Japan Tobacco

Thank you for participating in the investor meeting for Q3 2023 results at Japan Tobacco Inc. today. Before we start the meeting, I would like to ask you to make sure that your display name is accurate. Thank you for your cooperation. It's now my pleasure to introduce you, our CFO. Mr. Furukawa, please. I am Hiro Masa Furukawa, and I am the newly appointed CFO of the JT Group. Thank you for joining us today for the JT Group's financial results briefing for the third quarter of fiscal year 2023. First, I will detail our nine-month consolidated results for fiscal year 2023. Please turn to page 4. As shown on the slide, revenue and adjusted operating profit increased both on a constant FX and on a reported basis. AOP at constant FX increased 5.9% year-on-year, driven mainly by the tobacco business, which continued to grow. Within the tobacco business, pricing contributions outweighed the impact of higher input costs within the supply chain and accelerated investment towards HTS, driving a mid-single-digit profit increase. This performance was supported by increased profits in the pharmaceutical and processed food businesses. The consolidated AOP growth on a reported basis was negatively impacted by the appreciation of the Japanese yen against certain currencies, including the Russian ruble. Operating profit increased 9.1% year-on-year, driven by the AOP increase, as well as gains on sales of real estate and decrease in amortization of trademark rights in the adjustment items. Profit increased 9.5% year-on-year due to the operating profit increase. Moving on to the results of each business segment, starting with the tobacco business. Please turn to slide 5 to review the volume results. Total volume for the 9 months combining sales of combustibles and ROP altogether outperformed the industry volume trend with a 2.1% increase year-on-year. In the combustibles category, volume continued to increase, mainly in the EMA cluster, in line with trends highlighted in the first half of the year. Within the EMA cluster, several drivers led the volume increase. In Turkey, our sales volume increased significantly driven by strong industry volume including a favorable comparison against the weaker industry volume last year. In addition, global travel retail volume recovery continued as travel resumed. The volume increase was stronger in Asia, where COVID restrictions were lifted later than in other geographies. Lastly, several emerging markets within the cluster continued their strong momentum. Also, our market share in key markets increased. Especially in Japan, we continue to capture downtrading and also to increase our market share within the combustibles category, especially in the value price segment. I will come back on Japan in a later slide. These positive contributions outweighed negative factors such as the impact of lower industry volume in several key markets, including the Philippines and the UK, as well as the ongoing business disruption in Sudan. RRP volume increased 8.2% year-on-year, despite one-off items impacting 2023, such as the discontinuation of Plume S sales in Russia. Most of the RRP volume growth came from HTS, our strategic priority fueled by volume increases in Japan as Plume X share gains continued and incremental volume generated by the new launches of Plume X in a number of key cities in Europe. Turning to the financial performance of the tobacco business on slide 6. We continue to achieve strong top-line growth driven by solid pricing contributions in a number of markets, including Philippines, Russia, and the United Kingdom. This top-line growth has enabled us to maintain steady profit growth even under the increased input costs driven by inflationary pressure, such as high raw material prices, distribution, and utility costs, as well as the higher indirect costs, such as labor costs. Investments towards both combustibles and ROP continued, notably to fund the geo-expansion of Plume X outside of Japan. While total volume increased, the volume contribution to AOP was negative, as shown on the lower left-hand side graph. This was due to a lower market mix, resulting from a reduced volume composition from high margin markets, such as the UK. Similar to the consolidated financial results, currencies had a negative impact on reported AOP. This was mainly due to the appreciation of the Japanese yen against several local currencies, including the Russian ruble. Slide seven describes the performance of the three clusters within the tobacco business. The graphs on the slide show year-on-year changes in total volume, core revenue and AOP on a reported basis for each cluster. Let me start with the Asia cluster that includes the key markets of Japan, the Philippines and Taiwan. Total volume in this cluster was essentially flat year-on-year, as the impact of lower industry volumes in the Philippines and Taiwan was offset by the increased market share in the combustibles