece is running at double-digit, affecting consumer disposable income.
In our export and license business, Carlsberg, Tuborg and 1664 lager grew. We saw good growth in markets such as Turkey and Ireland.
And now, over to you, Heine.
Heine Dalsgaard
Thank you, Cees ‘t, and good morning, everybody. Before I go into the financials, a few words on the Russian business. Please go to slide 11. We announced our intention to sell the Russian business on March 28th. The complicated task of preparing the Russian business for divestment is progressing well, with teams across the entire business working on more than 150 separation projects.
In the accounts, Russia is no longer part of Central and Eastern Europe but presented separately as held for sale. Volumes in Russia for the half year declined by 2% and market share declined slightly.
Revenue increased organically by 22%, due to value management initiatives, including price increases. There was a significant increase in input costs, but this was offset by higher revenue per hectoliter, a positive FX impact of DKK110 million and the reversal of a tax provision of DKK230 million and therefore profit before tax improved. The net result from the Russian business was negative at DKK8.6 billion, due to the impairment charge of DKK9.6 billion recognized in March.
On the balance sheet, the assets and liabilities in Russia are presented in one liners under assets and liabilities, respectively. The net asset value increased during Q2 due to the appreciation of the Russian ruble versus DKK from 0.079 end of March to 0.138 end of June, as well as the development in the operating results. Therefore, end of June the net asset value amounted to DKK9.6 billion. The accounting treatment of Russia is presented in Note 8 in the company announcement.
Slide 12, please. We are very satisfied with our first half results, which really serve as a proof point of the resilience and strong fundamentals of Carlsberg. As Cees ‘t showed at the beginning of the presentation, volume, revenue and EBIT are well ahead of the pre-pandemic level of 2019.
Looking at adjusted EPS, we have delivered consistent growth during the past five years, even in the very turbulent times of the pandemic. From first half 2018 to first half 2022, adjusted EPS CAGR has been 22%.
The very strong CAGR for first half this year was achieved thanks to the very strong growth in operating profit and a lower tax rate, and of course, also supported by the share buybacks, which we have carried out every year since 2019.
We have maintained a consistent payout ratio of around 50% and a steadily increasing dividend payout in DKK. In March, we paid DKK3.4 billion dividends to shareholders, compared with DKK2.5 billion in 2018. Since 2018, dividends paid to shareholders are up by 36%.
Despite the very turbulent market conditions in the past few years, we have also continued the share buyback programs. In total, cash returned to shareholders in first half 2022 amounted to DKK5.4 billion, representing a CAGR of 21% from first half 2018 to first half ‘22.
Slide 13 and a few words on the P&L, please. Revenue was up organically by 20.7%. The strong growth was driven by volume growth of 8.9% and 11% growth in revenue per hectoliter due to a very positive channel mix, brand mix and price increases.
In reported terms, revenue was up by 23.6%. The currency impact was 3.8% supported by the strengthening of the Chinese, the Swiss and the British currencies that more than offset the depreciation of the Laotian kip. Small acquisition impact of minus 0.9% was due to the deconsolidation of Gorkha Brewery in Nepal.
We continue to manage the healthy balance of our business performance by applying our disciplined performance management drumbeat and the Golden Triangle, ensuring that we drive absolute EBIT growth by mitigating cost increases through both revenue per hectoliter and a disciplined approach to costs.
In the first half, cost of sales per hectoliter was up by 14% due to higher commodity prices and energy costs. Gross margin was 46.3%, which was a decline of 160 basis points. However, gross profit per hectoliter, which is the most important KPI these days, increased organically by 7%, thanks to the strong growth in revenue per hectoliter. OpEx as a percentage of revenue was down by 250 basis points, positively impacted by our cost.
Looking at the organic numbers, total OpEx was up by 11% due to marketing investments, which were up by 14%. Reported operating profit amounted to DKK6.4 billion, an increase of 31.8% in organic terms and 35.9% in reported terms. The operating margin improved by 170 basis points to 18.2%.
Special items amounted to minus DKK865 million, with the main contributing factor being the impairment and write-down of goodwill in Central and Eastern Europe, which in total amounted to DKK700 million. Another DKK139 million related to the impairment of trade receivables, obsolete inventories and commercial assets in Ukraine.
