Good day, and welcome to the Altria Group's Conference Call to discuss its investment in Juul Labs. Today's call is scheduled to last about one hour, including remarks by Altria's management and a question and answer session. I would now like to turn the call over to Mr. Bill Marshall, Vice President, Investor Relations for Altria Client Services. Please go ahead, sir.
Thank you, Maria, and good morning, everyone. We're very pleased that you're able to join us today to discuss our recently announced transactions, including today's exciting announcement of our strategic investment in JUUL. During our call, our remarks may contain forward looking and cautionary statements and projections of future results. Please review the forward looking and cautionary statements at the end of today's press release for various factors that could cause actual results to differ materially from projections. You can find our press release describing the transaction on the Investor page of our website.
Joining us on the call today are Howard Willard, Altria's Chief Executive Officer Billy Gifford, our Chief Financial Officer and Murray Garnick, General Counsel. With that, I'll turn the call over to Howard.
Thank you, Bill, and good morning to everyone joining us on the call. It's been an exciting December, and we're pleased to finally be able to talk to you about the 2 strategic investments we've made this month in Cronos and Juul. These investments complement our very strong core tobacco businesses and provide exciting opportunities for future growth. Let's start with today's announcement of our investment in Juul. Today, we announced that we've taken significant action prepare for Altria's future by investing $12,800,000,000 in Juul, a world leader in e vapor.
We believe this is a unique and compelling opportunity to invest in an extraordinary company and we're excited to support Juul's highly talented team and offer our best in class services to build on their tremendous success. Over our history, we've successfully identified growing tobacco categories, gained access to the leading companies and brands in those categories and then applied our strengths to increase their value and earnings contribution to our overall business. That was the case with John Middleton and with UST, and it's a similar approach we're taking with our investment in Juul. We are offering our best in class services to build on JUUL's remarkable early success. Importantly, JUUL will remain independent and retain complete operational autonomy.
It's important to both Juul and us that they continue to operate with the entrepreneurial passion that has made them so successful. Let's imagine the combination of Juul's leading market position, brand equity and deep innovation pipeline with our strong retail presence, our ability to connect directly with adult smokers on our company's databases while avoiding unintended audiences our leading sales organization, which covers approximately 230,000 stores and our deep regulatory affairs expertise. This investment and the service agreements create a compelling future and we expect that helping Juul accelerate its mission will create long term benefits for adult smokers and our shareholders. We believe the investment in JUUL represents the fastest and most sustainable opportunity to generate significant income in the e vapor category. Its unit economics today are attractive, and we expect our strong distribution infrastructure to help accelerate their financial performance.
We have long said that providing adult smokers with superior satisfying products with the potential to reduce harm is the best way to achieve tobacco harm reduction. Through Juul, we are making the biggest investment in our history toward that goal. JUUL has made significant inroads in the U. S. And we believe it has significant opportunities for further growth, both domestically and in international markets.
The global NGP market is large with estimated sales of approximately $23,000,000,000 Juul is well positioned to capture an increasing share of the global e vapor profit pool with operations currently in 7 countries outside of the U. S. And this growth will not overlap with our current business operations and serves to diversify our future income streams beyond the domestic market. Our investment in JUUL complements our leading non combustible offerings with Copenhagen and our U. S.
Commercialization rights to PMI's IQOS product, the leading global heat not burn product. Importantly, Altria and Juul are committed to preventing kids from using any tobacco products. As recent studies have made clear, youth vaping is a serious problem, which both Altria and JUUL are committed to solve. JUUL recently began implementing a number of actions to prevent underage vaping, including stopping the sales of flavored products to retail stores, enhancing age verification for its online sales, eliminating social media accounts and developing further technology solutions. Together, Juul and Altria will work to prevent youth usage through their announced initiatives, further technological developments and increased advocacy for raising the minimum age of purchase for all tobacco products to 21.
Let's now talk about our investment in Cronos. Through Cronos, Altria will be positioned to participate in the emerging global cannabis sector, which we believe is poised for rapid growth over the next decade. It will also create a new growth opportunity in an adjacent category that is complementary to our strong core tobacco businesses. Cronos will be one of the best capitalized cannabinoid businesses, which we expect will allow them to accelerate their strategies to achieve global leadership in the cannabis industry. Turning to our financials.
