Hello, and welcome to the BAT 2019 second half pre-close conference call. Throughout the call, all participants will be in listen-only mode, and afterwards, there'll be a question and answer session. Please note this call is being recorded. I will now hand over to Mike Nightingale, Head of Investor Relations. Please begin.
Good morning, everyone. Mike Nightingale here, Head of Investor Relations, and with me this morning is Tadeu Marroco, our Finance Director. Welcome to our first pre-close conference call. This is the first time we've held a conference call for our pre-close trading update, and we do hope that you'll find it useful. Just before we begin, I'd like to draw your attention to the cautionary statement regarding forward-looking statements contained in the trading update. I'll now hand over to Tadeu, who'll say a few short words on current trading before we open it up to questions. Unless otherwise stated, our comments will focus on constant currency adjusted measures.
Thank you, Mike. Good morning, everyone, and welcome. I'm very pleased to have this opportunity to talk to you about how we are progressing 2019, and I want to thank you for joining us this morning. As you can see from today's announcement, the business continues to perform well. We are building on the good progress we made in the first half and continuing our journey to transform the business. We are driving value growth in combustibles, we are investing to deliver step change in new categories, and we are transforming the business to create a stronger, simpler, more agile BAT. As a result, we are on track for one of our best financial performance for many years. We expect adjusted revenue and adjusted profit from operations to be in the upper half of our guidance range of 3%-5% for revenue and 5%-7% for operating profit.
This reflects a good performance in combustibles, where we are seeing share growth and strong price mix, as well as good growth in new categories. As you know, we have increased our focus on value growth and combustibles. We aim to deliver superior and winning product experience while driving efficiencies and reducing environmental impact. We have rationalized and simplified the portfolio. We are focused on the global strategic brands and investing in key markets. This is driving value share, which is up 20 base points with the strategic brands up 55 base points. In addition, I'm pleased to say we are back to growth in volume share, which is up over 10 base points, having been down in earlier in the year. We continue to expect industry volume to be down around 3.5% this year.
BAT full-year volumes are expected to be broadly in line with the industry after adjusting for the continuing impact of Egypt and Venezuela and a 60 base point impact from a one-off stock reduction in Russia. The good price environment has continued, and we expect full-year combustible price mix to be in excess of 7%. In the U.S., we are really pleased with how the business is performing, and we expect constant currency revenue growth to be within the 3%-5% group guidance range, with pricing and value share growth have more than offset the industry volume decline. U.S. value share is up 30 base points. We have worked hard to position ourselves and are growing in all the right areas, consolidating our leadership position in menthol and adult smokers under 30, and continue to grow our share of premium.
We continue to expect the U.S. industry volume to be down around 5.5% in 2019, with the timing and frequency of pricing during the year being one of the main drivers, as well as the impact from the growth of vapor. Although the vapor market has lowered, we are not anticipating a significant flowback to cigarettes in 2019. We would expect U.S. volumes to be down around 4%-6% next year, depending mainly on pricing and the regulatory environment. Turning now to new categories. Our approach to multiple categories development is underpinned by robust price product stewardship, age-restricted access, and responsible marketing practice. We expect to deliver good full-year new category revenue growth at the lower end of our 30%-50% guidance, reflecting the negative U.S. net flows.
The vapor market has lowered in the last few months, with industry vapor sales to retail in the U.S. down around 25% and consumer off-take down 10%, although we have seen some signs of recovery in the most recent data. New category growth, excluding U.S. vapor, is on track to deliver in the middle of the range, in line with our guidance at the interims. In the U.S., Vuse Alto continues to grow and has reached a value share of 11.1% in October, driving a value share of 70.5% for the overall Vuse family, which is now the number two in the market. At present, Alto is the only top five brand growing volume in declining markets and has more than doubled its off-take share of replacement cartridge in the second half.
I'm also pleased to say that we just received confirmation from the FDA that our Vuse Solo PMTA application has been accepted for scientific review. Vype continues to do well in the two largest markets outside the U.S. Value share reached 11.8% in the U.K. and 19.2% in France in October, with ePod now successfully launched in both markets. In Canada, Vype is the fastest growing brand, reaching a value share of 27.6% in October, up 507 base points since July. In THP, glo is holding share in Japan at 4.9% year to date. As you know, we recently launched our new glo devices, glo pro, glo nano, and glo sens, together with a new range of consumables. We have yet to see the benefits of this in our shared data, as distribution for nano and pro is still building, and we have only just launched glo sens.
