Good day, and welcome to the Altria Group 2019 Second Quarter Earnings Conference Call. Today's call is scheduled to last about 1 hour, including remarks by Altria's management and a question and answer session. Representatives of the investment community and media on the call will be able to ask questions following the conclusion of the prepared remarks. I would now like to turn the call over to Ms. Paige Magnus, Vice President of Investor Relations and Communications for Altria Client Services.
Please go ahead, ma'am.
Good morning and thank you for joining us. We're here this morning with Howard Willard, Altria's CEO and Billy Gifford, our CFO, to discuss Altria's 2019 second quarter and first half business results. Earlier today, we issued a press release providing these results. We're also including slides to accompany our remarks, and all of this information is available on our website at altria.com and through the Altria Investor app. During our call today, unless otherwise stated, we're comparing results to the same period of 2018.
Our remarks contain forward looking and cautionary statements and projections of future results. Please review the forward looking and cautionary statements section at the end of today's earnings release for various factors that could cause actual results to differ materially from our projections. Future dividend payments and share repurchases remain subject to the discretion of Altria's Board. Share repurchases depend on marketplace conditions and other factors. Altria reports its financial results in accordance with U.
S. Generally accepted accounting principles. Today's call will contain various operating results on both a reported and adjusted basis. Adjusted results exclude special items that affect comparisons with reported results. Descriptions of these non GAAP financial measures and reconciliations are included in today's earnings release and on our website at altria.com.
With that, I'll turn the call over to Howard.
Thanks, Paige, and good morning, everyone. Altria delivered excellent second quarter results, driven by the performance of our core tobacco businesses. We grew adjusted diluted earnings per share nearly 9% in the 2nd quarter with each of our core tobacco segments delivering double digit adjusted operating companies income growth, expanding their already impressive adjusted operating companies income margins and maintaining momentum on their leading premium brands. The strong second quarter was a big step up from the first as the negative smokeable inventory impact in the Q1 reversed to a benefit in the second. The second quarter also saw the benefits of our cost reduction program ramp up and we expect these will continue to build through the year.
In the second quarter, we made important progress further enhancing our business platform and non combustible product offerings for adult tobacco consumers. In April, FDA authorized PMI's IQOS product for U. S. Commercialization in the heated tobacco category. And in June, we signed an agreement to acquire 80 percent ownership of the companies that will globally commercialize ON, a leading product in the rapidly growing oral nicotine pouch category.
We also saw an acceleration of consumer trends that we believe further validate the strategic actions that we've taken over the years. We believe that with our leading premium brands with our leading premium tobacco brands, U. S. Commercialization rights to IQOS, the leading global heated tobacco product, our investment in Juul and pending transaction for ON, we're best positioned with a strong and resilient combustible business and the best non combustible portfolio in the U. S.
Tobacco market. Let's turn first to our Smokeable Products segment. The Smokeable Products segment generated strong adjusted operating companies income growth of 11% in the 2nd quarter, primarily driven by the benefit of higher pricing and the impact of our cost reduction efforts. For the first half, the smokeable segment delivered 5.7% adjusted operating companies income growth. BM USA is pleased with Marlboro's continued stability with retail share of 43.3%, unchanged versus the year ago quarter and up 0.02% sequentially.
Marlboro's performance continues to be supported by its leading brand equity, bolstered by investments in product expansions, packaging innovation, and digital loyalty and trade programs. In discount, L and M is performing in line with expectations and we are pleased with its increased profitability over time. We believe discount category dynamics continue to primarily reflect a churn between branded discount and deep discount offerings. The overall discount category grew a 10th sequentially in the quarter to 24.2% and the discount category remains essentially in line with historical share. Turning to cigarette volumes, the first half of twenty nineteen saw large inventory fluctuations.
Wholesalers depleted PM USA inventories by 400,000,000 units in the 1st quarter and rebuilt inventories by 500,000,000 units in the second quarter. The net result being a 100,000,000 unit benefit to reported volumes in the first half compared to a 400,000,000 unit depletion in the first half of twenty eighteen. We estimate that the adjusted industry decline rate in the 2nd quarter was 6%, up from 5% in the Q4 of 2018 Q1 of 2019. Over the first half, the adjusted cigarette industry decline rate was estimated 5.5%. Let me provide you with some perspective on the factors driving category volume declines.
Over the past 12 months, U. S. Cigarette which we estimate is primarily due to increased adult smoker movement to the e vapor category. We believe this reflects both increased availability of satisfying e vapor products that began mid year 2018 and higher levels of exclusive e vapor use. After considering the latest information, we are revising our 2019 estimate of U.
S. Cigarette industry volume decline rate to 5% to 6% from a range of 4% to 5%. We have also considered the combined effects of the current acceleration in adult smoker movement across categories and the recent strong national momentum behind raising the legal age to purchase all tobacco products to 21 and our estimate of cigarette declines through 2023. Specifically, we expand our 5 year compounded annual average rate of category decline estimate to 4% to 6% for our previous range of 4% to 5%. It's informative to compare smokeable business results versus historic category volume declines.
In the first half, adjusted category volumes were down 5.5 percent and the smokeable segment grew adjusted operating companies income 0.7%. By comparison, over the past 4 years, adjusted category volumes declined approximately 3% on a compounded annual basis and the smokeable segment grew adjusted operating companies income 5.2%. We believe this demonstrates how our strong and resilient smokeable platform can deliver profit growth in the current volume decline environment. Solid profit growth is also demonstrated in our Smokeless Products segment results. USSTC is successfully executing against its strategy of maximizing income while maintaining momentum on Copenhagen over time.
USSTC is one of the most profitable non combustible tobacco businesses in the world and offers a portfolio of satisfying products with the potential for harm reduction. USSTC grew its adjusted operating company's income by 10.8% in the 2nd quarter and 9.4% for the first half, reflecting consistently strong results so far this year. And Copenhagen's category leading retail share grew by 0.3% to 34.6% in the 2nd quarter. USSTC's smokeless volumes decreased an estimated 2% in the first half when adjusted for calendar differences and trade inventory movement. USSTC estimates that smokeless industry volume decreased 1.5% in the last 6 months.