Net financial expenses were DKK508 million compared with DKK262 million last year. The significant increase was due to FX, which mainly related to currency losses on intercompany loans in Eastern Europe and the depreciation of the Laotian kip. Excluding FX, net financials were down by DKK47 million to DKK230 million, positively impacted by lower funding costs.
The tax rate was 22%, down from 25.7% in the first half last year, reflecting the continued good progress on our tax initiatives.
The net profit for the Group was minus DKK5.3 billion, impacted by the write-down of goodwill in Russia and the impairment and write-down in Ukraine and Central and Eastern Europe. Combined, these more than offset the strong operating profit and the lower tax rate.
Adjusted net profit, that means net profit adjusted for special items after tax and the impairment in Russia, was DKK5.1 billion. This was an increase of DKK1.9 billion or 60% compared with first half 2021. Adjusted earnings per share were up by 64% as a result of the higher operating profit and a lower tax rate. Adjusted EPS was also supported by the share buybacks.
Please go to slide 14 and some comments on the cash flow and net interest-bearing debt. Operating cash flow increased by DKK2.6 billion to DKK8.4 billion. Thanks to the higher earnings and a positive contribution from trade working capital of DKK2.7 billion impacted by higher activity levels and our continued strong focus.
This was partly offset by the change in other working capital of minus DKK622 million. Other working capital was impacted by higher deposits and VAT payables. Looking at the average trade working capital to revenue, this ratio was minus 20.2%.
Free cash flow was very strong at DKK7.3 billion. CapEx was DKK1.6billion, which was on par with 2021. Net interest-bearing debt was DKK18.1 billion, which was a decline of DKK1.1 billion compared to the year-end 2021. The strong free cash flow more than offset the DKK5.4 billion cash returned to shareholders.
Slide 15 please and a follow-up on our capital allocation priorities. Continuous investment in our business to secure the long-term growth of the company is our first priority. In first half, we increased our marketing investments by 14% organically in support of our strategic priorities. The highest percentage increases were in Asia and Western Europe.
Our strong financial results give us the capacity to accelerate our investments in our SAIL’27 strategic growth priorities, such as strengthening our business in Vietnam, continued investments in growth priorities in China, growing our alcohol-free and beyond-beer portfolio and stepping up ESG initiatives, enabling us to deliver strong earnings and cash flow performance also in the years ahead.
Our second priority of having a strong balance sheet was maintained and even strengthened. With a leverage ratio at 1.11 times, we remain well below our target of below 2 times. We are currently operating with a more conservative approach to leverage than usual due to the general uncertainty related to the macro, the war, commodities, energy and so on, as well as being prepared for potentially buying out our JV partner in India and Nepal, where both the put and the call options have been initiated and find more details on this in the announcement.
Our third priority of an adjusted dividend payout ratio of around 50% was realized in March, with a paid out dividend of DKK3.4 billion, equal to 49% of the adjusted net profit for 2021. To deliver a continued and consistent increase in dividend per share remains very important to us.
Our fourth priority is distributing cash to shareholders, with this year continued with quarterly share buyback programs. In February, we have finalized two quarterly programs, each amounting to DKK1 billion. And today, we are launching the third quarterly program, also amounting to DKK1 billion.
The dividend and the share buyback carried out in first half amounted to DKK5.4 billion. Including July and up until the 13th of August, we have year-to-date returned DKK5.8 billion to our shareholders. The average purchase price in the second share buyback program was DKK905 per share.
Slide 16, please. Before we get to the outlook for the year, let me provide a little more details on the input cost situation and the possible consequences of gas shortages, in particular in Western Europe.
On input costs, it’s a well-known fact that the inflationary pressure is impacting us, as well as other industries. For our business, we expect cost of sales per hectoliter to increase by low-teens in 2022. This is slightly higher than expected earlier in the year and due to the continued increase in energy costs. Our methodology and our approach for managing the business, including the years with significant input cost increases remains unchanged since 2015, 2016.
