Hello, welcome to the BAT half year results for 2019. Throughout this, all participants will be in listen-only mode, and after, there'll be a question and answer session. Please note, this is being recorded. I'll now hand you over to Jack Bowles, Chief Executive. Please begin.
Good morning, everyone. I am Jack Bowles, the Chief Executive, and with me this morning is Tadeu Marroco, who from Monday will succeed Ben Stevens as Finance Director. I would like to take this opportunity to thank Ben for his immense contribution to the group over a career spanning nearly 30 years. As you all know, at the end of this week, after 11 years on the main board as Finance Director, Ben will be retiring. He leaves with the best wishes of the whole board for a long and happy retirement. Before I start the presentation, I need to highlight the disclaimer on page two and page three, which I will take as read. As usual, at the end of the presentation, there will be an opportunity for you to ask questions.
As we said in March, we are focusing on transforming the business by delivering value growth from our combustible business, driving a step change in new categories, and making BAT a simpler, faster organization, better equipped for the future. We are sharpening our operating model and reducing complexities. This is providing the capabilities and resources to invest in new categories and to grow operating margin. Our review of the organization is well advanced. We are looking at the numbers of business units, reducing organizational layers, and simplifying processes while further leveraging our shared services center. We will update you on our progress when appropriate. Turning now to the results. I'm very pleased with the half year. We have a strong performance in combustible and industry dynamics remains robust. Our combustible business continues to drive the financial performance of the group, and we are performing well.
We have continued to grow value share and our volume share is improving. In the new categories, revenue was up 27% and we're on track to deliver full year revenue growth around the middle of our 30%-50% guidance range on a constant currency basis. Over nine million consumers already enjoy our potentially reduced risk products. While I recognize there is more to do, we expect a strong acceleration in the second half. This is driven by the impact of the full year of additional investments and new product launches, which I will cover in more details later. We set some stretching guidance at our capital market days in March. I am pleased to say we are delivering on our financial objectives. Revenue, margin, profit, and EPS growth are all in line with the guidance.
We have done this while at the same time significantly increasing investment in the business. Cash and deleveraging the business is a clear focus for us in 2019. We continue to be confident of reducing our leverage by 0.4 turns, excluding currency translation. Overall, the business is performing well and we're on track for a good year. I will now pick up some of the key themes of the first half in a little bit more details. As I said, we have a strong performance in combustible. Total cigarette and THP volume declined 3.5%, broadly in line with the estimate industry decline. We continue to expect overall industry volume to be down around 3.5% for the full year. Cigarette price mix was strong at 7%, driven by a good pricing environment.
Corporate value share is up 10 basis points and the strategic brand portfolio delivered strong growth both in volume and in value share. Corporate volume share improved in Q2, and share in the first half is now level with last year. This was achieved even though we have reduced our combustible SKUs by 10% over the last 12 months, excluding the TPD implementation in Europe. In the U.S., we are winning where it matters with growth in value share, premium share, and SoV30 share. This was driven by good performance from Newport and NAS, which both grew volume share in the premium segment. Revenue and profit both grew strongly. This was driven by good pricing, reduced discounting, and improved mix. There was some additional benefit from the timing of expenditure and the effects of the Vype recall last year.
Volume was down 6%, mainly due to the industry contraction as we concentrated on building value share against volume share. This was against an industry down 5.4%. Following the additional price increase taken in June, we now expect full year industry volume to be down around 5.5%. The U.S. regulatory agenda continues to follow a robust process and is therefore moving slowly. There have been no material development in the U.S. FDA regulatory agenda on neither menthol or nicotine. In vapor, we believe we are well-positioned to meet the new May 2020 deadline for PMTA submissions. As I said at the Capital Markets Day, I am looking to drive a step change in our new categories performance. I firmly believe that a truly global group like BAT needs to be strong in THP, vapor, and modern oral.
I am pleased to confirm that we expect to deliver on our guidance of New Category revenue growth around the middle of our 30%-50% guidance range on a constant currency basis. In the first half, New Category revenue grew 27% on a constant currency basis. Vapor revenue was up 58%, with good performance from Vype in Europe and Canada and Vuse in the U.S. This was despite Q1 Vuse sales being impacted by the Vype restocking and trade uncertainty around potential Vapor regulatory development. Modern Oral is the fastest developing of the New Categories. We grew revenue by nearly 300%, mainly due to the growth in ENA and new launches, including Lyft in Russia. I am very excited by our rollout plans for Velo in the U.S., which started last week. THP consumables revenue was up 15%.
