Philip Morris International Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 20, 2023

Key Takeaways

  • Philip Morris reported a record quarterly adjusted diluted EPS of $1.60, up 16.9% year-over-year, driven by strong ZYN and IQOS growth alongside resilient combustible pricing.
  • Smoke-free products saw continued momentum with IQOS HTU in-market sales up 16% and shipments +27%, adding 1.4 million new users, while ZYN volumes in the U.S. accelerated over 50% in Q2.
  • Combustible net revenues grew +7% organically on robust pricing and resilient volume, supporting a 200 basis-point sequential improvement in adjusted operating income margin.
  • Management raised its full-year outlook, now forecasting organic net revenue growth of +7.5% to +8.5% and currency-neutral adjusted diluted EPS growth of +8% to +9.5% (to $6.13–$6.22).
  • The Wellness & Healthcare segment faced setbacks as an inhalable aspirin trial failed to meet dosing consistency and a goodwill impairment was recorded, delaying its 2025 revenue target.
AI Generated. May Contain Errors.
Earnings Conference Call
Philip Morris International Q2 2023
00:00 / 00:00

There are 10 speakers on the call.

Operator

Good day, everyone, and welcome to the Philip Morris International Second Quarter 2023 Earnings Conference Call. Today's call is scheduled to last about 1 hour, including remarks by Philip Morris International Management and the question and answer session. At the conclusion of questions from the investment community. I would now like to turn the call over to Mr. James Bushnell, Vice President of Investor Relations and Financial Communications.

Operator

Please go ahead, sir.

Speaker 1

Welcome. Thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2023 Q2 results. The press release is available on our website at pmi.com. A glossary of terms, including the definition for smoke free products, as well as adjustments, other calculations and reconciliations to the most directly comparable U.

Speaker 1

S. GAAP measures for non GAAP financial measures cited in this presentation and additional net revenue data are available in Exhibit 99.2 to the company's Form 8 ks dated July 20, 2023, and on our Investor Relations website. Growth rates presented on an organic basis reflect currency neutral adjusted results, excluding acquisitions and disposals. As such, figures and comparisons presented on an organic basis exclude Swedish Match up until November 11, 2023. Today's remarks contain forward looking statements and projections of future results.

Speaker 1

I direct your attention to the forward looking and cautionary statements disclosure in today's presentation and press release for a review of the various factors that could cause actual results to differ materially from projections or forward looking statements. It is now my pleasure to introduce Emmanuel Babaut, our Chief Financial Officer. Over to you, Emmanuel.

Speaker 2

Thank you, James, and welcome, everyone. Our business delivered to reach a record high quarterly adjusted diluted EPS of $1.60 This was driven by impressive ZYN and IQOS Growth coupled with strong combustible results. We delivered total cigarette and HTU shipment volume growth of +3.3 percent putting us well on track for our 3rd This excellent result underpinned double digit organic top line growth and ITAM's currency neutral adjusted diluted EPS growth. We also expanded our leadership in smoke free product in the period. Firstly, HEICO's strong momentum continued with adjusted in market sales volume ahead by plus 16% and shipments up by +27 percent.

Speaker 2

This reflects very good user growth of +1.4000000 in the quarter and continued strong traction across the world. This is increasingly driven by IQOSILUMA, which is now available in 23 markets, representing around 2 thirds of our IQOS business by volume. Secondly, And now 2 full quarters after the Swedish Match acquisition, ZYN is delivering an exceptional acceleration to our smoke free business. U. S.

Speaker 2

Volumes grew by over plus 50%, including a notable step up in June. We are delighted with this performance. Our combustible business also delivered better than expected results with over plus 7% organic net revenue growth after a very robust quarter for pricing and resilient volume. This was a key contributor to the strong plus 7 percent organic operating income growth with a +200 basis point sequential improvement in our adjusted operating income margin. Turning to the headline numbers.

Speaker 2

Positive volumes supported very strong organic top line growth of plus 10.5 percent with continued excellent IQOS momentum and a further acceleration in combustible pricing. This does not include the remarkable plus 19% pro form a Ex currency top line growth of Swedish Match led by ZYN with combined pro form a ex currency net revenues increasing by +11.1 percent. Our total reported currency neutral net revenues grew by +19%. Our organic net revenue per unit grew by plus 7%, driven by the increasing proportion of IQOS HTUs in our sales mix and combustible pricing. Due to these positive factors, adjusted operating income grew by a very robust plus 7% organically despite continued inflationary headwinds.

Speaker 2

This excludes the tremendous growth of ZYN and starting in Q4, Our organic result will include Swedish Match. Adjusted OI Margins improved plus 210 basis points sequentially and while still organically lower year on year by 140 basis points, This better than expected performance was notably supported by combustible strength and favorable timing of certain costs. We also increased our participation in the below Tier 1 segment in Indonesia, which now represents close to 40% of its industry volumes and is slightly dilutive to our margins. This organic delivery including the favorable timing of cost Combined with exceptional June ZYN volume and a lower tax rate allowed us to outperform our most recent Q2 forecast. We delivered adjusted diluted EPS of $1.60 representing plus 16.9 percent growth excluding and unfavorable currency impact of $0.13 notably due to the Japanese yen.

Speaker 2

While the Q1 of the year contains some exceptional headwinds and distortion due to timing and comparison effect, Our business delivered a strong first half including volume growth of +1.1 percent. Organic revenues grew by plus 6.8 percent with Swedish Match excellent ex currency pro form a net revenue growth of plus 17% for H1, demonstrating its growth accretion to our business. Combined pro form a currency neutral net revenue increased by around plus 7.5%. Following peak margin headwinds and notable operating income decline in the Q1, the strong improvement In Q2, narrowed the H1 organic decline to minus 2%. As in Q2, this excludes Swedish Match, which delivered an excellent profit performance and made a significant contribution to our adjusted OI margin.

