Japan Tobacco Inc. (OTCPK:JAPAF) Q4 2019 Earnings Conference Call February 7, 2020 2:00 AM ET
Tatsuya Tsukuura – General Manager, IR
Masamichi Terabatake – President, CEO & Representative Director
Eddy Pirard – CEO and President
Junichi Fukuchi – CEO of Japanese Tobacco Business, Tobacco Business Planning and Tobacco Business
Naohiro Minami – CFO, Executive VP of Communications & Representative Director
Vassilis Vovos – CFO and Senior VP of Finance & IT
Conference Call Participants
Nobuyoshi Miura – Citigroup
Ritsuko Tsunoda – JPMorgan
Makoto Morita – Daiwa Securities
Hiroshi Saji – Mizuho Securities
Good afternoon, ladies and gentlemen. I am Masamichi Terabatake, President and CEO of Japan Tobacco Group. Welcome to the JT Group’s 2019 Full Year Results and Business Plan 2020 Presentations. Thank you for your presence today. I would like to express my sincere appreciation for your interest in the JT Group.
My presentation will start with an overview of our 2019 performance. I will then introduce the Business Plan 2020 for the upcoming 3 years and the strategies for the group’s businesses. And finally, I will cover our resource allocation policy.
After my presentation, Eddy Pirard, CEO of JTI, will brief you on the international tobacco business, followed by Naohiro Minami, our group CFO, who will explain details of the results in 2019 and the forecasts for 2020.
Let me start with an overview of the 2019 full year results. In 2019, while the Japanese domestic tobacco business encountered a challenging operating environment, the international tobacco business maintained its strong momentum. As a result, adjusted operating profit at constant FX increased year-on-year, driven by the growth of the tobacco business as a whole.
However, this performance fell short of the target we have provided in February past year. The main reason we could not hold initial target relates to the Japanese domestic tobacco business. Following the nationwide rollout of three RRP offerings, we now clearly understand the areas of improvement for our products and consumer relations through increased two way communications with our consumers.
Profit decreased mainly due to the strong currency headwinds in our international tobacco business. On a positive note, we generated a consistent free cash flow, a level in line with the cash generation capacity of our businesses. We plan to pay a dividend per share of JPY 154 for 2019, as we communicated before.
I will now expand on the major initiatives we have undertaken in 2019. In the Japanese domestic tobacco business, we launched new RRP offerings in both high-temperature and low-temperature heating category. However, introducing these new products is not enough. RRP requires a dedicated business model for which we must adopt an entrepreneurial mindset and behavior without being constrained by our successful experience with cigarettes.
To succeed, it is particularly important to foster an entrepreneurial mindset among the sales force since they are the closest touch point with our consumers. This change requires time to gradually enable our employees to adopt a more proactive thinking and action, in time to gradually enable our employees to adopt a more proactive thinking.
In 2019, on a trial basis, we revamped the sales force evaluation system as an institutional measure to support the change. We will fully deploy this in 2020. The system recognizes the sales personnel who have taken up new challenges.
In cigarettes, we strengthened our product portfolio by launching little cigars, and we now compete in all price segments. In the international tobacco business, we continued to invest in emerging markets and towards integrating the recently acquired businesses.
In addition, we have initiated a transformation project to enhance our capabilities. We believe that there is still room to grow our cigarettes, which is the main pillar of the tobacco business. We intend to strengthen the business foundation for further growth.
In the pharmaceutical business, we have rebuilt the business foundation by restructuring the operations of Torii Pharmaceutical by progressing with our development pipeline. In the processed food business, we achieved the profit target we presented at the beginning of the year.
Going forward, we will continue to strengthen our business foundation towards sustainable profit growth by steadily implementing measures to achieve future growth in each of our businesses.
Let me move on to the 3 year Business Plan 2020. Over the Business Plan 2020, our strategic direction and goal will remain unchanged. We will continue to pursue sustainable profit growth by aiming to deliver a mid- to high single-digit adjusted operating profit growth rate at constant FX.
Let me now detail our strategies for the respective businesses to achieve this goal. I will start with the tobacco business, which will continue to play the leading role as our core business and the group’s profit growth driver. As I mentioned in last year’s presentation, we will further grow the tobacco business as a whole by thinking proactively, acting with speed and with a consumer-centric mindset.
So towards this end, it is necessary that we have the commitment by top management. That is why, starting this year, I will serve as the head of the tobacco business, and I will lead the overall tobacco business on hands-on basis.
Under this system, especially in the new RRP business, it is necessary to establish a system in order to overcome intense competition. We need to have an organization structure to better leverage synergies faster within the JT Group so we can optimize and allocate resources globally.
Following the consolidation of the R&D functions last year, we have consolidated the tobacco business corporate strategy and business development functions this year. This will be consolidated in Geneva.
Furthermore, RRP function in Japan has started to report JTI global RRP. And we are working towards integrating the quality assurance functions, whose role is to ensure product safety and reliability.
In the Japanese domestic tobacco business, it goes without saying that generating profits in a stable and sustainable manner is key to growing the tobacco business in the future. While we expect the situation to remain difficult in the short term, we continue to aim for profit generation by strengthening the top line in both the RMP [ph] and cigarettes categories.
With respect to the international tobacco business, our growth agenda will remain unchanged. We intend to continue delivering strong profit growth. In existing markets, our efforts will focus on enhancing the brand equity to gain further market share and seizing pricing opportunities.
Regarding geographic expansion, investments will drive organic growth while we leverage on any opportunities when there are appropriate opportunities. We will continue to strengthen our profitable business base. In RRP, we are now ready to launch high-temperature heating products in foreign markets as well, so we will explore opportunities for market entry.
During the course of the current midterm business plan, the cigarettes business will continue to be the profit growth driver supporting our commitment to achieve a mid- to high single-digit profit growth in the total tobacco business.
Now I will share details regarding the strategy for the Japanese domestic tobacco business. First, let me describe the outlook on the operating environment between 2020 and 2022. Regarding the tobacco industry trends and assumptions for our sales performance, visibility has improved compared to the past several years for two main reasons.
First, the growth of the RRP category has slowed. Second, the plan for excise tax increases over the coming years has been made public. This enables much bigger predictability. We expect that the total tobacco industry volume, including both RRP and cigarettes, will decline a low single-digit rate despite the full enforcement of the new indoor smoking regulation in April this year. And this is encouraging industry trend.
As far as the RRP industry volume is concerned, it has rapidly increased in the year 2016, 2017. However, in 2018, the speed had decelerated and we continue to see deceleration in the year 2019. However, going forward, we believe the growth would continue. Therefore, we expect the market rate – growth rate to be over 25%.
So there continues to be an intense competition for share of market, so under these circumstances, we expect each of the players continue to increase investments in RRP category, introducing devices in Japan while launching new devices and refills.
With regards to the cigarettes market, we expect industry volume to continue declining due to the expansion of the RRP category and the impacts of future excise tax increases. We also believe that down-trading will continue.
We believe the cigarettes business will remain core and an important source of earnings, while we also believe further investments in RRP category is absolutely necessary.
Based on the operating environment I have just described, let me explain our initiatives to strengthen the top line in both RRP and cigarettes over the Business Plan 2020 period.
First, regarding RRP, we will assign clear roles for each of the high- and low-temperature heating categories in consideration of each category’s features, the end game being to establish and maintain a competitive advantage in both categories.
In order to increase our RRP category share, our highest strategic priority is to capture share from competitors in the high-temperature heating category where volume is large and the market is already well established. This is our top priority.
In parallel, we also believe that the low-temperature heating category has high potential and because in Japan there are different needs. And as the pioneer in the low-temperature heating category, we aim to maintain our solid share while continuing to develop the segment.
Regarding our products launched in last year, areas of improvement have become clear. With respect to the high-temperature heating product, we have received requests from consumers regarding nicotine kick and the convenience of devices, including the number of consumables per charge. Regarding the low-temperature heating products, areas of improvement include taste and kick. With regards to Ploom TECH+, size and portability is an improvement area.
We plan to launch upgraded devices that overcome these challenges in 2020, and from now on, we will continue to upgrade the devices. In addition, we will also focus on the refills to improve the nicotine kick and expand the lineup of flavors.
With regards to RRP development system, we have consolidated teams involved, planning, procurement, development, manufacturing and a part of sales, in a single location venue in order to incorporate consumers’ needs into the new product development in the shortest possible time. We will take speedy actions under a seamless development system for RRP.
