Philip Morris International Inc

Q2 2021 Earnings Conference Call

7/20/2021

spk07: Good day and welcome to the Philip Morris International second quarter 2021 earnings 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 touch tone phone at any time. Media representatives on the call will be also be invited to ask questions at the conclusion questions from the investment community. Now I'll turn the call over to Mr. Nick Rowley, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.
spk06: Welcome, and thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2021 second quarter results. You may access the release on www.pmi.com. A glossary of terms, including the definition for reduced-risk products, or RRPs, as well as adjustments. Other calculations and reconciliations to the most directly comparable U.S. GAAP measures and additional heated tobacco unit market share data are at the end of today's webcast slides, which are also posted on our website. Unless otherwise stated, all references to ICOS are to our ICOS heat not burn products. All references to smoke-free products are to our RRPs. Growth rates presented on an organic basis reflect currency neutral underlying results. Adjusted net revenues exclude the impact of the Saudi Arabian customs assessments as described in today's press release. Please note that due to UK takeover code requirements, we do not intend to provide further information on this call regarding our offer to acquire Vectura Group PLC that has not already been disclosed in the Rule 2.7 announcement on July 9, 2021. A copy of the Rule 2.7 offer announcement is available on www.pmi.com. Today's remarks contain forward-looking statements and projections of future results. I direct your attention to the forward-looking and cautionary statements disclosure in today's presentation and press release for review of the various factors that could cause actual results to differ materially from projections or forward-looking statements. Please also note the additional forward-looking and cautionary statements related to COVID-19. Now, my pleasure to introduce Emmanuel Babot, our Chief Financial Officer. Emmanuel.
spk00: Thank you, Nick, and welcome, ladies and gentlemen. I hope everyone listening to the call is safe and well. Our business delivered a very strong performance in the second quarter of 2021, coming slightly ahead of our expectation to match Q1's record high quarterly adjusted deleted EPS of $1.57, despite the continued challenges of the global pandemic. Most impressive was the continued strong growth of ICOs, which made up 13% of our volumes and nearly 30% of our adjusted net revenues compared to 24% in the prior year quarter. HTU shipment volumes grew plus 30% and plus 12% compared to the same quarter last year and the previous quarter, sequentially to reach 24.4 billion units with strong growth across key geographies. We also continued converting adult smokers at a good pace, surpassing an estimated 20 million users, of which almost 15 million have switched to ICOS and stopped smoking. Combustible net revenues grew by plus 4% in Q2 on an organic basis, reflecting a partial volume rebound against a week prior year quarter and solid pricing, partly offset by market mix. Our adjusted operating income margin expanded significantly in both the second quarter and first half overall. And while we expect commercial investment to step up in the second half, this puts us firmly on track for a strong 2021 performance organically with an expected currency tailwind providing additional growth in dollar terms. Importantly, this outlook also allowed us last month to confirm our share buyback program, where we target $5 to $7 billion over three years. We are also delighted to announce that IQOS Illuma, the next generation of IQOS, will be launched in Japan next month. As we covered at Invest Today in February, this represents a major step in category innovation as we seek to accelerate our journey toward a smoke-free future. With regard to long-term growth, we also took important steps to build our modern oral and beyond nicotine business in recent weeks through the proposed acquisition of Fertin Pharma and Victura, which I'll come back to later. Turning to the headline numbers, our Q2 adjusted net revenue grew by plus 11.6% on an organic basis, or around plus 18% in dollar terms. This reflects both the recovery of the combustible business in many markets compared to the heavily disrupted second quarter of 2020, including the need for higher inventory levels and the continued strength of ICOs with plus 35% organic growth in RRP net revenue. For combustible, while certain geography and channel remain significantly affected by the pandemic, notably in South and Southeast Asia, South America and global duty-free, reopenings in much of the world have led to partial recovery in social location and a sequential recovery in our market share. We witnessed good organic growth of plus 5.1% in our net revenue per unit, driven by the increasing weight of ICOs in our sales mix and pricing on both combustible and ROPs. Our adjusted operating income margin increased by 270 basis points on an organic basis. This reflects the increasing weight and profitability of ICOs, higher combustible volume, the positive impact of pricing, productivity savings, including lower device cost and lower commercial spend due to the pandemic. Our resulting adjusted deleted EPS of $1.57 represent plus 17.8% organic growth and plus 21.7% in dollar terms, a very strong performance. Looking at the first half overall, our adjusted net revenue grew by almost plus 12% in dollar terms and by plus 7.1% organically. This was achieved despite a tougher Q1 comparison and reflect the Q2 factors I just mentioned and the consistent growth of ICOs where progress through the pandemic has been impressive. notably including the doubling of users in the EU region since the end of 2019. We delivered strong organic growth of nearly plus 6% in our net revenue per unit, again reflecting our shifting business mix and pricing. Our H1 adjusted operating income margin increased by 440 basis points on an organic basis, While we plan to increase commercial investments in the second half, as we noted at Q1, this remains an excellent performance. Our H1 adjusted diluted EPS grew plus 19.6% organically and plus 25.6% in dollar terms, also a very strong result. This brings me to guidance for 2021. We now expect an even stronger organic performance for the year than previously, supported by improved total industry volume for combustible following the easing of pandemic restriction. For net revenue, we are revising our organic growth forecast to between plus six and plus seven percent, representing the upper end of the previous range. We continue to expect organic adjusted OI margin expansion of around plus 200 basis points and we are raising our organic adjusted diluted EPS growth range to plus 12 to plus 14% or plus 15 to plus 17% in dollar terms. We also continue to expect HTU shipment volume of between 95 and 100 billion units. Given the strong momentum across our market, the need to maintain inventory duration and preparation for the rollout of ICO Siluma, which uses different consumables, we expect our full year HTU shipment to be slightly ahead of IMS volumes. This projected organic EPS growth, including an estimated favorable