We believe these declines reflect increasing adult tobacco consumer interest in both e vapor and oral nicotine pouches. In June, we announced an agreement to acquire 80% ownership of the companies that will commercialize on oral nicotine pouches through Helix Innovations, a newly formed operating company. ON offers a total of 35 SKUs, representing the broadest oral nicotine pouch portfolio in the U. S. Market today.
We expect the transaction to close in the second half of this year. In advance of closing, Altria Group Distribution Company began expanding availability of the ON portfolio to select retailers this month. Upon closing, our focus for ON will include further expanding retail distribution and visibility, building U. S. Production capacity, building the ON!
Brand through adult tobacco consumer engagement and preparing PMTAs for the ON! Portfolio. We're excited about adding ON! To our business platform and pursuing a leadership position in this new and rapidly growing category. Also in non combustibles, IQOS has shown to be a leading product internationally.
We're pleased to have access to an inhalable alternative that represents the 1st next generation tobacco product to receive FDA pre market authorization. We're ready to begin commercializing IQOS in the U. S. And are committed to its success. We expect the first IQOS store to open in Atlanta in September, along with other retail touch points, including mobile retail units and retail kiosks, all restricted to adult smokers.
We plan to have the IQOS website live in August, where adult smokers will be able to preorder their IQOS devices for pickup at the IQOS Atlanta store. Initially, we expect HeatStick distribution to be in approximately 500 Atlanta area stores. We are very excited to bring IQOS to adult smokers in the U. S. And intend to capitalize on this first mover advantage.
Turning to e vapor, the category continues to grow as adult smokers increasingly find satisfying options in the category. We of course participate in the e vapor category through our investment in Juul. After initial trial and experimentation with e vapor, adult vapor participation in the category declined from 2014 to 2016. The number of adult papers reaccelerated upon the availability of more satisfying pod based products. Based on our 12 month moving data, we estimate there are now 13,800,000 adult vapers as of June 2019, up from 12,200,000 at the end of 2018.
Importantly, that growth Importantly, that growth trend coincides with a trend towards more exclusive use in the category. According to our adult consumer tracking data, we estimate more than 7,000,000 adults vape and do not smoke as of June 2019. In the first half of twenty nineteen, we estimate that e vapor category volume grew by approximately 40% year over year across open and closed systems and all trade classes. Since 2017 and even considering more recent competitive product expansions, our data indicates that Juul has driven nearly all of the category growth. Juul's share of the category across both open and closed systems grew to 48% in Q2, up from 44% in the first quarter and its full year 2018 share of 33%.
Juul continues to be the category leader despite the removal of certain flavors at retail that caused the 1st quarter sequential volume slowdown. While competitors have responded increasing the availability of non traditional flavors, we believe their tactics will ultimately be addressed with full implementation of FDA's ENDS guidance later this year. Internationally, Juul continues to make progress expanding to additional markets. Since April, JUUL launched in several new markets, which include Ireland, South Korea, Austria and the Philippines. JUUL plans to launch in additional markets by the end of this year.
It's still early days for JUUL International Distribution. However, we are working to establish a measurement system that appropriately captures trade channels in overseas markets and provides a more complete view on consumer takeaway. Providing thoughtful solutions to address UV vapor use is a top priority. We know that the future viability of these products is at risk unless more is done to reverse the underage evaper use trend. We strongly believe that raising the legal age nationwide to purchase all tobacco products to 21 is one important step toward addressing this issue.
So far, our advocacy has helped drive significant progress at both the federal and state levels. Earlier this month, Ohio became the 18th state to make 21 the legal age of purchase. And now over half of the U. S. Population is covered by legislation requiring 21 as the minimum age.
Bipartisan federal legislation has also been introduced with broad support, so the effort has strong momentum. We believe it is critical to preserve e vapor products as an option for the more than 13,000,000 adults who use them and the 1,000,000 more adult smokers who are interested in non combustible alternatives. Earlier this month, in the case pending against FDA in federal court in Maryland, the court revised PMTA deadlines for new tobacco products on the market as of August 8, 2016 to be May 2020. According to the court order, new products for which applications have not been filed within this period will be subject to FDA enforcement discretion. We expect the new timelines to present a challenge for all companies impacted by the court's ruling.
In preparing their applications and we are offering regulatory consulting services. In summary, our 2019 plans remain on track. We're operating in a rapidly changing industry. We've long anticipated consumer adoption of new types of products with potentially lower risk. This is one of the main reasons we supported FDA regulation many years ago to facilitate this change and it's dynamics during The dynamics during the first half of the year further validate our strategy.
With increasing success migrating adult smokers to non combustible products, we're pleased that our strong core businesses are well positioned to provide profit growth through this transition. We continue to believe that we're building a business platform that enhances our ability to deliver solid performance and returns to shareholders over time and across a variety of scenarios. We reaffirm our guidance to deliver full year 2019 adjusted diluted earnings per share of $4.15 to $4.27 This range represents a growth rate of 4% to 7% from a 2018 adjusted diluted EPS base of $3.99 I'll now turn it over to Billy to provide more detail on our performance and other investments.
Thanks Howard and good morning everyone. We'll begin with additional color on our smokeable products segment. Reported domestic cigarette volume increased 0.3% in the 2nd quarter as trade inventory dynamics more than offset the industry rate of decline and year over year retail share declines. When adjusted for inventory movements and other factors, smokeable product segment cigarette volume declined by an estimated 7% for both the Q2 and first half. In the second quarter, the smokeable product segment expanded OCI margins by 1.8 percentage points to 54.4 percent driven by higher pricing and lower controllable cost, partially offset by higher resolution costs.
In the smokeable product segment, strong price realization reflects both pricing actions and greater efficiency and use of promotional resources, thanks to investments made in trade programs, data analytics and consumer data. Net price realization was 7% in the 2nd quarter and 7.7% for the first half. The mobile rewards program continues to resonate with adult smokers and drive visits to marlboro.com. In July, PM USA hit a terrific milestone with over 2,000,000 enrollees and more than 100,000,000 pack codes entered since the program launched in January. Beginning in April, PM USA expanded Myrtle Smooth Ice in the resale pack nationally, which is now distributed in over 113,000 retail stores.
Marble Smooth Ice continues to receive positive feedback from adult smokers and the trade. Between July September, adult smokers can earn up to 3 times the rewards points for every pack of MARBLE Smooth ICE entered. We expect this offer to encourage trial of MARBLE Smooth ICE and drive repeat purchase among adult smokers. Building on its early success in the Western U. S, Nat Sherman expanded Nat's to all 50 states in the Q2.