Our disciplined performance management approach sets the overall run rate for the business. Our Golden Triangle is our performance management tool, and we use it to drive performance and profit improvement in a balanced way.
Therefore, we are using value management initiatives, including price increases to offset the higher input cost through revenue per hectoliter, thereby growing the absolute profit per hectoliter and also total profit for the Group.
We are also maintaining our disciplined focus on costs by using our OCM methodology. At this point in time, we cannot comment specifically on 2023. However, we do expect cost of sales per hectoliter to increase further, but we will stick to the radar of aiming to grow profit per hectoliter also going forward. We will come back with more details on February next year when we give the guidance.
In terms of business continuity, the possible gas shortage has become an important topic for us in terms of Europe in general since the outbreak of the war. To mitigate the risk of gas shortages, we have made investments in Europe during the past couple of months to ensure that the breweries at risk will be able to operate with alternative energy sources as well.
Looking at our supplier, a shortage of gas may particularly have an impact on glass producers due to the energy intensive production. We are closely monitoring the situation. Applying the valuable lessons from the early days of COVID-19, we have established a crisis team that meets frequently to be able to take fast and appropriate actions, if anything changes.
At this point in time, the availability and contracted supplier plants have been confirmed by our suppliers. We are working with all key suppliers to ensure safety stock of critical components and commodities. In addition, our procurement team is developing contingency plans and measures.
And now to the outlook, please go to slide 17. Last week, we upgraded our full year earnings to an organic growth in operating profit of high single-digit percentages. The main reason for the upgrade was the strong operational performance in first half and a better than expected start to Q3.
In many European markets, the impact of the on-trade recovery was stronger than expected, and in Asia, most markets deliver stronger topline and earnings growth than expected at the beginning of the year. In addition, we decided to include profit from Ukraine in the regional numbers as a consistent level of operations has been achieved. The previous guidance included operating profit of zero from Ukraine.
Let me elaborate on the expected second half performance, as we are assuming a weaker earnings progress in the second half. The increase in commodity and energy prices will have a higher impact on our cost of sales in second half than in first half, due to the rolling off of the more favorable hedges, which we entered into last year.
While we will increase prices across our markets in the second half, these price increases will time lag the input cost increases. In addition, we have decided to further accelerate our SAIL’27 strategic priorities investments, including marketing investments across the Group and sales investments, particularly in China and Vietnam.
Lastly, we have tougher comps in second half than the first half and revenue per hectoliter will not benefit from the on-trade recovery as in first half.
We are closely monitoring consumer’s reactions to the inflationary pressure and the impacts on the beer consumption. At this point in time, we are seeing very limited change in purchasing patterns as beer is normally a very resilient category. However, there is a risk of lower volumes or down trading. We believe we are well prepared for this, having portfolios with different price points to cater for different consumer choices.
Despite the increasing input costs, we remain confident that our value management, including pricing initiatives, our strict cost focus, our growth initiatives, in particular in Asia and premiumization efforts across the Group will support the journey of continued earnings growth.
Based on yesterday’s spot rates, we assume currency impact on operating profit of plus DKK350 million, which is unchanged compared to previous assumptions. Net finance costs, excluding FX are assumed to be around DKK550 million, tax rate now at 22% and CapEx unchanged at around DKK4.5 billion.
With that, over to you, Cees ‘t.
Cees ‘t Hart
Thanks, Heine. Before opening up for Q&A, let me summarize H1. It has been a challenging half year due to the war, rising input costs and the pandemic. We delivered a strong set of results and are now significantly ahead of pre-pandemic levels.
Our Ukrainian colleagues have shown incredible strength and resilience since the outbreak of the war and thanks to their efforts, we reopened the breweries in Q2. We have announced our intention to dispose the business in Russia. Last week, we upgraded our earnings guidance for the year. And finally, we launched another DKK1 billion share buyback today.
Please ensure that we again this time we would like to limit the number of questions to two per person to ensure that as many as possible had a chance to get through. After your questions, you are welcome to join the queue again.
And with that, we are ready to take your questions.
Question-and-Answer Session
Operator
[Operator Instructions] The first question is from the line of Andrea Pistacchi from Bank of America. Please go ahead. Your line now will be unmated.