Speaker 2

We expect continued strong reported and organic operating income growth in the second half. Despite these headwinds, we delivered plus 5.9% growth in currency neutral adjusted diluted EPS to $2.98 in H1, providing a strong platform for the second half of twenty twenty three and beyond. Let me now walk through the mechanics of our Q2 net revenues. While not included in our reported shipment volume growth of +3.3 percent, Swedish Match Smokefree volume grew by +15%, providing impressive accretion to our overall growth profile. Combustible and HTU pricing contributed plus 6 points of growth.

Speaker 2

This primarily reflects combustible strength, partly benefiting from timing effect. As in Q1, In Japan and Germany by the annualization of 2022 excise tax increase and in the case of Japan, the transition to Illumina. These factors will have less impact in the second half as annualization recedes. We also continue to expect greater visibility on the likely outcome of the court ruling related to the German tax surcharge towards the end of the year. The increasing proportion of HTUs in our business again contributed positively, reflecting higher net revenue per unit, partially offset by unfavorable geographic mix.

Speaker 2

The positive mix impact of Overall volume growth and pricing are powerful drivers of our transformation and growth. Let's now turn to gross margins. While the year on year trajectory remained negative, we saw improvement versus the Q1 driven by Indeed, we achieved sequential improvement of 1.2 percentage point Despite increased inflationary pressures as top line growth accelerated and supply chain disruption and Illumina related factors started to dissipate in the quarter. In addition, cost phasing and the geographic mix of inventory movement, notably for HTU in Europe, increasingly normalized after an adversely affected Q1. Our IQOS business contributed positively to our gross margin in Q2 and we expect this to continue partly mitigating combustible.

Speaker 2

We expect further improvement in our year on year gross margin trajectory in H2 as headwinds continue to subdue, ZYN's outstanding growth continues and the underlying driver of our transformation accelerates. As expected, SG and A growth was much closer to net revenue growth in Q2 and at a more normalized growth rate with regard to our full year expectation. Indeed, with such a strong top line in Q2, SG and A costs were lower as a percentage of net revenues. While we continue to invest in IQOS and ZYN, our successful cost efficiency program continues to deliver, helping to finance growth investment and mitigate inflation, which remains a headwind. With $1,900,000,000 of gross Savings realized to date, including $820,000,000 from SG and A, we are on track Turning now to the 2023 outlook.

Speaker 2

We are raising our currency neutral top and bottom line growth forecast. We aim to be a growth company starting with volumes. In 2023, we expect to grow total volume for the 3rd year in a row even before factoring in the excellent progress of Swedish Match portfolio. As part of this growth, we are reiterating our targeted HTU shipment range of €125,000,000,000 to €132,000,000,000 while we expect a cigarette volume decline of 1.5% to 2.5%. We are increasing our organic net revenue growth forecast to +7.5 percent to +8.5 percent, Reflecting the continued momentum of IQOS, the resilience of our combustible business and the ongoing excellent growth of ZYN, which we expect to contribute positively in Q4.

Speaker 2

We expect strong organic operating income growth in the remainder of the year to support H2 margin expansion, despite the headwinds previously mentioned and certain technical impact. These relates to the increased use of 3rd party manufacturing in a few markets such as Indonesia and Ukraine and the related growth of the below Tier 1 segment in Indonesia I already mentioned. The full year estimated impact of this factor is around 40 basis points on our adjusted OI margin. And without this impact, we would expect to be broadly in the middle of our forecast organic margin range. On top of this organic evolution, we expect Swedish Match to add around 50 basis points of accretion.

Speaker 2

Our strong top line and OI outlook allows us to raise our forecast for currency neutral adjusted diluted EPS growth 2 +8 percent to plus 9.5 percent. This translates to a revised range of $6.13 to $6.22 including $0.33 from unfavorable currency at prevailing exchange rate, notably due to the Japanese yen and Russian ruble. This forecast continues to assume around $50,000,000 for incremental investment in the U. S. And our Wellness and Healthcare business.

Speaker 2

It also assumes around $1,200,000,000 in net finance costs, which includes higher interest on variable debt, partly offset by better returns on cash deposit. As previously mentioned, our forecast do not assume any contribution from a potential Focusing on the second half in more detail, We expect strong performance on all key metrics as smoke free products deliver an increasingly positive impact. In Q3, we forecast high single digit organic top line growth with HTU shipments of 31,000,000,000 to 33,000,000,000 units and adjusted diluted EPS of $1.60 to $1.65 including $0.06 of unfavorable currency at prevailing exchange rate. Looking ahead to Q4, we expect notably strong reported and organic OI growth Certain inflationary impacts are annualized and we increasingly benefit from an optimized Illumas supply chain and consumable. As I mentioned, Swedish Match will also be included in our organic figures during the quarter.

Speaker 2

The exceptional growth of ZYN is clearly margin accretive as visible in our adjusted H1 figures. Turning back to our results. Our total shipment volume increased by +3 for Q2 and plus 1.1 percent year to date. HTU shipment volume grew by plus 26.6 percent in Q2 We reached 31,400,000,000 units notably driven by continued strong performance in Europe and Japan. In addition to fundamental strength, HTU shipment to Japan were boosted in Q2 by around 2,000,000,000 units as we increased sea freight with corresponding increase in inventory level.

Speaker 2

As I mentioned earlier, total PMI adjusted IMS volume of HTUs increased by plus 16% in Q2, continuing the excellent trends in Q1. Shipment volume grew by +18.5%. Notably, this does not include the excellent growth prospect of oral nicotine, for which shipment volume grew by plus 14% in Q2 and plus 12% in H1 on a pro form a basis. Cigarette volume declined by a modest 0.4% in Q2 with notable support from Turkey and Egypt and by 1.7% for H1, reflecting a solid category share performance in a resilient category despite stepped up pricing. Our smoke free transformation continues to progress rapidly.