Nat's competes in the super premium segment and offers adult smokers a unique cigarette proposition of simply tobacco and water. And in cigars, volume grew 2.6% in the 2nd quarter and black and mild continued its strength in the premium tipped cigar segment. On the legislative front, we continue to monitor cigarette state excise tax increases. On July 1, SCT increases in 2 states, Illinois and New Mexico went into effect, bringing the weighted average SCT as of July 1 to $1.82 per pack up $0.03 from $1.79 per pack when compared to both year end twenty eighteen and the first half of twenty nineteen. In smokeless, USSTC expanded adjusted OCI margins by 4.1 percentage points to a remarkable 74% in the 2nd quarter, driven by higher pricing and lower cost.
USSTC's retail share declined 0.2% in the 2nd quarter to 53.9%. Copenhagen's retail share grew 0.3% of a share point to 34.6 percent and Skol's retail share declined 0.6 percent of a share point to 15.8 percent. In May, US STC opened the original snuff shop in downtown Nashville. The original snuff shop allows adult dippers to immerse themselves in Copenhagen's rich 200 year heritage and reinforces the brand's already strong equity among adult dippers. Turning to our alcohol assets.
In wine, the premium segment continues to be highly competitive. Saint Michel delivered adjusted operating company's income of $19,000,000 down 29.6% in the 2nd quarter, primarily due to higher cost and unfavorable premium mix. To help reinvigorate its portfolio, St. Michel is making investments to modernize its marketing approach through digital and packaging innovation, including the Q1 launch of 14 hands in aluminum cans. In beer, adjusted earnings from our equity investment in ABI were $212,000,000 in the 2nd quarter, up more than 35% year over year, reflecting Altria's share of ABI's Q1 results.
I'll turn briefly to our investment in cannabis. With its well capitalized balance sheet, we believe Cronos is making good progress in executing against its growth strategy. Cronos continues to focus on augmenting its management with top talent and investing in intellectual property and differentiated brands. Kratos also recently announced its agreement to purchase a state of the art production facility in Canada to advance its partnership with Ginkgo Bioworks and ultimately support large scale cannabinoid production and efficiency. We continue to be excited about the global potential of the rapidly growing cannabis category and believe that U.
S. Federal legalization is inevitable. We also believe Altria's capabilities will help Cronos establish a leadership position in such scenario. Moving to our capital allocation, we continue to return a significant amount of cash to shareholders in the form of dividends and share buybacks. In the Q2, we paid $1,500,000,000 in dividends and have a highly attractive dividend yield.
Altria's current annualized dividend rate of $3.20 per share represents an annual dividend yield of 6.4% as of July 26, 2019. In the Q2, we also repurchased 3,700,000 shares for a total cost of $195,000,000 which concluded our $2,000,000,000 share repurchase program. Yesterday, the board authorized a new $1,000,000,000 share repurchase program, which we expect to complete by the end of 2020. Our previously announced cost reduction program remains on track and we still expect to realize $575,000,000 in annualized cost savings by the end of 2019. The program includes savings from workforce reductions, 3rd party spending reductions and closure of our Newmark operations.
Workforce reductions were largely completed in the 1st quarter, so our 2nd quarter results reflect cost savings offsetting more of the incremental interest expense we incurred related to our transactions in the Q4 of last year. With that, we'll wrap up and Howard and I will be happy to take your questions. While the calls are being compiled, I'll remind you that today's earnings release and our non GAAP reconciliations are available on altra.com. We've also posted our usual quarterly metrics, which include pricing, inventory and other housekeeping items. With that, I'll open up the question and answer period.
Operator, do we have any questions?
Thank you. Investors, analysts and media representatives are now invited to participate in the question and answer session. Our first question comes from Judy Hong of Goldman Sachs.
Thank you. Good morning. So Howard, I guess I had a question around this cross category movement that seems to be accelerating, which is driving your reduced volume forecast for the cigarette industry. If you look at, I guess, a lot of the movement last year, a lot of that came in the back half of the year. So I guess, the comparisons are probably getting a little bit easier just from that perspective.
So are you expecting kind of that run rate 1.3% negative category cross movement on the cigarette volume to stay constant? Why do you think that that number doesn't necessarily fade if you're kind of comping against a tougher comparison in the back half of the year?
Yes. I think you make a good point. When you look at the growth that's occurred in the e vapor category, it really started to grow strongly at the beginning of 2018. And certainly, you had a much larger base in the second half of twenty eighteen that will compare against in the second half of twenty nineteen. So it certainly could result in a slowdown in the percentage growth of the category.
And frankly, that's why when we look at our annual estimate for the decline rate of the cigarette category, it's a range because I think it would take that into account.
And then can you just provide a bit more color just in terms of taking down kind of the medium term guidance down 4% to 6% and your level of confidence that that range is comfortable enough just given that that projection has come down in the last two quarters?
Sure. I think that we originally had a 5 year compound annual decline rate of the cigarette category of 4% to 5%. And we provided that the end of last year. And our thinking was that we knew that there was an acceleration in the growth rate of the e vapor category. But we also knew from experience both overseas and in the U.
S. That typically an acceleration of the growth rate of a category driven by newly available or more broadly available products tends to run its course in a year or 2. And so we felt fairly good at that point given the activity in the marketplace at 4% to 5%. In the Q2 of this year, a couple of things have happened that caused us to increase the top end of that decline range. First of all, IQOS was approved And I think that IQOS is going to be on a nice growth trajectory as it expands nationwide over the next couple of years.
So that's an additional influence on the cigarette category decline rate. And we also made our investment in ON. We think it's got a very strong portfolio of nicotine containing pouches and of course it will have access to our infrastructure. And then on top of that, we've also had increased momentum behind increasing the minimum age to purchase to 21. We've now got 50% of U.
S. Population in jurisdictions where the minimum age to purchase is 21. So we thought given that range of changes that it made sense to broaden the decline range for the cigarette category over the next 5 years.
Okay. And then my last question, Howard, just on Juul. So in December or I guess in February, you laid out your key transaction assumptions around JUUL, both U. S. And internationally.