Andrea Pistacchi
Thank you and good morning, Cees ‘t and Heine. Two questions then from me, please. The first one is just to get a bit more color on the COGS inflation and your guidance there. So I think you are guiding to 14 — you had 14% COGS per hectoliter inflation in H1 and you are guiding to, I think, you said, an acceleration in the second half. At the same time, you are saying that you expect low-teens COGS inflation for the year. So could you help us where these numbers a bit or should we interpret this as the fact that it will only be a slight acceleration in the second half compared to what we saw in H1? And then also on the COGS inflation, if you could just update us a bit on your hedge situation, where are you not hedged? The second question, please, is on price mix. If you could split out from the 11% price mix you had in H1, how much was price and then maybe comment on, at Q1, you were talking about you are working on a midyear price increase with retailers in Europe, whether you have been able to land that, how much potentially that is. And you were also talking about now in the prepared remarks about taking additional pricing in Europe in H2, is that a reference to that midyear price increase or is it something maybe incremental to that? Thank you.
Cees ‘t Hart
Thank you, Andrea. Over to Heine.
Heine Dalsgaard
Yeah. Good morning, Andrea. So that was a lot of questions. So let’s start with the COGS inflation year-to-date versus a year ago. So you are right, year-to-date is 14% up, full year guiding on something in the area of low-teens.
The reason why that still accelerates in the second half is due to the absolute numbers. So percentage wise, it’s going down, but in DKK, it is going up in the second half, also impacted by COGS increases already impacting our P&L in the second half last year. So the last year numbers are simply higher this year than last year. That’s why in DKK, it is an acceleration and in percentage, it is not.
On your second question relating to the hedge that’s in place, we are continuing the same hedge policy as we have had for the last few years. So we are hedging our main commodities. It is correct that the spot prices of some of the commodities are as well declining but we hedge.
That means as well that there is an approximate of 12 months sort of lag before that hits our COGS and levels of COGS being up and down. And then most recently, we have actually seen rising costs due to the higher energy prices and also actually higher sugar prices.
So, overall, hedging policy remains safeguard. We are not speculating. When we do the hedging, we are simply giving ourselves transparency and predictability. On the price mix part, over to you, Cees ‘t.
Cees ‘t Hart
Thank you, Heine. And Andrea, with regards to the price mix, the split, we don’t give details, but basically, it was more due to the reopening of the on-trade. With regard to a second round of price increases in 2022, customer’s negotiations started in Q4 2021. Those were based on the hedges done during 2021, and therefore, the price increases executed in H1 didn’t reflect the rising input costs following the war in Ukraine.
In other words, consumers and customers have in H1, you could say, benefited from our 2021 hedges that have postponed the indirect effect from the war. And as these more favorable hedges are now rolling off, our COGS and LOCs, well, in the second half of 2022 increase further, and therefore, that we does require a new round of price increases. And in most markets in CEE and Western Europe, we have engaged in new customer negotiations in late H1 or the beginning of H2, but it’s too early to report on the effect of that.
Andrea Pistacchi
Fantastic. Thank you.
Cees ‘t Hart
You are welcome.
Operator
The next question is from the line of Laurence Whyatt from Barclays. Please go ahead. Your line now will be unmated.
Laurence Whyatt
Good morning, Cees ‘t and Heine. Thanks very much. I’d like to ask three questions on three different regions today, if that’s possible. Firstly, on China, you mentioned you got growth in the first half, but of course, you have been now impacted by some of the lockdowns throughout April and May of this year. I was wondering if you could give us an indication of the exit rate particularly June’s growth rate, anything like that would be very helpful in China? Secondly, in the U.K., you have now had a reasonably decent period of the on-trade being opened and I was wondering if you could give an update on the progression with the Marston’s business. How much you are benefiting from the increased portfolio into the off-trade, but also any benefits into the Marston’s on-trade outlets in the U.K. now that that’s relatively fully open? And then, finally, assuming the call and put options go ahead as expected, perhaps this year. I was wondering if you could give us an indication of how having a fully consolidated and 100% ownership of the Indian and Nepalese business will change your ability to operate in those countries? Thank you very much.
