Q3 2019 Earnings Call
Okay and welcome to the Philip Morris International third quarter 2019 earnings Conference call.
Today's call is scheduled to last about one hour, including remarks by Philip Morris International management, and the question and answer session.
In order to ask a question. Please press the star key followed by the number one on your Touchtone phone at any time.
Media Representatives on the call well also be invited to ask questions at the conclusion of questions from the investment community.
I'll now turn the call over to Mr., Nick Rowley, Vice President and Investor Relations and financial Communications. Please go ahead Sir.
Welcome and thank you for joining US earlier today, we issued a news release containing detailed information on our 2019 third quarter results.
You may access to release on Www Dot PMI Dot com.
The PMI Investor Relations.
The glossary of terms, including the definition for reduce risk products or piece as well as adjustments other calculations and reconciliations to the most directly comparable U.S. GAAP measures or at the end of today's webcast slides, which are posted on our website.
Unless otherwise stated all references to I coasts, our to our heico's heat not burn products.
Comparisons are presented on a like for like basis, reflecting pro forma 2018 results, which have been adjusted for the deconsolidation of our Canadian subsidiary, Rothmans Benson and hedges Inc.
Or be age effective March 22nd 2019.
Today's remarks contain forward looking statements and projections of future results I direct your attention to the forward looking in cautionary statements disclosure in todays presentation and press release for review the various factors could cause actual results to differ materially from projections or forward looking statements. It's now my pleasure.
To introduce Martin King, our Chief Financial Officer Martin.
Thank you, Nick and welcome ladies and gentlemen.
Third quarter results continued to reflect strong underlying business performance.
The results include the better than anticipated timing of pricing and cost compared to our previously communicated assumptions for the quarter.
Our reported results in the quarter were impacted by an after tax charge in Russia of 315 million related to a final assessment by the Moscow tax authorities on excise taxes and VHP for the 2015 to 2017 period.
Additional detail on this charge is provided in today's press release.
Total shipment volume in the third quarter declined by 1.4%.
Excluding the net favorable impact of estimated distributor inventory movements due primarily to the heated tobacco unit inventory reduction in Japan. During the third quarter of 2018, our total end market sales volume declined by 3.6%.
Reflecting lower cigarette volume, partly offset by strong heated tobacco unit volume growth.
Approximately two thirds of the total end market sales volume decline was due to three markets in two of which the decreases were largely timing related.
In Pakistan, our cigarette volume was down by approximately 50%.
Totally in line with the industry decline, reflecting the timing of excise tax increase announcements compared to last year as well as the impact of price increases.
In Turkey, our cigarette volume decline was due mainly to the impact of two price increases this year totaling five Turkish lira per pack or roughly 44% on a weighted average basis, which disproportionately impacted our share given the timing of our price increases visa be the competition.
In Indonesia, or cigarette volume decline, mainly reflected lower share primarily due to widen price gaps between our brands and the competitions as well as a lower total market.
Heated tobacco unit shipment volume reached 16 billion units in the quarter.
Excluding the net favorable impact of inventory movements, primarily related to third quarter 2018 inventory reduction in Japan.
HT you end market sales volume increased by 28.3% driven by the E U and eastern Europe regions.
HD you shipment volume in the quarter was inline with our aims to you in market sales volume of 15.9 billion units.
Third quarter net revenues increased by 7% excluding currency.
Driven by higher Ht, you shipment volume and favorable pricing for our combustible tobacco portfolio.
Partly offset by lower cigarette shipment volume.
RFP net revenues reached 1.3 billion in the quarter.
We're over 17% of PMI total net revenues.
It is worth noting that our year to date September RRP net revenues of $4.1 billion have essentially reached the full year 2018 tool.
We recorded a strong combustible tobacco pricing variance of 5.9% in the quarter.
Driven, notably by Germany, Indonesia, Mexico, the Philippines, Russia and Turkey.
On a currency neutral basis, adjusted operating income increased by 8%.
While adjusted operating income margin grew by 40 basis points.
This margin expansion was achieved despite net incremental investment behind our piece in the quarter of approximately $170 million and was driven primarily by favorable geographic mix related to age to use reflecting the increased contribution of volume from high cost.
AGA fees with relatively high unit margins, notably markets in the EU region.
Our adjusted operating income and margin also benefited from the timing of costs as certain expenditures initially planned for the third quarter, we're not incurred by quarter end.
Adjusted diluted EPS increased by 5.9% excluding currency.
The lower currency neutral growth in adjusted diluted earnings per share compared to adjusted operating income, notably reflected the high relative growth contribution in the quarter from markets with sizeable non controlling interest for example, the Philippines with a non controlling interest a 50%.
Our total international market share, excluding China, and the US was essentially stable in the third quarter, reflecting lower share for cigarettes, offset by higher share for heated tobacco units, which reached 2.3%.
Our share of the cigarette category declined by <unk> 0.4 points, reflecting continued adult smoker out switching to heico's, particularly in the region, Japan and Russia.
Coupled with lower share, notably in Argentina, Indonesia, Korea, Mexico and Turkey.
Importantly, marlboro's share of the cigarette category increased by <unk> 0.2 points to 10.2% driven by Germany, The Philippines, Russia, Saudi Arabia and Turkey.
The share decline in Indonesia, primarily reflects the impact of widen price gaps between 7.8, notably a mild and competitive brands, particularly at the bottom of the market.
As you May recall, we increased our prices in Indonesia late last year in anticipation of a 2019 excise tax increase that ultimately did not materialize.
Our competitors largely maintain their prices, particularly following the government's decision to leave cigarette excise taxes unchanged, leading to the widened price gaps with our brands this year.
Although no formal regulation has yet been issued the government recently outlined a 2020 cigarette excise tax with an average increase of 23% in excise and 35% in the minimum annual price.
As the government has not yet announced the increase for each individual taxed here it is difficult to accurately gauge the anticipated volume and share impact in 2020 .
We do note however that while the potential tax pass on is relatively steep in the context of a two year stack with no excise tax increase in 2019.
Average percentage increase is broadly in line with historical levels.