category in Japan, the Philippines, and Taiwan, as well as the growth of PlumeX in Japan. For the financial results, the strong pricing contribution of Philippines was more than offset by a negative product mix due to down trading in Japan and the Philippines. The incremental investment in Japan towards growing our share in the HDS segment is also one of the growth limiting factors. As a result, revenues and earnings declined, also impacted by unfavorable currency movements. Next is Western Europe, including the key markets of Italy, Spain, and the U.K. Despite market share gains in most markets, total volume in this cluster decreased by 4.2%. This volume decline was mainly driven by the continued industry volume contraction in several markets, most notably in the UK. I will cover the UK in more details on the next slide. Financial results reported an increase in both revenue and AOP. Pricing contributions, especially in the UK, more than offset the negative volume variance, higher supply chain costs, and increased investment in Plumex launches. In addition, favorable currency movements supported the organic performance. Moving on to IMA, which hosts the key markets of Romania, Russia, and Turkey. Despite the impacts from the ongoing business disruption in Sudan and the lower total industry volume in Russia, total volume in this cluster increased by 5.4% year-on-year. As I mentioned earlier, main drivers of volume performance were a higher industry volume in Turkey, the growth in global travel retail especially in Asia, and the momentum in several emerging markets. Financial performance was driven by strong pricing contributions in Canada, Poland, Romania, Russia, Turkey, and other markets, as well as a positive volume contribution already mentioned, which more than offset the impact of higher supply chain costs. Currency movements were unfavorable in this cluster, mainly due to the Russian ruble. On slide 8, I would like to provide some additional details behind the business environment and our performance in the key markets of Japan and the UK. First is the Japan market. Total industry volume for combustibles and RRP combined remained flat year-on-year. Our total volume increased year-on-year, fueled by the growth of POOMX. In the combustibles category, our volume was slightly up by 0.3% versus prior year as market share gains enabled us to offset the impact from the industry volume contraction estimated at 4.8%. After a year in the market, CamelCraft continued to steadily gain market share in the value price segment where demand is growing. As such, Camel Craft was a key contributor to our combustibles market share increase of 3.1% point. In addition, Mevius E-Series in the mid-price segment also supported the growth of our market share in the combustibles category. I will detail an overview of our ROP category and our Plume X performance in Japan on the next slide. Turning to the UK market, total industry volume declined by 16.4% year-on-year due to multiple tax-driven price increases since the second half of 2021, easing of travel restrictions, and a significant inflationary pressure on consumers' disposable income. In addition, Down trading has accelerated, fueled by intensified competition in the value cigarette price segment and in fine cut. In this challenging operating environment, and despite a slight market share loss, we have stabilized our leading positions in the UK and have grown revenue driven by strong pricing contribution. Slide 9 describes the performance of PlumeX in Japan. Market share of PlumeX in the HTS segment continued to grow despite an increasingly competitive environment, with competitors actively introducing new products and sales promotions, as well as price reductions on certain products. I am pleased to report that for the first time, our market share in the HCS segment crossed the double-digit mark, reaching 10.5% in the third quarter. On an off-take basis, our HCS share also shows stable performance. Since the nationwide launch of PlumeX in August 2021, PlumeX has been the fastest-growing brand in the HCS segment in Japan, outpacing the average annual growth rate of total HCS industry volume. We have achieved steady growth for Plume X through various sales activities, as well as the rollout of consumable sticks utilizing both Mevius and Camel brands, discount campaigns, and price revisions for the device. In addition, as announced yesterday, the new Plume X device model, Plume X Advanced, will be introduced nationwide in a sequential manner from November 21. Plume X Advanced is available for pre-sale at the Club JT online shop from today, October 31. This new device includes a new heating technology which will improve the flavor satisfaction compared to the current model, as well as an automatic heating function that starts heating simply by inserting a tobacco stick. With the launch of Plumex Advanced, we aim to further acquire and retain users.