currency impact of approximately 18 cents at prevailing rates, translate into an increased adjusted diluted EPS range of $5.97 to $6.07. This guidance does not include any material impact of share repurchase or acquisition. We recently received board authorization for the launch of our three-year share repurchase program, where we target $5 to $7 billion starting in the period following our Q2 earning release. Please note this program is not affected by the proposed acquisition of Fertin Pharma or Vectura. Turning now to some of the key H2 assumptions underpinning the guidance. We assume that many of our key markets will have largely emerged from COVID restrictions, supporting better industry volume. Where significant pandemic-related challenges remain, notably Indonesia, the Philippines, and certain markets in South America, we assume no significant further deterioration from the present situation. We continue to assume no meaningful recovery in duty free this year, with intercontinental and Asian travel still subdued. A rebound in travel within custom areas such as the European Union has limited effect. In addition, following combustible pricing of around plus 3% in the first half, we anticipate a somewhat softer second half progression. We continue to expect the full year variance to be plus 2 to plus 3%. This reflects continued pandemic related changes in certain markets, notably in South and Southeast Asia. H2 also faces tough pricing comparison from the 2020 VAT reduction in Germany and new excise tax terms in Australia. The global semiconductor shortage continues to put constraints on device supply. And while the overall impact remains manageable, we have adjusted our device assortment to limit the effect on consumer availability. This dynamic is included in our guidance and we continue to monitor the situation closely. Despite these factors, we have multiple growth drivers in our business, and we are confident in our ability to deliver continued robust top-line progress. This revenue assumption includes higher expected device shipment and the launch of high-cost Illuma, which will contribute to less gross margin expansion compared to the first half. As mentioned previously, we will also step up our commercial investment in key areas, including portfolio expansion and product launches, such as Icosiluma and Icosvive, smoke-free category understanding and awareness campaign, and a number of commercial development projects. We anticipate around $300 to $400 million of incremental spending compared to the first half, which will impact our H2OI margin, but overall still expect to deliver a very robust expansion of around plus 200 basis points for the year. For Q3 specifically, we expect EPS of $1.50 to $1.55. Lastly, we continue to expect around $11 billion in 2021 operating cash flow, at prevailing exchange rates and subject to year-end working capital requirements. Before discussing our results in more depth, I want to highlight some of the positive regulatory developments in the quarter. Recognition of the arm reduction potential of smoke-free products continues to gain traction. Examples in recent weeks include the passing of a broad differentiated regulatory framework for RP by the Philippines House of Representatives and the institution of differentiated excise treatment for heated tobacco products in Pakistan. In Mexico, the ban on the import and export of electronic nicotine delivery systems no longer applies to heated tobacco devices which will allow us to resume imports of high-cost devices. While we are encouraged that the German government has recognized the important principle of differentiation between combustible cigarettes and smoke-free products on the basis of potential health impacts, we view the announced excise tax changes on heated tobacco as misguided, providing less incentive for consumers to switch away from cigarettes to less harmful alternatives. We also note the differing views among the key political groups in the country ahead of the fall election, and we are hopeful a new government could revisit the decision. In the EU, more generally, we remain optimistic that the revision of the tobacco excise directive will lead to greater harmonization in the structural approach to non-combustible product, taking into account the relevant good practices and experience gained by member states. Turning back now to our quarterly results, Q2 total shipment volume increased by plus 6.1% and by plus 1.1% for H1. This reflects continued strong growth from HTUs of plus 30% to reach 24.4 billion units in Q2, driven by the EU region, Japan, Russia, Ukraine, and encouraging progress from recently launched market in the Middle East. HTU shipments were around 1.4 billion units ahead of IMS volume for the second quarter, reflecting the need to maintain inventory duration in the growing business, sea freight lead times, and the first shipment of Illuma consumable. The plus 3.2% growth in our Q2 cigarette volume reflect the recovery of a number of key markets compared to a notably weak prior year quarter when pandemic-related disruption was at its peak. While our cigarette share improves sequentially, we continue to face some specific market share headwinds in addition to market mix effects, which I'll come back to. Due to the impressive performance of ICOS, heated tobacco units comprise 13.3% of our total shipment volume in H1, as compared to 11% in the year of 2020, 8% in 2019, and 5% in 2018. We expect this proportion to grow over time as the positive momentum on ICOS continues, providing a powerful driver of revenue and margin growth. Our sales mix is changing rapidly, putting us on track to achieve our aim of becoming a majority smoke-free company by 2025. Smoke-free product made up nearly 30% of our adjusted net revenue in the quarter and in H1, compared to 23% in H1 2020. IQOS devices accounted for approximately 5% of the $4.4 billion of R&P net revenues, reflecting longer replacement time and fewer second device purchases for existing users due to improving battery lives, functionality and reliability, and lower device prices in certain markets as we prepare for ICO Siluma. The plus 7.1% organic growth in H1 net revenue on shipment volume growth of plus 1.1% reflect the twin engines driving our top line. First is pricing on combustible and in certain market on HTU net of the lower device pricing I just mentioned. Second, the increasing mix of HTUs in our business at higher net revenue per unit continues to deliver substantial growth. And as explained at Invest Today, this is an increasingly powerful driver as our transformation accelerates. Let me now go into the driver of our first half margin expansion. starting with gross margin, which expanded by plus 340 basis points on an organic basis. This is driven by multiple levers, as explained in prior quarters, including the mixed effect on HTU and pricing across our portfolio. Our significant effort on manufacturing and supply chain efficiency are bearing fruit, more than offsetting the effect of combustible volume declines. with around $300 million of gross productivity savings delivered in H1. This represents a strong start on the journey towards our target of $1 billion over 2021-2023. This was accompanied by strong SG&E efficiency with our adjusted H1 marketing administration and research cost 90 basis points lower