Turning now to a more detailed discussion of our RP performance, we estimate that there were approximately $12.4 million heico's users as of quarter end.
We further estimate the 71% of the total or some $8.8 million heico's users have stopped smoking and switched heico's with the balance in various stages of conversion.
Ico says now commercially available and 51 markets. Following recent launches in Belarusian the United Arab Emirates and in the United States.
We're particularly excited by the launch of I coast in the us through our commercial arrangement with Altria.
The first I coast retail store has opened in the initial lead markets of Atlanta, Georgia.
Marking a historic milestone in providing better alternatives to the 40 million men and women in the us who smoke.
Hi goes is currently the only heat not burn product on the market authorized through the us food and drug administrations PMTA pathway as well as appropriate for the protection of public health.
As you are aware the merger discussions with ultra have ended although this chapter is definitively closed we havent ongoing relationship with Altria and both companies will focus on maximizing the ecos opportunity in the U.S market.
Last month, we took another important step in our journey towards a smoke free future with the launch of Ico Sthree dual.
This latest additions the Lycos family was designed with enhanced features to help adult smokers switch more seamlessly from cigarettes.
Ico Sthree duo allows two consecutive uses without recharging the holder wireless charging time is significantly faster compared to ico, Sthree and heico's 2.4, plus.
Ico Sthree duo is currently available in Japan and will be rolled out in most markets, where I coast is commercially available by the end of this year further strengthening our smoke free leadership position.
Let me now take you through the performance of Iclusig in the quarter.
In the markets, where it goes it's been commercialized excluding the us or HT you brands recorded a total combined share of 5.1% despite not yet being nationally distributed in many of them.
This share level or HQ brands would collectively be the fourth largest tobacco brand in these markets up from number six in the third quarter of last year.
In the region, where we are commercializing psychosis areas, representing approximately 57% of total industry volume share for heat more than doubled in the quarter to reach 2.5%.
This growth reflects continued strength across a broad range of markets as detailed as detailed in the HQ market share appendix included at the end of today's presentation.
On a sequential basis share increased by 8.1 point compared to the second quarter, given the impact of higher industry cigarette sales volume, reflecting summer seasonality. We believed that this sequential share performance understates the favorable momentum of heat to this point the end markets.
Sales volume for heat increased by over 9% sequentially versus the second quarter.
I think those continued its strong performance in Russia in the quarter with each share up by 2.9 points to reach 4%.
On a sequential basis versus the second quarter Keech share increased by 1.1 points well end market sales increased by over 40% to reached 2.4 billion units.
He'd share growth in the quarter was consistent with the pace of adult smoker adoption and our geographic expansion.
We are now commercializing I coast in cities, representing approximately half of the market by total industry volume compared to an estimated 40% at the end of the second quarter.
In Japan, our total share for Heatsticks and heat increased by 1.5 points to reach 17% in the quarter.
The initiatives that we introduced during the second quarter of last year continued to pay off and drove a step up in our share performance.
On a sequential basis the share of our HBU brands was up by 0.4 points were stable after adjusting for the estimated impact of trade loading in advanced of the October Onest tax and price increases.
Importantly, our weekly off take share increased sequentially during the quarter.
Reaching over 18% by the end of September .
Well, we acknowledge that our offtake shares tore the ended the period may have been favourably impacted by consumer loading ahead of the October onest.
Our share growth continued in the first week of this month.
We are encouraged by our age to you share performance in the face of increased competitive activity as the years progressed.
While the growing number of smoke free devices and consumables has contributed to competitive churn.
Coast remains the market leader with approximately 73% of HBU category share despite accounting for only around 20% of category SK use.
We believe the launch of Ico Sthree duo will further reinforce the ico spam lease leadership position.
This will be complemented by recent line extensions in our Heatsticks and heat lineups.
In Korea, the heated tobacco category remains highly competitive, particularly in the area of non menthol flavors and related new taste dimensions that are also present in the cigarette category.
Each share in the third quarter declined by 1.2 points or by one point on an adjusted basis.
Share for heats was also down sequentially versus the second quarter.
However, we began to see early signs of stabilization in heat offtake segment share over the course of the third quarter supported by recent launches that expanded the flavor lineup.
While we inked while we are encouraged by this trend we have a lot of work to do to reinforce the heated tobacco categories benefits and build upon psychosis leadership position.
In this regard we look forward to the upcoming rollout of Ico Sthree dual.
Turning now to our full year outlook as announced in today's press release, we're revising our 2019 reported diluted EPS guidance at prevailing exchange rates to be at least $4.73.
The 21 cent decrease compared to our prior guidance of July 18th of at least $4 94 was predominantly due to $315 million after tax charge in Russia noted earlier.
Our guidance continues to include an unfavorable currency impact at prevailing exchange rates of approximately 14 cents per share.
After excluding the reporting adjustments and tax items outlined on this slide our forecast continues to represent a projected currency neutral increase of at least 9% versus our pro forma adjusted diluted earnings per share of $4.84 in 2018.
Our guidance continues to assume an industry total volume decline in 29 team of approximately 2.5%, excluding China and the use.
As a result of recent cigarette price increases in selected markets, notably the Philippines, and Turkey, We now assume a full year total shipment volume decline rate, a 1% to 1.5% versus approximately 1% previously.
This revision solely reflects changes to our full year cigarette shipment volume outlook.
We continue to anticipate full year age to use shipment broadly volume broadly in line with our age to you in market sales volume with any inventory movements. This year in individual markets essentially offsetting on an aggregate basis.
We are maintaining our full year assumption of currency neutral net revenue growth of at least 6%.
Now reflects a higher combustible tobacco pricing variance of approximately 6% compared to above 5% previously which is effectively offset by the impact of our revised total shipment volume target.
While we continue to anticipate net incremental investments behind Rps of approximately $400 million, excluding currency, we're refining our currency neutral adjusted operating income margin expansion assumption for the year to approximately 150 basis points from at least 100 base.
This points previously.
In addition, please note that we are not with we now expect the full year contribution of Iqos devices to total RP net revenues to be approximately 15% compared to below 20% previously.