Turning to the geo-expansion progress of Prumex on slide 10. We are on track with the plan shared during our May Tobacco Investor Conference and expect to be present in 28 markets by the end of 2024. Since the last second quarter's results briefing, sales have already begun or will soon start in the five markets listed in the table on the left on this slide. As you can see, all of these markets have a certain level of HTS industry composition, meaning that the consumer awareness regarding the heated tobacco products already exists. Therefore, we can focus our investment on building the plume equity rather than on creating the awareness on HTS. In addition, where available, a lower tax burden on HTS burden versus combustible is likely to generate higher margins than combustibles. as we have done in other markets. We'll start in select cities initially, and we'll continuously work on strengthening our sales network towards the national launches within the market. In market where the Prumex is already sold, we have received very positive feedback from Prume users regarding the amount of vapors, the device heating speed, and the usable time per stick, and its price. We continue to leverage our global knowledge gained in each market to attract and retain users. Slide 11 shows the results of the pharmaceutical and processed food businesses. First is the pharmaceutical business. Revenue grew year-on-year due to the one-time income from the licensing at patented JT compounds and the sales increases in the areas of skin diseases and allergens at our subsidiary Tori Pharmaceutical. AOP increased year-on-year as revenue growth exceeded increase in R&D expenses. As a reference, I would like to update you on some clinical developments relative to our products. Shown in this slide, we filed the new drug application for JT061 cream, a therapeutic aerial hydrocarbon receptor agonist for separate indications in atopic dermatitis and plaque psoriasis in September. Moving to the processed food business. Revenue was almost flat year-on-year despite the revenue loss resulting from the transfer of the bakery business as the top-line in food service products grew fueled by the recovery in demand for food services, in addition to price revisions implemented in 2022 and 2023 in the frozen and ambient food segment. AOP increased year-on-year, driven by the price revisions implemented in 2022 and 2023, as well as top-line growth in the food service products, which offset the significant increase in raw material cost. From the next slide, I will guide you through our revised forecast for fiscal year 2023. Please refer to slide 13, which shows a consolidated revised forecast. Both revenue and AOP have been revised upward, both on the constant currency and reported basis. Core revenue and constant currency has been revised upward by 63 billion yen from the previous forecast, mainly to reflect the strong stock line in the tobacco business, and as a result, is expected to increase by 5.6% compared to the previous fiscal year. AOP forecast is now revised upward by ¥34 billion from the previous forecast, which had been kept unchanged, resulting in a 5% increase from the previous fiscal year due to the upward revision from the tobacco business as well as the upward revision in the pharmaceutical and processed food businesses. The forecast for the revenue and AOP on a reported basis, including the foreign exchange rates, have been revised upward by 85 billion yen and 38 billion yen, respectively, from the previous forecast to reflect a weaker Japanese yen against many currencies. There is no significant change in the foreign exchange impact on AOP from the previous forecast. This is due to the fact that the depreciation of several local currencies, such as the Russian ruble, are expected to be offset by the weaker Japanese yen. Operating profit has been revised upward by 45 billion yen from the previous forecast due to the upward revision of AOP and expected upward revision of gains on sales of real estate in adjusted items. Profit forecast has been revised upward by 7 billion yen from the previous forecast as the upward revision of operating profit is expected to be partially offset by higher financial cost and an increase in income tax. Free cash flow is expected to be ¥25 billion higher than the previous estimate due to the increasing AOP, an increase in gains on sales of real estate, and a decrease in capital expenditures partially offset by the deterioration in working capital. Slide 14 and onward will detail the revised forecast for each business segment. We start with the tobacco business. Regarding the volume forecast, combustibles and RRP combined total volume has been revised upward to reflect the stronger industry volume trend in several markets across the EMA cluster, including Turkey, as I have explained before. The continued share momentum in most market and the solid recovery in global travel retail largely driven by Azure. As a result, total volume is now expected to increase by approximately 1.5% year-on-year, despite some softness still expected in the last quarter due to the slowdown in the growth of the industry volume. Turning to the financials, core revenue on a constant currency basis is expected to increase by 63 billion yen against the previous forecast, reflecting the stronger pricing contributions and upward revision of total volume. AOP is expected to increase by 33 billion yen from the previous forecast, following the upward revision of core revenue, partially offset by the additional investment on Prumex. On a reported basis, including the impact of exchange rates, we have revised our views for some currencies toward the stronger Japanese yen, such as the Russian ruble. But overall, we have kept our assumptions toward the weaker Japanese yen as a result, as