So now that you've obviously have invested in the business for 7 months or so, can you provide us with some color on how those assumptions have changed if at all? And whether the PMTA deadline being full pull forward impact some of those assumptions going forward? Sure.
I think if you looked at our assumptions, I think we expected that Juul would have quite strong revenue growth following our investment. And I think we also had a belief that there was quite an attractive opportunity at the gross margin line as well. I have to say in the first half of this year, Juul has performed quite strongly against both of those assumptions and we feel very good about their performance there. With regard to developing operating companies income both domestically and overseas. I think it's we're not yet at a stage where we've got the information necessary to judge that.
There's still a bit in investment spending mode both domestically and overseas. And I think it's simply too soon to make a judgment on the progress they're making overseas. That's more of early days there. With regard to your question about the change in the filing date for their PMTA, there is no question that the due date for filing a PMTA on all the e vapor products being moved to May of next year represents a significant challenge for all the companies that are impacted by it. And certainly, Juul is very focused on continuing to work on that, continuing to ramp up their resource investment and we're providing them with consulting resources in the regulatory space as well.
But that certainly raised the pressure on I think all the companies in the e vapor space. With that said, I think the way that JUUL's performance has evolved here over the last several months, they should have a very strong case to make in their PMTA. If you look at their response to the increase in youth usage, Juul took very aggressive action in the Q3 of last year by removing their traditional flavored products from retail. They are really the only major player to have done that. And I think that was a big step forward in demonstrating their responsibility and their concern for the issue.
In addition, they have also been very supportive of raising the minimum age to purchase to 21. And a lot of those laws kick in July 1. And so we're going to start to see the impact of that going forward. And so I think that when you compare them to other players in the e vapor category, they've been more aggressive in addressing the youth issue. Secondly, I think they are also the primary driver of increased switching of adult cigarette smokers to the e vapor category.
And of course, that's something that the FDA is going to consider in looking at the PMTA is whether or not the company who is filing for the PMTA is having a significant impact on moving people down the continuum of harm. So I think they have a very good science and evidence to support their application, but there is no doubt that the shortened timeline represents an increased challenge for everybody.
Got it. Okay. Thank you very much.
Thank you. Your next question comes from Vivien Azer of Cowen and Company.
Hi, good morning.
Good morning, Vivien.
So my first question is on the cigarette volume outlook as well. I just wanted to be entirely clear, Howard, as you guys have revised to down 5% to 6%, what does that assume in terms of the evolution of cross category conversion?
Well, I think given that the range is 5 to 6 percent and for the first half we are at a 5.5% decline rate, it actually covers quite a broad range of scenarios in the back half of the year. It would still be supportive even if the volume in the back half of the year for the cigarette category declined at a lower rate. And certainly that could happen. It was raised earlier on the call that there is certainly a tougher comp for the e vapor category in the back half of last year. So it certainly allows for a slowdown in the decline rate of the cigarette category.
And it also allows for a continuation of the strong growth in e vapor. I have to say that I don't believe we're going to have a significant impact in the second half of this year from IQOS because it's going to be in a limited geography. That's probably more of a future year impact. But the benefit of having a 5% to 6% range covers quite a broad set of scenarios for the second half of the year.
Okay. That's helpful. But suffice it to say then, if the first half is down 5.5% at the midpoint of your now revised full year guidance, it does not contemplate a meaningful step function or in terms of the cross category movement, like you're not expecting cross category movement to become an even bigger headwind in the back half. Is that fair?
Yes, I think that's largely fair. And I think that given the much larger second half last year number of e vapors and the larger volume of e vapor in the back half of last year, I think we thought that was prudent.
Okay. Yes, I agree with that for sure. That's helpful. Thank you. And then just my other question is on the moist smokeless tobacco category.
So we've seen category volumes decline for 6 consecutive quarters now. You called out the impact of both e vapor as well as other oral tobacco products. So can you just offer some color on how you're thinking about that category through the rest of the year and perhaps on a 5 year basis because seemingly the outlook for moist smokeless tobacco has changed in line with cigarettes? Thanks.
Yes. I mean, I think the change in the growth trajectory of the smokeless tobacco category has largely occurred over the last 4 or 5 years. We'll remember back 4 or 5 years ago, the smokeless tobacco category was growing 4% to 5% a year. And I think the reason for that was that it was the primary recipient of adult cigarette smokers that were looking for an alternative. And they were moving to moist smokeless tobacco.
I think with the increased availability and attractiveness of e vapor products and certainly also now most recently these nicotine containing pouches. I think that folks that used to go to the moist smokeless tobacco category and drive nice growth there are primarily going to the e vapor category. And I think in the future, we'll have an additional option in nicotine containing pouches. And so I think that we expect that the category is going to remain kind of at a small decline rate going forward, although we haven't made a precise projection. I would point out that even given the slowdown in the growth rate of the category, it's still generating quite nice profit growth.
Absolutely. That's helpful. Thank you very much.
Thank you. Your next question is from Bonnie Herzog of Wells Fargo. Hi, thank you. Good morning.
I actually wanted to ask about your model again in the context of your weaker outlook for the industry SIG volumes. Just trying to think about this, if anything has changed with your model in terms of your ability to deliver profit growth over the long term? And maybe you could touch further on the different levers you have to pull to offset the ongoing SIG volume pressures such as pricing? And Howard, also I'm not sure, but I don't think you mentioned price increases negatively impacting your outlook for industry volume, but I imagine that's a factor too.
Sure. I think as we look at the opportunity to deliver against our long term aspiration of 7% to 9% EPS growth. We continue to feel good about the tools we have at our disposal to deliver that over the healthy resilient combustible business. I think you saw in the first half of this year, how the profit growth was quite strong in that business, despite the fact that there was a stepped up decline in the overall industry volume. And of course, the 2 contributors of that to that nice profit growth were price increases coming from both list price and improved promotional efficiency and cost reduction in the category.
And I think we have long believed that that business is quite resilient and can deliver nice profit growth even in an environment where the industry volume declines step up a bit. Now of course, in addition to the profit growth opportunity we have with our core businesses, we also expect once we get HSR approval to have equity income from Juul. And given Juul's strong revenue and volume growth this year, We would expect that going forward, in addition to having the profit growth from our core tobacco businesses, we'd get an equity income contribution from Juul. And we think that the sum of the growth from our combustible tobacco business plus the 35% contribution to our equity income from Juul, we think that that sets us up very well to deliver in the future. And then of course, as their international business develops, that is a further incremental opportunity for profit growth as 35 percent of economic interest brings that to our equity income line as well.