as a percentage of adjusted net revenue on an organic basis. This reflects the ongoing digitalization and simplification of our business processes, including our high-cost commercial engine and more efficient ways of working. We delivered around $120 million towards our 2021-2023 target of $1 billion in gross SG&A savings before inflation and reinvestment. Focusing now on combustible, we hold the leading international portfolio by market share and by brand strength. This gives us a formidable platform to accelerate the growth of ICOs via our commercial infrastructure, industry expertise and ability to communicate with adult smokers where permitted. It is therefore important to maintain our leadership through selective investment as we also drive return through pricing and efficiency. Despite good results in markets like Mexico, Saudi Arabia and Turkey, our Q2 cigarette share remained below the prior year with over half of this share loss due to market mix reflecting our high exposure to market like the Philippines and low presence in certain emerging markets with a strong rebound such as Bangladesh. Importantly, our share improved sequentially compared to the first quarter and we expect this positive trajectory to continue through the second half. This reflects a partial recovery from the COVID impact on social occasion where Marlboro over indexes, border closures and travel. However, the expected recovery is also supported by portfolio initiative, including in the value segment and the enduring strengths of Marlboro. We continue to target stabilization in our cigarette category share over time with HTU gains coming on top. I will now turn briefly to the South and Southeast Asia region. As covered last quarter after a difficult 2020, notably in Indonesia, volume headwinds have been moderating. However, the pandemic remains a major issue in the region with renewed lockdowns in a number of areas. Daily consumption patterns are still below pre-pandemic levels and the pricing environment remains challenging. We continue to expect volume growth in Indonesia this year as the industry improves, with encouraging recent share gain within the Tier 1 segment where we participate. Our overall share in both Indonesia and the Philippines was sequentially broadly stable in Q2, with our portfolio initiative geared at further share recovery over the balance of the year. In RRPs, ICOs continue to grow strongly in Metro Manila with an exit share of over 1% for EATS. For the region overall, we remain on track to deliver positive organic net revenue growth over the April to December period as outlined on our Q1 call. Moving now to ICOS performance, we estimate there were 20.1 million ICOS users as of June 30. After the exceptional addition of around plus 1.5 million adult users in the first quarter, we added a further plus 1 million in Q2 and plus 2.5 million year-to-date, building on the step-up seen in the second half of 2020. Our accelerated pivot to digital and remote engagement during the pandemic, combined with strong momentum for the IQOS brand, is paying off. We further estimate that 73% of this total, or 14.7 million adult smokers, have switched to IQOS and stopped smoking, with the balance in various stages of conversion. Strong conversion rates notably reflect the increased prevalence of IQOS 3 Duo, which offers a superior user experience to previous device version. We seek to achieve even higher conversion rate over time with the introduction of innovation such as IQOS Illuma. This user growth again reflects widespread momentum across all key IQOS geographies, including the EU region, Japan and Russia. It also reflects the enrichment of our offer and the segmentation of the category with new products and more price points, both above and below our initial HTU offering. In the EU region, second quarter shares for each reach 5.5% of total cigarette and HTU industry volume, plus 1.6 points higher than Q2 last year. As mentioned last quarter, we expected sequential share for HTU to be broadly in line with the first quarter due to the effect of seasonality and pandemic-related fluctuation on the combustible market. Underlying trends remain strong, with Q2 HTU IMS volume growing plus 50% year over year and around plus 11% sequentially when adjusted for estimated trade inventory movements. We expect to see similar dynamic in the third quarter with broadly stable headline share versus robust underlying growth. This excellent performance includes strong growth across the region with Italy and Poland as notable contributors. We continue to grow our EU region ICOs user base doubling since the start of 2020 despite the pandemic to reach over 6.3 million. Strong performance continued in Russia with 8% sequential user growth in Q2 and our HTU share up by 1.3 points to reach 7.3%. As in the EU, sequential share can be distorted by the combustible market. Adjusted for estimated trade inventory movement, this reflects close to plus 30% year-over-year IMS growth. After the excellent progress and geographic expansion of ICOs in recent years, the heated tobacco category in Russia is now large and growing. This very positive dynamic naturally attracts competition and as seen before in markets like Japan, heavily discounted competitive offering can generate initial consumer trials. We continue to grow our user base and with both our existing price tier portfolio and the future launch of ICO's Illuma, we see ample room for further strong growth. While we have historically focused on Russia in our earning calls, there is broad HTU growth across the Eastern Europe region with Ukraine, Kazakhstan, and Southeast Europe significantly contributing. We show here the excellent overall regional growth trend in adjusted IMAs. Note that following recent international sanctions, ICOS is no longer available for sale in Belarus, where we achieved a Q2 offtake share in Minsk of almost 7%. We continue to see sequential volume growth for both our ETH and fit lineup in Russia and Ukraine. Moreover, the solid and fit consumable continue to supplement user acquisition. In both Russia and Ukraine, the majority of consumer purchasing a LIL device are smokers entering the smoke-free category for the first time with high level of conversion in line with ICOS, benefiting from our ICOS conversion infrastructure. With this success, We also introduced Lille Solide in five further markets in Eastern Europe this quarter, with additional markets planned later this year. Japan, the adjusted total tobacco share for our HTU brands increased by plus 2.3 points versus the prior year quarter, and by 0.2 points sequentially to 21%. highlighting the strength of our price tier portfolio and broad range of SQ following the October 2020 price increase. IMS volume, adjusted for estimated trade inventory movement, grew by around plus 5% sequentially after accounting for fewer selling days in the first quarter. We continue to expect robust underlying progress in user growth and consumer of tech, supported by the launch of ICOS Illuma in August. As in prior years, with an additional excise increase in October 2021, there may be volatility on the timing of IMS and consumer of tech between the third and fourth quarters. In H1, the overall heated tobacco category made up around 29% of the adjusted total Japanese tobacco market, with ICOS maintaining a