shown in the slide, for score revenue AOP having revised upward from the previous forecast. Slide 15 explains the revised forecast for the pharmaceutical and processed food businesses. Regarding the pharmaceutical business, we have revised our forecast for revenue by 2 billion Japanese yen from the previous forecast due to an expected increase in net sales at three pharmaceutical and upward revision of overseas royalty income due to the Japanese yen depreciation. AOP is also revised upward by 2 billion yen in line with the upward revision of revenue. Moving to the processed food business, revenue was revised downward by 2 billion yen from the previous forecast, taking into account the sales situation of products for household use in the frozen and ambient food business. Despite the lower revenue forecast, AOP has been revised upward by 500 million Japanese yen to account for the more precise projection of utility and other costs. Finally, please turn to slide 17. As we have explained, thanks to our strong business performance, we have been able to accelerate growth while increasing investment in both combustibles and RRP. We are confident that we will achieve our revised full-year forecast. While it is too early to talk about 2024, I still want to share some very high-level directions that could play a role in the plan for the next fiscal year and beyond. We intend to continue our efforts to build our presence in RRP by driving the geographic expansion of Prumex. As per our plan, we intend to have the presence in 28 markets by the end of 2024. Obviously, we remain agile in our implementation by continually assessing the trends in each market where we plan to launch Prumex to enhance the accuracy of our projection. We continue to strive for efficiency in our supply chain and build a competitive cost base. Supply chain costs, including raw materials, logistics, energy costs, have increased significantly in 2023. Although the inflation has peaked out in the second half of 2022, we believe there will be a certain time lag for the inflation to be fully reflected in our supply chain costs. As a result, the rare Rate of increase will be slightly moderate in 2024, but we expect that cost will remain a headwind. Finally, like we have always done, we assess the impact associated with geopolitical risks and the global economic situation, changes in excise tax environment, and foreign exchange movement. In closing, I'd like to discuss the shareholder returns. We have not altered our forecast for the annual dividend from our initial projection of 188 yen per share. Based on the revised profit forecast, our payout ratio for fiscal 2023 will be approximately 72%, which I believe is on a level that is in line with our shareholder return policy. This concludes my presentation. Thank you very much for your attention.

Thank you, Mr. Furukawa. Now I'd like to start the Q&A session Let me introduce you to the speakers who will answer your questions today. Hiro Masahiro Kawa, CFO of the JT Group, and Koji Shimayoshi, JTI Deputy CEO. Next, I will show you how to ask questions. We're afraid we don't accept questions in this English line. If you have any questions, please send us an email to JT.IR at JT.com. JT.IR at JT.com. We will introduce your question accordingly. Thank you for your understanding. Thank you for waiting. The first question comes from Mr. Saji, Mizuho Securities. Over to you. Thank you. I have one question then. On page 13, You have the revised forecasts available in the consultative basis. 45 billion OP is up and 7 billion up for profit. So the corporate tax has been increasing and there is also a negative impact from financial income. So regarding your net profit or profit, It seems that you have revised up it by a smaller magnitude. So can you give me more detail of the items in between operating profit and profit? So your question was about revised forecasts on page 13 and the difference in the revisions between operating profit and profit. Mr. Furukawa, our CFO, will take your question. This is Furukawa speaking. Saji-san, thank you for your question. So, profit has been revised up by 7 billion yen, and regarding this, overall, financial expenses and tax expenses at the end of the fiscal year, there are some items that are uncertain, and we have accounted for that in our updated forecast. And what we mean by this is in emerging markets there are some FX losses that we are assuming in our forecast and other than that the hyperinflation accounting monetary losses are anticipated to increase that's another negative factor and furthermore due to higher ETR corporate taxes are likely to increase And of course, FX is likely to impact us as well. So those are considerable negative factors between operating profit and profit. So profit, that is why profit is only revised up by $7 billion compared to the previous forecast. Thank you. For Dividend Outlook, it has a material impact. So my question is, for these items, Is the probability of these items to materialize high or are you just accounting for some risks? Can you give me a flavor? Well, regarding FX losses, you will never know until we end the period. But looking at the past trends, we do expect this magnitude of FX losses to come through. And for hyperinflation accounting, for monetary gains and losses, FX has an impact. So for FX impact does have an impact by a certain magnitude. And for the increase in ETR regarding its certainty, I can't say that it's 100% going to come through, but our outlook is around the fourth quarter, we should account for this amount. That's where we're coming from. So it's really hard to give you a probability figure, but in forecasting our performance, we do believe, if we do believe that we need to acknowledge it, we have accounted for it in our assumptions. Thank you.