Cees ‘t Hart
Thank you, Laurence. Good morning. These are three questions, but we allow them. Let me take the first two and Heine will take the third one. With regard to China, our Q2 in China was a bit muted. It was 2% volume sales. We see at the end of that quarter, but especially in July and August volumes coming back.
So it was, if you like, skewed to that quarter a more blanket approach on closing parts of cities or cities at that moment of time in China. Now we see a more [Technical Difficulty] and shorter closure of parts of cities or part of the trade, and therefore, we are a bit, well, we are more optimistic about the second half.
In our guidance, we included some of short lockdowns in big cities in China. But and basically, we see them as we speak, but it will not impact according to our own judgment at this moment of time, heavily in the second half of the year. So we expect the momentum in China to come back in the second half of the year.
With regards to the U.K., first of all, we continue to be very glad with our joint venture in the U.K. 20% volume growth was driven by strong on-trade recovery. The off-trade channel declined by around 20%, but we gained some market share there and that is on the back of the full power, if you like, of the portfolio that we have now.
We lacked that a bit in the past. We now with the joint venture have a broad portfolio and see that in our negotiations with both off-trade and on-trade coming back that we gained from the strength of our portfolio in these negotiations. But also, of course, in widening our distribution and getting improved sales and especially then shares. With regards to India, I hand over to Heine.
Heine Dalsgaard
Yes. Good morning, Laurence. So we are as we also said, very satisfied with the ruling from the arbitration. With respect to the impact on our operations, well, India continues to be a very, very interesting long-term opportunity for us as set out both in our sort of current strategy and also in SAIL’27. It is a very, very attractive long-term market.
It is too early to say anything about the sort of short-term impact on our operations. The decision from the arbitration does give us new opportunities and options to end the dispute and our partnership and also to secure future sort of operational freedom of our business both in India and Nepal. So overall, it’s — we are satisfied with the ruling and it is certainly positive for the outlook.
Laurence Whyatt
That’s great. Thank you both very much.
Operator
The next question is from the line of Trevor Stirling from Bernstein. Please go ahead. Your line now will be unmated.
Trevor Stirling
Hi, Cees ‘t and Heine. So two questions for me and maybe I will sneak in a tiny third one at the end. First one, Heine, concerning H2, if I look at H1, I think, roughly, you are up about 275 bps compared to — because of margin compared to 2019. Is it fair to think that you can manage the same in the second half or do you think that versus 2019, they will be slightly lower, because of the COGS inflation that you mentioned? Second question then, I appreciate you are still not fully hedged for 2023, it’s too early to talk yet and put a number on it — a precise number on it. But at the moment, does it look like COGS inflation in 2023 is of the same order of magnitude as 2022, maybe a bit higher, a bit lower, any color you can give would be great? And the final sneaky one, the third one, India if the puts and the calls do go as per paper, what level of cash outflow could you be looking at to close off all of those transactions?
Cees ‘t Hart
Thanks for your questions, Trevor, and good morning. Heine, over to you.
Heine Dalsgaard
So, good morning, Trevor. So, you are right, a strong operating margin performance in first half. That will be lower in second half also versus 2019. It is worth just elaborating on the different factors here and the reason why second half will be low because it’s the same, both versus last year and also versus 2019.
There are basically three main reasons. The first is that the increasing commodity and also energy pricing will have a higher impact on our cost of sales in the second half than we saw in the first half, in particular, also due to the rolling off of the favorable hedges, which we entered into last year.
As a consequence then, COGS per hectoliter will increase both in first half — both compared to first half, but also compared to second half last year, and in second half last year, as we already said, we did see some impact from the higher commodity prices on our COGS.
Part of that as well also impact the fact that the — in order to cover that, the increasing sales pricing that we are implementing across our markets will time lag the cost increase. So that’s sort of the first part.
The second part is that we have proactively decided to further accelerate our investment into our SAIL’27 strategic priorities. And this includes, as we have said many times before, further marketing investments across the entire Group and it includes sales investments, in particular, into Vietnam and into China.