high share of segments and capturing the large majority of the category's growth. In addition to strong growth in existing markets, the geographic expansion of our smoke-free product continues. This allows us to provide access to better alternatives to an ever-increasing amount of adult smokers, as we aim to be in 100 markets by 2025. Our second quarter launches in Kyrgyzstan and Uzbekistan with both ICOs and LIL offerings take the total number of markets where PMI smoke-free products are available for sale to 67, of which over half are outside the OECD. A core driver of our continued success in smoke-free products is innovation. We are very excited to launch IQOS ILUMA, the next generation of IQOS, next month in Japan. Bailing on the success of IQOS 3 Duo, we believe this simple and intuitive device will support easier switching and higher conversion for legal edge smokers using smart core internal induction heating technology. As outlined at Invest Today, ILUMA will come in multiple device formats, and have its own range of HTU consumables. The ongoing success of Icos 3 Duo, almost two years after launch, demonstrated that significant innovation can have a lasting positive impact on growth. We plan for further market launches of Icos Illuma through the remainder of this year and in 2022. Naturally, for a major new innovation, and as seen with earlier version of Icos, The unit cost profile of ICO Siluma devices and consumables begin at a higher level, but we expect this to improve over time as scale increases. This dynamic is included in our guidance assumptions. We are continuing to commercialize ICOs VIVE with good progress in the first group of markets where we started in our own channel with an initially limited range of test variants and nicotine levels. IQOS-VIV is a premium product providing a superior experience and as we explained previously, the commercial infrastructure of IQOS allows us to deploy efficiently and at scale through a bespoke route to market approach. As we start to expand distribution and the consumable offering, we see signs of increased uptake and clear positive consumer feedback relative to competitive products. We plan to launch in further markets later this year and will continue to test edge verification technology in select markets. In addition to e-tobacco and e-vapor, we announced in February our intention to enter the small but fast-growing nicotine pouch category this year. To complement our internal development, we have two important acquisitions to establish a base of capability in science, technology, and manufacturing, and build our platform in a modern role. The first of these was Aegis News, completed during the second quarter. Aegis News has a relatively small branded portfolio of modern oral products, which provide us a foothold in the category. In addition, the proposed acquisition of Fertin Pharma will give us access to a range of promising oral delivery technology and capability, some of which could be applied to the modern oral nicotine space. We will return with further news on our commercial plans in this area later this year. I also want to come back to our Beyond Nicotine strategy, which we first outlined at Investor Day. We see significant opportunities in adjacent areas with our two focus corridors of self-care wellness, including botanical, and in-health therapeutic expected to have an addressable market of around $65 billion by 2025. The proposed acquisition of Fertin Pharma and Vectura can enable us to more rapidly expand our development capabilities in innovative in-health and oral product formulation while continuing to grow their respective CDMO activities. 13 has a range of promising oral delivery technology, including pouches, gums, and lozenges, which can be applied in both the modern oral nicotine and beyond nicotine areas, notably for safe care wellness products. With Vectura, we would gain access to differentiated proprietary technology and pharmaceutical development expertise to deliver a broad range of complex in-air therapies. Vectura has highly complementary human capital, technology, high-quality infrastructure, and deep know-how of inalienable formulation and device design development and analysis, drug-device combination, and pharmaceutical management processes and systems. These proposed acquisitions would fully leverage PMI's existing capability in life science, product innovation and clinical expertise related to inhalation. Such acquisitions can also enhance our progress on important sustainability priorities. Firstly, building our capabilities in modern role is a key enabler of broadening the reach and access of our smoke-free alternative to adult smokers around the world. And secondly, building a strong beyond nicotine business is a major objective as we strive to develop commercially successful products with a net positive impact on society. On ESG and sustainability more broadly, we are firm believers in the power of investor engagement to drive positive change. Given PMI's unique sustainability and transformation story, we have increased our own outreach. We published our second integrated report in May, which provides a comprehensive, detailed, and transparent disclosure of how we create sustainable value and how we are progressing toward our purpose and target, including our most important commitment of all to phase out cigarettes. We also had a dedicated sustainability webcast on June the 2nd, where we covered the fundamental alignment of our transformation and financial performance with addressing our impact on society. We shared the latest studies using real-world data on the possible association between accelerated cigarette volume decline and certain disease reduction in Japan. We also reaffirmed our commitment to diversity, equity, and inclusion as an essential enabler of future success. We continue to make progress on our 2025 roadmap with notable development in Q2 being our second certified carbon neutral factory in Switzerland, taking us one step closer to achieving carbon neutrality by 2025 and the publication of our eco-design principle as we seek to play our part in the circular economy. In closing, after delivering 1% total volume growth and 7% organic revenue growth in H1, we have raised our 2021 organic growth expectation to plus 6% to plus 7% in net revenue and plus 12% to plus 14% in adjusted diluted EPS. We are on track for an excellent performance. Moreover, we continue to invest in the future. Most immediately, this means the launch of Aiko Siluma in Japan next month and in more markets later this year. We are also investing in the broadening of our smoke-free product portfolio and geographic reach. This is critical as we seek to accelerate the number of adult smokers who switch to better alternatives with a growing positive impact on society. In addition, we are investing in the capabilities of tomorrow, as illustrated by our two recent proposed acquisitions, which provide a comprehensive development platform across our Beyond Nicotine focus areas. Finally, we are also committed to returning cash to shareholders through dividend and share repurchase, in line with our objective to deliver sustainable value and return to investors as we continue our journey towards becoming a majority smoke-free business. Thank you very much. I am now more than happy to answer your questions.