Marketing activities will be strengthened to enable consumers to recognize and understand the value of our products and to encourage them to continue using our products. As part of this, as announced yesterday, we will launch club JT on March 4, which we have announced a new online service.
We aim to enhance customer – or consumer convenience and realize higher-quality two way communications by integrating existing web services such as loyalty programs and online shops and providing information tailored to individual consumer needs.
We will also distribute new information and smoking areas. We will develop a digital marketing infrastructure considering the diversifying sales promotion activities and our ways of communicating with consumers in the future.
Also, we have started the development of next-generation devices. I will – under my leadership and bringing together knowledge from JT and JTI and ensuring that actions are taken swiftly across the group-wide basis. In order to overcome our challenges, we will continue to increase investments in R&D and marketing activities.
Regarding cigarettes, because of the excise tax increases scheduled for 2020 and 2021, we will optimize pricing opportunities. Moreover, in addition to maintain our market share in the above-premium price segment, we aim to regain market share by launching products to tackle down-trading.
Let us move on to the strategies for the pharmaceutical and processed food businesses. For the pharmaceutical business, a challenging business environment continues mainly due to the global trend of drug price revisions. On the other hand, we have reformed the business structure of Torii Pharmaceutical. The new structure is operational since the fourth quarter of 2019. In addition, we are making steady progress in enhancing our R&D pipeline.
For example, in Japan, we have filed a new drug application for anemia associated with chronic kidney disease. We also have received manufacturing and marketing approval for an indication of atopic dermatitis. We will continue to strengthen our business base by maximizing the value of each products as well as enhancing out- and in-licensing activities.
As for the processed food business, we expect the higher distribution and raw material costs to continue. However, we will achieve top line growth by increasing sales of profitable products while continuing to optimize production capabilities with respect to frozen and ambient processed foods, which form the core of the business.
Although each of these businesses will continue to face a challenging business environment, we aim to complement the group’s profit growth by continuing to implement our strategies.
Now I will explain our resource allocation policy. Our resource allocation policy will be based on 4S model and prioritizes business investment leading to sustainable profit growth. Furthermore, there is no change in prioritizing investment towards the growth of tobacco business.
We aim to enhance the shareholder return, considering profit growth in mid to long term, while we continue to secure a solid financial base. We continue to prioritize stable and sustainable dividend per share growth.
In my presentation last year, I shared that we would consider adjusted operating profit at constant FX our primary indicator along with profit, which reflects currency impacts, to determine the dividend per share. There is no change to this approach.
Next, I would like to talk about 2020 shareholder return. As explained earlier, there is no change in our shareholder return policy to deliver stable and sustainable dividend per share growth, considering we continue to secure solid financial base and pursue profit growth in mid to long term. Further, there is no change in our profit growth target in mid to long term.
In the past several years, we managed to achieve this target. So in FY 2019, FY 2020, we are below this target. Also, the profit has been declining due to the currency headwinds. The Business Plan 2020 is defined to attain mid- to high single-digit growth rate of adjusted operating profit at constant FX.
However, we believe that uncertainties will continue to affect the profit outlook, which include currency volatility and other onetime factors. Under these conditions, to ensure stability of dividend per share in the future, the dividend in 2020 is proposed to be JPY 154, at the same level as in 2019. We don’t foresee dividend reduction to ensure stability at this point.
Finally, I would like to convey to you once again my management philosophy as the JT Group CEO. Over the years, JT Group has continued to grow by anticipating challenges and by transforming with a long-term perspective, notwithstanding the significant changes in the business environment such as the peaking out of the Japanese domestic market and the tightening of regulations, to mention a few. We have achieved business expansion abroad through the large-scale acquisition of RJR International and Gallaher, rebranded Mild Seven as Mevius and pursued geographic expansion into emerging markets.
It goes without saying that the business environment surrounding the JT Group is not becoming any easier, not to mention the growth of RRP category. We are at an inflection point, ready to transform again. I will strive to ensure the group’s sustainable profit growth, with the ambition of being the first to offer new value to our consumers and RRP.
The 4S model, our management principle, remains the cornerstone for all our decisions and activities. In order to remain the preferred choice of consumers, shareholders, employees and the wider society, we will strive to fulfill our responsibilities, exceeding expectations wherever we can, through our sustainable profit growth. Thank you for your kind attention.
Now I will turn the floor over to Eddy, who will brief you on the international tobacco business. Thank you very much.
Thank you, Terabatake-san. And good afternoon, ladies and gentlemen. I’m pleased to be with you today to present the 2019 international tobacco full year results and the outlook for 2020.
2019 was an excellent year for JTI across all our KPI, key performance indicators. The successful integration of the acquired businesses in Bangladesh and in Russia enabled us to grow strongly versus the prior year, achieving a total volume growth in excess of 4%.
Excluding acquisitions, our volume declined less than 1% versus an industry contraction of 4%, as market share gains accelerated driven by our global flagship brands.
Positive price mix contribution across all our clusters, combined with an expanded volume base, resulted in currency-neutral net revenue and adjusted operating profit growth of 9.3% and 10.7%, respectively.
Importantly, 2019 marked the ninth consecutive year in which JTI achieved double-digit earnings growth at constant currency while also increasing our investment levels. It is worth noting that our financial performance both in terms of top and bottom line, when excluding acquisitions and inventory movements, remain strong, highlighting the strength of the business fundamentals we have built over the years.
In 2019, our volume performance was very strong both with and without acquisitions. Including acquisitions, our total shipment volume increased by more than 18 billion units compared to 2018, reaching a total of 446 billion units, a historical high for JTI. Such strong growth was primarily fueled by the acquired volume in Bangladesh and the volume carryover from Donskoy Tabak in Russia.
Organically, JTI’s shipment volume was very robust and outpaced the industry trend in the majority of our markets. We grew volume in more than 70 markets, including Brazil, Germany, Iran, Poland, Saudi Arabia, Spain and Taiwan, just to name a few, all led by market share gains. Once again, our focus on global flagship brands and their strong equity have been paramount in achieving such outstanding volume results.
Global flagship brands grew volume for the fifth consecutive year, reaching 277 billion units. This represents a 4% increase versus 2018 and a compounded annual growth rate of 3% since 2015, a remarkable achievement considering that, over the same period, tobacco industry volume has declined around 4% per year in our top 30 markets.
All four global flagship brands increased volume in 2019, supported by a consistent investment strategy aimed at strengthening their equity, portfolio and geographic reach.
Winston’s shipment grew 3.2% versus prior year, breaking volume and share records in 34 markets, including Brazil, Germany, the Philippines and Turkey and Romania as well.
Camel grew more than 5%, achieving double-digit volume increase in 23 markets, and setting share record in 11, such as France, Indonesia, Poland, Spain and Thailand. And LD, with a 6% volume increase, grew for the third consecutive year and was our fastest-growing brand in 2019. It also broke volume and share record in 15 markets, including Canada, Taiwan and the U.S.A.
Mevius returned to growth, increasing approximately 1% versus 2018, driven by the positive performance in markets like Cambodia, Mongolia and Myanmar.
The solid performance of our global flagship brands enabled JTI to achieve significant share of market gain and share of value across our top 30 markets. Share of market grew in 23 of our top 30 markets. Of a particular note was the share progression recorded in Europe, where JTI enhanced its presence in both ready-made cigarettes and fine cut.
These two categories still represent the vast majority of the regional nicotine industry retail value pool. Our cigarette share of market grew in more than 20 European markets, most notably in Belgium and Czech Republic, France, Luxembourg, the Netherlands, Poland and the U.K.
In fine cut, our share increased in more than 15 markets, with the strongest growth being achieved in the Czech Republic, in Italy, Poland and in Switzerland. Winston and [indiscernible] are today the number one brands in make-your-own and roll-your-own categories, respectively, across Europe.
Importantly, JTI was the only tobacco company growing share in markets – share of market in conventional products. This was primarily driven by our consumer-centric approach strategically positioning all brands across key product categories and price segments.
Let me highlight that the strong equity of all brands in both cigarette and fine cut, nurtured by focused investment, continue to play a pivotal role in enhancing JTI’s pricing power.
Strong pricing was once again the key driver of our financial performance. Including continued price and portfolio investments to strengthen our competitiveness and business agility, we recorded a total price mix variance of $875 million in 2019, with positive contribution from all our clusters.