Speaker 2

Due to the continued impressive performance of IQOS, Peated tobacco units comprised 16.4% of our total shipment volume in H1 as compared to 14% In the first half of twenty twenty two, despite the resilient cigarette category, including all smoke free product, This will be close to 18%. Powered by IQOS and ZYN, Smokefree product made up 35% of our adjusted net revenue in H1 compared to 30.9% for the same period In 2022, IQOS devices accounted for approximately 4.5% of our H1 inelible smoke free net revenue. Focusing now on combustible. Our portfolio delivered strong organic net revenue growth of +7.4 percent in Q2 and +5.2 percent in H1. This reflects Strong Q2 pricing with a notable contribution from Indonesia and the Philippines.

Speaker 2

While we don't expect the exceptionally strong Q2 pricing of 9.4%, which benefited from timing factors to be fully replicated in H2. We now forecast a full year increase of +7 percent to +8 percent. Our cigarette category share grew by plus 0.7 points in Q2 On a year over year basis, including contribution from duty free, Egypt and Turkey and by plus 0.1. In H1 resulting in only modest volume declines. Our leadership in combustible helps to maximize switching to smoke free product And we have fully achieved our ongoing objective of stable category share over the last 18 months despite the impact of IQOS cannibalization.

Speaker 2

The combination of a stable share in combustible and the continued growth of our leading smoke free brands position us to deliver total market share growth over time. We captured plus 1.1 points of international cigarette And HTU share in Q2 and plus 0.5 point in H1 with notable contribution from Turkey and Japan. Impressively, despite increasing competition in many markets, our volume share of the growing heat not burn category remains stable at around 75%. This is supported by ongoing Illumina market launches and increasing focus on our 2 tier HTU portfolio, providing adult smokers with an expanding range of innovative and high quality alternatives to cigarettes. TMI HTUs again strengthened their position as the 2nd largest nicotine brand In markets where IQOS is present, with a sequential share gain in Q2 of 0.2 points to record 9.2% share.

Speaker 2

We estimate there were 27,200,000 IQOS users as of June 30. This reflects excellent growth of +1,400,000 adult users in Q2 with notable progress in Japan and Europe in addition to a broad range of other geographies. While fundamentals remain very strong, I remind you that Q3 user growth can often be below the average for the year due to the seasonal factors evident in prior years. I will now turn to IQOS in the Europe region, where we are approaching a milestone of 12,000,000 users. This reflects the further rollout of Illumina, which is now available to around 70% of IQOS users in the region and the expansion of our 2 tier portfolio.

Speaker 2

As an illustration of its progress, Terria is already close to 100% of our HTU in market sales volume in the 1st launch market of Spain and Switzerland. Our 2nd quarter HTU share increased by plus 1.6 points year over year to 9% of total cigarettes and HTU industry volume. While sequential share is as usual optically affected by the seasonality of the cigarette category, Adjusted IMS volume continued to exhibit robust sequential growth and reached a record high on the 4 quarter moving average. This reflects strong year on year growth of plus 20% in Q2, outstripping the plus 11% growth in HTU shipments, which were affected by some residual effect from the inventory dynamics seen in Q1. We expect robust growth in HTU shipments, adjusted IMS and overall region organic revenue in the second half.

Speaker 2

We continue to be encouraged by the increasing number of European countries adopting multi year excise tax plans with clear differentiation of smoke free product. Over half of EU member states have now passed multiyear plans. Also in the EU, a number of member states are currently transposing the delegated directive withdrawing the heated tobacco product exemption from the flavor ban International legislation. The ban is scheduled to come into effect on October 23, and we will be adjusting our as required in line with this transposition. While short term volatility is possible, we do not expect A significant change is the structural growth of the category.

Speaker 2

To give some further color on our continued progress in the region, this slide shows a selection of the latest key city of Techshares. The success of IQOS continues across a diverse range of geographies from Western, Southern, Central and Eastern Europe, including market with and without Illumina. Despite the denominator effect of the combustible category I just mentioned, Share results remain very strong. We are very pleased with trends in Rome showing a sequential step up to 28% share following the Illumina launch. Robert's progress in London and Munich also bodes well for these 2 key markets.

Speaker 2

While the Q2 2022 comparison for share in Genius was helped by the popularity of certain bundle offers, The share of over 40% remains impressive and underlying uptake continues to grow. In Japan, IQOSILUMA continues to drive impressive growth momentum. Smokefree products made up over 75% of our Japan net revenue in H1, clearly showing the path for the broader company. Adjusted total tobacco share for our HTU brands increased by plus 3.4 points in Q2 to 26.3%, Further strengthening Terria and SENTIA's position as a clear number 1 and 2, if not burn brands, despite intensified price competition for mid and low price offering. Importantly, Adjusted IMS volume again grew sequentially, reaching a record high of 9,300,000,000 unit on the 4 quarter moving average as IQOS outgrew the hypnobone category.

Speaker 2

In addition to this excellent consumer trend, Our Q2 shipments to Japan also benefited from progressively switching back to sea freight during the quarter. In addition to strong IQOS gains in developed countries, we continue to see very promising growth in low and middle income markets. These slides highlight a selection of Q2 key city of Tech shares across markets in Eastern Europe, Africa, Asia and Latin America. Notable ongoing successes include Egypt with Kero Offtake shares surpassing 8.5% and Bulgaria With offtake share in Sofia exceeding 15% despite the usual impact of seasonality that I mentioned. We continue to see robust offtake volume growth across these important future markets.