spk07: Thank you. We will now conduct the question and answer portion of the conference. Again, in order to ask a question or make a comment, please press the star key followed by the one on your touch-tone phone. In the interest of fairness and time, We ask that participants keep it to a maximum of two questions each. Our first question comes from the line of Chris Groh with Stifel. Please go ahead.
spk05: Hi, good morning. Hi, Chris. Hi, and nice quarter there. I do want to ask you two questions, if I could, please. I want to start first with you have Icosaluma launching soon in Japan, and I assume it will go into more markets. I think in this quarter you had shipments above consumption. Would you expect that still to be the case? I know you mentioned building inventories. Would that still likely happen in the second half of the year, or we've already built inventories sufficiently to handle that launch?
spk00: Thank you, Chris. No, I think there was an element of preparation for the launch in this Q2. For the rest of the year at that stage, we expect IMS and shipment to be more aligned. So we don't expect to have further material differences at that stage emerging in H2.
spk05: Okay. And just a question on the combustible business. And I know you gave some good detail on that. I guess my question would be that you did have, you know, a softer market share overall in combustibles. I think you mentioned you expect your share to stabilize there over time. I just want to get a sense of you thought that you could stabilize your combustible market share this year. And I think related to that, just to maybe give a little more color around the pricing environment, how competitive it is right now in combustibles, I think that may be a factor that's contributing to less pricing for your business in that area.
spk00: Sure, Chris. So on this objective to stabilize our market share in the CC segment or CC category. That's a clear objective that we have. Of course, it's a year-on-year stabilization that we want to reach. We are stabilizing sequentially, quarter-on-quarter, and it's good to see that the Q2 market share is showing this kind of improvement versus Q1. We are not there yet in terms of stabilization year on year that's an objective that we have gradually for the coming quarters we'll see when we are able to to reach it but that's clearly something that we we want to pursue on the pricing environment as you have seen we started nicely the year q2 was still quite good outside indonesia we are reporting a price impact of about five percent so clearly positive H2 is more difficult as we've been flagging it in terms of basis of comparison. There was a VAT decrease in Germany. There is a different pattern in excise duty increase in Australia. So that is going to play. And we are also going to monitor what is the situation as hopefully we are exiting the COVID crisis. We'll see exactly what is the timing and how is the exit. But we know that many economies will still stay quite impacted by that. So we'll be, of course, monitoring the capacity of our customer to follow price increase, and that will be certainly driving our decision when it comes to price increase. So I would say we're going to monitor the situation. We're going to see what is happening. There will be certainly question on evolution of inflation here and there as well that we're going to take into account. So a lot of unknown at that stage, but we'll take that into account to monitor and decide on price increase. Nevertheless, we have been flagging the fact that after 3% increase in H1, we do confirm the overall bracket of 2% to 3% for the full year, which means that we expect notably and partially because of tougher comps in H2 and H2 that could be less favorable in terms of price increase than H1.
spk05: Thank you for all the perspectives.
spk00: Thank you.
spk07: Our next question comes from Michael Lavery from Piper Sandler. Please go ahead.
spk04: Thank you. Good morning. Hi, Michael. I just wanted to ask a couple questions on Indonesia. One follows on some of the pricing discussion, I guess. You called it out obviously as an offset to some of the favorable pricing. Can you just help us understand a little bit better the dynamics there and what to expect looking ahead?
spk00: Sure. So remember, Indonesia was a very tough market last year, really hit hard by the pandemic. It doesn't mean, unfortunately, that the country has exited the crisis. And until recently, there has been new announcement of lockdown and restriction. It's probably that the impact was so strong last year that we are comparing to probably favorable basis of comparison. But the situation is certainly not back to normal there. Nevertheless, what we have seen is certainly an improvement of the situation, again, based on probably favorable comparison. We are doing well ourselves when it comes to the premium market, what we call the tier one, you know, with more excise duty, and we are gaining share there. And that explains that we are able to grow our volume this year. But we are also, unfortunately, at the same time, seeing the tier two category, the one enjoying lower taxes that is still gaining ground and probably getting close to 30% market share. It used to be, at the end of last year, around 25%, 26%. So that is playing the other way around. And hopefully, this is going to be corrected with evolution on the excise duty policy put in place by the government. But of course, we don't have any news on that. And we don't know if and when it's going to happen. So that is a situation that we are facing in Indonesia. There is clearly improvement versus last year. It doesn't mean that the environment when it comes to possibility of price increase is becoming favorable, but at least it's no longer the kind of very negatively oriented market that it used to be for us last year.
spk04: And just to confirm then on your pricing, are you saying that you're not getting any increases or have you actually lowered prices?
spk00: We are impacted by the increase in duty, so we are increasing price, but it's still having a negative impact. And that's why there is a difference between what we are reporting in terms of price impact with Indonesia and without Indonesia. So overall, it's still having a bit of a negative impact.
spk04: Got it. So your increases aren't fully offsetting the duty increase? That's correct. And then just on IQOS in Indonesia, I know you haven't called out a launch there and the internet can be a funny creature, but we find about a dozen stores in Jakarta that all look quite proper and have really official sounding language. Are those resellers of products they're getting somewhere else or do you have a sort of a quiet launch there? Can you just give a status of how IQOS sits in Indonesia today?