However, early indications are encouraging. For example, consumers have told us they really like the benefits of our induction heating technology. They like the fast ramp-up time and the push button and appreciate the improved sensory experience. This is a good performance in a very competitive market, where we have seen a lot of new product launches from competition in the first half. Importantly, we continue to grow share in the overall nicotine market in Japan strongly, and we have reached 18.4% year-to-date, up from 16.3% last year. In Russia, glo has been demonstrating consistently improving performance, with share of tobacco nicotine now over 1% in key cities, including Moscow. In modern oral, Velo's rollout in the U.S. has now expanded to 75,000 outlets.
The brand has already reached a category volume share of 9.2% in October, with shares in excess of 20% in nine states and more than 10% in a further nine states. Lyft and Epok also continue to do well, consolidating their leadership of the modern oral category outside the U.S. In Russia, Lyft is the fastest-growing modern oral brand in 2019. Moving on to the balance sheet, we are determined to reduce leverage. We remain committed to a full-year reduction in currency-neutral adjusted net debt to EBITDA of 0.4 x and are on track to deliver fully a free cash flow after dividends of GBP 1.5 billion. To summarize, the business continues to perform well, and we are on track to deliver on our commitments to high single-figure EPS growth on a constant currency basis.
If FX rates were to remain as at November 25th, fully adjusted diluted EPS growth would benefit from a current translation tailwind of around 1.2% this year, with this becoming a headwind of 2% in 2020. We are expecting a strong performance in 2019, driven by good revenue growth and continued share gains in combustibles, together with good revenue growth across our new categories. Thank you. I will now open the call to questions.
Thank you. If you wish to ask a question, please press zero one on your telephone keypad now to join the queue. If you find your question has been answered before, it's your turn to speak, you can withdraw from the queue by pressing zero two to cancel. Once again, that's zero one to ask a question or zero two if you need to cancel. There'll be a brief pause now while we register your questions. Our first question comes from the line of Adam Spielman at Citi. Please go ahead. Your line is open.
Thank you very much, good morning. Thank you also for such a detailed press release. My question concerns the definition of market share, particularly, I guess, in glo in Moscow and also for Velo in the U.S. You talk about over 1% market share for glo in Moscow and about 9% in the U.S. Is that shipment share, or is that Nielsen share across the whole of Moscow and the U.S., or is it share within the stores that you are selling? Obviously, sometimes these definitions can change. That's my simple question, or my first simple question.
Okay. Look, this is shipment share of the whole country. It's not where we just say the shipment share of the place where we are talking about.
Right. Perfect. Very simple. Thank you. Am I correct that as I think about the whole shape of this set of reports, I think on the one hand, clearly volume in Russia or shipment volume, because of the destock, is getting weaker, and Egypt and Venezuela. On the other hand, sales growth overall, constant currency, is fine. That suggests to me that perhaps if anything, the U.S. is getting a little bit stronger as we come to the year-end. Is that a fair point, that the U.S., if anything, is getting a little bit better for you, and that is offset by slight weakness in other markets?
The U.S. market specifically, we are keeping our guidance of 5.5% for the industry decline. We have seen recently a small uptake in terms of heated tobacco products. We are not making any change to the guidance still, but this can well be a consequence of timing of pricing. We are yet to see a major relevant impact coming, for example, the news flows from vaping. We haven't seen that yet. That's why we are keeping our guidance at 5.5%. Now, saying that, we are very pleased with the results we are getting from revenue in our U.S. business, within our range of 3%-5%, as we stated in the statement this morning. This, coupled with good pricing and share environments across the world, is giving us the upper end of our guidance this year.
In terms of volumes, I quoted in the interims about Egypt and Venezuela. Just as a reminder, Venezuela, I think that we all know what's happening there, and we basically have ownership, or we control the market. We are leaders in the market; we suffer most because of the deterioration of the economic situation there. In Egypt, we had a health tax that impacted the low end of the portfolio, where we are more present. I mentioned those two points there. In Russia, the reduction distribution in inventories has to do with the fact that we are looking, as I said before as well, to all the same opportunities we have in terms of cash management initiatives. One of that is review improvement in supply chain.
We saw an opportunity happening from Russia as a consequence of the closure of the BAT factory in Saratov, and this will translate in some impact this year. That's why we are flagging that.
Okay. Thank you very much.
Thank you. Our next question comes from the line of Gaurav Jain of Barclays. Please go ahead. Your line is open.
Thank you. Good morning, thanks for the detailed press release as well as the conference call. I have a few questions. Number one, is on the 2020 U.S. volume outlook. Does this include any impact from minimum age 21 regulation?