This primarily reflects the favorable geographic mix impact of greater HBU volume in relatively high margin geographies, notably markets in the EU region.
The longer life span the latest heico's devices compared to prior versions and the impact of Heico's device retail price changes in select markets.
We now anticipate full year operating cash flow of approximately $9.2 billion.
Subject to year end working capital requirements.
The change compared to our prior assumption of approximately $9.5 billion reflects the impact of the after tax charge in Russia.
Separately, we now expect 2019 capital expenditures of approximately $1 billion compared to approximately $1.1 billion previously.
Dividends remain the primary use of our operating cash flow after capital expenditures last month, we increased our quarterly dividend rate by 2.6% to $1.17 per share. This equates to a total quarterly dividend of approximately $1.8 billion or approximately 7.3 big.
$1 annually.
To close on our full year guidance and assumptions I would like to touch on our anticipated fourth quarter performance.
Importantly, we expect currency neutral net revenue and adjusted operating income growth to be inline with our year to date September results.
However, our currency neutral adjusted diluted EPS growth will be lower than our year to date September performance due to the following factors.
An unfavorable income tax rate comparison of roughly four percentage points versus the fourth quarter of 2018 during which our three month tax rate benefited from the full year impact of further clarifications related to the us tax reform and a continued hydro.
Relative adjusted operating income growth contribution from markets with sizeable non controlling interests.
We expect these two factors to serve as a drag of approximately nine percentage points on our fourth quarter currency neutral adjusted diluted EPS growth rate compared to our pro forma adjusted diluted earnings per share of $1.17.
In the fourth quarter of 2018.
To conclude we recorded strong underlying business performance in the third quarter, reflecting the quality of our execution against each of the key metrics of net revenues.
Operating income margin and diluted EPS on a currency neutral adjusted basis.
The fundamentals supporting our strong combustible tobacco portfolio are intact.
The favorable momentum for Heico's continues across geographies further supporting our confidence in our age to you shipment volume target of 90 to 100 billion units by 2021.
We are excited by the recent launch of Ipos in the us and the global launch of Ico Sthree do.
Finally on a currency neutral basis, we're maintaining our full year 2019 growth assumption for net revenues of at least 6% and our anticipated full year 2019 growth rate for adjusted diluted EPS of at least 9%.
Thank you now happy to take your questions.
Thank you we will conduct a question and answer portion of the conference again in order to ask a question or make a comment. Please press the star Keane followed by one on your Touchtone phone.
Our first question comes from the line of Chris squarely at Stifel.
Hi, good morning.
Hi, Chris Hi.
I guess my first question for you and I think you could you help explain some high level just that you do have more pricing coming through in the combustible business in relation and therefore, there's a negative volume application certainly in this quarter there was.
Thats just whether it was the timing of tax increases are there certain markets you'd call out. If you said those I'm sorry, I missed on I, just want to get a little more color on thats understand the application to guidance for the year for volume.
Yes, the two markets to call out our Turkey in Philippines.
Remember in Turkey, we had a tax increase back in April the pass on was about $4 and 20.
Turkish lira and at the time, we took.
Two Turkish lira shortly thereafter.
Amidst a lot of scrutiny on inflation from the government.
At the time also the other competitors did not move immediately we lost quite a bit of share.
And now we've been able to take another three Turkish lira in August which the other competitors also followed immediately and so you're seeing basically our opportunity to take pricing in Turkey come with the situation were taken as soon as we can but were in fact, a little bit late now we've been able to pass the full tax and a little bit more.
So we're on track in Turkey, after having to delay a bit the pricing from what we would have normally done and the second one to call out as the Philippines.
There was a tax increase announced to take effect in January 2020. The tax goes from 35 pesos per pack to 45 pesos per pack and you're seeing US move ahead of that with pricing that started already in August late August .
Now that we have clarity on the on the tax to come and also because in Philippines. Once the tax is clear the trade will tend to try to buy more volume and end to end take some of the benefits from the from the tax increase so those two or situations, where we're taking pricing as we can get it.
We were obviously doing very well with volume through the first half of the year end you see US now in the second half moving a little more with pricing in a couple of markets, but if you look at stand back and look at the full year picture, what we're saying volume down one to one and a half pricing at 6%, it's actually a pretty good balance and our overall share for the year, we anticipate.
To be positive against the industry decline of two an app. So when you look at the bigger picture long term, it's a very nice balance mix between volume share and pricing.
I would agree thank you.
Second question, if I could in relation to I Cosan Rps and.
You have a.
My math is right here, if I numbers right you have even inventory builds I'm trying to get to and and in our piece you're today does that come out in the fourth quarters, we think about.
The your inventory not being a factor for your shipments for the year you did mentioned that end market sales should roughly approximate.
Your shipments so just wanted to put those two numbers and then just to think about your RRP revenue in the fourth quarter have you given any color on that sort of the agree with that should grow or the degree to which these inventory changes if they do occur could weigh on that quarter.
Let me, let me be crystal clear on RP HQ inventory there has been no inventory build and there will be no inventory build for this year, our end market sales in our shipments for the full year will be approximately the same and they were also even in the quarter, we had 60.
I mean billion of shipments and 15.9 billion of end market sales, what you're seeing Chris I think maybe there's some confusion is it last year in the third quarter, we drew inventories down in Japan in particular around 4 billion units. So the reference to X inventory is so.
You can compare apples to apples would essentially saying is at 4 billion back to last year to make the comparisons equal.
But this year our inventories are.
Flatbreads to use and so forth.
And in fact, we don't anticipate by the end of the year any inventory builds really in age to use or cigarettes, we should end the year fairly lean on inventory.
Okay, that's clear and thank you for that for clearing that up thank you.
Our next question comes from the line of Michael Laferrari of Piper Jaffray.
Good morning, Thank you.
Looking at a Indonesia youve.
Called out the volume headwinds in this quarter, but on a year you're slightly.
How do you reconcile that with the price gaps that you've cited as a headwind for the quarter and and then just looking ahead, what should we think for the outlook for the market I know you know, perhaps a little bit tax tiered detailing yet but.