Device sales were scaled back in anticipation of the launches of Glo Pro and Glo Nano in the second half. As a result, THP revenue rose 4%. This is expected to accelerate significantly in the second half, driven by new product launches. As you will see later, we have a lot of activities planned for the remainder of the year, and we expect a strong second half. Before we go into some of the details on new categories, I would like to talk about our brand portfolio. Following the acquisition of Reynolds, we have the opportunity to rationalize our large new category brand portfolio, focusing on core drive brands and fewer SKUs. We have therefore decided, subject to regulatory consideration, to consolidate and rationalize our vapor, THP, and Modern Oral brand portfolio into three global brands. In vapor, this will be Vuse. In THP, this will be Glo.
In Modern Oral, Velo. This consolidation will be completed by the end of 2020. This will allow us to focus our resources and internationalize our consumer propositions, creating strong global brands. I will now move on the new categories in more details based on the existing brand lineup. In vapor, Vuse Alto is performing well in the U.S. and is up 320 basis points since the beginning of the year. Awareness for the brand is still low at 30%, and active distribution is only around 25%. There is significant opportunity for further growth. Our focus is therefore on building Vuse brand through increased digital and face-to-face consumer activities. We have a significant uplift in support planned in the second half. In ENA, we continue to lead the category. In the U.K., vapor represents 25% of the total nicotine market, and we have a value share of 39%.
Vype achieved a record value share of 11.6% in June. This was driven by the success of Vype ePen 3, which grew value share by 410 basis points. In France, Vype reached a value share of 17.3%, led by ePen 3. We are now the number one player in the retail vaping market in France. Elsewhere, in Germany, Vype reached 12% share of total vapor consumers. In Canada, Vype reached 21% value share, driven by the successful launch of ePod at the beginning of the year. In Modern Oral, we are growing share rapidly in both the established oral tobacco markets in Scandinavia and new oral markets like Denmark and Switzerland. We are market leader in the Modern Oral category in both Sweden and Norway, with a 57% and 73% volume share respectively.
As you can see from the slide, this is driving strong growth in our share of the total oral category in both markets. In Switzerland and Denmark, we are also leading the development of the category with our Modern Oral offerings, achieving 42% and 67% volume share of the total oral category respectively. Modern Oral is an exciting, fast-growing category with significant consumer appeal. There are no device requirements and no limitations on where and when consumers can enjoy the products. We believe the category has significant untapped potential. We are performing extremely well, with revenues up almost 300% in the first half. Ultimately, new categories are all about expanding our share in the total nicotine spent by consumers. I'm delighted to say BAT remains the fastest-growing nicotine product company in Japan. Our overall share of the total nicotine market grew by 80 basis points this year.
In July, we reached a weekly record of 18.3%, up 160 basis points. This has been driven by growth in both THP and consumables. Glo is performing well in Japan, where THP now represents 24.4% of the market. Glo has captured 28% of segment growth since Q4 2018. Share in June is 5%, up 30 basis points despite significant competitor activities. In other markets, we have made good progress in a short period of time. Let's remember that Japan alone continues to represent more than 60% of worldwide THP volume. We will first prioritize Japan for our THP innovations, followed by launches in ENA. We have a strong pipeline of product launches and marketing support planned across new categories in the second half. Glo Nano is our new slimmer device addressing affluent explorer consumers' demand for a stylish day usage product. Glo Pro utilizes induction heating technology.
This delivers better satisfaction and a rapid heating for a quicker taste release. Glo Sens combines vaping technology with real tobacco, creating a bridge between THP and vapor for a satisfying full taste experience. We plan to launch Glo Pro, Glo Nano, and Glo Sens in Asia in the second half. These new products, combined with our newly launched flavor, will deliver our consumers better satisfaction and design. We are the only company to offer flavor capsules in Japan, which already represents 22% of our sales. We also have significant vapor activities planned for the second half. We will begin rolling out a new global brand positioning and campaign unifying Vuse and Vype, and supporting the migration of the portfolio to Vuse brand by the end of 2020. This will be backed by significant increased brand-building activities. Following our consumer segmentation, we are further strengthening our vapor product portfolio.
In the U.S., we plan to roll out a 2.4 milligram nicotine variant of Vuse Alto to address an emerging segment for lower impact products. In addition, we have just commenced a special promotion offer of $0.99 for Vuse Alto Power Kit. This is in response to the current competitive pricing environment and to drive awareness and trial. We also plan to launch an upgraded device for ePen 3 with better battery life and improved functionalities together with a new range of flavors. Finally, we are excited by the Modern Oral opportunity in the U.S. and we have ambitious plans for Velo, our Modern Oral nicotine product. The rollout is already underway with a rapid distribution expansion supported by digital, radio, and TV advertising, and direct consumer engagement. In addition, we expect the outcome of our MRTP application for Camel Snus by the end of the year.