The debt incurred to finance the Cronos and Juul transactions will increase our interest expense going forward. Earlier this morning, we announced the cost reduction program designed to deliver approximately 500 $600,000,000 in annualized cost savings by the end of 2019. We expect the savings generated through the program to offset most of the expected interest expense increase in 2019. We remain committed to maintaining our investment grade credit rating. While we'll provide more detailed guidance for 2019 in Q4 earnings release in January, we expect that 2019 adjusted diluted EPS growth will be slightly below the low end of our long term 7% to 9% growth aspiration due to debt incurred from our announced transactions with Cronos and Juul.
And we maintain our long term financial goals to grow adjusted diluted EPS at an average annual rate of 7% to 9% and to maintain a dividend payout ratio target of approximately 80% of adjusted diluted EPS. In summary, we're excited about what we believe will be the most compelling offering for adult tobacco consumers and investors. With ownership or exposure to the leading brands in each of our categories, including Marlboro, Black and Mild, Copenhagen, Jewel and IQOS. With that, Billy, Murray and I will now be happy to take your questions.
Thank you. Our first question comes from the line of Vivien Azer of Cowen and Company.
Hi, good morning.
Hi, Vivien.
So I was hoping that you could just comment on how you're thinking about the longer term economic benefits of this stake. Given that you have a 6 year standstill, it seems like you're now incentivized to accelerate volume declines in the cigarette category. But just trying to understand how you offset that to get to your aspirational 7% to 9% earnings growth target? Thanks.
Sure. I think if you look at the performance of our core businesses this year, obviously that factored in very rapid growth in the e vapor category and really close to 100% of that growth was driven by Juul. So if you look going forward, we're going to have access to 35% of the economics of Juul, both from their performance in the U. S. Market as well as overseas.
And we think over time, this is going to give us an attractive income stream in a rapidly growing category in the U. S. Market as well as overseas.
Thanks. And just a follow-up on that.
Can you just talk
about the agreement? I guess I'm a little bit surprised that there's no pathway to control given the size of
the check and the valuation? Thanks.
Sure. You are right that we have a 35% economic interest. We have rights to maintain that, but we also have a standstill to not go above that. And I think given the strong performance of the business and its expected upside, we felt even without a pathway to control, this was an attractive deal for us. And of course, we'll continue to build the relationship there over time.
Okay. Thank you very much.
Our next question comes from the line of Bonnie Herzog of Wells Fargo.
All right. Thank you. Good morning.
Hi, Bonnie.
Hi. I had a quick follow on question in terms of the control and just thinking about your ownership of this company. Wondering if there are any provisions to prevent any of your competitors from acquiring a stake in JUUL in the future? Just trying to think through that given your ownership at this point.
Yes, there are restrictions on that. It's a fairly complex provision, but we feel fortunate to be the tobacco company that's partnered up with Juul at this stage.
Okay. That makes sense. And then I was hoping you could just spend a little bit of time walking through for us when this process started with JUUL and maybe what was the driver behind this decision of yours? For instance, I guess I'm wondering if you've seen a sharper deceleration of your sig volumes recently that might have been a key catalyst for you to pursue this stake at this point?
Sure. I don't know that there's any significant change in the cigarette market that drove a big change in our interest in Juul. But we've been in dialogue with them for quite some time. And I think our belief had always been that it was a very successful e vapor company in the U. S.
And we believe they had strong financial performance and the potential for future growth. And we've been modeling their financials for quite some time and modeling their expected growth path. And I have to tell you what continually happened was they exceeded our optimistic growth projections. And then ultimately, when we were able to go in and do due diligence, we found out that their financial situation was also quite attractive. So I think ultimately we concluded that having access to this rapidly growing company and having the opportunity to provide our infrastructure in order to accelerate its growth was quite an attractive financial opportunity for Altria.
Perfect. That makes sense. And then I'd love to hear a little bit more color on how you envision having both IQOS and JUUL to some extent, I guess, in your portfolio of reduced risk offerings? And how well you think they will coexist? I'm just trying to think through, especially in the U.
S. Market, assuming IQOS gets approved, how do you see the consumer base and their interest in these different technologies? Do you envision dual usage of these 2 technologies in any way? And then finally, I'm just trying to think through the prioritization and how you think about that given your stake now in Juul? Sure.