Speaker 2

Now moving to Swedish Match, which is meaningfully accelerating our smoke free growth trajectory. As covered earlier, the business delivered outstanding currency neutral net revenue growth of plus 19% in Q2 and plus 17% in H1. This means that in the first half of the year, Swedish Match has added 70 basis points of currency neutral growth to our pro form a top line and plus 60 basis points to our adjusted OI margin. In the U. S, ZYN delivered another Exceptional quarter with volume growth of over 50%, reflecting positive momentum across the country.

Speaker 2

Elsewhere in smoke free, recent trends of share gain in U. S. Small snuff as well as category mix headwinds in Scandinavia broadly continued. The cigar business performed well with Q2 organic net revenue growth of plus 16%. This reflects ongoing share gains despite being an early mover on category pricing.

Speaker 2

I would like to again Congratulate and thank all the Swedish Match employees for continuing to deliver terrific results as we thoughtfully integrate our activities, which is progressing very well. Looking at ZYN US performance in more detail, exceptional year over year volume growth in can of plus 53% also reflect a +22 percent sequential increase versus Q1 2023. This accelerated growth reflects progressive increase in distribution and a broad nationwide step up in store velocity As the category gained strong traction with adult nicotine user for its convenience and pleasurable experience. This includes California, which implemented a statewide flavor ban in December. While such Elevated rates of growth may not continue indefinitely.

Speaker 2

The structural indicators remain very encouraging. Impressively, zinc category volume share grew plus 2.2 points compared to prior year and plus 1 point sequentially despite continued discounting from less premium offerings. Retail value share also grew to Now let me provide an update on our innovation and expansion plan as we further accelerate our smoke free transformation. 1st and foremost, the global rollout of IQOS Illumina continues to be a top priority. We launched Illumina in 6 markets in Q2.

Speaker 2

And with HTU manufacturing constraint now normalized, We aim to be present in around 50 markets by the end of the year. The most significant opportunity to drive accelerated growth is in the U. S. We are investing behind ZYN and readying our organizational and commercial capabilities for the launch of IQOS in Q2 next year. As mentioned in today's release, we are also on track for IQOS, ILLUMA PMTA and supplemental MRTPA submission in Q4 2023.

Speaker 2

Our philosophy on the U. S. Remains unchanged. We will seek to accelerate our top line with IQOS and ZYN, supported by disciplined investment and leveraging both Our extensive experience in Smooth Free Product and Swedish Match infrastructure and knowledge, while continuing to deliver strong bottom line growth for PMI. Our pilot city launches for Bond in the Philippines and Colombia continue to progress well.

Speaker 2

The learning from this market will be integrated as we roll out more broadly starting next year. The international expansion of nicotine pouches remains a key medium term opportunity, notably for ZYN as the world's leading brand. We are now preparing for the launch of re launch of ZYN in several markets. In e vapor, Our refocused approach in select market is progressing with VIVE1, our newly designed pot based system introduced in 4 markets and VIVE NOW, our disposable product in 6 markets. Now let me discuss our Wellness and Healthcare segment starting with its first clinical trial results for our inelible aspirin product.

Speaker 2

While it was observed that the experimental product had a rapid onset of effect, which is a key medical advantage sought, There was significant variability in inhaled dose among subjects. The study was therefore been unsuccessful And as a result, product design improvements are required. Our plan was to file this product with the FDA later this year. However, additional time is now required and the outcome is therefore less certain. In addition, the CDMO business has been facing slower than anticipated development, including cost related challenges.

Speaker 2

Consequently, we recorded a non cash goodwill impairment from our annual assessment as detailed in today's release. While these elements will postpone the achievement of our 2025 aspiration to reach over $1,000,000,000 Of net revenue from wellness and Eschar product, they will result in a corresponding decrease in the level of investment in 2024. Our ambition to build and monetize our product pipeline are unchanged. As in the early days of developing IQOS, Certain headwinds are to be expected and the 2021 acquisition in this segment has provided us with unique and enabling R and D capability. We remain committed to developing our Wellness and Healthcare business and continue to see Attractive mid and long term growth potential on many fronts such as inelible drugs, NFT and consumer wellness products, including nonrecruent cannabinoid, in line with applicable regulatory requirements.

Speaker 2

We also aim to accelerate Victora's growth and will be exploring potential partnership to enhance its CDMO business. We plan to discuss all these topics, including our plan for IQOS in the U. S. And a full update on our Wellness and Healthcare business at our Investor Day on the 28th September in Lausanne, Switzerland. Moving now to sustainability.

Speaker 2

Addressing the product health impact of combustible product by switching adult smokers to smoke Product such as IQOS and ZYN remains our most critical priority. This transformation is at the core of our strategy, driving accelerated growth and returns over time from a more sustainable business. In addition, We remain committed to delivering best in class progress in other key sustainability areas. With our extensive agriculture and manufacturing supply chain, human rights are very important responsibility for our company. We released our first dedicated report on the topic last month detailing our strategy to promote, Respect and protect human rights and the progress to date in implementing our human rights commitments.

Speaker 2

Our performance on human rights is included in the 19 KPIs of our Sustainability Index, which comprises 30% of executive long term equity compensation weighted towards our product transformation. Our goal is to conduct comprehensive human rights impact assessments in our 10 highest risk market By the end of 2025, this help us better understand and address our impacts and we are making excellent progress with 7 completed to date. Addressing climate change is another priority for us, and I am pleased to share that PMI was included in the Forbes 1st ever Net Zero Leaders List ranking 7th overall for all U. S. Public To conclude today's presentation, We delivered a very strong first half despite the number of headwinds, putting us on track for the 3rd consecutive year of positive volume and organic net revenue growth of over plus 7%.