This could give us a major opportunity to further develop this important potentially reduced risk product category. Outside the U.S., we have a number of new market launches for Epok and Lyft planned in the second half. In summary, we have significant activities planned spanning all three of our new categories, and we are confident that this will drive an acceleration of our growth in the second half. I will now hand over to Tadeu, who will take you through the financials in a little bit more details.
Thank you, Jack. I'm delighted to be taking over from Ben as Finance Director. I have worked with Ben for many years, and he has been a great mentor to me. I'm honored to be succeeding him. My focus will be on delivering a stronger, simpler, faster organization, ensuring we can free up resource for investment while generating cash to delever the balance sheet. As we grow our new categories business, I'll be driving efficient and effective resource allocation to ensure we maximize returns on investments. This is vital as the complexity of our multi-category business increases. This virtual cycle will increase operating margin, supporting our ambition to expanding margin by 50 to 100 basis points per year. It will also drive the 0.4 times annual reduction in leverage ex-currency we are targeting, fund increasing investment, and deliver investor returns. I will now turn to the numbers.
Revenue grew 4.1% on an adjusted constant currency basis. This was driven by a strong adjusted revenue growth of 5.2% in strategic combustibles. I should remind you that combustibles still represents 92% of our business. There was a good performance across the regions on an adjusted constant rate basis. In APMEA, volume including THP was down 2.3% and revenue grew 1.6%, with pricing was partially offset by lower sales of THP devices ahead of new product launch planned for H2. Despite increased market investment, profit from operations was up 4.6%. In AmSSA, volume was down 3.5% and revenue was up 7.5%, driven by strong pricing and higher revenue from new categories. Profit from operations was up 0.8%, with good performance in Canada, Nigeria, and Kenya, partially offset by significantly increased marketing investment. In ENA, volume declined by 4%.
Revenue was up 4.6%, with good pricing combustibles and a more than doubling of our revenue in new categories. Profit from operations was marginally higher due to the impact of increased investments in new categories. As Jack has already covered, in the U.S., we had a good performance. Revenue grew 3.7%, driven by strong pricing, reduced discounting, and improved mix. Profit from operations grew 11.2%, benefiting from the timing of investment and MSA costs, and the prior year comparator impacted by the Vype recall. Overall, we plan a significant increase in new category spend in the second half, in particular in the U.S., in support of Vuse Alto and the rollout of Velo. This will result in a more balanced performance across the regions for the full year. I'm delighted that after several years of transactional FX impact, we are back on a path of consistent margin growth.
On an adjusted basis, margin grew 110 basis points ahead of our guidance. This was after absorbing the increased investment in new categories, which was a headwind of 110 basis points. We made good progress on margin. We are on track to deliver on our guidance of 50 to 100 basis points of margin improvement for the full year, alongside the increased investment we are planning for the second half. Our growth in adjusted revenue and good cost management delivered a 5.9% increase in constant currency profit from operations. At constant rates, adjusted net debt at the half year was GBP 2.1 billion, higher than year-end 2018 levels. This was driven by the timing of the MSA payment, which occurs in the first half, and the implementation of IFRS 16, which increased the reported net debt by GBP 0.6 billion.
First half operating cash conversion was 66%, reflecting the normal timing of MSA payments in the first half. This is similar to H1 2018, if we adjust for the impact of the early MSA payment in December 2017. We expect a strong second half cash performance with a full year operating cash conversion in excess of 90% and a net CapEx of around GBP 800 million, allowing us to meet our target of GBP 1.5 billion of free cash flow after dividends. We are committed to the lever at 0.4 turns to a ratio of 3.6 at the end of 2019, excluding the impact of currency translation. This is based on delivering strong EBITDA growth and free cash flow after dividends of GBP 1.5 billion. We remain committed to growing the dividends and a payout ratio of 65%.
On a constant basis, adjusted diluted EPS grew 7.1%, delivering on our high single-figure earnings growth commitment. With a currency tailwind of 1.7% points, adjusted diluted EPS was up 8.8% at current rates. This was driven by growth in operating profit and a good performance from ITC. Net finance costs increased mainly due to the lower investment income and the impact of translational FX from the relative weakness of sterling against the US dollar. We continue to expect the full year net finance charge to be around GBP 1.5 billion. We also expect an effective tax rate of 26% this year, down from the 2018 level of 26.4%. On currencies, if rates were to stay where they are today, the translational FX impact on full year results would be a tailwind of around 3% on operating profit and EPS.