So I don't know that we feel that our model has really changed on how we would deliver, although I have to acknowledge we've widened the range a bit, but we still feel very comfortable about our long term 7% to 9% EPS aspiration.
Okay. That's helpful. And then speaking of Juul, is there anything you can share with us in terms of the improvements maybe you've been seeing in JUUL's business either sequentially or year over year? And you touched on their expansion internationally and that seems to be going quite well, but they have been investing quite a bit to build that growth. So just how should we think about Juul's model, I guess, over the long term?
Obviously, we don't have a lot of visibility yet, but maybe you could shed a little bit of light on that for us, please.
Sure. I think there's been quite a bit of change in the marketplace in the e vapor space in the U. S. For the first half of the year. So JUUL withdrew their flavors.
There was a slowdown in their volume growth in Q1, although they went back to strong volume growth in the Q2. So I think that's the first thing I would say is that despite their withdrawal of non traditional flavors from retail, they still seem to have a healthy growth profile, which I think is a positive. And that's occurring despite the fact that the other major pod based manufacturers have not decided to withdraw their flavors from retail. As a matter of fact, they've increased availability and they've been growing the flavored volume that they have at retail. So certainly that has an impact on Juul, but they still had a nice healthy growth rate in the first half of the year despite that.
And I would expect that Juul will have a benefit when the FDA finalizes their ENDs guidance and those other players have to join JUUL in restricting the availability of flavors at retail. So I think that's another positive that is likely to come in the second half of the year. So I think overall in the U. S. Market, I think it's been a strong performance for vapor overall and certainly for Juul.
I think overseas, it's still early days. And I think it's probably going to take another year to really get the same kind of positive assessment that we're able to get for the U. S. Market today. But certainly, their expansion is going well and I think with the passage of time, we'll see how they do overseas.
Your next question is from Michael Lavery of Piper Jaffray.
Can you just touch
on what if anything you have included for ON in guidance in the second half?
I think it's important to remember, Michael, that we expect that to close in the second half. So from a standpoint of anything material, we don't expect anything material this year from
on. And
any more specific on the timing? Is that imminent later in the second half? Do you have a sense of when that might happen?
No. We're working with the other side, but we expect it close in the second half.
I would point out Michael though that we have agreed in advance of closing that AGDC is going to provide distribution services to expand the product availability in at retail that started this month. So we are the benefit of starting to expand its availability in the marketplace in advance of closing, which I think is a real plus.
And does that have service revenues related to it or is it just position the brand to be in a does it just set up the brand to be in a better position once it closes?
Yes. I wouldn't think of service revenues as being at all material. It's really the real benefit is that the business is going to get a chance to ramp up so that it is much better positioned to compete with the other players post closing.
And then just looking at Cronos, do you have any involvement in helping partner to shape their plans or as far as that contribution to your equity income, is it just sort of you're left with whatever you get?
No. I think we have quite a bit of influence on their strategy going forward. We have the majority of the seats on the Board and we work very closely through our Board representatives at helping Cronos think through their plans going forward. And I think we invested in them because we thought they had an excellent management team and a good strategy to begin with. And I have to say we work very well together and I think we're making real progress, although we acknowledge in the cannabis space overall it's early days.
No, it sounds like good alignment though. That's nice. And then just on your medium term now 4% to percent decline outlook for the cigarette category, you mentioned the revision having some consideration for things like IQOS being approved and your expansion of distribution for ON and of course the vapor momentum we're seeing. Is it fair to assume that if IQOS had stronger momentum than in some markets more something like Japan perhaps, clearly that would be a very different number. At the moment, you have a it seems like a pretty modest conservative expectation for what that will do.
How are you thinking about the 5 year view for that?
Yes. I think I would say that that provides an opportunity for kind of a mid range performance on IQOS. I can tell you if we had a Japan like performance, we would be delighted. And at some point, we might be considering whether or not to step up the decline rate again. We feel like there's a fair amount of opportunity for IQOS to grow even within that 4% to 6% decline range because our assumption is that given the rapid growth rate we've seen in e vapor in 20 18 and in the first half of twenty nineteen, we think that the e vapor products are broadly available throughout retail and have been for over a year.
And at some point, we think that you're going to reach a saturation point on e vapor. And you might even see an impact from the shakeout of many of the e vapor products coming out of the market next year. So I wouldn't necessarily draw a straight line for growth on the e vapor category. And I think that leaves plenty of opportunity for a strong growth on IQOS. And I think oral nicotine pouches, their overall impact is likely to be smaller than either e vapor or heat not burn.
But we do believe that these clean white oral nicotine pouches are likely to appeal 1st and foremost to MST users, but I think are also a good alternative for adult cigarette smokers. And they are much more approachable than traditional moist smokers tobacco pouches or even snooze pouches.
That's helpful. Thank you very much.
Thank you.
Thank you. Your next question is from Paula Kaufman of Morgan Stanley.
Hi, good morning. It's Pam Kaufman. And I just wanted to follow-up on the questions about your updated long term rate of decline of 4% to 6%. If we assume that your volumes will decline at 5 percent annually, which is the midpoint of your outlook for the industry through 2023, your volumes would be about 20% to 25% below where they are today. What gives you confidence that you can sustain your long term growth algorithm and generate continues to generate pricing growth in excess of those volume declines?
And I guess based on the frequent rate of downward revisions recently for the industry for this year, what should give investors confidence that your outlook for the midterm won't go lower?
Sure. I think the confidence we have that we can continue to generate nice profit growth out of our combustible segment is driven by the experience we've had in driving profit growth in that business through both pricing and cost management. And certainly, when we've seen in prior periods a step up in the decline rate of the volume, typically we've had the opportunity to continue to drive similar profit growth by utilizing those tools slightly differently going forward. But certainly in the event that we see a modest slowdown in our ability to grow profit in the combustible segment because of a higher rate of volume decline, we would have a further offset to that to further accelerate profit growth of our EPS coming from the equity income contribution from Juul. And we feel strongly that the sum of our combustible profit growth added to the equity income we get from Juul that that ought to compare favorably to our ability to grow profit in the past.