Speaker 2

The powerful trajectory of our Smokefree business give us confidence in a strong full year performance with excellent operating income growth. Outstanding momentum continues for IQOS And ZYN, the world leading Hypnotburn and oral nicotine brands. And we have exciting plans to further grow oral nicotine pouches in the U. S. And internationally along with the U.

Speaker 2

S. Commercialization of IQOS next year. Importantly, we remain steadfast in our commitment to generously reward our shareholders, including through our progressive dividend policy. In short, our Smokefree transformation continues to deliver sustainable growth. We look forward to sharing more with you on the next phase of our transformation at our Investor Day on September 28.

Speaker 2

Thank you very much and we are now delighted to answer your questions.

Operator

Thank you. We will now conduct In the interest of fairness and time, we ask that participants keep to a maximum of 2 questions each. If time allows, follow-up questions may be taken. You may rejoin the queue again by pressing star and 1 on your touchtone phone. Our first question comes from Pamela Kaufman from Morgan Stanley.

Operator

Your line is now open.

Speaker 3

Hi, good morning.

Speaker 2

Good morning, Sam.

Speaker 3

I wanted to ask about your full year guidance. You exceeded your own Q2 guidance by at least $0.13 but did not flow through the EPS beat to the full year outlook even when factoring the greater FX Headwinds, what's tempering the flow through of Q2 upside and how much does this reflect conservatism around the balance of the year versus a more cautious outlook on the second half or higher investments? Thanks.

Speaker 2

Thank you, Pam. When we look at the driver for beating our initial expectation for Q2, I think we can probably make 3 buckets. One is the outperformance of ZYN versus our expectation. And that's something that we are, of course, Taking into account as we see a better trajectory for ZYN than initially anticipated, remember that we'll only contribute to Our organic growth on revenue in Q4, but that is, of course, helping the adjusted EPS growth excluding ForEx. We also see some costs that have been moved to H2 and that is if you want cost that are we going to see in H2.

Speaker 2

So it's not Net addition for the year. And then there was, as we said, some better news on financial cost, cost on our debt. There was also some element on tax. And of course, this one is more uncertain and more difficult to predict for the 2nd part of the year. But I think as always, we are building scenario for the full year.

Speaker 2

We've been including in a clear way What we see a real change in the trajectory and on which we have visibility for the second half. On things where we have postponement or things with good news, but of course, we still have a lot of uncertainty on H2. Of course, we have to be a bit more cautious When we take them in the scenarios.

Speaker 3

Okay. Thanks. And then just on operating margins, You pointed operating margins closer to the lower end of your initial guidance range of down 50 to 150 basis points for the year. Can you discuss the puts and takes impacting your margin performance in the second half?

Speaker 2

So when you look at the margin, really things are happening as expected, I would say. So after Q1, which was not coming as a surprise to us, We said from now on, we're going to see an improvement of the margin trajectory. We knew that inflation would Still be there for the rest of the year, although in the 2nd part of the year, we're going to be facing comparison where inflation was starting to kick in. So that's going to have Some impact, but we knew that a number of other headwinds start to abate. And here, I'm talking about the disruption on the supply chain and Among other things, things connected with airfreight, the cost attached to the launch of Illumina and the fact that not everything was optimal.

Speaker 2

So we started to see improvement in Q2 as expected, and we're going to continue to see improvement in the rest of the year. And then what we see playing in Q2 that we expect to see playing in the rest of the year are the fundamental positive drivers that we have for our margin. First of all, the fact that IQOS growth is having a positive impact On our margin, we said it in the beginning, we expect a positive contribution on margin evolution for the year from the Itnerdam business. Remember, we have a higher Gross margin rate on our consumable for IQOS. So as we are growing IQOS, that is having a positive impact.

Speaker 2

There is no when it comes to our smoke free business another driver that is positive for our margin, which is ZYN and ZYN in the U. S, which is also accretive to the margin. You don't see it in the organic reporting so far, but it's going to start to kick in, in Q4 and we expect to have another A nice positive. And then the third element that I think you see of course nicely in Q2 is our pricing power. We see today very clearly on combustible.

Speaker 2

We have some headwinds that are temporary coming from Germany and Japan It's not burn, but we retain pricing power, which is positive for the long term. And these are good elements. Of course, in front of that, we will keep investing and making sure that we are maximizing the growth potential. But that's really what is behind the margin development for the year. Now on top of it, and I think We've been flying that during this quarter.

Speaker 2

We have the development of businesses that are coming with lower margin because we are Buying to 3rd parties, and that is a different margin dynamic. And also this business, which we called below V1, which is In fact, we've reduced excise duty in Indonesia that is coming with lower margin. It's more a technical effect, I would say. And as mentioned, without that, we would have been in fact in the middle of the bracket that we gave, the 50% to 150% negative. And again, this is not reflecting the positive contribution for ZYN.

Speaker 2

So I would say, as a summary, things are happening as expected, And we start to see the fact that we have on the long term some fundamental positive driver for our margin that I summarized.

Speaker 3

Thank you. That's very helpful.

Speaker 2

Thank you.

Operator

We will take our next question from Vivien Azer with TD Cowen. Your line is open.

Speaker 3

Hi, good

Speaker 2

morning. Hi, Gideon.

Speaker 4

So I wanted to follow-up on the commentary And then certainly consistent with the very robust trends that we're seeing in the Nielsen scanner data, Accelerating growth, strong market share gains. You've spoken in the past about the opportunity to offer some incremental investment to that business unit To expand the sales force, improve distribution and drive velocity, can you just talk to us about where you are in that assessment Time horizon for ZYN, please? Thank you.

Speaker 2

Sure, Vivien. Yes, ZYN is of course, I mean, we knew that the brand was great. I think we are seeing something that is above our initial expectation to be very clear for the time being at the time Of the acquisition of Swedish Match, there is clearly a growing awareness of this category. We see a lot of Poly usage, so you have a percentage that is fully converted by the lot of poly usage. We talk about people discovering that they can enjoy their nicotine In moments where they cannot enjoy whether they're combustible cigarettes or other inelible product, that is certainly playing.