Well, the idea behind the range of 4%-6% is exactly to cope with those uncertainties. The reason why we have mentioned the drivers of uncertainties that on the regulatory front, you're absolutely right. 21 age, minimum age is present as we speak. Generally , be around 40% of the sales in the U.S. We don't know if there will be federal legislation that will increase this percentage and by when. We want to try to flag these possibilities. That's the reason of the range. There are other regulatory environments that can impact positively the markets is on the vaping side, depending on how more the enforcement will be in terms of PMTA coming in May. Plus, the guidance that we expect from the FDA, as an interim until the PMTA, we are uncertain about that.
I think that on the regulatory front, these are the major swings and hence the range. The other elements of the range has to do with the timing of pricing, as you can imagine as well, and the whole of macroeconomics like gas price and the macro itself.
Sure. That's very helpful. Second is the guidance for new category revenue for 2020 and longer term. Your guidance is 30%-50% for the next few years, and we yet find that every few months, it's very hard to forecast what's going to happen in the U.S. vapor market. Is there an opportunity for you to reframe the way you communicate the new category guidance to the market?
Yeah, look, I think that more important is the ambition that we have set of $5 billion revenue by 2023, 2024. This, we are sticking to that. For sure, that to get to that position, this will require between 30%-50% growth on average. You are right. One thing that we have learned is that it's unpredictable. The U.S. is just showing that for us. It's hard to forecast on the short term. You're absolutely right on that. Depends on regulatory framework, depends on consumer acceptance, our ambition is completely unchanged; we are confident that we are doing the right investments in consumer insights. We are doing the right investment in terms of renting the building; we have a lot of plans coming through in 2020 in terms of new launches.
We can provide a bit more detail in 2020 if necessary, but the bigger picture is the ambition to deliver the $5 billion. We are very happy with the performance that we have underlined in terms of vaping. You saw the statement that we released today. We have more than doubled our share in Vuse Alto over the last three months in the U.S. We are doing extremely well with the equivalent of Alto, which is Vype, sitting in Canada, in France, where we are now market leaders, in the U.K., which are the biggest markets in vaping. We are making very good inroads in terms of modern oral, not just in U.S., but outside the U.S. as well. We are increasing our competitive position THP with the new launches. That's what matters.
Our ambition continues, our commitment, our levels of investment, and we want to get to the $5 billion 2023, 2024.
Sure. Thank you. If I can ask one last question? I believe you haven't really shared your capacity for Velo so far, and what the capacity and distribution plans can be going forward. Can you shed some light on those?
Yeah. We don't have any constraints in terms of Velo capacity. We have, as I said, now we present in 75,000 stores. By the end of the year, we want to be above 100,000 stores in Velo. We have been setting our capacity to be able to cope with all this demand, and in terms of minimum cans, and we are not expecting any type of restrictions from that side.
Great. Thanks a lot.
Thank you. Our next question comes from the line of Alan Erskine of Credit Suisse. Please go ahead. Your line is open.
Hi. Good morning, guys. Just two questions from me. One is on the net debt to EBITDA guidance. You're saying that you still expect it to be down approximately 0.4 x, excluding the impact of FX. If the exchange rates stay as they are, if sterling stays at GBP 1.28, GBP 1.29, would that also be the case in reported terms? Might it even be more favorable? My second question is just on the price mix benefit of in excess of 7%. Can you give us some idea of what the geographical mix component is within that? Thank you.
Okay, Alan. Good morning. Net debt beat this 0.4x FX. You are right, if the currency stays, it's a big if, no? It's very unpredictable, you know that this needs to happen the 31st of December. If it stays around the GBP 1.5, we are in the range between 0.4x - 0.5x; we'll probably be seeing some uptick in the 0.4x guidance FX. In terms of the price mix, we are facing a positive geographic price mix. We are basically seeing a bit short than 1%, something close to 0.65% on the geographic mix. It's basically a consequence of us making big inroads in the likes of Japan, for example, which is something that has changed over the previous years, where we used to have drags in geographic mix, we are very pleased now that we have upsides come from there.
Thank you.
Thank you. Just as a reminder to participants, if you do wish to ask a question, please dial zero one on your telephone keypads now. Our next question comes from the line of Alicia Forry of Investec. Please go ahead. Your line is open.
Hi, good morning. Just a few questions from me. One, you mentioned some recent improvements in the U.S. vaping market. Just wondering if you could sort of flesh out a bit what you're seeing there, what your current assessment is of that market. Do you think safer products in the U.S. can see positive volume growth in 2020, assuming approvals from the FDA come through, with limited disruption to business? Secondly, I was wondering if you could discuss, in heated tobacco, what you've seen as far as pricing developments in markets where glo and IQOS are competing against each other. That would be helpful. Thank you.