This was a strong first half with revenue, margin, profit, and EPS all delivering in line with the guidance we gave. In March, I stood up and gave stretching financial guidance for the full year, and I can confirm that we are on track to deliver against this. In constant currency, we expect revenue growth in the mid to upper half of our 3%-5% range, adjusted profit from operations growth in the upper end of our 5%-7% range, and continue delivery on high single-figure earnings growth. Thank you, and I will now pass back to Jack for a few closing remarks.
Thank you, Tadeu. In summary, I am determined to make BAT a winner in all nicotine categories, transform the business, and build a BAT, a stronger, simpler, and faster organization. Our combustible business is performing very well. Pricing is strong and market declines are in line with historical levels. We continue to build on our strong position in combustible tobacco. As we step change in new categories, we will build stronger global brands and provide consumers with great new potentially reduced products, increasing the opportunities for 150 million consumers to enjoy our products. We have work to do in new categories. I'm excited by our pipeline of product launches for the second half and into next year. I am confident we will deliver a strong second half with full year revenues growth around the middle of our 30%-50% guidance range.
I am committed to delivering high single-figure adjusted diluted EPS growth on a constant currency basis, strong cash flow, and tight cost control, while investing further in the brands and capabilities to build a global multi-category business. I'm looking forward to a strong second half and delivering on the full-year guidance we gave in March. Thank you. I will now open up for questions.
Thank you. Ladies and gentlemen, if you wish to ask a question, could you please press zero and then one on your telephone keypad? If you wish to withdraw that question, you can always do so by pressing zero and then two to cancel. There'll be a brief pause while the questions are being registered. Our first question is over to the line of Owen Bennett at Jefferies. Please go ahead. Your line is now open.
Morning, guys. I hope all well. I just had a couple of questions on reduced risk in the U.S. I see with recent Nielsen numbers, NJOY seems to be having a bit of success. Just some comments on that. Secondly, you spoke about moving to GBP 0.99 with Vuse Power Kits. Is that something that everyone is doing at the moment in terms of move to that price point?
Yes. Thank you for the question. I'm not going to comment on competitive activities. What I can tell you is that Alto is performing well, that there are some price scam issues in the market, and I will respond accordingly in limited geographies. That will make sure that we continue on our path of growing Alto in the U.S. market. The brand is growing strongly. We will do more investments in the second half, as we said in the presentation, and we'll make sure that the Vuse brand is growing significantly in H2.
Okay. Just quick follow-up. Obviously, Altria reported numbers. They're talking of the opportunity around IQOS and heated, and say there's quite a significant opportunity there. I was just wondering to that extent, why you continue to be quite quiet around plans for Eclipse/Vype? I know you say you want to focus on Modern Oral, it just seems a bit strange to me to ignore a category or at least be a bit more vocal around your ability to compete in that segment if you needed to.
Yeah, I think you have to consider the fact that the categories that are emerging and strong in the U.S. are already established, like the vapor category. On top of that, we see a great opportunity in oral tobacco. No devices, you can use it everywhere. That we consider that this should be the two points of focus for the time being. We have a product that is there in the U.S., but I prefer to focus my resources and make sure that we are successful in the vaping category. That is the biggest category in terms of new categories at the moment. Oral tobacco, that has a lot of potential moving forward.
Cool. Thanks very much. Appreciate it.
Okay, we are now over to the line of Gaurav Jain at Barclays. Please go ahead, sir.
Hi. Thanks a lot for taking my question. The long-term U.S. volume market decline was recently updated by Altria from -4% to -6%. They gave a number of reasons, including higher cannibalization of e-cigarettes, also high cost taking off in the U.S. Do you have any view on how the long-term U.S. cigarette volume declines pan out? How should that impact your long-term EBIT growth in the U.S.? Thank you.
Thank you very much for your question. Our view related to the market goes to the end of the year, we say around 5.5%. Why? Because there has been an additional price increase in July. That's the inflection between the previous guidance and the 5.5% that we're giving now. We don't see any major shifts in terms of the e-cigarette development in the U.S. Also, we see that since the beginning of the year, the price of petrol has increased significantly from GBP 2.50 to GBP 3.90 recently. To GBP 2.90, sorry, recently. These are the major drivers in terms of the size of the market. After that, we'll have to see what happens with the pricing in the market and with the development of e-cigarettes and oral tobacco in the market.
Sure. If I can ask a question on leverage. You are reiterating your leverage reduction targets, and investors are worried about your high leverage in a context where the industry is changing so rapidly. Is there an opportunity for you to accelerate your leverage reduction target, maybe by reducing dividend growth or through working capital improvements? There is a margin gap between you and Altria in the U.S. Why can't that be closed?