So the second part of the lower growth in earnings, both margin wise and absolute in the second half has to do with a proactive decision to accelerate growth investments in order to make sure that Carlsberg sort of remains strong and there is a growth earnings outlook also in the years to come. So that’s the second part.
And then, basically, the third part of the reason for the slower growth in earnings in second half versus first half has to do with tougher comps from last year as you, I am sure you remember, last year, in particular, Q3 was extraordinarily strong in Western Europe. So that’s the first question. It was a bit of a long answer, Trevor, but it is because it is rather complicated. So, yes, we do expect lower earnings growth versus 2019 in the second half.
When it comes to the 2023 hedging impact, I think, it was. We are seeing COGS increasing and our expected COGS increases in 2023 to go up. It is too early to give sort of precise comments on 2023 COGS and also LOCs, by the way, due to the volatility. But as said, we are expecting cost of sales increases also next year.
But it is important as part of that to highlight that we stick to the rigor of continuing to fight for growing the net profit, and thereby, offsetting the COGS headwind by increase in revenue per hectoliter and also in continued discipline in our costs.
The last part of your sort of third question, Trevor, that was on the cash out relating to a potential buyout of our partner in India and Nepal. As said, we are very satisfied with the ruling, but we cannot and are not allowed to comment on anything relating to potential cash out.
Trevor Stirling
Thanks very much, Heine.
Heine Dalsgaard
Thank you.
Operator
The next question is from the line of Nik Oliver from UBS. Please go ahead. Your line now will be unmated.
Nik Oliver
Hey. Good morning. Thanks a lot. And I will keep myself to two questions. First of all, on China and margins in that market, I guess, I am surprised to the upside. I think in the past we used to think about China being a roughly 20% EBIT margin market. But just any observations you can give us on the margin profile going forward? And then, secondly, one for Heine, I guess, when you took over, I remember, the CFO role, you flagged some typical CFO type targets, getting the interest rate down and getting the tax rate down and we have seen good progress on that. As you move on, has that all been achieved or do you think there’s more to do on the Carlsberg’s side? Thank you very much.
Cees ‘t Hart
Thanks, Nik. With regard to the second question, we are still making sweat for the coming months, but he will answer himself. With regards to China, we continue to progress and to improve our margins. It is indeed significantly above the 20%, in fact, 25%, 26% as we speak and it has to — has a lot to do with the further premiumization.
As you know, the big cities are very much focused on international premium brands and WuSu, which give us good margins, and by that, the further growth of big cities will also enhance our margins in the future. Then, Heine, over to you and your legacy.
Heine Dalsgaard
Yeah. Good morning. So has it all been achieved sort of the areas that are typically within sort of a CFO focus. The journey that we have been on for the last years will continue. The rigor we have put in place, both when it comes to the general performance management, but also to sort of the specific CFO drumbeat areas like interest tax, also cost and cash will definitely continue also going forward. So that has nothing to do with me. That rigor and that discipline will continue and there is still more to go for.
Nik Oliver
Well, that’s a nice clarification. Thank you.
Cees ‘t Hart
Thank you.
Operator
The next question is from the line of Mitch Collett from Deutsche Bank. Please go ahead. Your line now will be unmated.
Mitch Collett
Good morning, Cees ‘t. Good morning, Heine. I am also…
Cees ‘t Hart
Good morning.
Mitch Collett
… happy to just stick to two. So, my first one is on the big step-up in associate income, I appreciate in the statement, you say it’s driven by Nepal, but the increase seems pretty big compared to the scale of that business. So can you comment on the drivers of that? And then my second question, just philosophically on the timing difference between COGS and price increases. Why is there a gap between you being able to recover in price, is it because competitively, it’s hard to take up prices soon enough or is there something else that you would like to flag? Thank you.
Cees ‘t Hart
Okay. Thanks, Mitch. The first question, Heine, over to you.
Heine Dalsgaard
Hey. Okay. Good morning, Mitch. So the question on the associate income in the P&L, so there are basically three factors behind it and you are absolutely right that Nepal in itself is not the only one. But Nepal is one of the reasons why associate profit goes up.