I think our belief has long been that adult tobacco consumers are going to try the variety of products that are available to them and they are ultimately going to choose the category and brand that most appeals to them. And I think we know that after cigarettes being overwhelmingly the primary choice of adult tobacco consumers, they are increasingly interested in alternatives. And I think our belief has been that it's very difficult to forecast which products various consumers will ultimately decide on. And so we've been in a position to try and make sure that we've got access to the best brands and the best products in each of the alternative categories. And I think we feel very fortunate to have access to IQOS in the U.
S. Market. And I can tell you we're very eager to be able to market it once we get FDA approval. We're growing a little bit impatient, I can tell you. However, I also have to say that given the growth rate in e vapor this year, clearly that is an attractive category for adult cigarette smokers.
And given the growth of JUUL, we really felt like the best way to participate in that category was with Juul. So I have to tell you, we actually don't think about the various brands that are carried by our sales force as being competitive with one another or being at all in conflict. And what we find is that the sales force treats them all very well and they're all 1st class citizens. And frankly, I think they all benefit from the fact that there is a highly capable category oriented salesperson that understands each of the categories well, that's in there talking to retailers who also have that category management approach. So we think actually that IQOS and JUUL will coexist just fine.
I think you'll have a whole variety of consumers that will try each of them. And ultimately, over time, I think the consumers are going to pick the one that's right for them. And I think there's room for both of these products to be highly successful alternatives to cigarettes in the U. S. Market.
Okay. That's really helpful. And then one final question from me, if I may, although I still have several others. But just was hoping you could possibly frame for us when you expect this deal to be accretive and possibly how long after it gets antitrust approval, which I know is tough to figure out or time?
Bonnie, this is Billy. Based on our modeling, if you think about the last three announcements we made, Cronos, JUUL and the cost reduction program, if you take them in totality, we see accretion in the 2nd full year. And so that's what we've modeled and that's what we feel good about, confirming that through our due diligence processes. And so that's where we stand on that. And I'll let Murray address the HSR.
Yes. Well, we plan on filing our application for HSR approval very shortly, and we're very optimistic about getting approval in the short term, we're very confident we'll get approval.
All right. Thank you. Congrats.
Thank you.
Our next question comes from the line of Steve Powers of Deutsche Bank.
Yes, thanks. Hey, good morning, guys. Howard, so how much of JUUL's business over the last 12 months have you concluded comes from underage consumers? And how confident are you that progress can be made to eradicate that consumption? And I guess lastly, what is the risk that you assign to the idea that Juul's products ultimately may not receive FDA approval through the PMTA process given their known association with underage consumption?
Yes. I think it's hard to nail down exactly how much of the volume could be attributed to underage use. We believe it's quite a small percentage, although we don't at all discount the fact that youth usage of e vapor products is a big problem that needs to be resolved. And if it's not resolved, it's going to put the whole category at risk, including for adult cigarette smokers. So I think it's a small contributor to volume, but it needs to be a big focus of Juul and certainly will be a big focus of us working with Juul.
We have access to information through our measurements of the legal age plus adult cigarette consumer. And we see significant interest and significant purchase of JUUL by adult cigarette smokers. So I think the overwhelming percentage of their volume is actually other tobacco users, adult tobacco users that are interested in the category. And I think that we acknowledge that there's work to be done done and I think Juul agrees with us on that to make sure that we drive down youth usage and we're prepared to make the investments and make the decisions necessary to do that. Probably the greatest focus we've had over the last couple of months is a focus on raising the legal age to purchase all tobacco products to 21.
And we will continue to focus on that until we accomplish it and our goal is to accomplish it as quickly as possible.
Okay. And I guess is there anything you can offer in terms of some of those underlying JUUL financials and financial assumptions that you mentioned? Because I think, while qualitatively the investment in JUUL makes strategic sense, you're paying effectively 2.5 times what the private market valued Juul at 6 months ago. For an asset that also 6 months ago, I think you implied may start to plateau in terms of growth as we rolled into 2019. And that was before the FDA stepped in to spur self regulation in e vapor.
So I guess just in that context, why is a $38,000,000,000 valuation, 40% almost of your current market cap, 19 times externally reported Juul revenue. Why is that the right valuation for Juul?