Yeah. We have plans to even strengthen our cash generation from next year onwards. I think that we have opportunities. We guide this year that we will be above 9% conversion. We think that for next year onwards, we can be a bit more optimizing working capital and CapEx and bring this target to at least a 95% growth. This will give us the reassurance of the GBP 1.5 billion of free cash flow after dividend generation. We have to consider that over time, as the profit grows, this number also will be growing over time. We are pretty confident that with the combination of a strong cash generation like this BAT today with the strong earnings that we have already guided, we will be able to delever at 0.4. By the end of 2020, we should be very close to the 3 tiers in terms of ratio.
Sure. If I can ask one last question around Velo launch in the U.S. The margins on your smokeless tobacco product are pretty high. Is there a risk that Velo is going to cannibalize your own business before it goes into the growth opportunity which is available in the market?
No. We see that there is a lot of complementary because of the new moments of users from consumers, we don't see this as a direct cannibalization at all. It's very different from THP. We have actually very strong margins also in this type of products. I know that the U.S. combustible is also very high, we are less concerned about that because we don't see this level of cannibalization being that much.
Sure. Thanks a lot.
Okay, we are now over to the line of Adam Spielman at Citi. Please go ahead, sir.
Thank you very much. My first question is really about marketing spend. You said that in the first half, U.S. profits were perhaps a little bit higher than usual because of reduced marketing spend. Then you sort of said in the second half, marketing spend will increase on the new categories. One question is, are you able to quantify in any way at all the impact of the reduced marketing spend in the first half and equally in the second half? That'd be my first question.
Adam, actually, we didn't reduce marketing investments in the U.S. in the first half. What we were saying is that in the second half, we have further increased marketing investment. The performance in the U.S. was pretty much driven by the fact that we have a very strong pricing with less discount, improved mix. We grew value share by 30 basis points. This all contributed. On top of that, we had some timings, one-offs that I would say related to the Vype recall. Remember that we are lapping a semester last year where we had to stop selling the product, and on the same time, we had the write-off cost related to the recall. On top of that, we had MSA charge movements that also impact favorably the U.S. in the first half.
What we said is that in the second half, we don't have these one-offs in the first, and on top of that, we're increasing further the investment behind a new category in U.S. specifically.
Are you able to quantify that in any way at all, the increase in investment?
Well, the only thing I can say to you is that these one-offs that we have, if you strip out the one-offs in the first half of the U.S., you still would give us a kind of high single-digit operating profit, will not be the double-digit that you are seeing in the report today.
Yeah.
You have to take into consideration as well that there was some movements in terms of one-offs in other regions. I expect at the end of the year that we'll have a much more balanced profits across the regions in BAT.
I suppose that perhaps answers what was going to be my next question, because my next question was going to be, if your marketing spend goes up in the second half, is there anything to offset that with lower costs to ensure that you get your guidance? Is the answer to that fewer one-offs, or how should we think about what offsets the increase in marketing?
Adam, this is Jack. I think your question is very important. What we want to do is to invest the right amount of money in the business. We have new launches that are coming through. We want to make sure that we'll put sufficient resources related to that. The second point is, we're very committed to delivering the financials for the full year. We have the space to continue to invest more in the second half of the year. We believe that the offers that we have for the consumers for the second half are very powerful to look at the different segments that we're going after. I think that we have the possibility to deliver the financial results and to invest. Of course, as you're saying, we are doing a huge efforts in terms of cost base.
There is a reorganization of the company that we are undertaking as we speak. Also we reduce the number of SKUs, as I said, in combustibles. We're reducing the number of SKUs in new categories, we are making sure that we're sweating our cost base as hard as we can.
Yeah.
Okay. Thank you very much. That's very clear, Jacques. One final question from me. I noticed that if I look at your new category sales half on half, they're quite volatile. An example of that is that if I think about e-vapor, let's say in the U.S., it was quite low in the first half of last year, then it jumped up a bit, and sequentially, it's fallen a bit. I guess that's to do with pipeline effects. I was just wondering, and I assume there are going to be more pipeline effects in the second half as you launch new products in Japan, and also some of the new e-vapor products globally.
I was just wondering if you could sort of talk to that in any way, if you can somehow disaggregate what is sort of really going on an underlying basis versus pipeline filling. As we do our models, it's quite confusing seeing this volatility in the line items.
Specifically in the U.S., the major driver for the variance that you are referring to is related to the Vype recall. If you strip it out, the numbers will be very different when you compare second half 2018, first half 2019. You have to take this into consideration. There is elements of pipeline, but I don't think that the element of pipeline would be as strong as to justify any major swings as the one that you refer to.