The other reason has to do with a very strong performance in our business in Portugal, so Super Bock, which is also an associate, that is, of course, significantly up versus last year, also due to the reopening. But, in general, Super Bock has performed extraordinarily well this half year and significantly up versus last year and then there are a few one-offs in particular in Asia.
But the main drivers in total, that is the Nepal deconsolidation, which now moves to — moves the profit to share of profit in associate. And then from a business point of view, the very strong performance in our associate in Portugal, Super Bock.
Cees ‘t Hart
Then with regards to the gap between the COGS increases and the price increases. That’s predominantly an issue in Western Europe. As I said earlier, the customer negotiations started in Q4 2021 and these were — these negotiations were based on the hedges done 2021, and of course, also on what we felt was possible from a competition point of view. And what we then registered was an increase in the cost and basically rolling over of our hedges and that indeed leads for the second half of the year to higher COGS.
But in Europe, normally, we only have one price brand, one brand negotiation per year. So we are now in unchartered territory that we need to go back to the negotiation table with our customers. We expect that it will take time and hence we expect or we see already a gap between the increase of the COGS and then the timing of successful price increases.
Mitch Collett
Very helpful. Thank you.
Cees ‘t Hart
Thank you, Mitch.
Operator
The next question is from the line of Simon Hales from Citi. Please go ahead. Your line now will be unmated.
Simon Hales
Thanks and good morning, gentlemen. Just one — maybe just one question, just coming back on the whole COGS issue. Heine, I wonder if you could just help us understand a little bit perhaps what proportion of your sort of cost bases either directly or indirectly exposed or at risk from spot price moves and energy costs from here, I mean, any help you could give us there? And then associated with that, on the risk of gas supply disruption in the coming months in Europe, you mentioned you have got alternative energy sources at your breweries. Does that mean that you don’t expect that you would have any production outages within your brewery footprint in the coming months? And then the second question, with regards to your full year guidance from here, I wonder Cees ‘t what are you building in, in terms of potential deteriorations in consumer demand perhaps as we move through the latter half of this year and inflation really begins to bite on the consumer? And then just this third quick clarification in response to sort of Mitch’s question around associates, when, Heine, you talked about there were some obviously some one-offs in that associate contribution in the first half. I wonder if you can just quantify that to help us with our modeling going forward?
Cees ‘t Hart
Thanks, Simon. Let me take the disruption and the other questions will be answered by Heine. With regards to the disruption on our production or possible disruption, we have done a risk assessment on our European breweries.
And also of course, looked at the risk of reduced gas supplies and in some breweries in Europe, we have invested in new equipment to our boilers. And that means that we now can shift between natural gas and oil, and in some cases, also use electricity for our boilers. So the conclusion of that is that we don’t see a major risk on our production from reduced natural gas supplies. Then with regards to the COGS, Heine, over to you.
Heine Dalsgaard
Sure. Good morning, Simon. So on your question on COGS and the proportion of energy that is hedged, we are, as I said, of course, for good reasons only hedging our own gas use. But for 2022 from Western Europe around or it’s actually more than 85% of our year-to-go use is hedged and for Central and Eastern Europe, it is more than 50%.
So for this year, we feel relatively comfortable. For next year, it is around 60% for Western Europe and around 25% to 30% for Central and Eastern Europe. So these are for the markets where we can actually hedge gas usage. That is not the case in a lot of Asian markets as you are very well aware.
Let me take the one with the associates, then Cees ‘t will comment on the consumer demand impact. The assets, there are three factors driving associates, the deconsolidation of Nepal, the strong results in Super Bock and then the one-offs, which are primarily in Asia. The biggest part is the business impact, the one-offs also a magnitude of a bit more than DKK100 million. On the consumer demand, Cees ‘t?
Cees ‘t Hart
So, with regard to that, so far we have not seen any impact from higher prices and inflation in our regions and countries. We expect, of course, some impact in the second half of the year, although for this year, it will not impact us that much anymore, because as you know, the season is almost over. However, we have a wide range in terms of brands in our portfolio and also a good stretch in our price from, let’s say, the top premium brands to the very affordable brands.