Speaker 2

I think there is Very positive lifestyle element around the development in the U. S. That is gathering momentum. So that is, I think, explaining the success of ZYN that It's the icon of the category and of course taking today the lion's share of the growth of this nicotine pouch progression in the U. S.

Speaker 2

Now that is very good news, of course, because that means that we have a very dynamic business in the U. S. To be very clear, it's not Marginal at the group level, so you will see and you already see in the performance impact of this ZYN US performance. So that's great to have another driver for our smoke free performance and globally for the financial performance of the company. That is setting the scene very well for IQOS because on top of what is successful, we're going to be able to build a very efficient Commercial engine, you said it increased sales force.

Speaker 2

We're in the making of that. It's happening progressively. It's of course Going to help both ZYN and IQOS, but that also bodes very well for our capacity to develop IQOS successfully in the future in the U. S. We're going to have a convergence of strength between ZYN and IQOS.

Speaker 2

So To be very clear, we haven't been suddenly increasing at that stage by several 100 people to the sales force. It's happening gradually as we build The capacity for IQOS starting Q2 next year. There is other investment that we are doing in our Digital capacity and the digital commercial engine, again, just the beginning. So I don't think it is really today beyond the growth that we see behind ZYN, but these are additional strengths and capacity. And again, I think we are very excited about the amazing teams that IQOS and ZYN

Speaker 4

That's really helpful. Thank you for that. And then just moving to the Wellness and Healthcare segment for my second question, please. Understanding some of the challenges around the clinical trial, I was wondering if you could just comment on your aspiration to delever the balance sheet, post the Swedish Match transaction versus the potential need incremental M and A as you think about an ultimate $1,000,000,000 revenue target understanding that you pushed out the date for that. Thank you.

Speaker 2

Yes. And I want to be very clear. I mean, the focus is on deleveraging the balance sheet. We are focusing on Extracting the great potential that we have in our smoke free business, I mentioned IQOS and ZYN together. We certainly want to grow VIVE as well.

Speaker 2

But I think there is so much potential on IQOS and ZYN that it's, of course, the key focus today. And we are spending our time, energy on maximizing the potential there and that's going to generate De leveraging. So the time today is not for us to think about, I would say, Structural move on M and A in other spaces, we are very much focused on optimizing This great potential that we have in our smoke free business today. Thank you. Thank you.

Operator

We will take our next question from Jhrav Jain with Barclays. Your line is open.

Speaker 5

Hi, good morning.

Speaker 2

Hi, Gaurav. Hi. So I have a question on ZYN in

Speaker 5

the U. S. So the volumes Coming in much ahead of where I think consensus is where we were. We also know that U. S.

Speaker 5

Cigarette volumes have Persisted at very weak rates, despite easy comps. So what do you think is the cannibalization rate of Xin on U. S. Cigarettes today. And as you project out IQOS growth over the next 7 years, if Xin's cannibalization is higher Then what is thought of, then does it mean that the cigarette universe is smaller, which implies that the IQOS opportunity is smaller?

Speaker 2

It's Gaurav, an excellent question. I believe first of all, I'm not going to give a precise answer, as you can imagine, I believe that there is probably some cannibalization for the reason I mentioned. We see behaviors Developing of people that probably are or were combustible User and they discovered that they can enjoy the nicotine in a different manner with certainly Positive perception on when they can do it and the impact on them. Now I'm not able to tell you whether this is something very material. So I don't have any data at that stage.

Speaker 2

And I'm sure we'll try to elaborate on the ZYN driver on the 28th September. But as I said, I'm not able to share with you any hard data on how it's materializing. Frankly, I don't think that This is going to be really relevant for IQOS because maybe in a kind of super marginal manner that here we talk about With IQOS smokers who want to enjoy when they are still enjoying today combustible cigarette, a different product that is Mimicking very closely their pleasure with clearly personal benefit on their health, but also on their lifestyle. So I don't see the ZYN moment as something that is going to compete with IQOS in a meaningful manner. So I think that that's not something that we see as a risk to undermine IQOS potential in the future.

Speaker 5

Sure. Thank you. And the second question I have is on this EU heated tobacco flavor ban and you mentioned that there could be some volatility. Now the experience in California has been pretty bad for the menthol cigarette ban and that only 70% of the menthol smokers Seem to have been retained in the cigarette market. So like what is the precedence?

Speaker 5

Is there any precedence of a flavored Heated Tobacco Ban Anywhere, which helps you form the view that the impact will be quite minimal.

Speaker 2

Yes, there is, Gorav. So I will take 2 examples. 1 in Europe, when there was the mental the flavor ban in May 2020, where it had minimal impact on the combustible business, very, very small. So that's one illustration. And the other one is actually because here we talk about growing products.

Speaker 2

The other one here Is the ban on flavor in California that impacted ZYN at the end of 2022. And there was a few weeks with a blip on the volume and then the momentum came back on non flavored product Actually with even more intensity and the blip has been swallowed and you don't see today an impact of this So I think here you have 2 element experiences that show that this is having minimum impact. And again, we're comparing in California with growing category, which maybe is more appropriate. But Referring to combustible in Europe in May 2020, the impact was de minimis.

Speaker 5

Okay, sure. Thank you so much.

Speaker 2

Thank you. We will take

Operator

our next question from Bonnie Herzog with Goldman Sachs. Your line is now open.

Speaker 6

All right. Thank you. Hi, Emmanuel.