In terms of just where are you said from the category standpoint can you give a sense of what 2020 might look like.
Okay, So for Indonesia, the overall market.
So far this year is up slightly as you would expect with with no tax increase in very muted pricing. We are losing some share as we mentioned in the in the script the price gap between our premium brands in the low end is hurting our share but it's also.
Causing some mix erosion as volume traits down we do have some new initiatives at the lower price tiers that are doing very well, but within our portfolio were being dragged.
By mix as well as by the overall share loss.
And so our shipments for the year are coming in slightly slightly negative is or for sorry year to date are coming in slightly negative as well now as far as that the the situation in Indonesia going forward. The government has said they are going increased the tax they've used the number 23%, it's not final and hasn't been released particularly by tax year.
They've also said, though that the band oil price.
Minimum price would go by 35%, which would have a very positive effect from the point of view this mix issue because it would cause the low end to the market to move up and close some of the gaps that have been the biggest problem for government revenue collection as well as for our own.
Mix issue now the total volume is hard to estimate going forward until we see the details on both the increase amounts, but also by individual tiers, but.
But overall when you look at the the the increase of tax from 23% over a two year period and realize that the pass on actual retail price.
Is lower than the full 23%.
It's not a disaster from that point of view, although we will have the challenge next year of going into the year without a lot of annualization of pricing that we normally have because of the way the Indonesian markets with lot market works with lots of small price increases so Indonesia, I get the longer term big picture resetting the gaps for.
Perhaps having a chance to address some of this mix issue is net positive. However, the the challenge for next year will be the overall.
Lack of Annualization on pricing and the potential impact on the volume due to the relatively larger sized increase all at once as opposed to coming over a period of time, So we'll wait and see what Indonesia unfolds, but.
But.
It gives us some opportunities as well.
And just on Japan, you called out some headwinds from Downtrading as well for the Cigarillos can you just give a sense of how to think about that segment and is there more of a headwind from that going forward, we should anticipate.
The other couple of things to know about the Cigarillos segment. One is we it's not considered in the cigarette and age to use to overall cigarette volume that weve been.
Using as the basis, so as Cigarillos grow.
We may have some distortions coming from that that will have to explain in quarters going forward and we'll we'll break that out for you.
The Cigarillos category benefits from a preferential tax if you will we don't know whether this will last likely I think eventually the government will close this situation.
Because so cigarillos for example can be priced below cigarettes at the bottom in the market and still have you have higher margins.
Now there was initially a category that was opened.
It and J.T. when the class C product.
Separate tax category phased out they actually transferred some of the class C brands over into Cigarillos. So we would guesstimate that probably by the end of this year it could be a three to 4 billion total year number for Cigarillos.
So it's starting to get big enough to have an impact on the total market.
Obviously.
We don't think this category should have preferential tax going forward, but.
We'll have to monitor the situation and decided.
We ourselves would have to compete in it at some point in order to not be at a disadvantage.
But overall I think that the situation, Japan with our focus being on heated tobacco and I coast in the real benefits coming from our gains in those categories or net positive right now.
No Thats very helpful. Thanks, One quick last one you mentioned in duty free some headwinds from China in particular.
Having a little bit more enforcement on what.
People are allowed to bring into that market.
Clearly there is some consumer interest in that country can you give an update on what if any status.
Change you may have had in your negotiations with CMTC to potentially launch with some sort of joint venture or something in China.
I really don't have any new news with regards to our cooperations with CMTC, we continue to.
I hope that.
That Rps and I coast in particular is an area for potential cooperation, but we don't have any additional progress on that youre right duty free numbers have been affected by the fact that the the allowances the amount of of product that individual tourists are travelers are allowed to bring back into China.
It has been reduced and more strictly enforced and that is is having an impact on what was a very robust duty free business of age to use not just to travelers from China, but other countries as well.
And you see in the.
Numbers for the Middle East.
Africa duty free that H. to you is down this quarter, it's partly because of the comparison, whereas last year, we were ramping up and building some inventory to deal with higher sales. This year. We're in a reverse situation, where we're bringing some of the volume down in order to to to account for the new situation with the.
Traveler limits, so it's pretty big swing, but it's in the Grand scheme of things is not major and as I said before the total.
Sales and shipments for.
Heated tobacco units around the world were were equal for the quarter.
Okay. Thanks.
Sure.
Our next question comes from the line of Bonnie Heck Bock of Wells Fargo.
Thank you how are you.
Hi, Good Hi, I have a question on your guidance for Q4, you mentioned EPS growth will be below year to date trend. So just wondering how much lower you talked about I think a nine point drag from the factors you mentioned, Martin, but shouldnt that be offset by your expectations for stronger margin expansion.
Ken So just trying to get a sense, if you're expecting Q4, you test growth closer to your your full year guidance has 9% or below your I guess I'm.
Really trying to get a sense of how conservative this might be especially given the momentum you're seeing in your pets that.
Yes. Thanks for the question Bonnie the answers, we expect it to be well below the EPS number well below our where we had been year to date.
We would expect the operating income and revenues to be inline with where we our year to date with a drop off from operating income to earnings per share is is quite steep.
Driven primarily by this big difference in corporate tax rate last year in the fourth quarter, we were catching up.
On positive news and interpretations of the U.S. tax Act and we had the benefits for the full year hitting in one quarter. So we had a relatively low corporate tax rate in the fourth quarter last year.
This year, it's little bit the different story that were slightly behind our 23% projection for the full year, so far through the year. So in the fourth quarter, we would expect the tax rate to make up that difference in bring us back to 23%. So the gap between the two years its four percentage points, which is pretty big impact.
And then on top of that you have this.
Non controlling interest interest line, which is being.
Has affected us already even Q3 c, it, but it's even more pronounced in Q4.
The two markets, we called out with significant pricing.
Just to put it in perspective.
In Turkey, the pricing was over 40%.
And in Philippines. It was it was just below 40% at 37%. So these two markets with very significant pricing are being bringing bigger increases than than other markets. Obviously in in operating income et cetera. However, they have noncontrolling interests, we called out Philippines with 50% Noncontrolling interest so your your share.