And in that respect, we think that our portfolio really can help the consumer at the moment that they really want to have some affordable luxury in our premium brands or an affordable beer with regards to our mainstream or below mainstream price brands. So in that respect we also look back in history. It’s, as you know, a resilient category, so we feel we are and we are basically also confident that we can cater for the storms ahead.
Simon Hales
That’s great. Thank you so much.
Cees ‘t Hart
Thank you, Simon.
Operator
The next question is from the line of André Thormann from Danske Bank. Please go ahead. Your line will now be unmated.
André Thormann
Thanks for that and good morning, Cees ‘t and Heine. So my first question is in terms of China, I mean, I wondered if you could elaborate a bit on what the current status is on the big cities strategy and what these accelerated investments will mean to the big cities strategy. That’s my first question. And then my second question is just on the point you just made, Cees ‘t, on down trading, as I heard and I want to make sure that I heard it right, do you expect some impact in the second half on down trading and what is that about, just to be sure? Thanks a lot.
Cees ‘t Hart
Sure. Just to prevent any confusion. No. I don’t think this year we will see any, let’s say, impact of higher prices on our business, because the season is almost — also we don’t expect a lot of down trading. We don’t see at the moment, as we speak, a lot of down trading.
Of course, we don’t know what 2023 will bring. But, again, I would like to highlight that we feel and we are confident about the portfolio we have and the price points we cover in the market by which the consumers has a lot of choice either at the high end or at the low end of the price range.
With regards to the big cities strategy and the investments in China, maybe it’s good to repeat where we are at this moment of time. By the end of 2021, we were at 41 cities. But we have adjusted our big cities concept, because we, as you know, went into the 41 cities with the international premium brands.
But the desire of distributors on WuSu was so big that we saw WuSu very strong already in other cities, which are also relatively big and now we merge these two kind of cities, so to say, and that brings the total number of cities to approximately 61 by the end of 2021.
So if we take it from 61 big cities by the end of 2021, we plan to have another 15 cities in 2022 and that rollout has continued, however, it has been delayed a bit by COVID restrictions in Q2 and by that we want to accelerate this in the second half of the year going forward and end at 76 cities by the end of this year. And when we talk about the investments in China, we are talking about seeding further new big cities in the future by which we will accelerate our growth in China in the future.
André Thormann
Thank you so much.
Cees ‘t Hart
Can we have the last question, please? Thank you, Simon, sorry, André.
Operator
The last question is from the line of Sanjeet Aujla from Credit Suisse. Please go ahead. Your line now will be unmated.
Sanjeet Aujla
Hi, Cees ‘t, Heine. Just one from me, as you are preparing the business for further cost inflation into 2023, is the focus on protecting profit per hectoliter or actually growing profit per hectoliter?
Cees ‘t Hart
Thanks for this question, Sanjeet. Heine?
Heine Dalsgaard
Good morning, Sanjeet. So, as always, we are ambitious in Carlsberg. So, and as said, we do see cost — further cost inflation coming our way. Our key focus is in the years to come to continue to grow our absolute profit and profit per hectoliter, even though we have significant cost headwind.
And we do that with value management initiatives, so continue to grow topline and revenue per hectoliter and we do that by continuously having a strict discipline on our cost by sort of our OCM methodology that has served us well for the last six years. So our ambition certainly is in the years to come to continue to grow profits.
Sanjeet Aujla
Great. And just one point of clarification. Just…
Cees ‘t Hart
Yeah.
Sanjeet Aujla
… on the COGS increase to low teens from 10% to 12% previously. Is that entirely the recent step-up in natural gas or is there some benefit from lower commodities kind of within that that’s more than offset by high natural gas, is that the right way to think about it?
Heine Dalsgaard
The main reason has to do with the increases in energy pricing.
Sanjeet Aujla
Okay. Thank you.
Heine Dalsgaard
Thank you.
Cees ‘t Hart
Thank you, Sanjeet. That was the final question for today. Thank you for listening in and thank you for your questions. We are looking forward to meeting some of you in person during our roadshow in the coming days and weeks, as well as our Capital Markets Day in September in Copenhagen. Have a nice day.
Be the first to comment