Importantly, our price mix was above our 5-year average, demonstrating the continued resilience of the tobacco pricing model. As a result of the investment efforts to expand and diversify our geographic footprint, pricing gains generated across our key markets, notably France, Russia, Turkey and the U.K., were complemented by an increasingly robust contribution from other markets such as Germany, Iran and the Philippines.
Furthermore, emerging markets in Africa, Asia and the Middle East have gradually increased their price mix [ph] relevance, reinforcing our confidence in the sustainability and the flexibility of our growth model.
I would like to say a few words around our geographic expansion. Over 5 years ago, following a strategic review of the international business, we shared with you our intention to expand our presence, notably in emerging markets. Well, since then, a number of acquisitions and greenfield developments have taken place.
Today, emerging markets represent circa two thirds of JTI’s total volume. Increasing the volume weight of emerging markets was done in a profitable manner by consistently increasing our unit price or core revenue per stick.
Since 2015, this important indicator has grown at a compound annual growth rate of 11% at constant currency, reflecting improving price mix dynamics among or across emerging markets, including Ethiopia, Iran, the Philippines, Romania, Sudan and Turkey.
Importantly, unit price have grown more than 3% CAGR on a reported basis as well. Needless to say this is a strong validation of our business development decisions taken over the years, decisions that have supported and will continue to support JTI in achieving its growth ambitions in a sustainable manner.
Now on to Russia, a market that remains an important driver for JTI and the tobacco industry overall. Our 2019 performance in Russia was robust. Share of market remained at 39%, underpinned by global flagship brands and the improving momentum of the local heritage brands acquired with Donskoy Tabak.
Global flagship brands continued to gain share of market, exceeding the 25% threshold during the year. The resilient performance of Winston, still by far the first choice of Russian consumers, was complemented by the outstanding growth of LD in the market.
LD grew share by 1 percentage point, driven by significant portfolio expansion, including the very successful migration of Saint George and Monte Carlo. The positive performance of LD, coupled with the addition of Donskoy Tabak’s legacy brands, enabled JTI to reinforce its strong leadership in the fast-growing value segment, which today represents circa 70% of the total industry volume.
All these achievements, we’ll realize while continuing to seize pricing opportunities which remain strong in spite of the down-trading and volume contraction impacting the overall industry.
Now let me share with you some highlights of our 2020 business outlook for Russia, starting with the industry volume trend. Cigarette industry volume is expected to decline between 5% and 7% in 2020, broadly in line with the annual average decline recording in Russia in the recent years.
This decline will continue to be driven by historical high illicit trade level and, to some extent, by the expected moderate progression of reduced-risk products. We expect the pricing environment to remain robust and normalized following the impact of 2 excise – tax excise increases on the first half of 2019.
This year, we will continue to strengthen our leading position in cigarettes while broadening our footprint in reduced-risk products. In E-Vapor, we will build on Logic Compact’s early success, steadily expanding its retail presence. We will also enter the heated tobacco category.
Taking onboard the learnings from Japan as well as our insights specific to Russian consumers, we will introduce a heated tobacco offer in the first half of 2020. The device will be branded Ploom, while the vape sticks will be endorsed by Winston, the number one tobacco brand in the country.
Provided consumer feedback and adoption are in line with expectations, then we will expand the rollout while also considering opportunities for additional market launches and product enhancements.
Moving to another important market, the U.K. 2019 was an excellent year for JTI in the U.K. market. We grew share across all product categories, breaking records and significantly strengthening our leading position in a solid pricing environment. We have been fueling the momentum of our brands in ready-made cigarettes and fine cut through commercial initiatives aimed at injecting innovation, strengthening retail presence as well as ensuring price competitiveness.
In ready-made cigarettes, we increased share of market and share of value by 1.8 and 1.7 percentage points, respectively, mainly driven by the growth of Benson & Hedges and Sovereign.
In fine cut, our shares grew by more than 2 percentage points, primarily led by the exponential growth of Sterling, which exceeded the 10% market share threshold for the first time; as well as by the incredible resilience of Amber Leaf, the number one tobacco brand in the market.
We expanded our presence in reduced-risk products as well, a category which we estimate to represent no more than 6% of the total nicotine industry retail value. Logic consolidated its position, supported by the share gains of compact in closed tanks and LQD Epiq in the open tank category. We also launched Nordic Spirit in the nicotine patch category, responding to emerging consumer demand.
For 2020, I have great confidence in JTI’s ability to continue performing strongly in the U.K. market.
We enter 2020 with a strong and broad-based momentum. Our investments in strategic acquisitions and organic expansion have enabled JTI to accelerate its share gains in 2019, recording an outstanding growth of 1.5 percentage points across our top 30 markets.
Global flagship brands volume continued to increase strongly, fueled by the positive performance of Winston, Camel, LD and Mevius, and despite industry headwinds. Price mix contribution remained strong and above JTI’s 5-year average, demonstrating once again the robustness and the resilience of the conventional products growth model.
We also continued seeding in reduced-risk products, expanding Logic Compact in additional 24 markets, a significant increase compared to our initial plan disclosed here a year ago.
In addition, leveraging consumer insights, commercial learnings and new capabilities acquired in recent years, we started exploring opportunities in new categories such as nicotine patches and, from the first half of this year, in heated tobacco.
This positive business momentum across geographies and product categories, coupled with an increasingly balanced footprint between mature and emerging markets, will be paramount for the achievement of our 2020 targets.
The 2020 outlook for the international tobacco business is built on robust assumptions. We will continue growing our share of market and outperform the industry volume contraction.
Global flagship brands will play a key role in fueling share of market growth, as related volumes are anticipated to increase by 1%. Pricing is expected to drive another year of robust core revenue and adjusted operating profit growth at constant currency. As of today, we have already secured circa two third of the pricing plan for the whole year.
As mentioned by Terabatake-san, investments will continue, and we will ensure adequate prioritization of resources throughout our business. We will continue to support the growth of our conventional portfolio in markets that matter while stepping up our efforts in reduced-risk products.
Finally, the transformation initiatives that kicked off in 2019 are gradually unfolding, with the purpose of removing impediments to growth and building on our strength, including new capabilities within the organization such as global business service centers, digital and agile ways of working. These initiatives will significantly strengthen our business foundations, paving the way for more years of sustainable growth.
Ladies and gentlemen, thank you for your attention; and the interest, your interest in JTI. I will now hand over to Minami-san for the review of the JT Group financial results. Thank you very much.
Hi. I am Naohiro Minami, Chief Financial Officer of the JT Group. I will take you through the consolidated financial results for 2019 and the forecasts for 2020. I will start by covering the highlights of our consolidated financial results for 2019.
Adjusted operating profit at constant FX, our main KPI, increased by 0.9% year-on-year. This is driven by the growth of total tobacco business, which combines the Japanese domestic tobacco and international tobacco businesses, offsetting the decline in the pharmaceutical business.
On a reported basis, adjusted operating profit declined 13.4% due to currency headwinds. Operating profit declined by 11.1% mainly due to the decline in adjusted operating profit despite onetime compensation gains related to the termination of license agreements for 6 anti-HIV drugs in Japan in the pharmaceutical business. As a result of decline in operating profit and higher financing costs, profit decreased by 9.7%.
Free cash flow reached JPY 404.2 billion, driven by a stable cash generation ability of our business operations, supported by a onetime gain in 2019. Year-on-year, this represents an increase of approximately JPY 300 billion, as we had no cash-outs related to acquisitions in 2019.
In addition, I would like to explain the key variances from the revised forecasts issued in the third quarter. Adjusted operating profit was slightly below the revised forecast. Although we have decided to carry out an impairment of capsule manufacturing machines for low heating temperature [ph] products in the Japanese domestic tobacco business, it was mostly offset by better-than-expected sales volume in the international tobacco business combined with a onetime gain from out-licensing and lower costs in the pharmaceutical business.
Profit exceeded the revised forecast, as the effective tax rate ended below the level we had forecasted in the third quarter. You can find a full analysis of our consolidated and business segment results in our earnings report.
Let me now review the highlights of the performance of each business segment, starting with our volume performance in the Japanese domestic tobacco business.
In cigarettes, JT sales volume fell 7.9% year-on-year due to a decline in overall cigarette demand and lower market share. Our market share within cigarettes category decreased by 1.0 percentage points, impacted by intensified competition in the value segment due to down-trading.
JT cigarette sales volume decline was larger than indicated in our third quarter revised forecast, circa 7.5%, due to the same factor which has impacted our share. On the other hand, our Camel-branded little cigar products launched in December have steadily gained market share recently.