Bearing some of that big increase.
With your partners and therefore, the step down of those to the tax and the non controlling interest we call that as nine percentage point drag versus the the number last year, which was $1.17 on the on the adjusted pro forma basis. So that it's a very large gap between the ROI and EPS number.
Tony.
Okay. That's really helpful color appreciate it and then actually wanted to ask you about the deal talks with Altria. If I may I know they vendetta, but I'd be curious to hear why you considered merging with altria.
To begin with and then why the timing place right now I guess and the talk start age I'd like to hear from you how youre thinking about the U.S. market and then how that impacts maybe change Kevin of course, the talks have and Ed and then just in terms has talked recently investors over the last month at half their wise.
Fair amount of concern that maybe you were saying something in your business that made you feel compelled to navy seek a deal. So if you could just touch on that on I think that would be really helpful. Thank you, yes sure yes.
Thanks to the question volume, Okay. So Algeria discussions we're a natural outgrowth of the fact that we were launching I close in the us with PMTA approval. So to natural I think for the two companies to sit down and discuss whether that to best arrangement or whether there was other alternatives for example, a merger.
And whenever you're looking at a merger between two companies. The first thing you start to to look for our strategic benefits primarily synergies around revenue.
In our case, obviously was about RP portfolios and having the right product mix for the for the future of combined company potentially having a better opportunity with with a wider range of products.
We were looking at the us market being very profitable very large 20 billion.
Profitability in that market with with growing profitability over time, obviously, you look at cost synergies, although that wasn't really a key driver here and then regulatory synergies because it from our perspective, the us market as a pretty big role and setting the the regulatory framework for the world. So yes, we look.
At all these different categories and then we put it also into the larger context and one of the big things was the environment was developing rather rapidly as we were in these discussions with all the news around E vapor and the regulatory approach from the FDA et cetera, We also pretty clear feedback from our shareholders with a lot of question.
It's about whether this would make sense and shareholders feeling that they could if they wanted to.
Be exposed the U.S. market by ultra separately, they didnt need PMI to do that so we obviously heard quite a bit from shareholders and then of course, you have the distraction to management.
That would come with overcoming the environment the shareholder feedback and so forth. So in the end both management teams decided that the best path was for us to collectively focus on ico success in the us which incidentally as this was developing.
Became even more of an opportunity because we felt the fireman's gave ico see even more of a chance since it's the only heated tobacco market with FDA PMTA authorization.
And so we've chosen this path we are definitively done with merger discussions we've chosen the path of working without you on heico's the mergers off the table.
And we're going down a path, which is very promising and we're very happy with.
Now as far as concerns about whether this was some way to offset results I think this quarter's numbers in our picture for the full year I think should give people some confidence on that I mean, if you step back from the Big picture, We've got a very positive situation, we have the total industry.
There were predicting to be down, 2.5%, which is at the better end of the range.
That weve seen long term for the total tobacco industry ex us and China, our volume, we're predicting that come in between one and one and a half meaning we're gaining share pricing at about 6%. So theres a nice healthy mix between the two.
Revenues were seeing at least 6% ex currency.
Adjusted right.
We're seeing good growth on Rps, and H. to use, particularly coming from markets with high margins like the EU, managing our cost and investments cc the margin expanded 150 basis points.
Estimating for the full year, and then you see our EPS.
Guidance.
At least 9% despite the non controlling interest.
Issue and so forth. So I think thats, a pretty good indication of a very well shaped BNL in a good overall positive business momentum. So I hope people take that as the as the at the the true picture the situation and realize that there was no.
No merit to the idea that.
Discussions without you had any do with our base business.
Alright. Thank you so much very helpful.
Okay. Thank you Bonnie.
Our next question comes from the line of Robert ramp then yes.
Hello.
Three questions for me if I may the first is on Japan, I'm interested to know what categories doing in particular versus Two Q2 q I mean, I can say that youre Sarah's improved.
Competitive launches over the same period and that are more coming.
Well on the apparel category would be great.
Okay, you want you want to one of the time or.
Okay, Yes, yes.
Alright, so overall heat not burn category for Japan continues to grow.
From the end of last year till now it's up about two percentage points were at about 25% for the total category. We've gained most of that so we're maintaining in fact, improving a little bit our segment share.
But.
Quench really it's not quite so smooth there was a bigger step up in Q1. It continues to grow but I think if you look at it more from the beginning of the year you can see the overall picture with of course as you mentioned additional product launches coming from various other competitors. So we're gratified by the category growth.
And our ability to grow within the category is intact as well our segments share is solid and you see that from our exit shares from C stores. It over 18% for this quarter. So I think we're on a on a steady.
Trend of Japan.
Continuing to grow its not.
As fast as say, a Russia, which is growing spectacularly right now, but it's good solid growth given the total size of the category NR share already very substantial in Japan.
And we're also gratified by doing so I think the launch of duo can be underestimated. This product is very.
Positive from the point of view consumer experience those that have been of us they've been using it.
We're surprised at how much of a difference it need being that you have the today the experiences anytime you want and the very fast charging time to come back to the first experience. It just makes it seamless and you don't have to worry about the charging are waiting or the device, it's really a very nice.
Step forward as far as the overall consumer experience. So we have high hopes for dual particularly in Japan and Korea.
Where we will focus the first of volumes as we ramp up production.
Thats very clear.
On a station Australasia more broadly so APAC revenue for the region declined a lot kind of sequentially and year on year trying understand what's driven that you flagged some.
Price write downs and venture right.
Yep.
All of them specifically, what the run rate is in that market.
Well, we did we did have some device price adjustments in the quarter.
In Japan, we used to have a pricing ladder that was more or less 11, nine 8000 yen.
For three multi and 2.4 plus now in Japan 2.4, plus is almost gone very few people buy it it's doing very well and other markets, but but in in Japan.
We now have dual coming at 10000, essentially and then multi three and multi fill out the the pricing latter down from there.