What's important to consider, Adam, is that's why we gave a guidance of 30%-50% in average in the years to come. What is important to consider is there is a lot of fluctuation related to new launches, our new launches, competitive launches. That creates a distortion on the monthly basis. Nonetheless, we confirm and we affirm that we're going to deliver 40% around the middle of the range of 30%-50%. That's important to us, and we're putting a lot of efforts related to that. I vividly remember your question at the investor day where you said that we have to make sure that we can balance additional investment and not only delivering financial results at the end of the year. That's what we are doing. I took your advice, Adam.
Thank you very much. Thank you for answering so clearly.
Cheers.
We are now over to the line of David Hayes at Société Générale . Please go ahead. Your line is now open.
Thank you very much. Hi, everyone. I'm going to go for three questions if I can. Firstly, just on pricing, the outlook for the full year. I wonder whether you can tell us what % of pricing you've already taken for this year and what the outlook is for pricing, therefore, for the full year. Secondly, you just mentioned again about the cost savings and as you rationalize the portfolio. Is that having any effect on volumes negatively, or would we expect that to have any effect on volumes negatively in the second half as you go through that process? Thirdly, just on the FDA update on nicotine amendments. For both you and Altria, you seem very confident that there won't be any more updates before the end of the year.
I just wonder whether you take that to mean anything in terms of what's going to be the outcome of those proposals. Thanks very much.
Okay. Sorry, I was trying to get the first question first, then the others. I'm going to pick up two, the first one and the last one. The second one I didn't hear. I leave it to Tadeu. The first one was related to the pricing. Where are we in the pricing? We are at 78% of our pricing in the first half of the year. That's a very strong position, and we're happy with that position. Still some to go for the second half of the year. The second thing is related to the FDA. Very clearly, as we said during the presentation, I would say the doomsday scenario that has been spoken about in the last three years is not yet materializing.
We are very confident in the robustness of the process of the FDA in terms of regulatory framework. We do not hear, at the moment, any significant movements related to neither nicotine reduction nor menthol ban. Of course, there will be some things happening in terms of e-cigarettes in the U.S. market. We consider that we will be in a good space for the new deadline that has been fixed, which is the summer of 2020. I think that we have a robust portfolio that continues to grow. We have opportunities to grow further and beyond. As I said, for e-cigarettes, especially for Alto, we have a brand awareness of around 30% and an active distribution in the market of around 25%.
That gives us a lot of space to invest and to grow the brand in the U.S. The third question, I didn't hear, I'm sorry, because I was trying to get the questions one after the other. Tadeu?
You can confirm. I think that you are referring to the volumes and implication of the volumes on price due to the pricing. Is it right?
No.
No.
It was more actually the SKU rationalization, the portfolio rationalization, which obviously is helping the cost save generation. It's just whether, as you go through that process, does it have a negative volume impact at all? Either have we seen that or does it have an impact negatively in the second half as you rationalize the portfolio and take some of the SKUs out of the market?
Yes. We don't see any major impact from rationalization of the portfolio and volumes. What we are seeing is that there are some specific markets where, for different reasons, mainly related to tax increase, and we are losing volume in a very low value, low margin markets like, for example, Bangladesh, where we had an excise increase in the second half of last year, which raised the floor of the market by 30%, and the illicit trade grew tremendously sharply in that period. The market went down 10%, and we are market leaders there. Venezuela, where we also are market leaders, and there is a massive issue related to the economic and social problems in Venezuela right now. Egypt also took some price in the low end, hitting us where we were leading in the low end of the segment.
This is a drag that could add up to close to 2% of our report, 3.5% now. A big part of this drag will probably continue over time because these are situations that we don't see unwinding for the rest of the year. As I said at the beginning, they are very low margin, low value, and there is minimal impact in terms of the group financials related to those volumes. In terms of the portfolio rationalization, we are not seeing any downsize material related to that.
Okay, that's great. Thank you.
Okay, we are now over to the line of Nico von Stackelberg at Liberum. Please go ahead, Nico. Your line is now open.
Thank you. Good morning, guys. You basically said that you're not aware of plans for the FDA to advance a rulemaking process on nicotine. Now the FDA or former members of the FDA have publicly said that they expect a preliminary rule at least to leave the FDA for HHS. Altria also said the FDA may publish a nicotine rule by the end of the year. Just trying to appreciate maybe diction's coming into play here, but so what's the difference between your view and Altria's and sort of what has been said? I have two more questions, but maybe just one at a time.
Yeah, thank you very much. Yeah, the FDA as we said, did not make any moves related to neither nicotine nor menthol, and we do not hear anything about that very clearly. In terms of nicotine, in terms of e-cigarettes, sorry. Of course, we've always said that we need a more efficient regulatory environment related to e-cigarettes, especially related to the epidemic of underage usage. We have been always extremely clear that we will not have some activities in there and that our marketing code that we have in the company is very strict related to that. We never have been ever considered as promoting our products to underage smokers or underage users, and we'll continue to do so. In terms of further regulatory activities related to e-cigarettes, we are very well equipped with the approach that we have in the market to respond to these kind of evolutions.