JT RRP sales volume increased by 0.5 billion to 3.3 billion stick equivalents, and the RRP off take share within the category was approximately 9%. Our share within the category increased from last year, driven by the expansion of our RRP portfolio.
The recent share increase was supported by the high retention rate generated by the rich-flavor refills for Ploom TECH+ launched in November. In 2019, the RRP market share in the tobacco industry was approximately 23%. At the beginning of the year, we aimed to increase our total share, which combines our cigarette and RRP market share.
Despite a year-on-year increase in our RRP market share, it has ended the year below our initial expectation. Combined with intensified competition in the cigarette value segment, our total market share declined versus last year.
Turning to the financial results in the Japanese domestic tobacco business. Cigarette pricing gains in January, September period and the full year RRP sales volume increase was more than offset mainly by cigarette sales volume decline, unfavorable comparison in sales volume for Ploom TECH devices and the impairment of capsule manufacturing machines for low-temperature heating products.
As a result, core revenue and adjusted operating profit decreased 2.3% and 10.4%, respectively let me provide more details about this impairment: Taking into account the scale of low heating temperature products business based on the current and future outlook for RRP market size as well as the improved utilization rate of high-speed lines, we decided to take an impairment on the mid-speed lines. And doing so, we were able to optimize our production capacity according to the volume assumption for the Business Plan 2020.
Moving on to the financial results in the international tobacco business. As Eddy just outlined the strong financial performance at constant currency, I will focus on reported figures in Japanese yen, which includes the effect of FX.
As highlighted on the slide, all key currencies generated negative FX impact. Due to these currency headwinds, core revenue went from a currency-neutral high growth of over 9% to a 0.2% increase on a reported basis.
Adjusted operating profit declined 11.4% due to currency headwinds offsetting a solid business performance. In 2019, the total negative FX impact on adjusted operating profit amounted to JPY 84.8 billion mainly due to the depreciation of the Iranian rial and Russian ruble as well as weaker U.S. dollar against the Japanese yen.
Turning to the pharmaceutical and processed food businesses. In the pharmaceutical business, revenue and adjusted operating profit decreased mainly due to the termination of the license agreements for 6 anti-HIV drugs in Japan and lower overseas royalty income.
As shown on the consolidated results slide, the pharmaceutical business exceeded the forecast provided in the third quarter. This is mainly driven by a onetime gain in October-December period following the signing of a license agreement with Chinese company Salubris for a compound in development for anemia associated with chronic kidney disease.
In the processed food business, revenue decreased, as growth of staple food products was more than offset by the decline in sales of other products with lower profitability.
On the other hand, adjusted operating profit increased, driven by pricing, improved product mix and cost reductions more than offsetting revenue decline and higher material and logistic costs.
Now moving on to the financial forecasts for 2020. Let me start by detailing the forecasts for our consolidated performance. Adjusted operating profit at constant FX is expected to be stable year-on-year, as the total tobacco business growth of approximately 3% will offset mainly by lower overseas royalty income in the pharmaceutical business, costs related to the headquarter transfer and investments in IT systems.
On a reported basis, adjusted operating profit will decrease by 2.5% due to currency headwinds expected to reach approximately JPY 13 billion. Operating profit is expected to decline by 6.2% due to the factors mentioned on the slide.
Please note that the sale of our headquarter building, which aims to accelerate communication within the company, is included in the forecast based on certain assumptions.
Profit is expected to decline 12.4% due to a decrease in operating profit and a higher effective tax rate relative to 2019, which was reduced by a onetime factor. Regarding free cash flow, we expect continuous stable cash generation ability of our business operations.
Next, let’s move on to the forecasts for the Japanese domestic tobacco business. As already announced, we recognize that 2020 will also be a difficult year in terms of profitability for the Japanese domestic tobacco business.
I will start by explaining our volume assumption. In 2020, cigarette industry volume is expected to decline by over 5%. In spite of the regulatory change for indoor smoking, we foresee a moderate decline versus last year, as the price increase was limited in October 2019.
JT cigarette sales volume is to decline by approximately 6%. We expect our sales volume to decline more than the cigarette industry volume due to a lower cigarette market share. This share decline is related to the continued competition in the growing value segment.
As a countermeasure, we plan to launch Camel-branded little cigars at JPY 330 in March. And we’ll target to increase our share among the value segment by expanding product portfolio to better address the needs of consumers.
The RRP market size within the total tobacco industry is forecast to be circa 25%, a modest growth from the previous year. JT RRP sales volume will exceed 3.5 billion sticks, following the sales annualization of Ploom TECH+ and Ploom S which were rolled out nationwide in 2019.
Moving on to the financials. Core revenue and adjusted operating profit will decrease by 5.1% and 9.2%, respectively. Although we include pricing assumptions expected in October 2020, as well as other positive factors such as an increase in RRP sales volume and the non-recurrence of a onetime negative factor, these will be more than offset mainly by the decrease in cigarette sales volume and the incremental investment in sales promotion and R&D for RRP.
To give you more details about investment towards RRP: We recognize the pricing in October 2019 as one of the top line investments to maximize RRP sales volume in 2020.
Also, in addition to the Camel-branded refills for Ploom S which were launched in January, we will work towards expanding our refill lineup and also towards an upgrade of existing devices.
Turning to the international tobacco business. As explained by Eddy, the international tobacco business is anticipated to perform strongly in 2020, driven by continued pricing gains.
Reported core revenue and adjusted operating profit on a Japanese yen basis are expected to increase year-on-year, driven by strong business performance despite continued FX headwinds.
While we forecast a further depreciation of Iranian rial and Turkish lira, we anticipate an improvement in other major currencies, including the Russian ruble. As a result, the total FX impact is expected to decrease significantly compared to the previous year. In addition, the U.S. dollar is anticipated to weaken against the Japanese yen, although the impact should be limited.
Moving on to our forecasts for the pharmaceutical and processed food businesses. In the pharmaceutical business, revenue and adjusted operating profit are expected to decrease following the decline in overseas royalty income due to the sales expansion of competitors’ anti-HIV drugs overseas and the drug price revision impacting Torii Pharmaceutical.
In the processed food business, revenue is expected to grow versus previous year, driven by higher sales of focused product categories. The solid top line momentum will be more than offset by a significant increase in logistics costs and expenses related to the 2017 manufacturing optimization program, which are mainly skewed to 2020. As a result, adjusted operating profit is forecast to decrease.
To summarize our performance in 2019. Adjusted operating profit at constant FX increased as growth of the total tobacco business exceeded the decline in the pharmaceutical business. Profit decreased mainly due to currency headwinds. The Japanese domestic tobacco business revised down its forecast twice during the course of 2019.
In 2020, uncertainties will remain due to the industry-wide intensifying RRP promotions and increasing competition in the cigarette value segment. However, thanks to consumers’ feedback on our 3 Ploom offerings and a more moderate RRP category growth, we have a clearer view on the business environment in Japan. These assumptions are incorporated in our forecast for the Japanese domestic tobacco business, and we will strive to achieve our target.
The JT Group aims to deliver its currency-neutral adjusted operating profit target while maintaining a competitive level of investment to strengthen its business foundation for mid- to long-term growth.
For shareholder returns, we plan to pay an annual dividend per share of JPY 154, as announced at the beginning of the year. In 2020, as explained by Mr. Terabatake, we plan to offer an annual dividend per share of JPY 154, the same amount as last year.
Thank you for your attention.
Now let me introduce the members who will take your questions today: JT Group CEO – President and CEO Masamichi Terabatake; JT Group CFO Naohiro Minami; CEO of the Japanese tobacco business, Junichi Fukuchi; JTI President and CEO Eddy Pirard; JTI CFO Vassilis Vovos.
We’ll now move on to Q&A, but time is limited. Therefore, please ask, keep your questions simple. And we would like as many people to have the opportunity to ask questions, so please keep your questions to one question each. And please state your name and affiliation before you ask your question. Now does anyone have a question? Please raise your hand if you do. So Mr. Miura, please
Q – Nobuyoshi Miura
This is [Nobuyoshi] Miura from Citigroup. Thank you very much for this opportunity. So I have a question to Terabatake-san. So for the next couple years, so the outlook related to management for the next couple years. So as Mr. Minami mentioned in his presentation, RRP, there are many uncertainties, but however, we are seeing some stabilization within the Japanese domestic market.