With regard to your question about how comfortable are we with 4% to 6% as a 5 year compound annual growth rate of cigarette volume declines. We feel like that's a wide range that covers a whole variety of scenarios. And at this point, we feel quite comfortable given conditions in the marketplace. But I would point out that one of the reasons that we've worked so hard to build the leading portfolio of non combustible tobacco products is that our belief is that it's hard to predict with precision, the pace at which adult cigarette smokers may switch to non combustible tobacco products in the future. And so what we've done is we've essentially built a product portfolio of non combustible tobacco products such that if the movement of adult cigarette smokers out of cigarettes into these other product categories accelerates, we have the opportunity to benefit from that movement with profitable products that lead their categories.
And essentially, if there's a step down in our ability to grow profitability in the combustible business, we would expect to make it up either in with IQOS and heat not burn, with ON and oral nicotine pouches or through our equity income from Juul. So we think we've hedged that opportunity, although I have no reason to believe that that 4% to 6% range is inadequate based on the current market conditions and our understanding of what the future is going to bring.
Thanks. Also it seems like there may be a number of regulatory developments coming up this fall. What do you expect from the next wave of the National Youth Tobacco Survey? And would you expect this to impact JUUL's PMTA's approval prospects? And then separately, the FDA indicated that it plans to publish a proposed nicotine rule later this year.
You believe that they'll stick to this target? Sure.
You're right. We do expect probably in the Q3 to get another update on youth usage of e vapor products. I think it's hard to determine what exactly those figures will show, but it would not surprise me if you saw youth use of e vapor products continue at the prior year level or even take a step up because there's been a number of actions taken to drive down use of e vapor products. But I don't know that we've had the time that is passed to get the impact of that. Even the FDA's ends guidance on restricting flavors to at retail hasn't been finalized yet.
And while there's been a benefit from Juul withdrawing their flavors, the other manufacturers have expanded the availability of flavors. So I think you're going to have to wait until FDA finalizes that guidance and enforces against the other players to get the impact. There's been good progress on raising the minimum age to purchase to 21, but I would say the bulk of that impact is a July 1 and moving forward kind of impact. So that's going to take a while. So I think the expectation is that a lot of the actions that and frankly the FDA has expanded their advertising campaign to discourage the expectation would be that it's going to have a significant impact going forward.
I just think that the expectation would be that it's going to have a significant impact going forward. I just don't know that I would expect that it's been a long enough period of time for those actions to see it in the September numbers. With regard to FDA issuing further later this year. Given the past track record, I think that means that it may or may not come out. But I think we've communicated before, we think that ultimately any implementation of a nicotine sailing on cigarette products, we think is a very long term action and it would take quite some time for FDA to finalize that regulation and implement it.
And of course, we don't think that what they have proposed in the past is feasible today. And we don't think it's supported by the science. So we may expect to see some short term progress there, but we think it's a long term impact.
Thank you.
Thank you. Your next question is from Chris Growe of Stifel.
Hi, good morning.
Hi, Chris.
Hi. I just had 2 sort of follow-up questions. I guess first, have you given any kind of update on receiving FTC approval for your JUUL investment? And I know that your guidance incorporates, you said some modest profit contribution from your investments this year. It would seem like you have some profit built in for the year.
Is that presumably in the Q4? We don't have an update yet from on this FTC approval?
Yes, Chris. On the FTC, we still expect approval latter part of this year beginning of next. And I think what we had said previously about both Cronos and Juul is we had no material impact in our guidance.
Okay. And
then in relation to IQOS launching in September, just want to get a sense of the is there a step up investment that occurs in the Q3 to accommodate the launch of the products or thinking about the phasing of earnings or are a lot of those expenses already been sort of realized or undertaken as part of the P and L?
Yes. When we issued guidance, we said we incorporated the IQOS lead market. Certainly, there are always puts and takes, but we run various scenarios when we have that range of guidance and that's all incorporated.
Okay. And I have just one final question, which is in relation to the June price increase that occurred in combustible. Are there do you believe inventories are at the right level today or was there any kind of build given that came a bit of a surprise that occurred around that pricing that might have to work through in the Q3?
Yes, I think it's informative to look at where the inventories ended the Q2, compare that to historical levels and they're essentially in line with historical levels of inventory.
I agree. Okay. Thanks so much.
Thank you. Your next question is from Owen Bennett of Jefferies.
Good morning, guys. Hope all well. And yes, just one question from me. I just if I saw that right on the slide, you said that Juul is basically driving all the additional adult and baby use. I mean, that seems kind of very impressive.
I was just wondering in the context that I mean there's competition that haven't removed all their flavors, competition as well spending a lot of money doing TV adverts, etcetera. And what do you think is actually just driving that success of Juul and actually being the contributor to all that additional growth?
You're right. I think Juul's had an impressive first half and they've had some challenges that they've taken on that the other participants haven't. And frankly, I think it's further evidence of the fact that amongst adult tobacco consumers, I think Juul has real brand equity, and I think it has a superior product. And I think that as more and more adult tobacco consumers are exposed to the product, I think increasingly folks are adding JUUL to their tobacco product use. And as you saw from the numbers that they're setting down their cigarettes and moving over exclusively to e vapor, I think in increasing numbers as well.
So I've been very pleased by it. Certainly, there's a high level of competitive activity in the marketplace, but I think that Juul has performed quite admirably in the first half of this year despite all that activity.
Okay. And then just one more follow-up. In terms of you said there's a likely continued increase in youth usage and I'd imagine obviously, that's going to be a key focus of a PMTA. So all the players will need a good grasp of potentially how much of their volumes are coming from youth. So I mean, obviously, Juul driving all the additional adult use, if youth usage is still increasing, I mean, have you got any sort of idea of how much your share of that Juul is taking or whether that's dropping off now?
Yes, I really don't. And I don't know that I'm in a position to be able to forecast what the used numbers are going to show in the Q3 when they come out. I just know from experience back in the late '90s, when you had a step up in youth use of cigarettes, a similar very comprehensive effort was put in place to drive down youth usage of cigarettes. It was ultimately quite successful. But the impact of all that activity, it didn't happen in a quarter or 2.
It happened over the following 1 to 3 or 4 years. And so I think I've just steeled myself to the fact that despite all the progress that's been made, including raising the minimum age to purchase to 21 and jurisdictions with other half the population and progress at the federal level, I've sort of just looked at the past and I've steeled myself to the fact that even if we're winning that battle, it may take a bit of time for the results to materialize.