And one of the consequences of of of reducing the pricing for the existing inventories of three and multi and a little bit of 2.4 plus is yes, we did have to revalue the inventories in Japan. So you see that onetime effect.
Hitting the quarter, so, it's probably disproportionate to whats really happening with pricing because you're taking an inventory and revaluing as opposed to just having the effect of the sales that you actually made in the quarter.
Does that make sense.
It does any talk to give off you could quantify that number.
No I mean, I think you see it in the pricing line and in that line. There you can try to pick up the effects that we haven't given individual.
Inventory revaluation type numbers.
Okay, Great and sorry, My last question just.
Can you give color on market share in the UK and specifically, London, I mean, just anecdotally I've seen a lot of around them over to hit the market where E. Cigarette uses very high in the wholesale prices. So I'm curious to hear how I guess is doing in this market.
Yes, Hi post is doing better in London in the UK admittedly from a relatively small base.
But it's up it's up over 1% in London.
Depending on how you define the city right, but it's it's doing much better it's grown.
At a much faster rate in the last few months than it was before and we're encouraged by the the pickup that we're seeing in the UK and London in particular now it's from a small base and we have obviously, many other markets where the share as much higher but it's very good to see it moving and we anticipate better.
Results coming forward.
Great. Thank you very much.
Our next question comes from the line of Pamela Kaufman of Morgan Stanley .
Hi, good morning.
Hi pack.
Hi, I have a follow up question on your discussions with Altria were there any changes to your agreement with Altria icons that emerged from your merger discussions that more closely aligned each of your interest.
There is sufficient for Altria 10, best behind and push the product.
Yes, I mean, I think one of the benefits of the merger discussions and going through all the discussions about how we would align et cetera is that we came out of this period with better understanding of each other and better alignment both regulatory and how we would go about heico's et cetera.
The.
Current agreement that that is the one we had before that we're continuing to commercialize under.
But I think we did come out of this whole thing with better alignment better understanding better push for for Ipos in the us and I think given the news flow around E vapor and everything else I think we both agree that there is even more of an opportunity for ipos in the us than we might have have understood a few months ago.
And if there were any doubts about outreaches alignment in interest behind Iqos I think I think it's very clear they are fully focused on it they were before but but even more so perhaps now that I coasts is as even bigger opportunity in the us.
Given the news flow and the whole situation around de vapor now I mean, we haven't disclosed the terms of the agreement, but but outages has very good incentives to.
Make sure that I coast does very well and we're very happy with the arrangement the agreement their execution in Atlanta. So far has been excellent and we look forward to some good success coming out of that.
Thank you.
Just related to that are you seeing any impact from the home health care around anything in the U.S. Im consumer attitudes towards RFP is outside of the U.S.
Given the potential over this issue to create confusion among consumers.
Do you anticipate any impact on close this performance.
We don't although we are working hard to make sure that I coast distinguish from the issues in the us.
Making sure it's understood that this is not an easy cigarette. This is a heated tobacco product, making sure. It's understood. Our track record we have 12 million plus users now we have very good conversion practices to make sure that we're focused on adult smokers.
We have lots of experience in over 50 markets with making sure that the people to convert tyco's, our former adult smokers.
We also emphasize that this is scientifically substantiated product we've got the FDA authorization.
So we're we're able to really make sure that ipos heat not burn is in a different category.
At the same time, when we're engaging with regulators and others were very clear to say that the the issues that they're hearing about in the U.S.
Our not coming from authentic properly manufactured closest to me cigarettes in other words, it would be unfortunate for a properly manufactured properly regulated E cigarettes to be.
Caught up in this this issue around the unfortunate illnesses and very unfortunate does that have been reported in the U.S. It we from what we understand that is a different issue from from a a properly done a cigarette like we will have or do have already but we'll have better versions of with our mesh and so we have work.
It's hard to both make sure that it's understood what E cigarettes are and how they can be property regulated to make sure. These issues don't evolve, but also to make sure that they understand the heat not burn and nikos are truly a different category and shouldn't be even in the discussion around the issues they're hearing about.
From the us not I mean, when it comes to the youth access issue.
This is where we focus on our good conversion practices and are very stringent.
Focus on adult smokers.
Thank God and should we expect you to file any PMT applications next year.
Maybe related to tyco's mesh.
Well with regard to heico's mesh as you know we have the improved device. We are working very hard to ramp up our production. We are on track to be able to launch in a market. This year and we are very much focused on expanding production and capacity. So that we can satisfy a number of international more.
Markets next year, so our full focus with Nash is in international markets. Obviously, you were focused in the us on heico's heat not burn the agreement with Altscher now with regard to mess, we are putting together a packages scientific substantiation, which we could use in the future with a number of different regulators and that work needs to have.
Happen regardless.
So so thats, our that's our plan for meshes to get it into as many markets internationally as we can.
At the end of this year, starting but really next year is the big ramp up.
Thank you.
Okay.
Our next question comes from one of Adam Spielman of Citi.
Thank you I will tell us sort of both general question, because there's a lot of taking on the signed about these results first thing was that the March was substantially better than I was expecting.
Other key results you said you'd be investing much more heavily in the third quarter, but that you said that didnt seems come through and I was just wondering why.
You also said the proliferation resistance. So good margin growth was that you'd actually done very well.
Hi margin markets for all piece specifically you.
The same time the market share growth from the you as you said yourself with a little bit disappointing.
I'm wondering if you can sort of bring all those things together, while I was the margin. So strong correctly, you said it probably wouldn't be entering Q.
I think you can give a little bit more color about what you still think underlying market share first thing in the you is coal.
Hi cost. Thank you got to be with us question.
Okay. Thanks, Adam for your question.
Well first of all with regard to why the margin was better.
It's two things one is additional pricing, which we called out for the Philippines, Turkey is two examples the other pieces costs were lower in the third quarter shifting to the fourth quarter, you're right. The 170 million for RP related investment compares to the 200 million that we had said.
And plant, but they're also some additional costs throughout various areas.
Of the company that shifted the total impact is probably about 30 for the Rps and about 40 or 50 million for all the other costs netted together. So when you move that from one quarter. The other does it.