And it seems as if we are having less risk factors, so we are seeing increased visibility in RRP market. So this year may be the bottom, and next year onwards, it will start to evolve, but of course, we have the tax, excise tax, hike as well, so – but it seems as if the market is stabilizing as a whole. So given all these into context, what is your outlook for the next couple years?
Thank you very much for that question. So within my presentation, I’ve mentioned the next 3 years, the AOP under current FX. So a mid- to high single-digit growth is what we expect to see. So this year, we expect to see a flat trend, but going forward, tobacco business as a whole – so we should be able to reach that mid-level in terms of the growth.
So we do have the plan, but in terms of currency – so for instance, last year, we have seen the cash flow from pharmaceutical business. And this year, we have cash flow coming in from the divesting of the headquarters building. And that is why, the net income and cash flow, we might see some variance because of these cash flow. However, in terms of tobacco business, well, that is our outlook.
Now in terms of the domestic tobacco business, as mentioned, up until last year, I myself felt that there is not much visibility. And – but I have been leading the business under that situation this year. In fact, to be exact, since last fall onwards, I started to really get involved in business, tobacco business, and others.
And we are starting to see a better visibility into the business. So in 2021, 2022, we do have opportunity for pricing because of the tax hike. So RMC, we do expect to see a robust trend.
Now for RRP category. So we – until we are fully convinced that we can gain the market share, I think we still need some time to get that conviction, to be honest with you, but this year, this is a year to solidify our base. And that is why we are making investments, but we have much more clarity as to what sort of countermeasures we need to take.
So we believe we should start to see the results coming next year onwards. We will be launching new products. And actually, I’m leading the development of these new products, but again it would at least take a year, 1.5 years or so in order for us to launch new products. So 2021 may be the timing we will be able to launch new products.
So we would have upgraded products for this fiscal term. In 2021, we should be able to launch new products. So once we have that visibility in terms of the Japanese domestic market, RMC will continue to be solid. And RRP would also need to gain its robustness. So perhaps, the second half of next year, that will be the timing that we can actually share those thought with conviction with the market.
Thank you very much for that. And question on the global basis. So those are all positive stories. Now in terms of risks, though, so – and a global business. So this is inclusive of the Japanese domestic. So you have 30 or so core markets on a global basis.
So from a global international business, it seems the regulation, the regulatory climate is rapidly changing, so what sort of impact would it pose on JT Group? So of course, the impact shall differ according to different market, but if you can also explain on that front.
Unidentified Company Representative
Should I continue with that? In terms of regulations, as mentioned. So in various markets, various countries, regulations differ. So for instance, in Europe, this year, this spring in fact, the menthol, the RMC menthol, would no longer be able to be sold. So this is the TPD2, because of the introduction of this regulation. So that is under progress.
But now in terms of RMC, the regulation being – we shall not see a critical impact in terms of regulation on RMC for the next 3 years or so. Rather we see more risk in the geopolitical risk rather than the regulations. So for instance, Iran will be one market. And Brexit, that is another factor.
So we are much more concerned in terms of these geopolitical risks rather than the regulatory risks. Shall I give you more details? Or – so Eddy, would you like to give us more color on this?
Maybe regulation, yes. Thank you for the question. Regulation is not new to our industry. As you all know, regulation has been a challenge for many, many, many years, but somehow when we fear the worst, we realize that the investments that we have continuously supported behind our global flagship brands in particular has paid a huge dividend.
I’ll just give one example because I think it has been close to many people’s hearts, including investors when it came about. And this is the regulation that affected the U.K. market both in terms of plain packaging but also in terms of the display ban.
We have never had such a momentum as the one that we have in the U.K. market. And we have not seen a dramatic impact on these regulations that seemed, when they were announced, to be extremely adverse to the industry, to what we’ve been building over the last few years.
So somehow, it’s a message of confidence that I’m sending through, which is that we are accustomed to tightening regulations over time, and we have an ability to approach regulation in a way that is not a substantial impact for – to our business.
The more our business has been spread geographically is also reducing the meaningfulness of any individual risk going forward in terms of regulation. I hope that’s helpful as well.
Unidentified Company Representative
Do you want to talk about Iran as well…
Iran. I’ll talk about Iran. Iran is a market where, as you know, we’ve been operating since 2002. Iran has been the subject of very strict regulations and sanctions, as you all know. We have a lot of pressure on our business, but it doesn’t, again, affect our business to the extent that we thought it could.
It is difficult. It is challenging, but through good planning, good execution at local level, we managed to maintain momentum. In fact, last year, 2019, was the strongest ever on record despite all the operational challenges that the local team is handling extremely professionally and always in compliance with the law.
Unidentified Company Representative
Thank you very much. As Eddy mentioned, 2019, we had some really good numbers, but since 2020 onwards, the sanctions are lifted, so it seems as if we are seeing some stronger trend happening. So as of 10th of January, we are trying to really evaluate the content of the sanctions that has been announced.
So the manufacturing sector seems to have a large proportion within the sanction, but in terms of the agriculture commodity, they may be exempted from the scope of the sanctions. So the question is which line our products may fall in. That is the most important concern for us, and we are evaluating that closely.
Now in terms of Brexit: So Brexit has been decided already, but in terms of trade agreements, nothing has been finalized. So as far as we’re concerned, so within the year 2020, perhaps we shall not see a significant impact from Brexit.
So towards the end of this year, we shall watch what sort of trade agreements will be forged between U.K. and EU. And depending on that, our countermeasures and the impact on our business may differ.
So as mentioned, the inventory pileup and also what sort of a contingency plan we may have, we continue to explore what will be the best plan in light of the current situation. Thank you very much for that.
[Foreign Language] Fujiwara-san.
Thank you very much. I am Fujiwara from Nomura Securities. Earlier, Terabatake-san talked about domestic RRP; and that you’d like to generate good results, starting from the second half of next year. But when you look at the underlying trends and how it was so far, I think the probability of this being achieved is low. Maybe internally some changes are happening. I’m hoping that’s happening, but being an outsider, I can’t see what’s happening internally.
And how is your company changing? And how do you feel with regards to generating results? What kind of progress are you feeling personally as President? Can you give me more flavor on that? Thank you very much.
[Foreign Language] Yes. To your point, from the outside, I’m sure that you may feel some apprehension and concern. And last year as well 2 years ago, I went around all of the sales bases and I talked with all of my people. And I think I am actually feeling that our company has started to change.
From a consumer-centric point of view, compared to what I thought personally, you have to admit that our company wasn’t really consumer-centric. Our strength in the tobacco business was refills. And at HQ, we would plan what kind of cigarettes we wanted to develop and sell. And our sales bases regionally around Japan will sell our products and through sales outlets. Well, that was our strength in the past.
However, the same product being sold nationwide, I think there’s a limit to that kind of business practice nowadays. It’s a matter of customer feedback and how they feel. Is customer feedback reaching our R&D people? I have to admit that it probably had not reached our development people. And in here too [ph] I told my people that there was a disconnect and we need to reconnect with our customers. And that is why we reorganized sales, especially in Japan.
We wanted to give more authority to people in the field. We wanted our people to think on their own feet and focus on how they’re going to develop their business in their own region.
So whether it be the branch managers, we wanted to give them more authority. And with regards to how we assess our people, I think we’ve made dramatic changes, then we’re going to execute it from this year.
It’s a matter of what kind of proposals they can make. It’s a matter of how many times they communicated with the customers. It’s more about assessing their behaviors rather than how much trade they were able to achieve.
So it’s not just going to be on a top-down basis any longer as much as before. They’re going to be the market leaders. They will need to think about what they need to do. So that’s something that changed greatly.
On the development side of things, I touched upon this in my presentation, but last year, since July, we made drastic changes. The RRP development team, whether it be procurement, planning, manufacturing technology or R&D; and our salespeople, they are concentrated in Sumida, and now they’re performing as one team.
They used to develop department by department, but now, by project, they are able to work together as they are physically concentrated now. So that’s one of the large changes we made. And we have been able to raise the speed of the way we do our business. So that’s one thing.
And personally, the tobacco business, in order to expedite the speed of business, I decided to head the business so that we could progress with the RRP business faster. There’s many things that you need to make decision [ph] on. It used to be something else for cigarettes, but it doesn’t apply for RRP.
For example, devices, batteries, risks, they are different from the cigarette business. And each of departments, they were communicating with one another and that was taking a lot of time. So we wanted all of the issues to be raised quicker than before.