Okay. And is that then not a risk given kind of we need to see impact by May next year when the PMTA has got in, so 3 to 4 years is not really kind of I mean what's needed in this instance?
Yes. Certainly, really to all the e vapor companies that are now going to be filing in May of next year, they're going to have less time will it pass to allow, youth vapor rates to decline. So I think that's a risk really across the category for people that file. But I would point out that FDA, I think, has indicated that they appreciate the impact that the e vapor category is having on converting adult cigarette smokers down the continuum of harm. Clearly that switching and particularly, the switching to, e vapor use without continuing to use cigarettes is accelerating.
So I think ultimately FDA is going to have to balance that favorable adult movement down the continuum of harm, which is quite strong and quite favorable against the fact that, UV vapor rates have not yet stepped down. But I think FDA certainly has access to a lot of expertise and I think they can certainly assess whether or not the step down is coming and consider that as they review those PMTAs.
Thank you very much. Much appreciated.
Thank you.
Thank you.
Your next question comes from Adam Spielman of Citi.
Thank you. Thank you very much. I've got two questions if I can. The first one concerns down trading in the existing cigarette business. So one of the things that clearly you're doing is you're taking prices up and price gaps are widening.
But at the same time, you presented data, and it's not the first time, but there's really there's very little down trading. There's many churn at the bottom end. And I'm really intrigued by that because I don't think it's a historic pattern. I sort of wonder why it is. Is it maybe that actually within, let's say, Marlborough, there are more people buying cheaper variants?
Or is there some other explanation about why there isn't down trending? So that's the first question.
Sure. I think you are right that the strength of the premium category in the U. S. Has been persistently strong really since 2011 when we launched the new Marlboro architecture. And as a matter of fact, since 2011, the overall discount category is down more than a share point.
So the U. S. Market has been quite strong in that regard. And the premium category is much larger in the U. S.
Market than it is in many markets overseas. So I wouldn't say that this phenomenon that is occurring today is unusual compared to the last 6 or 7 years. I think it's actually more the pattern. The price gap over the last year or 2 has gone from 29% to 31%. So it's had a small increase, But I would say that's not a material increase.
And I think that the strong equity of the premium brands in the category, I think, has in the category, I think has an impact on consumers deciding they'd rather pay a bit more to get their brand of choice rather than move down into discount. So I think it's a sign of a very healthy premium category. Now with regard to whether or not there's movement within the Marlboro portfolio, certainly in the period during the Great Recession and shortly thereafter, there was an increased movement between the both premium price part of the Marlboro portfolio and the special blend. But given the strength of the economy today, there's really not an appreciable movement, into that part of the portfolio. And of course, the pricing that we share each year takes into account the change in the weighted average price across the Marlboro portfolio.
So that's factored into the numbers.
Okay. Thank you very much. And I just wanted to follow-up briefly on an answer you gave to earlier in the call. So you said that in 2Q, it was a question about JUUL, that you said in 2Q that JUUL was growing very, very nicely. But I was wondering, I know you're not going to quantify that to the last decimal place, but I was wondering, so relative to the run rate in the second half of last year, are we sort of talking volumes up 20%, up 50%, up 100%?
And is a ballpark in that direction of 10%. Are you able to give some sort of ballpark figure for that sort of growth?
Sure. In the first half of twenty nineteen, the category growth was 40% for the overall vapor category and it was 195% for Juul and that's on Slide 18. And of course, we also referenced Juul's share growth in the Q2 compared to the Q1 and the full year 2018. Their share growth was 48% in Q2, up from 44% in Q1 and up from 33% in full year 2018.
Thank you. That's very helpful.
Thank you. Next question is from Steve Powers of Deutsche Bank.
Hey, great. Thanks. So following up on your comments related to the PMTA process and the need for filers and the FDA to balance youth usage against the efficacy of e vapor to convert adult smokers. I guess looking for a little bit more color on how that factors in, to how you may consult JUUL specifically in its PMT application process? Because on the one hand, it's leading that adult conversion, so that's a positive.
Yet on the other hand, it's their current product is clearly associated with underage usage and the potential lack of data on the efficacy of their steps to reduce that usage just being in hand by the time approval needs to be granted. It just seems a potential liability. So what's your perspective on those dynamics as it relates to Juul and how that might impact how they apply or their application in general?
Yes. I don't know that I have more to say on that topic. I think the youth usage of e vapor products is a challenge that every filer is going to have to deal with. And I think ultimately FDA is going to have to take all of that on board. I think we have the benefit though that the FDA can approve a product through the PMTA process and then require the filer to do post market surveillance.
And if they find that the favorable outcomes they expected to come from that product don't materialize in the years that follow, they can withdraw their approval. So I think that, in a situation like we're faced here with e vapor e vapor where there's very strong conversion of adult cigarette smokers, but we don't yet know whether or not youth rates are going to go down quite what the timing will be. That might very well be a situation where post market surveillance was frankly designed for that situation. And FDA can approve certain products, require post market surveillance and essentially change their view based on what happens in the years that follow.
Okay. That's very helpful. Yes, that's clear. Thank you very much. I guess the second question I have is just another follow-up on Juul and your comments earlier.
I know you said that Juul has been performing impressively and quite strongly against your going in expectations, year to date. But just to be clear, is it fair to say it's trending above expectations at least as it relates to the U. S? Because I'm just trying to triangulate between the lowering of your smokeable volume outlook and the primary role that e vapor is playing in that and presumably the role that Juul is playing in that conversion. So it either suggests that Juul is trending above expectations, your own expectations or that you've seen better than expected performance from some of the other e vapor brands.
So just maybe can you clarify those dynamics please?
Yes. I would say that in the first half of the year, Juul is generally performing in line with our expectations. I don't know we had a range of expectations. So I don't know that it's substantially exceeding those expectations. I would say that one factor that did occur particularly in the first half of this year that I think probably has an impact on the cigarette category decline rate is that not only did we see the number of adult papers increase as we expected it to going to $13,800,000 compared to 12.2 dollars from June to the end of last year.