Speaker 2

I am Good morning, Beren. I wanted

Speaker 6

to circle back to your guidance with just maybe a quick follow on question. Your full year guidance implies, I guess, more riding on Q4. So just hoping you could help us understand maybe your level of conviction and or visibility that your business really will strengthen so much later this year. And then I know it's early and I don't expect you to guide next year, but is there anything we should think about that you're investing in this

Speaker 2

Yes. So, Bonnie, trying to be back on H2, I think you see it already in Q2. I mean, the momentum behind IQOS There we see it 1.4 we estimate 1,400,000 user growth in Q2. That's an excellent number. We see in market sales going up.

Speaker 2

We know that there is seasonality, but it doesn't mean that the consumer of tech is going to decrease. There is more launch of Illumina and some of them that happen in the end of H1 that is going to contribute as well in the 2nd part of the year. So we see very robust momentum there. We see the work that we've been doing. And as we said, the Highest intensity of price increase has happened in Q2.

Speaker 2

It's going to be lower in H2, and we've been defending our market share Well, in a market that is resilient, and we may discuss why CEC is so resilient, but the fact is that combustible is proving to be resilient in many geographies. And then there is a ZYN moment, Clearly, the ZYN momentum, which we're not saying we're going to keep growing at 50% of course, but clearly, we expect momentum to continue super nicely On ZYN and starting Q4 that will also contribute to the organic growth, but in any case it's going to fully contribute to adjusted EPS growth excluding ForEx. So all that give us the Confident that we are set for a very, very good and very strong H2 in terms of performance. Now when we look towards 20 24, we believe that the growth drivers are going to stay the same. So IQOS with, of course, a launch In Q2 in the U.

Speaker 2

S, but let's be clear, it's going to be the beginning. So it's not going to immediately Of a huge impact, it's going to be a ramp up as we explained. But there will be a number of countries where Illumina will be fully delivering. Look at Japan, that's quite interesting what happened in Japan. In fact, we've seen kind of another acceleration on Market share and volume 1 year after the launch of Illumina.

Speaker 2

So it's not as if the whole positive impact was happening In the 1st weeks, I would say, it takes some time to create the awareness, the understanding and the positive appreciation. And then we're going to have ZYN and nicotine pouches. ZYN, first of all, starting in the U. S, but a number of exciting launch outside the U. S.

Speaker 2

As well. So that is boding well for 2024. But of course, it's premature to talk about 2024 and we'll give guidance in due course.

Speaker 6

Okay. That all makes sense and helpful. And then I just for my second question, I was hoping for some more color on And it looks like your shipment volume was really strong in the quarter and then your market share has increased nicely. Excuse me. So could you talk through key drivers of this?

Speaker 6

And then I believe BAT is cutting their prices on Global Hyper starting August, so could you talk through the current competitive environment and then maybe how you expect it might change in light of these actions as well as how You may need to respond, if at all. Thank you.

Speaker 2

Sure, Ben. So Japan, of course, is a matter of Great satisfaction. I was alluding to it, on the fact that 1 year after the launch of Illumina, we see a Further acceleration of our market share, we are now above 26%. And as I said, that shows that The brand keeps doing inroads, converting more people, making a big difference versus competition. And we are actually, we've seen our capture share of the growth of the category that continues to grow increasing.

Speaker 2

We have a 2 tier strategy between Terria and Sentia that is proving to be very efficient. So we have The premium range, Terrier, with a lot of innovation, great flavor experience. And then we have Sentia, which is, of course, at a lower level in terms of positioning. But with these To, I would say, range, we managed to really reach the broadest possible number of Illumina user and that's clearly showing some great success. We are back in Japan to See freight progressively.

Speaker 2

So that was expected. Last year, the shipments were lower than The consumer of tech and this year that is of course not we're going back to the normal situation that was absolutely planned. And we see indeed competition while Well, trying to fight, they see the category that keeps having a lot of traction and gaining share. They are fighting to keep growing when Illumina is clearly doing well. And so far, they believe that their way forward is to come with Cheaper consumable, that's of course their decision.

Speaker 2

I won't comment on that. It's clear that Despite that, we managed to grow the share. But it's good to see that there is a clear growing Commitment from the whole industry behind the category in Japan.

Speaker 6

All right. Thank you again.

Speaker 2

Thank you, Denis.

Operator

We will take our next question from Matt Smith with Stifel. Your line is open.

Speaker 7

Hi, Thank you for taking my question. Good morning, Matt. I wanted to ask about the pacing of the rollout of Oluma to 50 markets From the 23 markets where it's available today, do you expect that to be fairly evenly spread across the second half? And could you talk about the rollout or the expansion, The impact on your operating margin in the second half as well as your gross margin?

Speaker 2

Yes, Matt. So there will be a progressive difficult for me. I mean, there will be events in Q3 and Q4 Of launch of Illumina number of countries. This first I need to tell you whether it's even spread because I would have the ability to do that depending on The size of each market, but it's going to be relatively well spread. Let's be clear, we have already 2 thirds of the IQOS volume that are exposed or benefit from Illumat's presence.

Speaker 2

So it's not marginal, but a big part of it has already been done. And as we said, at the beginning of Illumina, We were not fully optimized on the product, on the productivity. It doesn't mean that everything will be done at the end of the But we expect to certainly see an acceleration of productivity reduction in the weight in the 2nd part of the year and that will have a positive impact on margin evolution, absolutely in line with what I explained, a number of headwinds that are receding in line with expectation. But that's really what you can expect for Illumina in the 2nd part of the year. Thank

Speaker 7

And if I could ask just a follow-up question on the combustible performance. It's been stronger in terms of both volume and Organic revenue contribution. And you've made a couple of comments about the demand environment holding up better than your expectation Relative to the elevated pricing, can you talk about the factors that are allowing the consumers to hold up better than your expectations. Do you expect that to continue now that you're going to lap some pricing action?