And that is why I personally decided to handle the business. And because it’s a new business, we obviously will go through trial and error, but we need to start small but grow it and make it bigger.
And because the mentality is different, that is why I decided to lead. At least for the next 2 years, we will stay this way until we’re able to establish a good foundation for the RRP business.
Kawasaki-san, we’d like to take your question next.
Thank you very much. My name is Kawasaki from UBS. I have a question about international tobacco business. So this time the guidance for the international tobacco business. So you have M&A effect has taken its round and the volume will be down, but the pricing will continue to be strong.
So the JTI guidance in the past in terms of pricing, you weren’t actually focusing too much on pricing. Rather you would look at the overall plan. Of course, as a result, the pricing [extruded] its effect in the past, but you didn’t necessarily put that in the initial guidance.
But this time, for this year’s guidance, 8% of pricing has been factored into the plan for JTI. So what is the – how realistic is this? And what are some of the background to this?
So for instance, in Russia you expect to see moderate tax hike. Will that explain that entirety of the pricing increase? So it seems as if, in comparison to before, you are much more aggressive in terms of pricing. So if you give – if you can give us more color as to why you have incorporated this number in your guidance for this year.
Yes. Thank you for your question. I’m not sure that I can pinpoint to the 8% that you referred to, but let me just broadly explain the pricing view that we have…
Can I – because my assumption is like your guidance on in – on volume is actually a 3% of decline, right? And then on value basis, sales growth is actually 5%. So this difference actually is like [ph] this 8% pricing effect.
Yes, yes. So that’s more the numbers that I had in mind. Thank you for clarifying. I’ll pass on to Vassilis in a second, but overall, we see the pricing environment to be fluid. We are quite comfortable. Especially, as I said in my presentation, already having secured two third of the pricing for this year, we have visibility as to what’s happening. We also observe competitive environment and behavior, and we feel comfortable that the assumptions we’ve put are solid into the plan.
So it’s not a change of heart and being more bullish than we were in the past. I think we’re reflecting what we see in the overall environment despite the fact that it’s not easy to compete, but we believe that pricing will more than compensate for the down-trading that we see in a lot of places, the price mix [ph] impact and also other factors like illicit trade in some markets. Maybe for specifics I can pass on to Vassilis.
Yes. Thank you, Eddy. So I think pricing is an inherent part of our profitability model since the beginning. Maybe we have been having some years of difficult pricing, maybe you remember, in 2017, getting out of TPD2 in the European region in Russia, but pricing is always a very central part of our model for revenue growth.
Now what – and you’re right. I mean it’s a little bit of a quick calculation, minus three, plus five equal eight, because there’s mix also involved, but the general idea is correct. But what we can see here, we demonstrated already how good and strong was this year in 2019 the pricing.
And what we also see usually when it comes to pricing is linked to whether we are forecasting excise tax stocks, whether there is discontinuity on the way the excise taxes are moving. And we see more and more, in more and more countries, we have predictability of the excise calendar.
You mentioned Russia, for example. Russia, we see now we have a 3-year calendar that is calling for an excise tax increase of 4%. The first one of these years was 2020, and it happened in January. Now 4% tax increase in Russia compares with increases of 10% in January last year and 10% in midyear rating.
So it is clear that the government also realizes that there is a need for predictability of the revenues, which helps us also to have a predictability of our increases and how we can exercise our pricing power. So one element is the visibility we have on the tax calendars.
The second element, of course, is the strength of our brands. So our brands have pricing power, and we can use this strength to lead pricing and to take pricing above taxes. And as Eddy said, already today, we know that two third of our pricing is secured for next year. And Russia is going to be a factor, but it’s not the only driver of that. Russia pricing is going to be good. We’re going to have good pricing also when we are lapping developments that happened last year in Philippines, in Turkey. We will have pricing in Germany. We think we have strong pricing possibilities in the U.K.
So the benefit of our large geographic footprint is also something that is conveyed now into the pricing because we have many different sources of growth and using the pricing element to help us with revenues.
Tsunoda-san, over to you.
JPMorgan. [Ritsuko] Tsunoda is my name. I have a question for you. For the Japanese tobacco business and for dividends, I have questions related to these subjects. Mr. Terabatake, in your explanation as well as in your responses in the Q&A session it seems that for Japan, in the domestic market for RMC, the demand outflow from RMC to RRP, if it doesn’t stop, you won’t be able to stop your profits from declining in the domestic tobacco business. That is the impression I get.
With that as a backdrop: Around this time last year, Terabatake-san, you were saying that there will be no dividend cuts. You said it here. And this year, the guidance is challenging. However, you have set forth a dividend policy of JPY 154, which is flat.
However, when you think about the profit levels of the domestic tobacco business going forward, with regard – because it’s so uncertain, going back to the answer in the Q&A earlier, you were saying that presumably visibility will heighten from the second half next year, which means that I’m rushing to conclusions.
But with regards to when you give out guidance for 2021 and going back to your past comment of not cutting dividends, will you be able to say that and state that next year as well?
Thank you very much. I wish to say so. However, with regards to the outlook we have on our minds from what we’re seeing, with regards to cash flow generation, it’s JPY 370 billion for this year, and last year, it was JPY 400 billion. So from a cash flow point of view, we are not in a position to cut dividends at this point in time, and we believe this level is going to be ongoing for a while.
So dividend cuts is something we are not really anticipating, and I believe that I’ll be able to state that we won’t cut dividends next year. However, when you think about the payout ratio, in net profits there are fluctuation factors such as gain on sales of real estate as well as other factors.
When you think about the stability of net profits, that is one of the reasons why dividends are flat this year. However, we are not thinking about cutting dividends next year. With regards to the outflow from RMC to RRP in the domestic tobacco business, maybe Mr. Fukuchi would like to say a word.
For 2020, for the domestic tobacco business, if I may make some remarks. 2020, I believe it’s going to be an important year, and I think it’s going to be a year that will connect to the future. It will be a transitional year. Particularly, it’s a matter how we could capture growth for the RRP business, as well as profit growth. It’s going to be an inflection point this year.
And there are two major things that are going to be happening in 2020. For RMC, including little cigars that is, as you know, there will be a price increase in October, so it’s a matter of what we do. And that will lead to 2021 as well.
With regards to what kind of pricing we can take, for major brands Mevius, Seven Star, American spirit MPs [ph] it’s a matter of raising loyalty as well as being prepared in the value segment. It’s a matter of whether we can be well prepared in these two segments.
For RRP, on the other hand, as Mr. Terabatake said, last year, we were able to clarify the challenges we face through our initiatives. And with regards to countermeasures, we’ve been able to reveal what we need to do to a considerable extent, so it’s a matter of implementing the countermeasures, whether it be for devices or refills. We will continue to launch new products. So we would like to ensure that we are successful on that front, and it’s a matter of customer feedback.
We need to ensure that we capture feedback and reflect that onto marketing, sales activities and the development of our products swiftly. And we would like to reinforce what we do in 2020. We will be investing for that purpose and we will be spending our resources as well, and that’s what we’ll be doing in 2020. So it’s an important year, and it – we hope it will be an inflection point for us.
So you were saying building the foundation in 2020, but for low-temperature heating products for your company and for 2021 and 2022 and the tax increase, the degree is expected to be quite big. For the tax increase, will you be able to perfectly pass that on to the price of the products? Because one can say that that’s going to be a challenge.
And it’s probably not possible, but maybe taking the opportunity of the tax hike, by increasing prices of your products and going through pricing, for RMC, that will be a negative from a volume standpoint.
And for low-temperature heating products, if the tax hike is quite substantial, that will be a disadvantage for your company from a strategy point of view, and I’m concerned of that happening.
So when you think about that, building the foundation of your business in 2020 will be very important. And of course, I’m probably not the person to preach to your company, but I just wanted to confirm if your thoughts are on the same page.
With regards to the degree of increase of the taxes for low temperature and high temperature, it’s true that low-temperature products are going to be higher, but against RMC and the degree of the increase, for heating products we still believe there’s an advantage.
And thinking about the shape of the product, I believe that low-temperature heating products will still have an advantage over high-temperature products. So we would like to continue to exert on our advantage. And this is something that has already been decided, so we can prepare for cost reduction. And that’s already in our menu, but in any case, we would like to ensure that an appropriate level of profitability is secured.
One more thing is when the tax hike occurs and how we’re going to increase the prices. As of last October, for our products, some of our products went through a price increase. Some of the prices were left flat. And we are analyzing the consequences of that because consumers buy devices and then buy the refills then after.
