Business Page – May 09, 2004

On the line: Demerara Tobacco Company Limited Annual Report 2003

Annual Report cover

If turtles could talk

Demerara Tobacco Company Limited, which ceased manufacturing in Guyana in 1997, and is now entirely in the importation and sale of cigarettes will hold its 70th AGM at Hotel Tower on Thursday, May 14, 2004. Business Page today reviews the Annual Report for the year ended December 31, 2003, including the report of the directors and the financial statements for the year ended on that date. Financially, the company has again done extremely well with a return on assets and earnings per share being the stuff of which financial dreams are made. Indeed, while the company is reporting continuous growth, British American Tobacco, its ultimate parent company reported a decline of 25% in profits for 2003 from 2,113M pounds sterling to 1,567M pounds sterling.

Even as he lamented "the continuation and escalation of the difficult conditions in the country which started in 2002, the Executive Chairman of the Company, Mr Michael B. Harris, expressed pleasure in reporting another successful year. The Chairman reported an increase in total volume of sales of 1.4% but a decline of 14% in the sale of Benson & Hedges, the company's premium brand. With a reported fall in the population it seems that Guyanese are actually smoking more not less cigarettes. One colleague has suggested that the company benefits from the depressed economic and social conditions as Guyanese turn to cigarettes - and that other vice, alcohol - for temporary relief. In the process, Guyanese are clearly ignoring the fatal dangers medically established as associated with cigarette use. Interestingly, the cover of the company's 2003 Annual Report, with an eye on marketing, depicts images of Shell Beach and includes four turtles. Is it not fascinating to ponder what turtles might think of cigarettes?

Clearly conscious but obviously very defensive about what he refers to euphemistically as "the on- going controversy surrounding our industry" internationally, the Chairman spent a large part of his report defending the industry by highlighting steps such as anti-smuggling(?) and the unlawful trade in the company's products, and speaking extensively about smoking being a lifestyle choice. What he has failed to note, however, is that it is not a choice which he and many of his fellow directors would make, and clearly the company is shifting responsibility to the victims of smoking who in Third World countries are not sufficiently informed about the life-threatening dangers of smoking.

While the Annual Report will come as a joy to the members of the company, it does raise a number of issues, including the country's tax policies, one specific tax matter and by omission, questions of governance. Demtoco shares with some of our other public companies the dominant influence of the controlling shareholder who operates the winner-take-all style common to governments. Minority shareholders are at best passive investors with practically no say in how the entity is managed.

Performance

Sales for the year were $3,121M, an increase of 7% over last year. Last September, this column questioned the price increase in July 2003, describing it as "a case of exploitation of a market in which the company boasts a market share of 98% in the company's key brand." The exploitation is borne out with the reported gross profit percentage of 113% compared with a more measly 97% last year! Net profit for the year has topped the billion dollar mark ($1.16B) for the first time in the company's history and represents an increase of 16.7% over last year.

After taxes of $556M, the company is left with $601M out of which it has paid some $228M in interim dividends, and is proposing to pay a final dividend of another $228M, costing the company a total of $456M or 75% of the year's profits available for distribution. While such a payout may seem high by local standards, it should be noted that the company's needs for investment are negligible as its business is now entirely trading. By contrast, the group (BAT) is paying out 799M pounds sterling out of the year's profit of 631M pounds sterling, making the payout ratio 127 per cent! What is particularly significant is that after the dividend, the group has a negative accumulated loss.

The company is clearly not following the group's practice when it comes to dividends - but then it does not need to. When dividends are declared, every shareholder receives his/her proportional share leaving less money in the company. What the company does, no doubt under instructions from its parent, is forgo the dividend that it might otherwise be able to pay, retain that money in the company and then lend it interest-free to its related parties. As a result of this strategy, group companies now owe the Guyana company $395M, a level that keeps rising annually.

Royalty?

One of the charges in the accounts is an amount of $120M for royalty charged by the ultimate parent company. This is difficult to understand and hard to justify. This is a trading company that buys a branded product and it must therefore be assumed that ownership passes at the time of sale. The company does not trade under any other name, and sells only group products which it buys. What then is it paying a royalty for? Could it that this is a legacy from the days when Demtoco was manufacturing under licence? If this charge is not commercially justifiable, what then would be the basis for the payment that has amounted to $500M over the past five years?

Earnings per Share has increased by $4.03 to $25.72, which is likely to be reflected in an increase in the share price, that is, assuming that holders would want to part with their shares, the price of which skyrocketed last year shortly after Business Page had opined that the market was grossly undervaluing the shares.

Return on assets measured by profit before tax as a percentage of total assets is a staggering 139 per cent, compared with 8.3% for the group companies. But annual earnings to full-time employees (now down to 13 from 16), is also quite impressive averaging $3.5M per employee, up from $2.7M in 2002. With no disclosure of remuneration to key management personnel as required by IAS 24, no further analysis is available for shareholders. Does BAT support this as well?

Regulatory framework

As they did when they published the company's half-yearly report as required by the Securities Industry Act, the directors did not even acknowledge the existence of the Securities Council or the draft Guidelines on Corporate Governance published by the council with which it is more non-compliant than not. This is truly regrettable behaviour by an international company which would not dare to behave so cavalierly in its home country, as is obvious from BAT's Annual Report available on the web. Unfortunately, Demtoco is not the only Guyana company to reflect such a dismissive attitude in relation to the Securities Council, and unless that body begins to show that it means business, it will soon earn the type of reputation which the Office of the Registrar of Companies has.

Is it this type of carelessness that allows the company to describe a "substantial shareholder" as one with 10% rather than 5 per cent, or permit it to ignore the requirement for disclosure of summary particulars of any contracts of significance between the company and related companies?

Conclusion

Once again, the increasing profitability earned by the company and the 98% market share raise questions about the competition from smuggling. Duty and excise tax paid by the company averages less than 50% of cost of sales, and there is clearly a matter for tax policy-makers here. This column noted last year that cigarettes are as susceptible if not more, to smuggling as say fuel, refrigerators, stoves, etc, yet we appear unable to control the smuggling of those commodities while doing so successfully with cigarettes.

Demtoco is now indisputably the most successful company in Guyana. The group must feel vindicated about its decision to move from manufacturing to trading. The industry does contribute a substantial sum to the national coffers, but there are serious health costs to be borne by the country, citizens and consumers. The bulk of the company's profits are not compensating the nation which has to bear the cost of smoking's consequences. The company is managed in some ways like the Bookers of old, one standard for the colonizers and another for the colony.

Can and how does Guyana resolve such a dilemma?

Next week, we will look at GT&T.

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