Sure. I think one thing I'd point out when you compare this valuation to the public market value in the Q2 of this year, When you look at a multiple of revenue and you look at past 12 month revenue, the company's sales growth has been so rapid that if you look at the multiple that we're paying compared to what happened in the second quarter, they're not all that different. But I think that when we did our assessment of the valuation of the company, we did it much more on a financial projection and a discounted net present value of the cash flows. And frankly, we do believe that the significant growth that JUUL has had over the last year, when you look over the number of years in the future, that growth is going to continue. There certainly may be some disruption here as Juul works to address with the rest of the industry and with the FDA, youth usage of the product.
But we do expect there to be continuing long term growth of the e vapor category. And I think when you look at that the the economies of scale they've already got given their significant volume in the marketplace today and you factor in further economies of scale as they continue to grow, the unit economics are attractive today and they get more attractive in the future. So we actually are quite comfortable with the valuation and expect there to be upside over time.
Okay. And does that I mean that math just seems to imply that you are now expecting U. S. Cigarette volumes to as they have been accelerating negative, just the math seems to imply that you are projecting that to accelerate negatively further into the future. Is that I mean, is that fair math?
Yes. That's not the way I think about it. I mean, if you look at this year, on a 9 month basis, obviously the e vapor category had significant growth and the cigarette category declined about 4 point 5%. And while we don't make forward projections on what the cigarette category volume decline is going to be, I think you may see that kind of decline rate persist for some time. But you don't need to see a step up from there to have our economic interest in Juul be a very attractive income generator over time.
And that's taking into account only the U. S. Performance of the business. If they are successful overseas, which we believe they will be, then that is an income stream that doesn't have an offset within our current business model, which was another thing that made the economic interest very attractive to us. Understood.
And what in terms of
realizing the economics, in terms of in terms of realizing the economics in terms of a return on this investment, do you have visibility to cash returns from this business in terms of any kind of dividend commitment from Juul? Or is there an expected monetization event through an IPO? Like at what point does this start contributing cash to Altria?
Yes, I would say that in the next 1 or 2 years, I think the expectation is that they're going to be continuing to invest in capacity and in growth in both the U. S. And overseas, but the business becomes highly cash generative fairly quickly after that. And we would expect that there's the opportunity through dividends to receive cash from this investment and there's other potential opportunities as well.
Okay, understood.
Thank you
very much. I'll pass it on.
Thank you.
Our next question comes from the line of Michael Lavery of Piper Jaffray.
Good morning. Thank you.
Hi, Michael.
With the international presence, even if it's early for JUUL and you're now partnering with them and having an economic interest in that. How do you see your relationship with PM evolving if you're participating with a direct competitor there?
Sure. I mean, I think the way we think about it is that we're an investor in Newell and we're a provider of services here in the U. S. Market. So I don't anticipate that it should have a significant impact on our relationship with PMI.
We remain fully committed to commercializing IQOS to great success here in the U. S. And I think whether we were an investor in Juul or not, they were going to be competing both in the U. S. And overseas.
Fair enough. Thank you. And just one more on the near term outlook. If I'm remembering it right, earlier this year, you talked about being above your normal range for the next 2 years, obviously driven largely by the tax reform benefits. Clearly, you're updating that differently for next year on new information.
But how should we think about the next couple of years? Would it be right to assume that you're above your normal range for 2020 no longer applies? And as you look into next year, is it the buybacks that are the difference? If you're talking about these savings coming through that offset or roughly offset the interest expense cost. Is it the fact that you won't be doing buybacks?
And actually, could you address that? I'm assuming you're not, but I'm not really sure if you said that out loud. Can you just talk about how to think about the moving parts for next year?
Yes, Michael, this is Billy. If you think about it, I don't want to go much further than we did in the release because I don't want to brush on giving guidance. But I think what we're trying to tell you in the press release where we had previously said we saw the opportunity possibly to exceed our 7% to 9% long term that next year we have anticipated that we would be lower than the low end, slightly lower than that. That's where you have the interest cost. And then with the cost reduction program ramping up through the year with full annualization, call it, in the 3rd or 4th quarter, that, that will largely offset the interest burden from the 2 transactions.
After that, you're right, we had previously said that tax investments would play a part in that future growth. Those reductions that we had anticipated reducing those investments through time are included in the cost reductions that you see stated in the earnings release.
And I think what we communicated in the release is we remain confident in our long term aspiration of 7% to 9% EPS growth.
Okay. Thank you very much.
Thank you.
Our next question comes from the line of Pamela Coughlin of Morgan Stanley.