spk00: So there is no official launch. There is a Nycos club where we may gather some users. As you know, Indonesia is first and foremost a Cratec market. And while we certainly have the objective to develop a specific heat-not-burn device for Cratec, we haven't been launching it yet. So we do that, of course, addressing only part of the population, the one with the purchasing power. that can afford the current devices, and also a small group of people that are non-cretic, if you want, smoker, but that's a very small fraction of the consumer. So that could be the element that you are referring to, but there is no official global launch, if you want, at that stage.
spk04: Okay, thanks so much.
spk00: Thank you.
spk07: Our next question comes from Gaurav Jain from Barclays. Please go ahead.
spk01: Hi, good morning. Hi, Gaurav. Hi. So a couple of questions from me. So one is, you know, on the guidance that you had at Investor Day, you know, greater than 9% EPS growth over 2021 to 23, and you are clearly coming quite ahead of that this year at almost 13%. So how should we interpret it is what I'm trying to understand, that there is a slowdown in the next two years because you have these tax gap closures in Germany, which will impact the high cost realization in that market next year and potentially in some other European markets? Or these are just independent numbers?
spk00: Well, thank you for the question, Gaurav. I think you're going too far. We've been sharing this three-year guidance and objective at the time of the investor day, more than 9%. We are off to a strong start because we are targeting indeed for the first year 12 to 14%. You know, it's clearly above the nine. So I think we are compliant for the time being with the overall beyond 9%. And, and that means that we are certainly on good track to deliver the more than 9%. But I don't see a contradiction between the more than nine and what is certainly good news, which is a strong start in in 2021. Sure.
spk01: And if there is more of these tax gap lawyers in Europe, how would that impact your you know, potential to achieve this EPS growth guidance?
spk00: I mean, of course, you can make whatever scenario, you know, and it's difficult to react to the most extreme scenario. But I think we are taking into account, and we always said that, that there could be some reduction, gradual reduction, to the gap between CC and heat not burn product when it comes to excited duty. That is absolutely factored in in our guidance. We have the capacity to increase price. We've been repeating the fact that ICOS and the consumables that are coming with ICOS is a premium product. That is really a superior experience for the customer, and that is commanding a premium in terms of price positioning as well. Today, thanks to the lower exercise duty, very often you're going to have consumables at a cheaper price than the premium combustible product like Marlboro. That is something that, of course, could be a change, and we could increase price. And at the same time, we continue to see more and more governments and regulators saying that there should be a difference between combustible and heat-not-burn because heat-not-burns are a better product and that should be used certainly as an incentive to have smokers switching to heat-not-burn category and to move to better product for them. So we certainly believe that There will be some decrease in some country, but it's not going to be necessarily the case everywhere. We could also envisage increase in the gap. We haven't seen that recently in the EU, but we've been seeing that being installed in other countries. And on the long term, we continue to believe that there will be still some nice difference between the two that is fully justified by the by the fact that these are better products. So a long answer to say that we are ready to cover for certainly possible reduction in the gap. We think that some of that is going to happen anyway, for sure, Germany being one example. And at the same time, we believe that there will be a growing, I would say, consensus on the fact that there should be a clear differentiation between combustible and heat-not-burn product.
spk01: Sure. Thank you. If I could ask a quick one on Japan. So we have the Cigarillo price gap closure, the tax gap closes in October, and that will throw up a lot of volumes up in the market, which will be moving. And you're launching Icos Illuma. So is there a potential to launch a lower priced Icos variant, maybe reposition Icos 3 Duo at a lower price point to capture these volumes from the Cigarillo category, which will probably move?
spk00: Certainly, Gaurav, with ICO Siluma, we are going to enrich the premium category for heat node burn product. And as we keep saying, that's going to be a real, I would say, major change for customers. And it's going to represent for them clearly a big, big progress, killing the remaining pain points. And therefore, of course, we focus on that for the time being. We believe the potential is huge, as we've been highlighting. Now, depending on how the market is evolving, certainly we'll see what is the interest of launching new devices with a different positioning. The ultimate goal, as we also said in several instances, is certainly, in any case, to have a full coverage of the spectrum of the market, from the most premium positioning to certainly more value for money, you know, designed to cost, simple products that are, of course, delivering an experience that is not at the level of the premium experience, but that, you know, is value for money and good enough experience for all the type, I would say, of customers. So Japan will make no exception in our willingness to cover once again the full market from premium to medium and even low price positioning.
spk01: Thanks a lot.
spk00: Thank you.
spk07: Our next question comes from Bonnie Herzog from Goldman Sachs. Please go ahead.
spk02: Thank you. Hi, Emmanuel. I wanted to circle back just on guidance. I just have a couple of questions. Thinking about this, you raised your EPS guidance for the full year as you expect industry volumes are improving, but it still does imply a decent step down of growth in the second half despite lapping a relatively easier comp. Now, you did call out a few things like you called out incremental costs associated with the rollout of Illuma and maybe some gross margin pressures as you expect to sell more devices in the second half. So I just want to make sure I understand all of the puts and takes or any incremental pressures you're expecting in the second half. And then I just wanted to also clarify as it relates to buybacks, You did mention your guidance doesn't include a material impact from any share buybacks, but just wanted to verify, you know, does this mean, you know, you're not going to be buying back as aggressively, you know, in the second half of this year, or you're just not, you know, including buybacks at all in the guidance? I just wanted to make sure I understood that.