So we’re trying to figure out how much of an impact that price increases have or don’t have. So we would like to ensure that we respond appropriately upon doing the analysis.
This is Takagi from SMBC Nikko. I have a question to Mr. Terabatake. So you’ve mentioned about the pace of expanding RRP has become much more stabilized and the – we are seeing much higher visibility in the market. That’s what you mentioned in the presentation.
But on the other hand, the slowdown of the growth of RRP as a category, this may pose a tough environment for your company. So there must be some negative impact as well, the reason being, if we are seeing slowdown in the growth of the category, may be difficult to really improve your current position.
You are definitely more of on a defense, and it may be difficult to regain the pricing power within the market. So what will be your take on this environment? Of course, it would be great to have innovative products being launched into the market, but that is again quite challenging. So if you can comment on this, that would be helpful.
Also another point was in this environment. So if you can have much pricing power and if you can manage profitability, is that really possible? So for October 2020, that will be the next timing for the opportunity for price hike, but how would you foresee the opportunity?
Thank you very much for that question. So as I have mentioned in the presentation, RRP category last year accounted for 23% in terms of category share, and this year onwards about 25% or so, so about 2 percentage point increase that we have seen from 2018 to 2019. So that is the speed we are looking at.
And as you rightly mentioned, in order for us to increase our share within the category is we really need to be on the defensive to increase the market share within the high-temperature category. So if you were to look at low temperature and high temperature, the top priority is high-temperature products, and that is where we put our priority in developing our products. So that is our current state.
Now given the limited pie, the limited size of the market, it is true that consumers are using more of the competitors’ products. So that is why we need to launch products that are better than the current offerings. We need to provide better service than what is available now.
So in terms of visibility of such initiative, that the timing is the mid of next year, the middle of next year. That is the timing we should have a better visibility. Of course, we will continue to launch upgrades of the current offerings for this year as a way to that step.
So some of the issues, we have much more clarity, so we’d like to address those at this point on a steady basis. And the products offering – offered right now – we’d like to launch products that is better than what has been offered in the market to the consumers. So that is our prime focus.
Now you may ask about the pricing strategy. As Mr. Fukuchi mentioned, RMC, we will keep the pace as we have conducted in 2019. Similar trend will continue for RMC. Now for RRP, as Fukuchi, Mr. Fukuchi, mentioned, that we are studying carefully the impact of pricing.
So from our experience in 2019, the price elasticity perhaps is not so high for RRP, at least not as much as we initially expected. So we will try to manage this and try to address this in the way we can.
So if you were to ask, do we not have any price leadership or not? Actually, probably we have some because we have more than 48% of the market share. We have some degree of pricing leadership. So premium to sub-premium price segment. And also value, where that will be impacted by down-trading, we will launch products in those specific price category.
So the consumers may stay in the same category – or same price segment, but they may down-trade to lower the pricing, but any case, as long as we have that receiving in [ph] we should be able to capture those consumers and gain profit from pricing. Thank you very much.
Daiwa Securities. My name is [Makoto] Morita. I have a question around Russia and the situation around RRP in Russia. Last fiscal year, how much was RRP market share? And for 2020, what is the outlook for RRP market share? And how about the outlook for the next 3 years?
Also, if you are assuming that RRP is going to continue to expand, I’m sure JTI watches what’s happening in Japan. So how are you going to protect the profit pool in Russia so that the same situation doesn’t happen like what happened in Japan? In order to avoid what happened in Japan, what kind of support is expected from Japan to Russia?
I will try to answer that. And first of all, it is clear that we have a very strong portfolio of combustible products in Russia. And as you know, Winston is the number one not only tobacco brand. It’s the number one FMCG brand in the Russian market. We have very strong JVs [ph] with LD. And with the acquisition of Donskoy, we have a very strong position also at the value. So on the combustible side we feel that we have built a portfolio that is very strong.
Now your question is more about what is the size of the RRP segment. And what is the situation today? What we could say about the future and how we would manage that. Today, about 10% of the value of the market, as we close the year ‘19, is in RRP. And in a roughly split, 20% of this is in E-Vapor and 80% of this is in t-vape.
As you know, in E-Vapor we have introduced our brand Logic already in Q1. And we even have expanded the distribution of Logic in a number of key cities, and we are very encouraged by the results we see with Logic today. It’s a small anecdote, but it’s very interesting to say that, in December in Moscow, we are number one, above the key leading competitor who has been JUUL until now. So Logic performance on the E-Vapor segment is very strong, and we will continue to pursue that.
We also see that there is a business of interest of us in the T-Vapor. And as Eddy explained in the presentation, we are ready in the first half to enter in the T-Vapor category with the Ploom product.
And we are doing that in a very dynamic way by carrying the brand name of Winston, which as I mentioned before is a very strong brand. So it will be a combination of Ploom and Winston in the Russian market.
Now we are confident about our capacity to build that business as well. We are confident about our capacity to make profit out of this. Your question about where is the segment going, I think it’s very difficult to answer.
One reason why it’s difficult is because the Russian market is very different from the Japan market. It’s not only about the affordability; and the fact that, as you know, the premium segment is very limited compared to Japan. It’s about the consumer habits, the consumer tastes, the less importance of menthol, the fact that consumers want more strong cigarettes. And the average nicotine level is higher. So there’s a lot of differences with the Japanese market.
And I would think that it would be very difficult to see an evolution of the T-Vapor category and the same degree that we have seen in Japan, but what is more important is that we are now determined to enter. We saw that there is a size that is of economic interest for us, and we will be there in the coming weeks.
Unidentified Company Representative
If I may follow up with regards to the support from Japan to Russia. What we are poised to introduce in Russia is the Ploom S device, a compatible device, but we unified our R&D capabilities. So for the products that were introduced in Japan, faced various challenges such as kick or the low-temperature part or you won’t be able to smoke 20 in one charge. And an improved version of the product will be introduced in Russia.
So the kick is better and you will be able to smoke 20 sticks with one charge. So the learnings from Japan already have been reflected in the updated device that will be sold in Russia. And that will be introduced in Japan as well, accordingly, eventually in the future.
May I confirm one point for Japan? The predictability is higher was one of the comments that was made. How about for the international business? For example, when you look at Russia, is visibility going to come down? Or is visibility going to continue to be high, as was the case from before?
The evolution of the RRP segment or about the overall market conditions.
The overall market conditions, total JTI business trends and performance, predictability.
Yes. As we’ve mentioned before, I think the predictability of the – on the Russian market environment is increasing. We have now seen that the government has realized that they need to tackle the problem of the illicit trade. The illicit trade, as you know, was created and accelerated because of the consequent high tax increases. I think this is one of the drivers why the government has decided to go with tax increases in the area of 4%.
Just as a parallel information: The tax increases this year, 4%, the inflation is in the area of 8%. So you see that there is an area of affordability that is improving there. So for us, the fact that the government is determined to tackle more seriously the issues of illicit, including trying to harmonize the tax, excise tax, levels of the surrounding countries that are part of the Eurasian union, I think it is contributing to the predictability.
I also think, at this moment as we speak, there is a number of legislative initiatives, regulatory initiatives under discussion within the Russian regulators which also will give more visibility that are linked to the possibility of establishing a minimum retail sales price, of banning the discounting at key accounts.
I see all these moves, we see these moves as positive, as adding better to the predictability of our revenues in the future in the Russian market. So we are very optimistic, combined with the strong position of our portfolio.
Unidentified Company Representative
So for the global tobacco business and how RRP is going to play out and the visibility trends, honestly speaking, I don’t think the visibility is high as it is in Japan because taxes are pretty much set in place in Japan. And people who are interested in the product already have one.
And with regards to marketing, products may increase in number, but we pretty much have a market that’s set in place. For the restrictions, the regulations as well as taxes, because they’re already solidified, that is a big factor. But when you look at the U.K., for example, for T-Vapor, as well as Italy, I believe it was last year that the heating T-Vapor product tax regime kicked in newly. And our competitors introduced a product that was low priced.
And we have monitored the trends. And when we reach a certain point, we might have to follow, but to protect our RMC franchise, we need to continue to monitor the trends that are underway. And at the same time, for e-cigs, Logic is doing well. And for e-cigarettes, countries around the world will probably see some developments around the tax regimes.