Okay. Just coming to your first question. Yeah, we saw a reduction in terms of sales to retail. The problem that we saw in the vaping U.S., way has basically driven by both consumer uptake and retail confidence. In terms of sales to retail, I mentioned volumes in terms of cartridge, comparing the position that we had in middle of the year, that was before all these new flows coming through the market. We had a decline around 20%-25%, and we are seeing recently a recovering around 7% when you compare the first positions of November compared with October. We are seeing some recovery from that. For sure that we are performing better than that, because we are gaining share in that depressed industry. In terms of your question around the FDA, yeah, it's still very uncertain, the positioning of FDA.
We are still to be seen what will probably materialize from that. We are trying to engage as much as we can with the FDA. One thing that we are very confident with is the fact that we have received the approval from the FDA for our first submission of Vuse Solo for scientific review. This is quite important for us in terms of our portfolio of papers in the U.S. We have to bear in mind that all types of guidelines that FDA will be issuing to address mainly the youth epidemic, which we fully support and endorse, this will be interim steps until we get to the May 2020 with the PMTA coming through. That's the major impact on that. Now, your second question, can you remind me, Alicia, on the second question was related to what?
Sure. I was just wondering about in heated tobacco, in markets where glo and IQOS are competing against each other, if you could update us on how pricing has evolved on heated tobacco in your experience thus far?
Yeah, look, this varies a lot. It depends on the markets. If you take Japan, for example, we have more than one price position in the markets. We have some of those products positioned in the premium of the markets, some more in the WAP of the markets, in the weighted average price of the markets. If you see outside Japan, has been a bit below premium, more on the average of the prices. We are trying to compete in those price positions with IQOS. We are not seeing much of the similar pricing between us and them. I think that this has been very stable over the last few months, I would say. Okay.
Thank you. Our next question comes from the line of Sanath Sudarsan of Morgan Stanley. Please go ahead. Your line is open.
Good morning, guys. Just two questions from me. One, on the coming back into U.S. volumes and your expectations for 2020, in your range of -4% to -6%. Tadeu, can you just walk us through why you see the top end of the range being favorably impacted by PMTA, please? The second one is on your NGP guidance, which you have longer term of about $5 billion by 2023, 2024. How much of that do you see coming from the U.S. overall? Thanks.
Sanath, look, we always said that the PMTA will create a contestable space between GBP 1 billion - GBP 1.5 billion in the U.S. We saw by our own experience how cumbersome can be the process of generating all the scientific material to get through the line. As you know, it's not just the science that will be important here, but also marketing practice. We believe, given the time resource, physical resource in terms of knowledge, and also financial resource, that a number of the current players will probably not be continuing in the markets after this guideline is established. That's why it depends a lot in terms of enforcement, in our perspective, and also depends on what will be done until then in terms of the guidelines that the FDA is supposed to be releasing.
That's the level of uncertainty that we have that could have an implication in the FMC markets, and that's the reason why we are putting this range. That's basically the reason of the range. In terms of the $5 billion, this will be a combination, not just about the geography, but will be a combination of categories. And as you can imagine, this evolves in a very frequent basis. As you launch new products, you'll see the attraction to consumers, and it's very hard to predict necessarily by market and by category where we're going to land. For sure, we keep saying that we have invested a lot in terms of consumer insights. That's the most important thing, to be able to navigate into this multi-category strategy that BAT has.
There is a lot of insight and foresight that we are generating that we have invested heavily over the last 12 months. We have very good information of each category, and that's what defines us in terms of resource allocation, where we deploy our investments. For sure, if you see after we are in a market with the one category, a bit more traction than we were expecting, we will invest more. This necessarily probably will make this as a kind of a change in targeting within the $5 billion. All our indications it shows that that's the number that we'll probably be later being able to achieve, which will mean, for us, a number close above 20% of our revenues coming from new categories.
Thank you very much. Just going back to the first question on the numbers and volumes. Does that mean that you expect from the PMTA process some migration of consumers back into the cigarette fold from NGP?
Well, in the U.S., 40% of consumers are dual users between vaping and cigarettes. I think that's what you could say, depending on how hard is the offers are in the market for vaping, that you'll probably be seeing less outflow of consumers from cigarettes to vaping. I think that that's the event that might happen depending how the regulatory environment will impact the market.
That's very helpful. Thank you very much.
Okay.
Thank you. Our next question comes from the line of Nico von Stackelberg of Liberum. Please go ahead. Your line is open.