Pretty significant impact and I would emphasize this isn't.
Spending lower spending permanently it's just a movement from one quarter to the next hence the fourth quarter.
Impact now as far as talking about what we called out the EU impact of higher margin volume coming from from age to use.
That was more of a total year picture when we were explaining the the device weight in the margin I mean in the RFP revenues being around 15% to help folks with their modeling and so forth now for E OUP growth.
Growth during the quarter, you're right sequentially. The share growth was about 0.1, which was was was not as much as you might expect especially since the end market sales were up 9%. So you have a seasonality impact where cigarette volume sales are higher in the summer and that obscured.
The fact that that each to use were actually up very nicely at 9% and if you look at the year over year. The share was up more than double from 1.2 to 2.5. So you know the EU growth rate is continuing at a very nice clip, it's obscured a bit just when you look so.
Well actually in the quarter and we always said share in particular tends to be little bit lumpy. When we look at but we look at user acquisition. We look at end market sales those are more direct leading indicators of where it's going in the momentum in the EU is very solid very good.
And that will eventually of course lead to continued improvement in margin as the volumes in the you are already very significant by the way if you look at the.
At the number of units shipped but they are growing at a very nice pace and of course, there coming with.
Substantially higher margins than the average elsewhere.
Hi.
But your questions or.
Yes, certainly with 40 or 50.
Moving to for sure does I mean, there's a very minor congratulation waste your time even also.
My question is it's a minor what I mean Wally words.
Seasonality effects cigarette smoke.
The next few years and review isn't case me, but I suppose the more important point.
Yes, if you can try and give some color about Russia, because we've been Russia things are clearly you guys, well, but again that seem to be very bullish how do you have the ISO excellent growth sequentially in Q1 s I think when Frac. What's in Q2, then that even more other surprising but very sharp growth sequentially in Q3.
How should we think about.
The passion of this and how I guess also congratulate you I mean should we think well if you're modeling.
Should we just assume 20 or 30 bips of market share expansion of course.
I will average it will work councils.
And equally in Russia, how should we think capacity given the volatility in.
And market share as you're reporting.
Yes, so first just quickly the seasonality topic because it does also affect Russia.
What we're seeing is it heated tobacco units.
Seasonality is different from.
Combustible cigarettes, and one of the reasons is because people are more likely to use it indoors. So.
The cigarette consumption in Europe for example increases as people have more time outdoors. During the summer months left phrase to use it doesnt seem to move as much because people can use it more in their houses et cetera, without bothering, others and so they feel much less constrained about their sigurd their consumption of age to use.
Depending on how the weather is.
And this also partly is your answer on Russia.
If you remember in the first quarter, we called out that the share phrase to use in Russia was flattered by the fact that the consumption of cigarettes was much lower during the Super cold weather and Thats because people don't want to go outside the U.S, one and so it swung the other way in a slightly different quarter in.
In Russia and helped explain some of that difference in share and we talked down the share in Russia in first quarter and we were right. It came back and showed exactly where we were in the second quarter and here you have the opposite reflect going on in the EU because of the warm summer months seasonality impact night, and we saw that also by the inquiry.
And elsewhere that the seasonality impacts are part of explaining.
The reason why the share tends to come a bit lumpy.
Again, we have we have a underlying vision view on how fast we're acquiring consumers and that's really our focus in our biggest forward looking number we've been giving that number on an aggregate basis, you see it and the step up.
This quarter to over 12 million.
And occasionally we have given it broken as to regions, but that's probably our best.
Way of having a look forward on what's coming with share.
Well I never thought think vis vis vis vis.
You call it gives us a year or just sort of ongoing so in Japan do so talk about an underlying market, we're sort of essentially flat.
You can talk about something like glass in the years.
Orange in Russia.
How can I just figured that tries to exclude some of these.
And volatility practice I mean, we went down that path in Japan, because of the heightened concerns and because of the issues we had about shares.
And being impacted by competitor inventories and so forth I mean I.
I hesitate to get into that sort of reporting everywhere in the world. We've done it sort of on a temporary basis to try to.
If people more transparency on the Japan situation, given where we were last year.
But I don't think we need to go into that with the EU. We're we're growing very nicely. We're delivering the results. We see this strong year over year, there's no slowdown in momentum in the EU. So I think we will we will stick with what we've got and eventually even in Japan and other places we made we may stop doing.
In that extra trend has he wants it's no longer needed.
Okay. Thank you.
Thank you.
Our next question comes from one of the and is there of Cowen.
Hi, good morning.
I did.
So I wanted to touch on my cousin the last please in looking at.
The introductory bundle that's being sold it seems like it's very attractive proposition for the consumer at $80 for carton of consumables plus a device.
Would you be able to comment at all on who's funding that promo because it seems like the implied price at the device is $25, which is far lower than what I've seen even on a promoted basis in international markets. Thank you.
Yes, I think I'm going to leave those sorts of questions to Altria, who is commercializing ipos in the us.
The answer is funding it I mean, they are responsible for the commercial expenditures around the launch.
And so the answer would be it would be their program and their funding in their their decision on on how to approach the consumer in the US obviously, we've shared with them and continue to share with them all of our experiences from around the world and and.
What we've seen in the many markets, we've launched and but it's their program and their their decision on it and I think I'll leave it to them to answer those specific questions like that.
Okay. That's fair enough and then my second question also on Ipos in the U.S. I can certainly appreciate.
The optimism that you're expressing on the call today in particular in light of growing concerns around potential health effects with.
Neighbor.
But as I reflect back on some of the pre market consumer work that you guys did in the U.S. relative to some of the other countries, where you are running similar consumer trial.
Recall correctly on us trial, and conversion look closer to Italy, or Switzerland than it did even in Germany, but certainly not in Japan or South Korea.
So can you just remind us.
Why you have so much confidence because yes, like Italy, certainly at this point at a 4.6% chair is clearly a success story, but it was five years and the Megan thanks.
Well I think we've said in the past that if you look at consumer readiness for.
Reduce risk products in the openness to.
Switching out of smoking that we see a lot of receptivity, we said in the us the ability to communicate with consumers is actually very good.