As, for instance, the evolution happened related to 2020 and the new deadline, then we're ready to cope with that. We're a strong company with a very strong R&D and with very strong capabilities in the U.S. to respond to that environment.
Okay. The next question's on cash generation in general. You've given some numbers here, and they are quite adjusted. I was just sort of wondering if you could maybe help out on just a statutory basis maybe, or a statutory on constant rate basis. Could you just help me with the cash flow from operations in terms of where you see that by the end of the year? Of course, MSA payments, I'm not interested in the MSA payments. I've realized that was a big technical for the first half. The working capital was a little bit lower than I'd expected. Just, can you help me square that, please?
Yeah. Nick, we have a distorted and difficult read of the cash flow because of the MSA payment that was done in December 2017. That impacts the first half of last year when you compare this period with the previous periods. If you take this apart, and we try to do that when we report on a normalized base, there is basically one movement, a high movement in terms of working capital. This is basically inventories movement. Our conversion this time was around 66%. Last year was slightly better, was around 70%. As we expect to be ahead of 90, I would say I'm expect to be very close to between 94, 95 for the end of the year. From next year onwards, like I said before, we are targeting a threshold of 95 in terms of conversion of operating cash flow.
Excellent. Thank you. Finally, just a quick one. We've discussed this before back in March, the PMTA for Glo, I was just sort of wondering, do you have an update here? It seems like it's taking a little while to get that application through. Why is it taking so long? Is it sort of like thinking around which product you PMTA? Yeah, what is the general thinking there? Thanks.
PMTA of THP?
Yeah, exactly. THP in the U.S. Glo, yeah.
It's a good question. We already have a product that went through PMTA. We are covered with that. I do consider that the objective is to have the best product that is put in the PMTA, and it takes a bit of time. I'm not concerned related to that because the market in the U.S. is already very strong in terms of new categories and the leading categories are by far e-cigarettes for sure, where our performance is improving. Oral tobacco, that is something that we see has a very big potential in the U.S. I'm not concerned related to that for the time being.
Okay. Thanks, guys.
Thank you.
Okay. Before going on to the next line, which is Richard Taylor at Morgan Stanley, could you please, if you have any further questions and haven't already, press zero and then one to join the queue. Richard, over to you.
Good morning, everyone. Thanks for the question. Can you give us an update on the developments for Modern Oral in Europe ex Scandinavia? Any positive developments we should be thinking about there?
First of all, we're having a very good performance in Scandinavia, even in traditional snus markets where snus can be up to 50% of the total market. It's a category that is growing because there is a consumer need related to that. The second thing is from the experience that we have in Switzerland, we saw that the category is growing very fast. Now that that category of oral tobacco is bigger than THP in Switzerland. Last point, as I said, I highlighted in the presentation, we're doing some trials in Russia at the moment, and we see that after some weeks, we have 25% of the category. We do consider that we have extremely good products.
We have very good IP also related to these products, and we have the capability to roll out. The benefit of this category, as we all know, there is no devices and the margins are extremely good. We do believe that the potential outside of Scandinavia is big, and that's why we're launching Velo in the U.S., and we expect strong results for the second half of the year related to Velo launch in the U.S.
That's very helpful. Thank you. How should we think about the phasing of the investment in terms of U.S. versus the rest of the world through the rest of the year, please?
Yeah, this would be a competitive information, so I would not go there. What I can reaffirm is that we've invested more in the first half of the year, also slightly more in combustible business in order to make sure that we continue to do the right job in combustible business. We did not reduce the investment in combustible business. We've increased it slightly in the first half of the year. We will roll out the different plans that I presented earlier through the presentation. It's not a question of allocation of resources between the U.S. and the rest of the world, but more covering the consumer needs and doing the right launches for the different new innovations that we have. We will have also for 2020, a stronger pipeline in order to be successful in the market.
Okay. That's very clear. These two questions are related, the two last questions are related. It'd be very helpful if you can give us guidance on your expectations for net debt to EBITDA for the full year on a mark-to-market basis. I can see the currency adjusted basis, it would be very helpful on a mark-to-market basis. I suppose this is a follow-up to Gaurav's question earlier. Jack, at your Investor Day, you said you wanted to prioritize deleveraging. I wrote down you saying that, "The huge debt allows me to bring a sense of urgency and focus to the people of BAT." It looks like growing EBITDA faster is your plan A, but it isn't really speeding up the deleveraging. What other options should we be thinking about? Is it accelerated cost savings? Is it something with a dividend?