spk00: Sure, Bonnie, very clear. So maybe starting with the buyback to make it clear. No, no, we're not making any kind of guidance on what's going to be the buyback or assumption. As we said, we want to be really super flexible. And frankly, all scenario for the magnitude of the buyback in H2 can be envisaged. But precisely because we want to keep flexibility, we don't want to put any kind of assumption on the amount of buyback for H2, so that's really the way you should understand it. Now, on the H2 margin versus H1, because I guess that's really your question, I think you started to summarize well the reason for a different margin evolution profile, but I'm happy to go through all the elements. Certainly, what's going to be common between H1 and H2 is strong dynamism in top line with continued favorable evolution of course on our high cost business. We are still facing on the CC business also some relatively easy comp last year so that should have an impact on the evolution of our CC business. We continue to have the nice mix impact driven by the high cost growth on our revenue per stick so that is going to stay and of course That's the reason why we are raising the guidance on the revenue organic growth to six to seven I mean it's our confidence on the continuation of a strong dynamism on revenue growth in H2 then on other element that could be different there is as I said it a Answering a previous question on price, we see H2 possibly being more challenging than the 3% price increase on the CC business that we delivered in H1. So that's clearly one element. Another one is the level of productivity. You have seen the number 300 million in H1. We target 1 billion over a three-year period. Obviously, the 300 million is not necessarily a sustainable amount if you want for a six-month period. So there was some front-loaded element in productivity this year. It doesn't mean that we don't intend to generate a nice productivity in H2, but not necessarily at the same level as the 300 million in H1. So that's going to be another element. Then there are all the impacts of the launch of Illuma, and I see indeed on the margin two impacts. One is the fact that when you launch a new product, It's true for any business, any industry. Your costs are not optimized. You don't have yet the volume to fully amortize all the investment. You haven't been optimizing all your processes. So there will be an impact on the gross margin coming from increased cost as we launch Illuma. This is going to, of course, disappear over time. I'm not able to tell you exactly how long it's going to take, but let's say 18 to 24 months is the typical time I would say, horizon to get to full productivity when you have some innovation. So this is going to have an impact on H2. Then we said it as well, the fact that we're going to sell more device and Illuma device that is going to boost revenue, but it's not going to have the same impact as consumable on the gross margin. And of course, with an impact on the gross margin rate. And last element that I have certainly top of mind, that this is this 300 to 400 million increase investments in H2 versus H1. And these investments are going to be obviously where it's going to make an impact for the company. So it's about innovation. It's about commercial and marketing capacity. It's about digitizing further our business and the company. That's where we're going to put that money. So you need to take all these elements into account to understand the different profile of margin evolution between H1 and H2. But having said that, obviously, we are still targeting a very nice growth of our revenue, OI, and adjusted EPS in H2, obviously.
spk02: OK. That was really helpful, and I appreciate all that. So obviously, there's a lot of puts and takes, but broadly, given the RAISE guidance, you feel pretty darn good about the momentum and just, you know, the improvements in industry volumes. So that's encouraging. If I may, I wanted to ask a second question just on the competitive environment, you know, especially as I think about what Japan Tobacco is doing by launching their new Plume X. And it sounds like they plan to launch it at a pretty steep discount to drive trial Now, this sort of coincides with the launch of Illuma in Japan, so just wanted to understand your strategy in terms of positioning Illuma, especially as it relates to price. Maybe overall, how concerned are you with stepped-up competition, and how confident are you that you're going to be able to maintain share and ultimately continue to take share? Thanks. Thanks.
spk00: Yes, Bonnie, certainly that's, of course, a very good question and happy to elaborate on it. First and foremost, and that's probably the most important in my answer, we are really happy to see competition really taking now the Eat Not Burn category as a big priority and showing, I think, increased commitment, engagement behind the category. We think that you know, the shared vision on the fact that we need jointly to phase out cigarettes and develop better product for smokers is a way certainly to accelerate the journey to unsmoke the world. So to see competition realizing that this is a great category, this is answering smokers' need and expectation, putting More innovation, more investment in the category, that's just great. And I think we can start seeing, you know, in some geography where competition increase investment, we can see the overall growth of the market accelerating. And of course, as we take a lion's share of that, that is very good news. Having said that, Obviously, what is important for the smokers is the capacity to find with the Eat Not Burn technology and proposal, something that is mimicking to the closest way possible the experience versus combustible cigarette. And that's where our technology, our capacity to innovate is making a big difference. And that's where probably some of the competition is struggling a little bit. And that is the reason why some of them believe that they have to discount their product to get some traction. So what does it generate? Well, at the end of the day, it generates the fact that you may have a trial because, you know, the device is coming almost for free, the consumable is cheaper. But then if it's not satisfactory, if it doesn't provide the same pleasure, the same benefit as what you have with a Nyquist experience and will have, you know, further more with IQOS Illuma, then whether you switch back to IQOS or you may just be back to combustible cigarette because you have the feeling that that's not satisfactory versus what you really enjoy. And therefore, it's not whether playing the role of converting smokers to eat not burn and you create lower average consumption per device and lower loyalty. So we continue to be firm believers that at the end of the day, just the right technology the right experience will convert the majority of the smokers to switch to better product and to the heat-not-burn category. And we believe that this is exactly what we are offering with IQOS, and that makes us confident in our capacity to retain big market share. It doesn't mean that we're not going to propose also a simpler device, always with our capacity to innovate. targeting, as I said, different purchasing power, different expectation, but certainly we will continue to lead the way when it comes to a premium product delivering a superior experience.
spk02: All right, very helpful again. Thank you so much for all of that.
spk00: Thank you, Bonnie. Thank you.
spk07: Our next question is from Pamela Kaufman from Morgan Stanley. Hi, good morning.