Hi. Good morning, gentlemen. Just my first question, please, on the illicit trade. Do you have any call-outs by market on where the illicit trade has been particularly severe? Then secondly, I'm just trying to back into your free cash flow before the dividend. Could you give me a rough steer on where you hope the dividend growth to come out for the full year, or vice versa? Could you give me a rough indication of where you see free cash flow ending up before the dividend? Thank you.
Hi, Nico. Nico, the duty not paid market has actually increased. We have seen increase overall in 2019, and this is driven by markets, for example, that has a big weight in the market, for example, Ukraine, the likes of Russia, and the likes of Pakistan. We are saying that. We are also seeing a decline in markets where, for us, we are overexposed, like South Africa, which is a good news. For the first time after many, many years, we are seeing improvement in duty not paid in South Africa, in particular. As a consequence of that, we'll be growing share, we'll be growing NTO, we're growing profit in South Africa, and which we are very pleased with. The other market, which is very relevant for BAT, is Brazil, as you know.
Mm-hmm. Yep.
Brazil's duty not paid has been growing fast over the last few years. Given the new government and a new direction in terms of enforcement, for the first time after many, many years, we are seeing NGP growing in the low end, low single figures, with a good expectation for the next year because the economy in Brazil starts to picking up again. Overall, it's a story of increase in density, but where we are most overexposed is a good story for us.
Good. Thank you.
In terms of the free cash flow, yeah, we set up a dividend that will be 1.5x our dividends around GBP 4.85 billion. You can have from that, the numbers are before dividends. This is part of our strategy to delever the company. As you know, we are putting a lot of focus in terms of CapEx that I mentioned before, working capital conversion, operating cash conversion rates; we expect to be north of 95% moving forward. These are the strengths of the balance sheet. As you know, BAT is a very cash generative company. The other thing is that we have a very good match between the currency breakdown of our debts and the currency earnings today.
Because the company today is very different than what it used to be a few years ago after the acquisition of Reynolds, because our exposure to emerging markets, financially, in terms of earnings, is much less than it used to be, which put some more strengths in terms of our balance sheet.
Thank you so much.
Thank you. Our final question comes from the line of Rey Wium of SBG Securities. Please go ahead. Your line is open.
Hi, Tadeu and Mike. I'm just curious if you can maybe just elaborate a little bit more about the trends in Russia. First thing, I just want to clarify, this 60 basis points of reduction that you're talking of, so Mike sort of indicated is around about 4 billion sticks hits in the second half. Related to that, obviously, it looks like tobacco heating products are making good growth in Europe as well as in Russia. I just want to know if you can just share a bit on your plans, specifically in Russia. If we look at the trend in Japan, obviously, first-move advantage is important. Do you have any capacity issues or will you be able to fulfill the demand in that market? That's basically, I just want to get a feel on the Russian tobacco heating market. Thank you.
Okay. The Russians, as part of the cash exercise we discussed before, we have to make a full assessment of our supply chain in a number of key markets for us. We saw an opportunity in Russia to reduce the level of inventories that we had there, because we had the factory closure of one of the factories there in Russia happening during the year. As a consequence of that, we adjusted our inventories by 4 billion. You're absolutely right. That reflects in the GBP 0.6 billion one-off. This is generating more cash and helps with the cash generation in working capital that I have always said that would be a priority for us to manage. We have done a bit here and there, but that's the most relevant market. We are growing share in Russia. Everything is doing well in Russia.
Have a strong portfolio of combustible there. THP, we are very pleased that we have seen consistently growth since January to now, with the new launch and reaching the markets. We haven't seen, for example, glo pro in the market yet. We just launched glo nano there. We reach more than 1% share in the key cities of the country, not just in Moscow. The same is happening in reality in Ukraine and in Kazakhstan as well. We are getting more and more traction in glo across Eastern Europe. There is no issues at all in terms of capacity for THP or either for everything that we are doing in terms of reviewing supply chain in Russia. Okay?
Yeah. Excellent.
Thank you. As there are no further questions at this time, I'll hand back to Tadeu to close the call.
Okay. Thank you very much. In summary, delivering a strong financial performance in line with our guidance. We are very pleased with constant currency revenue operating profit in the upper half of our guidance range. High single-digit favorable constant EPS grow,th, plus a 1.2% currency tailwind for EPS at current rates this year. Our deleveraging on track. Our combustible business performing very well with strong pricing and share gains. Our U.S. business expects to deliver strong revenue and profit performance, good growth in new categories in the second half as we gain share, and creating a stronger, simpler, more agile BAT, which is in line with the priorities that Jack set at the very early beginning of the year. Our restructuring project is completely on track, as we will be updating more on those points and more of that in February when we have our year-end release.
Okay. Thank you very much for joining us today, and we look forward to seeing you in February at our prelims. Okay.