There are.
Rules around.
How we need to report and do it with the FDA given that the pre market.
Authorization, but compared to other countries around the world the ability to communicate with consumers is very good.
And now as far as any studies, you might be referring to Vivien I would imagine there very old by now if you're talking about studies done back when we were looking at Italy and.
In Japan, they would be about five years older more by now.
And you have a tremendous sea change in the us with regard to People's receptivity to reduce risk products understanding of.
The issues around smoking et cetera. So.
We have high confidence that the us will perform well know we've always said, it's probably somewhere in between where the EU has taken time and effort in energy because of the consumer receptionist any ability to communicate.
And it probably won't be as quick as say, Japan, or Korea started out where they were there was a phenomenon and it kind of off on us.
So we'll see right. It's early days, but we have we have.
Heightened expectations given the the news flow that's happened in the us if you're a smoker and considering alternatives and this is the only.
Product with PMTA authorization in the heated tobacco space and it's got your taste and performs very very well I mean, I think it's got to be very high consideration, maybe even higher than it would have been a couple of months ago.
So I think Thats, where we are on the us among fair enough. Thank you very much.
You can be.
Our next question comes from the line across Jain of Barclays.
Thank you good morning.
Good morning.
So on the Capex declined $100 million for this year.
Recall that shifted.
Dealer, there's a change to both expectations.
Neither.
We've sharpened our pencils, we are better and better at getting more capacity out of the existing assets, particularly when it comes to.
Production of heated tobacco units are uptimes keep improving waste rates keep declining our ability of our of our factories to produce sufficiently continues to improve beyond our initial expectations and so we've been able to scale back some of the investments.
And you know usually at the beginning of the year, we put our capacity plans down as best we can.
But there's probably a little bit of opportunities to sharpen the pencil and clean up the estimates who come to a two a closer number and we're we're near the end of the year now so we've been able to revise and refine our numbers and come to the billion, but it's not shifting to next year, nor is it an indication of.
Not needing the capacity feeding our capacities.
In line with our 90 to 100 billion estimate that we have for by 2021, we're well on track to hit that and Thats. The capacity number we're focused on for heated tobacco units as well as of course preparing for for mesh and the E cigarette platform for ramp up that I mentioned earlier.
Sure.
Coming to the new product category. So there's a lot over discussion at on Martin model do you have any plans in that category.
Around which category I wanted to maradona around the modern autocad.
Yes.
Yes, I mean, we continue to monitor we look at it very closely.
But yes, right now we don't have a modern oral product on the market, but we certainly have studied it and looked at it.
In most of our markets right now today, we don't have huge oral category.
But we are interested in that that.
Product because it is.
Reduce risk product category, and we think it may play a role in the future.
Okay and then my last question just on the stock price.
Tacos added close in 2011.
Got you do something to change the trajectory like launch share buyback, which has progressed. So now that your balance sheet does more under control and Youre not planning on Monday.
There doesnt seem to be any obvious solution for you owned.
Well from with regard to stock buybacks, we've said that our focus in the interim time next 18 months or so it's too.
Get into the leverage ratios that go with our mid single a credit rating and we are committed to that you see us slowly de leveraging.
Over the last period, and we'll continue to do that once we get into the range for the mid single a then the board would be able to reconsider starting stock buybacks I share with you that perhaps the underlying.
Feeling that our stock.
He is a good bye but.
But we aren't ready yet to be able to.
To start as buyback program until we get our leverage ratios to to the range that goes with our mid single a rating.
Okay. Thank you.
Thank you very much.
And ladies and gentlemen, some from one more question. Our final question will come from the line of Alan Bennett of Jefferies.
Hi, Mark I know fall.
And on just one question for me then so on the adding guidance you call out the Hyatt growth in markets, we sizeable non controlling interest.
Just hoping you could provide a bit more specific can't intensive which markets. They are well source of growth you've actually seen in operating income and also what is driving the strong growth. Thank you.
Sure.
The one we called out and it's probably the best explanation for this is Philippines.
With 50%.
Non controlling interest in the Philippines, and we haven't given the specific market profitability, but you can see from the pricing in from the fact that are Marlboro share. For example is way up as we get Uptrading.
Marlboro's now hit 40% share this quarter. So so you can see in the Philippines I think you consensus in the Philippines at the profitability is is up substantially.
Obviously, we share that with our partners.
With 50% so when when your overall growth in the operating income line is being boosted by an affiliate like the Philippines, and then half of it goes to the non controlling interest when you go to the EPS that growth. There is not obviously as pronounced Turkey is another example, where there is a non controlled.
The interest.
And there are others I'm not going to go through the whole list that you can see I believe in the Pierre now you see that the non controlling interest line that you see there has been growing.
And it's pretty substantial in third quarter, and we expected to take another significant step up in the fourth quarter as the full impact of the pricing in countries like in affiliates like Philippines in Turkey kick in.
Since their pricing only started partway through the second quarter I mean, the third quarter.
In the case the Philippines. It was the end of August and the cases of a.
Turkey was in August as well so the fourth quarter, we'll see another step up in non controlling interest.
Thank you very much appreciate it.
And that was our final question I'll now like to turn the floor back over to management for any additional for closing remarks.
Yes, I mean, I think I'd, just like the close with.
The thought that our overall year is is showing very good momentum.
We pointed a little bit to the fourth quarter.
And that we expect the currency neutral growth of net revenues and adjusted operating income to be inline with our year to date. However, the impact of the Noncontrolling interest and the tax rate differential.
Leads us to about a 9% drag at the EPS line. Nevertheless, I think if you stand back and look at the Big picture, we have a very positive year with good momentum going forward with nice balance between volume share pricing margin expansion and the growth of heated.
Vacco units, especially coming from from some higher margin locations like you were seeing broad geographic success of heated tobacco units in our smoke free future.
Strategy is paying off throughout the results of the company as well so I think that would close it and thank you all very much for listening.
Thank you ladies and gentlemen, this does conclude Philip Morris International third quarter 2019 earnings Conference call. You May now disconnect have a wonderful day.