Business Page – On the Line - Annual Report  - Demerara Tobacco Company Limited 2005

Sunday, April 23rd, 2006

Introduction:

Demerara Tobacco Company Limited, a subsidiary of British American Tobacco, p.l.c., buys a branded product from a fellow subsidiary, pays more than US$600,000 in 'royalties' to the parent company, has one single distributor and no more than fourteen employees and pays another US$1,000,000 for management services from fellow subsidiaries and technical and advisory services from the ultimate parent company. The company also has an average of in excess of another US$1,000,000 due from a related party on which it receives no interest.

The company will be holding its 72nd Annual General Meeting this coming Thursday to announce that despite the floods which 'hampered distribution', the company has increased its profits before tax by some 6% on an increase in sales of 2% (on a 3.5% increase in volume).

Last May, after the high-visibility Minister of Health returned from one of his overseas trips he announced to the press that anti-tobacco legislation, like Tarzan, would be 'coming soon'. One year later, there is no legislation and the company that controls 97% of the market announces that its sales of cigarettes have increased by 18,000,000 sticks!

One year after announcing that his ministry would be conducting a survey biennially, the company can boast of the huge success with its after-work lime and music competition promising original music or an iPod - hardly the sort of thing that attracts non-youths.

Nation of Smokers:

Even as the country's population declines or flattens, cigarette sales continue to rise, with every single Guyanese, from the cradle to the wheel chair, on average smoking a total of thirty-six packs of twenty cigarettes per year. With tobacco being the leading cause of preventable death in the world today, and with administrators and public health officials emphasising preventive rather than curative medicine it would have been good if the Minister had been faithful to his public pronouncement and ministerial mandate. This total neglect by the Minister makes the statement by the Managing Director that the company has 'demonstrated over the years its commitment to work with the Government to ensure that legislation developed is reasonable to all parties involved' troubling. It is either pure rhetoric with no substance or indicates that despite the commitment of the company, the government is simply not interested in legislation - a case of Hobson's choice.

For the third successive year, the company's AGM will be presided over by a new Chairman. In 2004, it was Mr Michael Harris who held the triple title of Country Manager, Managing Director and Chairman who was followed in 2005 by Mr Christian Preuss, Chairman and Managing Director. In 2006 the Chairman is Patrick Smith a non-executive director while the position of CEO (ag) is held by Guyanese accountant Mr Chandradat Chintamani. The company has not disclosed the number of employees which at December 31, 2004 stood at 14 with average remuneration of $4.4M. per employee for that year.

Key management personnel earned $28.5Mn but unhelpfully the company neither discloses the number of employees nor key management personnel to allow for any meaningful comment.

Commentary:

The gross profit margin, which measures the relationship between the sales value and the cost of the items sold, fell from 52% to 50%, prompting a 14% price increase from December 2005. With three price increases between 2002 and 2005, there appears to be no price elasticity for the company's product. This should be good news for the administrators considering any tax increases to restore the relationship between duty and excise paid and sales to what it was a few years ago when it was 33%. It is now 24%.

In dollar terms, gross profit fell by $37M. but because distribution costs were reduced by $62M. and administrative expenses fell by $52mn., profit before tax increased by $70M. Edward B Beharry and Company Limited with decades of experience in the business is now the sole distributor of the company's product for the entire country, a move that has seen a decline in distribution expenditure of 23%. There is no breakdown of the category of administrative expenditure but the notes disclose that expenditure payments to related parties alone amounted to $334 M. raising the question whether some of these are charged to cost of sales.

The company remains a major taxpayer and its effective rate of tax on profits declared is 49%. Earnings per share increased by $1.38 while dividends declared and paid totalled $521M, representing 91% of after tax profits compared with 94% in 2004.

Overloaded GRA:

Inclusive of royalties, management charges and dividends, payments to group companies amounted to $720 M, representing an extremely attractive return to the group. The attempt by the company to justify a royalty payment of G$130M, by stating that the product is manufactured to 'predetermined specifications' is hardly convincing even to a non-smoker who can buy the same product almost anywhere outside of Guyana. And while every company can and should determine its business model, paying US$1M, for management services when all the company does is bring in a product and sell it immediately to a sole distributor seems to defy business logic. That Business Page has been sharply attacked by the company for raising some of these very issues in the past ought not to make them less worthy of repetition particularly in the absence of reasonable justification. Surely even Guyanese shareholders must be willing to put aside their appreciation of good dividends in the broader fiscal and national interest.

And is it a measure of bigness that the group can simply decide to discontinue the payment of interest at the paltry rate of 2% per annum or that it will lend an additional G$235M. to a fellow subsidiary? Is Guyana the gem in the BAT jewel and is this because the GRA - busy preparing for the introduction of VAT, dealing with smuggled weapons and more recently money laundering - has taken its eye off the ball?

Under the tax laws, even where management charges are in fact allowable, this is limited to 1% of turnover which would mean that such charges would be limited to $34M. and that $170M. of management services and technical and advisory services would otherwise be disallowed. In fact the financial statements which are audited by Jack A Alli, Sons and Co. show a total amount of disallowable expenses of $81M (which includes all forms of disallowable expenses including group charges).

Just by way of comparison, NBIC which is owned 51% by Republic Bank of Trinidad & Tobago and which has 11 branches and 558 employees in Guyana charges $48M by way of management fees which include directors fees and expenses.

Conclusion:

After the public spat which the company had with Business Page last year over the issue of corporate governance, it is heartening to note that the Annual Report which bears on the face 2006 instead of 2005 has included a new section on Business Principles including the principle of good corporate conduct. It seems clear that for the company however that 70% of shareholding means 100% control. Could they not make a concession to the local minority shareholders or does the company consider that former CEO Charles Quintin represents the interest of those shareholders?