So currently it is not clear yet. And also for Asia, some countries are banning RRP across the board, such as in Singapore as well as in Thailand as well as for Taiwan. They are not open to RRP, but in the next administration it’s a matter of what kind of discussions are going to be underway. But currently it’s uncertain.
So to that end, visibility in Japan is rising, but globally speaking, the regulations as well as the tax regimes are different country by country. Some have one. Some do not, which means that they’re not as high in visibility compared to Japan, but we do have the know-how that we have built in Japan. So if there are new developments, I think we are prepared to tackle them. Thank you.
This is [Hiroshi] Saji from Mizuho Securities. My question is about the organization of the company. So from R&D, you’ve integrated on a global basis, so in terms of tobacco business even the business planning would be consolidated as one. So what is the ultimate goal that you are aiming for? What is the reason for conducting this organization change? What is the kind of impact that we expect to see? I’d just like to confirm on that part.
Also, the global tobacco business, whether is Russia. It’s quite robust, likewise in U.K. And the story is quite clear in terms of the global tobacco business. And I believe you are making investments into new areas, Asia and also Europe. I think the current trend has not changed over the years, but on a long-term basis, for instance, we may see changes in RMC.
Are you starting to see some changes in terms of RMC? So are you starting to see any new developments or new markets that may actually provide future revenue? If you can share those thoughts, that would be helpful.
Unidentified Company Representative
So in terms of the organization, I will answer. And in terms of JTI’s new route or new directions, Eddy, maybe you can share with us later. So let’s talk about the organization: Rightly said, we have integrated the R&D, the line, last year. And this year, corporate strategy and also business development, RRP, would also be consolidated this year. And going forward, we will be looking into quality assurance.
So what are – what is the driving force behind that? So the – in the era of RMC, even without those efforts, JT and JTI, we were able to prevail even without those efforts, but now in this area of RRP and if you look at the competitors, I think you would have an understanding.
So they are concentrating the global resources, and they are focusing and launching those all into the Japanese market. And after succeeding in Japan, they would like to deploy elsewhere. So that is true for marketing [ph] investment. So for instance, they have lowered the pricing of the devices to further enhance the popularization within the market.
So because we are the only ones disclosing a PL in Japan, we become quite obvious, but if you looked at their numbers, each one of the competitors are investing a heavy amount in Japan. So as far as JT Group is concerned, the – we are focusing on R&D on a global basis. We talked about the example in Russia.
So one organization, we share different issues. And for instance, with the Russian market we will introduce products in RRP after learning from the lessons in Japan. So unless we have one RRP, one group, we would not have been able to do so.
So when you look into this category of RRP, it is important that we have one global system that is for R&D, marketing and even digitalization. We need to have one system because we are no longer in a state that we can separate Japan as opposed to other markets. We need to be as one.
So in order for us to launch this – and that is we have decided to integrate all the different functions. I myself, I’ve been working together with Eddy and, of course, Mr. Fukuchi on a monthly basis. We are in close contact to discuss in details about these issues. So what would happen in the future, of course, I cannot give you too much information right now, but first thing first. We’d like to solidify the base as we speak.
If I understand the correction – the question correctly. And I think you’re trying to make reference to the momentum and the trends that we see in Europe, which are quite clear. And the question is what will happen in the rest of the world. Do we start seeing some trends that are interesting and they could give confidence on our global performance?
I’ll go back to one of the things that I said in the presentation which supports very much the strategy that we have followed over the last few years, which is to balance the footprint of our business. As you’ll remember, a few years ago, we came in front of you with a business that was very exposed to just a few markets. And if one of our markets caught a cold, the whole company was sick. And we have changed that profile of the business quite significantly over the years. As I mentioned, two thirds of our total volume is now coming from what we would call the emerging markets.
And the trend in the European, the more stable and historical or legacy markets that we had, we have never grown market share as fast as we have. This is the result of a continuous strategy over many, many years of investing behind our people, our brands in a very consistent way. No matter what the environment was, we try to maintain that focus.
That has served us very well. And now we are benefiting from those trends when maybe the environment is a bit more confusing or difficult to navigate in because of the emergence of new products and the likes. We kept the core very solid.
What we see in the emerging markets and the markets we have evolved, we see positive trends, as I explained before, on pricing, on early market share developments. It doesn’t mean that everything is easy. We’ve got our own challenges, but overall when we look at the profile, the trends that we have established in the more mature markets, we see we can duplicate them.
When we introduce our global flagship brands in market that for a long time, we’re not exposed to them, we see that there is natural traction; and that’s a very encouraging sign. And we see this now in the development, in share of market of our key flagship brands that I’ve explained before. So we are cautiously optimistic that, that trend should not change, based on what we know so far.
So the next person will be the last question, due to time.
I’m Miyake from Morgan Stanley. Profits in Japan, in order to go back to profit growth. I wanted to ask my question in parts. One is for RMC or combustibles. Opportunities for pricing will be when the tax hikes occur. And when down-trading happens, sub-premium or the value segment is what you will reinforce so that you can take on the people who down-trade.
So when you look at just the RMC business and strive for profit growth, it seems that pricing as well as the portfolio enhancement is going to aim for profit growth again. But for RRP, devices are not what generates the profits, but it’s about selling refills in order to grow profits. That’s your basic business model. How should I understand this? With changes in taxes, if the prices increase – and the degree of the price increases also matters with regards to how the market is going to develop.
So for device, refills, combustibles; and the roles that they’re going to, respectively, play; and how profits are going to look like in the domestic tobacco business is what I would like to hear about, not over the short term but over the medium to long term.
Thank you very much for the question. For RRP, I’ll be talking about high-temperature heating products as well as low temperature. For high temperature, the market is more than 20%. So the market is already there, and in it we need to ensure that we secure good market share.
The reason why we are behind is already clear. So we need to sure that we – make sure that we overcome those challenges so that we can increase our share and recover share. If we are able to recover share, we will be able to generate profits that are in link with our share on a 5-year horizon. Of course, we run simulations internally. And we run simulations as to how much profit can be generated when we secure a certain volume level, but if it’s going to take 3 years or 5 years or 10 years, the profit level is going to differ, obviously. So it’s a matter of how we could do and reach this as much as possible. So that’s the nature of the high temperature market.
For the low-temperature heating product category, it is not as large. However, when you think about the reason why RRP products are selling on a global basis, I think there are three major reasons, which I may have talked about before.
One of the reasons is because health concerns, personal health concerns. The consumers opt to buy RRP for that reason. Number two is, for example, e-cigarettes in the U.K. are cheaper in price, so they offer those products. And number three is consideration towards people surrounding yourself, due to the odor, especially when you look at customers in Japan, a third reason, consideration to others.
Odors or the smell of a RRP is one of the reasons why they buy RRP low-temperature heating products, and data backs that up. And we believe there is a potential for growth in the low-temperature heating product category. We believe that we could reach a certain size for this segment. And if it reaches that certain size, as pioneers, if we could secure a high share, we believe we could generate profits through the low-temperature heating products category as well.
So at this point in time, we might be in the advanced investment stage, but we would like to ensure that we do what we need to do in 2020 so that in the future we could create a good profit pool.
And if I may add a word from a CFO or a financials point of view. As a matter of course, we don’t want to pour water on desert sand. That’s not what we want to do. For RRP, RMC, why – the reason why we want to do both is because, as Mr. Fukuchi mentioned earlier, we believe that there is a good profit pool. And before, we weren’t – didn’t have good visibility, but now we are able to confirm that there is a market out there, and that is why we need to secure that piece of the market.
We didn’t know how much this market was going to grow, and we didn’t know when we were able to launch our products in the past. And we confused you with regards to the initiatives that we implemented in the initial phases. However, looking out into the future, we want to ensure that we capture the future profit pool. And we are trying to design our future.
We are listing up what we need to do and we are also listing up all of the items in a time line. So we’re currently in the design phase so that we could achieve our plan and gain more feasibility.
So for the next 3 years, profitability may fall and the price mix effect may be a negative. However, it’s a matter of thinking about what kind of function this is going to play in the ultimate profit pool. So we’re thinking about affairs [ph] over the longer run.
And I guess we’re getting constructive feedback because we were not able to present a solid answer as to how we are going to do this, but in any case, we would like to enhance the feasibility of what we are trying to achieve.
It is time. We would like to conclude the investor meeting on the financial results for 2019. Once the preparations are made, we would like to distribute those online. Thank you all for coming to the investor meeting amidst your very busy schedule. Thank you very much.