Speaker 2

Look, so far, I think that we've seen that pricing up doesn't mean that the consumer is Going away, I'm not able to tell you how it's going to further evolve in the future. I think what we see globally on the combustible market is first of all A few markets where because of the demographic, we see the consumption of combustible going up. I could certainly mention India, Probably Egypt, Turkey, probably Vietnam even if it's not a big market for us where we see combustible Business going up. The resilience is also coming from a number of markets where there is a ban on smoke free products. So of course, That is to some extent protecting the combustible business.

Speaker 2

As you know, that's clearly not something that we like. We think that it's a big mistake, But that is probably providing some resilience to the category overall. So that would be my analysis on combustible. Thank you

Speaker 7

for that, Emmanuel. I'll pass it on.

Speaker 2

Thank you, Matt.

Operator

We will take our next question from Owen Bennett with Jefferies. Your line is now open.

Speaker 8

Afternoon, Emmanuel. Hope you are well.

Speaker 2

Hi, Owen.

Speaker 8

Yes, I'll just give you one

Speaker 3

quick question.

Speaker 8

So related to heated competitive dynamics, So all three of your major tobacco peers now appear to be in a better spot at least versus the past. With regard to product offerings at least and money they're investing into this, I was just wondering if you could comment on trends in some of the more competitive heated markets where all three of your major peers now have a presence, those like to be free for example. So How is IQOS shareholding growth? Is Illumina having less traction in these markets than others? Are you seeing trial of other brands and consumers coming back to white off?

Speaker 8

Thank you.

Speaker 2

Sure, Rowan. Actually, you may have seen that our share of the category has remained stable in Q2 at around 75%. So it shows that indeed there is Increased competition, but the quality of IQOS and notably Illumina, but not just Illumina, the overall IQOS Proposition is allowing us to even if we are more premium to maintain our share of the category, which is very good news. Here I'm talking about volume. You can imagine in terms of value that is even higher.

Speaker 2

Now let's be clear. Since the beginning, we knew And I can say we were hoping for the whole industry to embrace if not burn as the category of the future for Inelible nicotine product and it's great to see a growing commitment from all the player behind that. So No doubt that they will come with innovation. Ourself, as you can imagine, we're going to continue to innovate as well. And we will see certainly innovation and maybe new things coming in the future.

Speaker 2

Now after 6, 7, almost 8 years of launch of IQOS, I think in term of franchise, in term of impact, in term of strength, in term of Brand Power, I think we are really second to none and we made a clear gap and differential. And I think that this is exactly what we did with Marlboro in the past, which Marlboro was a superior product and recognized for the brand that was unique. But on top of that, we managed to create a unique brand that was extremely appealing. And I think with IQOS, that's what we are repeating today. So IQOS products are clearly better recognized as such.

Speaker 2

It's a different customer experience, but then the IQOS brand is also iconic and people are seeing that as part of lifestyle and product they want to associate themselves with, which is a recipe for long term success.

Speaker 8

Thank you, sir. Appreciate it.

Speaker 2

Thank you, Owen.

Operator

And we will take our final question from Jared Thinks with JPMorgan. Your line is open.

Speaker 9

Yes. Hi, guys. So, like you talked about the ability to use sea freight finally to supply Japan As you progress throughout Q2, would you be able to confirm that you're no longer capacity constrained on the Tres 6?

Speaker 2

Yes. So we can confirm that for the market where we've been launching today, we have no And therefore that's the reason why we've been able to move to sea freight. Now there is still a ramp up for the remaining market that do not have Illumina today And this ramp up is, of course, accompanying the growing capacity. So it doesn't mean that today we could serve on the 1st July 100% of all the market IQOS market with Illumina consumable, but we have no longer pressure restriction and the fact that We are back to see freight and we have a plan to accompany the growth of the remaining markets in the coming months.

Speaker 9

Got it. And maybe just a follow-up on that. So you guys did call out Europe in with IQOS saw some further Negative inventory move in Q2. Should we expect that to reverse in H2 because actually it's On the whole, in H2 1, it's been somewhat sizable, the negative inventory impact.

Speaker 2

Sure. In fact, Japan was finishing with lower shipment volume than consumer offtake in 2022. That has been reversing in 2023. And Europe went the other way around. Remember, we had to load because of uncertainty on availability of product and energy supply in the manufacturing side.

Speaker 2

And that was expected that the catch up Has been happening mostly in Q1, but still a little bit in Q2. And now we expect to move to normal pattern of shipment versus consumer of tech or in market sales. And therefore, we expect to have a strong H2 both in terms of shipment progression and in market sales in Europe. Back to normal.

Speaker 9

That's clear. And if I can just follow-up, just one last one. On Russia, given the news last week or this week. Just can you give an update on if that business is fully ring fenced at this point?

Speaker 2

Look, on Russia, we have nothing new to say. We've been explaining in the past communication That the situation was complex. There is no new element. I'm not going to comment on the situation of company that I know nothing about. And we have nothing new to report on Russia at that stage.

Speaker 9

Got it. Maybe just in terms of supply, like Russia is not supplying any neighboring markets at this point, right?

Speaker 2

Well, we are, as you can imagine, complying with all regulation restriction sanctioned today, and we are obviously fully compliant.

Speaker 9

Perfect. Thank you.

Speaker 2

Thank you.

Operator

It appears we have no further questions on the line at this time. I will turn the program back over to management for any additional or closing remarks.

Speaker 1

Thank you. That concludes our call today. Thank you again for joining us. If you have any follow-up questions, please contact the Investor Relations team. Have a great day.

Speaker 9

Talk to you soon. Thank you. Bye.

Operator

This does conclude today's program. Thank you for your participation. You may disconnect at any time and have a wonderful day.

Powered by Quartr