We also saw a pretty good step up in the number of adult vapers that are no longer smoking. And certainly, if somebody goes from smoking to dual using cigarettes and e vapor then moves all the way to exclusive e vapor use that could have a modest step up on the cigarette decline rate. So certainly that happened in the first half. I don't know that we had a hard and fast view on what would happen there, but certainly it stepped up. And compared to history, it's at a higher level than it's been since 2014.
Okay. So just to clarify, so it sounds like Juul and the industry performing at the higher end of your going in expectations plus maybe a bit more full conversion, full cessation of smoking than was implied in the baseline. Is that a good summary?
Yes, I think that's right.
Okay. Thanks a lot.
All right. Thank you.
Thank you. Your next question comes from Gaurav Jain of Barclays.
Thank you. Good morning. So I have a question on your smokeless tobacco business, where margins are 74%,
EBIT per can
is north of $2 So if you expand ON, there is a risk that you cannibalize your own smokeless business unless the margins of ON at scale are similar to your current smokeless business. So how do we think about that dichotomy?
Yes. We're you're exactly right. We're very pleased with the high margins that we're able to achieve in the smokeless category. From a standpoint of ON, we think through time they will achieve tobacco like margins.
By tobacco you mean smokeless like margins?
That is correct.
Sure. Now coming to cigars, now I'm aware that it is a very small part of your business. But FDA clearly has a 3 pronged approach here to flavored cigars. They will finalize the draft guidance by October 2019. There will be a PMTA by May 2020.
And then there is a rule making process as well. So how should we think about the cigar business long term?
Sure. I think we feel good about our cigar business. You were right that the FDA has said they're going to finalize some guidance on flavors in cigars later this year. I think we along with others in the industry have stated that we don't think they have a very good science and evidence base to restrict the availability of flavored cigars. So we think ultimately that is going to be challenged.
And we feel that there's a very strong case to challenge that. Secondly, you're right that for products that don't already have a market order because they are grandfathered or have received an SE, they're going to have to file PMTAs on this new accelerated deadline of May of next year. So for some cigar companies that could pose a significant issue for them and they may lose the ability to sell some of their cigar products. By and large that doesn't apply to us. The vast majority of our cigar products have market orders either because they're grandfathered or have received SE notices.
And then of course with regard to any rulemaking they might make in the longer term relating to flavors or other things. Again, they're going to have the obligation to support that with science and evidence and we feel good about our ability to make case that our cigar products in any case are responsibly participating in the marketplace.
Sure. Thank you. And if I can ask one last question. So on cigarettes, what we have seen this year is that pricing has gone up above expectations and volumes have come in below expectations. And the substitute product, which is e cigarettes, they aren't really taking any pricing and they haven't taken any pricing for 2 years.
So as we look out, does the e cigarette cannibalization increase over time as price gaps keep widening? And what has been your experience over the last 2 years?
Yes. I'm not going to speculate on future pricing. I think that consumers are moving into a vapor because of significant benefits that those products have unrelated to price. And I'm not going to speculate on future pricing. Thank you.
Sure. Thanks a lot.
Your next question comes from Petros Baugaris of Goldman Sachs.
Good morning, everybody. Good morning. We've discussed IQOS' inclusion in the MSA before and how that operates as a tax. But I'm wondering with respect to
how IQOS is counted towards
the MSA, will one And as a follow-up, are there ways through different product And as a follow-up, are there ways through different product iterations or some other modification for IQOS not to be included in the MSA?
Yes. I think when you think about it, 1 HeatStick would be the equivalent of 1 cigarette because the definition incorporates it that way. And I'm not going to speculate on what future product iterations could be inside or outside of the MSA.
Thanks guys.
Thank you. The floor is now open to questions from the media. And your first question comes from Jennifer Maloney of Wall Street Journal.
Hi, good morning.
Hi, Jennifer.
I'm wondering if you can give
us an update on direct mailings to your cigarette consumers and onsets or inserts in cigarette packs on behalf of Juul, how many have you sent out and what are the redemption rates looking
like? Yes, we don't share level of that detail. Both direct mailings and onsets to date have occurred. And I know that there is further activity that's planned between now and the end of the year communicating about the benefits of Juul, but we haven't shared numbers or fine details on that.
Broadly speaking, have the results of those changed your estimates for sort of what cannibalization you expect to see specifically on your brands from Juul?
No, it hasn't.
Okay.
I don't think we've seen anything that caused us to change our views on JUUL's growth rate or the cannibalization of our products.
Okay. Thanks.
Thank you.
Thank you. Your next question is from Robert Branson of UBS.
Hi, thanks for taking my question. Just a follow-up on that cannibalization question. So could you give us more color on what is the cannibalization rate of e cigarettes, I. E. For every 100 puffs, how many are coming from cigarettes?
1 of your peers put that number at 25%. Would you be would you disagree with that?
Yes, I don't know that I've got a precise point of view on that. I think we think about it more along the lines of how the category growth rate in e vapor is developing and then we take into account all the impacts on the overall cigarette category. I don't know that we've kind of looked at it that way and I don't know that I have any greater precision to share with you.
Okay, fair enough. So second question, just on IQOS, your earlier comments seem to infer that your expected range is between 0 in Japan at 20 and you're at the midpoint, so I'm guessing around 10%. Can you give us some color on what your expectations for IQOS in the U. S. Are based on?
Yes. I don't know that we've firmed up an expectation for IQOS. I think our belief certainly we know the experience in the variety of markets overseas. I think our belief is that that's one of the key things we're going to learn in going into the Atlanta test market. And I think we'll know probably in the next 6 to 9 months kind of what the U.
S. Experience is with IQOS. And of course, we're going to put significant resources and significant activity behind it in order to drive it towards the high end of what it can do in the U. S. But I don't know that we've got a precise answer as to how we think it's going to compare in the U.
S. To overseas. But we do know that we're going to put the resources behind it to make sure that it does as well in the U. S. As is humanly possible.
Fair enough. Thank you very much.
Thank you.
Thank you. At this time, I would like to turn the call back to management for closing remarks.
Thank you, Christy. To close, we're on track to deliver against our 2019 earnings guidance. We believe Altria is well positioned through the combination of excellent profit growth from our core tobacco businesses and strategic positions in key non combustible product categories to lead our industry through a period of evolution, just as we have in the past. Thanks again for joining us, and please contact our Investor Relations team if you have further questions.
Thank you. This does conclude today's conference call. You may now disconnect.