spk00: Hi, Pamela.
spk03: So I was hoping that you could elaborate on your plans for increased investment in the second half in terms of what initiatives you'll be spending behind, how much will be for LUMA versus VIV or the other reduced risk offerings. And then in terms of the level of spending, the $300 to $400 million, Is that primarily related to the launch in Japan? And should we think about annualizing this level of incremental investment for next year as you expand into additional markets?
spk00: Thank you, Pamela. I have to say I fully understand your curiosity and that you want to know more about this extra 300 to 400 million. But I'm afraid I will have to disappoint you because, as you can imagine, that is super sensitive. And we don't want to disclose the detail of that. Nevertheless, I'm certainly happy to say that we are putting investment in places that are going to move top line, i.e. growing more volume, more conversion on smokers switching to ICOs. Certainly, you know, part of the amount is going to be behind the launch of ICO Siluma, but not only, there are also commercial activity as we see a number of markets returning to a certain normalcy. I would not say we are fully there, but certainly more reason to re-accelerate a number of marketing and commercial activity, and that's going to be important. We are also accelerating in terms of innovation and we are putting more money in life science and to build more presence in our P category notably, so that's part of the acceleration. And we also signal it's going to be much more marginal, but that we may have to very selectively reinvest here and there on CC where it's possible. I would say it's going to be a small fraction of the extra investment, but we have this objective of stabilizing our market share. So I think with that, Pamela, you have really what is behind the 300 to 400 million. No, you don't need to necessarily annualize that, but let's be clear. We're going to launch Illuma in many more countries next year in 2022, and I'm not able to elaborate at that stage on what's going to be the plan in terms of investment, but I would expect that, yeah, we certainly want to invest with a great return on this new offering and new technology, so that will have some impact on our investment next year. Remember, nevertheless, we have a very ambitious program to generate 1 billion efficiency on SG&A. We have ambition to be very dynamic on revenue. And therefore, our goal over a three-year period is to reduce nicely the SG&A on revenue ratio to create a driver for increased profitability. And of course, including all these investments that absolutely remain a big ambition that we have.
spk03: Thank you. That's very helpful. And my other question is, can you discuss the rationale behind the new management structure in the Americas? I'm just curious how, if at all, it influences the company's priorities in the region. Should we anticipate any changes to the way that ICOS's U.S. rollout is conducted or any changes in the company's strategy towards the U.S. market, particularly given that Deepak Mishra's background is in strategy and M&A?
spk00: Well, thank you for highlighting the great talent of Deepak, and we're all very pleased to see him taking his new responsibility. I think it just, you know, highlights certainly the potential that we see globally for America, but notably, of course, for the US. We want to keep working in close... interaction with Altria on ICOS. We flagged the fact that we could have, certainly for ICOS-V, some ambition. So you will allow me not to elaborate more on that, but that certainly means that we see the U.S. as clearly a country where reduced-risk products have a great potential, and we want to participate in that potential.
spk03: Thank you.
spk00: You're welcome.
spk07: Our last question comes from Vivian Azur from Cowen. Please go ahead. Hi, good morning. Thank you.
spk08: Hi, Vivian. Hi. My first question is on Viv. I was wondering if you could expand and offer any preliminary insights. I know that it's still early days, but for the consumers that are engaging with that product, are they skewing towards legacy ICOS consumers? Are they newer ICOS consumers? new consumers to the platform in general. Any other insights would be very helpful. Thank you.
spk00: Sure, Viviane. So, I mean, indeed, on Viv, this is what I could call a soft launch. For a number of reasons, we want to learn the category. We are learning in many dimensions, including edge verification, which we see as absolutely paramount. And the obvious initial move from us was to put Vive as a nice complement for some of the already ICOs that have not been used in the case of poly usage, you know, and that was a natural move from people who were knowledgeable of ICOs already, the technology, the great experience the ICOs brand can provide. I think we are moving now to new dimension. We have beyond this, you know, initial move, some great feedback coming from consumer that show that it's not only the elegance of the design, but the overall experience, the quality of the product that is comparing very well when we do test versus competitors. So time to certainly accelerate in our ambition that will come with more launches, of course, development of more flavors. After this first step in the category, you should expect us to certainly increase ambition on vaping.
spk08: Perfect. Thank you. And my follow-up question is just on capital allocation. It's been a while since we've seen the company be this acquisitive. In short order, do you feel comfortable that you've filled white space or knowledge gaps in your portfolio, or should we expect more bolt-on acquisitions going forward?
spk00: Thank you. My view would be, Viviane, that with the proposed acquisition of 13 and Vectura, we would certainly really build a very strong platform on which for our two ambition on inner therapeutic and on self-care wellness, we would have indeed very strong platform and notably from a life science perspective. So for the life science, that would be great. So that's certainly the view that we have today on that topic.
spk07: Thank you.
spk00: Thank you.
spk07: This concludes the question and answer session. I will turn it back over to management for closing remarks.
spk00: All right, well, let me leave you with some key messages then. First, despite the slower recovery from the pandemic in certain markets, we are happy to report a very robust first-half performance with a record high adjusted diluted EPS and raised 2021 guidance. Second, the impressive growth of high cost continues and we remain on track to deliver our target of 95 to 100 billion units for the year. Third, our combustible business is improving sequentially as the recovery from the pandemic gains traction in many key markets. Lastly, we are building towards important milestones in our Beyond Nicotine strategic vision as part of our business transformation. Thank you again for joining us and talk to you soon.
spk07: This concludes today's conference call. You may now disconnect. After saving with customized car insurance from Liberty Mutual, I customize everything.
Disclaimer

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Q2PM 2021

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