Is it brand sales, asset sales? It would be great if you could give us some color into your thought process here, please.
Yeah. Let's start from the beginning. We are doing a lot of efforts. I will not give breakdowns or direction related to that because that's forward-looking. We're doing lots of efforts in terms of our cost base. As I said, we're reorganizing the company to be a more effective and efficient organization and to declutter the organization. That will bring some savings. We are doing a lot of efforts in terms of reduction of our CapEx moving forward because we've done a lot of investment in the last two years in terms of CapEx. Now it's time to harvest on that. We're going to continue to reduce the number of SKUs in both new categories and combustibles in order to free up some cash. All the other options I'm not going to comment on because it's not the right time to do it.
Just to complement on your request, Richard. I can even tell you where we stand now, but it's really not helpful because BAT is a very cash generative company at the second half of the year, because we are just lapping the MSA payment and a lot more of cash will come, it will be generated until December. Also, we expect to have a stronger second half in terms of earnings compared with the first half. We are on track to deliver the GBP 1.5 billion free cash flow after dividends. With the stronger earnings in the second compared with the first half, deliver at the upper range of our guidance in terms of earnings, that we'll be able to delever at the 0.4 at currency neutral.
As you likely point out, the 31st December is a key date for us in terms of exchange rates. Everything that I can say from there is pure speculation.
Okay. Thanks very much for the questions and answers, cheers.
We have time for, I afraid, one final question. We are going to go to the line of Gerry Gallagher at Deutsche Bank. Please go ahead, sir, your line is now open.
Thanks very much. I had more of a comment to make rather than a question. I couldn't let today's call go by without mentioning Ben on behalf of the investment community. On behalf of everybody on this call and those that can't make it, I just want to offer Ben all the very best for a long and fulfilling retirement. I'm very conscious that a number of people on this call haven't been involved in BAT as long as I have and a number of other people who cover the company. I just wanted to outline for those people what Ben has been up to through his career at BAT, just so that they can understand the impact and the very positive impact he has had on the business.
As Jack said, Ben joined in 1990, but I think it's important for people to understand that Ben has been far from a career accountant. He's had roles in marketing. He's run the business in Pakistan and Russia. He's run corporate affairs. Ben was in charge of merging Rothmans and BAT in 1999, which is a transaction that happened very quickly after the demerger of the insurance businesses in 1998. My recollection at the time was that that deal was kept incredibly tight amongst a few people at BAT. For Ben to take that up and do the excellent job of integration he did, I think is extremely commendable and noteworthy. That was one of BAT's major acquisitions we've seen over the last 20 or 30 years. Ben has also been in charge of strategy, M&A, and IT.
In 2004, he went off to run the European business before becoming the CFO of the business, in 2008, 11 years ago. That's something I will come back to in a second. Clearly, a CFO can't be judged and shouldn't be judged by the numbers alone, far from it. I just want to highlight one, which is one that most people would say Ben has got most control over and has had also in a number of his roles in the past. The year before Ben became CFO, the margin of BAT was 30.5%. The margin at the end of 2018 was 42.6%.
I think he's, as we've heard today, set the business up to be in a position where post his retirement, the business is in good shape to continue to drive the margin of the business higher whilst maintaining the momentum sustainably in the top line of the business. I think that is to be commended. One final point I do want to make. You may recall when Nicandro retired, I said to Ben that he should be very worried because I've known him longer and he's been around longer in terms of exposure to the investment community. Well, the reality is, I've got nothing that I can say that can wind Ben up.
I think the reality of that and the reason for that is you're just, Ben, a decent bloke, and I've had a lot to do with you over the years, but I've enjoyed our time together. As a CFO of a business like BAT over 11 years, you've had 22 half-year and full-year results, but the reality is you've had a lot more than that, if nothing other than before very recently, you had the quarterly updates as well. I hate to think how many questions you've had from people on this call and people in the past, and you've handled them all with extremely good grace when we all know that some of them were, if not stupid, pretty close to stupid, and the grace with which you dealt with them on each and every occasion is to be commended.
With that, Ben, my very sincere and on behalf of everybody, sincere wishes for you, your family, as you move forward into the next stage of your life. Thanks very much, Ben, and good luck. Thanks, Gerry. I appreciate your comments.
Thank you very much, Ben. Yes, an amazing career with BAT, and best of luck for your retirement and using your magnificent new boat. Thank you very much for listening. If you have any follow-up questions, please contact the investor relation team. I'm looking forward for a strong second half and delivering on the full year guidance we gave in March. We look forward to speaking to you in February next year at our preliminary results announcements. Thank you very much.