Hi, good morning. Thanks for the question. Just a follow-up to the prior question. How should we think about your plans for deleveraging and prioritizing cash between debt pay down and buybacks?
Yes. I think when you think about it Pamela, we have a pretty rigid capital allocation process that we've stated before. Look, we have a little bit of capital expenditure for our core business, but for a business there aside, it is tiny. But with those high margin businesses, we'll be sure to allocate capital to that. Next is dividends.
And then we look at excess cash. And I think your question is related how do you think about that excess cash. And you've seen this in the past. At times, we selectively reduce debt and at times, we look at share repurchase programs. That's the type of analysis we'll go through to use that excess cash that the business naturally generates to the benefit of our stakeholders, both debt and shareholders.
And so we'll do that analysis on an annual basis and we'll inform the investment community of those decisions.
Okay. Thanks. And then can you elaborate on how you think about Juul's growth prospects in the U. S? How do you think about the market share that they can capture over time?
And what the opportunity is for pricing dynamics for their pods and devices?
Sure. I think as you saw in the release, when you look at their market share of the overall U. S. E vapor market and you include open tanks and all the e vapor products that are sold in the U. S.
And you use all trade classes, they have about a 30% market share in the market today. That's up dramatically from the prior year. And I think as we think about their growth opportunity going forward, I think we believe they have 2 places to grow from. First of all, I think that they're going to continue in the future to attract incremental consumers who are users of other e vapor products. And then I think they're also going to have strong growth from accessing adult cigarette smokers that are looking for alternative products.
And I think that when you look at their healthy growth rate that they had this year, it would not surprise me if over the longer term, they continue to have strong growth year after year.
Okay. Thanks. And then just in terms of the international expansion, I know you mentioned that there are provisions in your agreement that preclude investments by some of your competitors. But are there any similar
Yes. I think I don't think that there are any restrictions on their ability to link up with others to support their efforts overseas. And I would also tell you that I think we think of this when we ultimately get HSR approval and the shares convert and we join their Board, we think of this as a cooperative arrangement to drive Juul's growth. So even to the extent that today there are limitations or restrictions, if there are future opportunities come up that we jointly agree is going to help further drive the growth of the company, my expectation is that we'll collaborate and find a way to make
that happen. Okay. Thank you.
Thank you.
Our next question comes from the line of Julie Hong of Goldman Sachs.
Thanks. Good morning.
Good morning. So I guess
I had a few follow-up questions. First, just in terms of thinking about JUUL's growth prospects again, Howard, I guess in the past you've kind of talked about some of the leading brands in e vapor category sort of having a short life cycles. And so I guess I'm just curious based on your due diligence sort of the sustainability of the equity of Juul because obviously that kind of plays into the growth and the valuation of what you're paying here?
Sure. Yes, I mean I think certainly we have had a number of other e vapor brands that had a short burst of growth and then saw their market share and volume fall back. However, there has never been an e vapor company that has had the level of growth on a consistent basis within a same store universe that Juul has had over the last 3 years. And so I think we think of the growth phenomenon for Juul as really being about a year old because their dramatic growth across all mainstream retail channels has really happened in the last year. But of course, we've been monitoring their growth in the much smaller number of stores that they have been in for 3 years.
And what you see is over that entire 3 year period, they've had a persistent upward growth trend. And actually because they expanded into incremental stores over time, we've actually been able to measure the growth trend by store cohort from when they entered the store. And what we found is that they have a consistent and persistent healthy growth rate up without really any examples of a fall off in their volume growth. And we think that that is attributable to the fact that unlike many of the other e vapor products that were short term successes. This product is actually quite satisfying to adult tobacco consumers that are interested in alternatives.
And we found that in the research we've done consistently with adult cigarette smokers that are interested in alternatives and have tried Juul.
Okay, got it. And then just to clarify, so the kind of the media reports around the revenues of JUUL and the profit margin being at 75%, is that sort of the right numbers to kind of think about the near term? And then as you think about the per unit economics between a combustible versus Juul, is the biggest difference really, DXI's taxes and MSA advantages the product has? Or is there sort of difference in terms of other costs that drives the margins much higher?
I have to say, given the frustration I felt from some of the media coverage before we announced this deal, I'm not going to corroborate any of the leaked information. But I can give you some perspective on how to think about the economics of Juul compared to cigarettes. You're exactly right that when you look at the retail price of cigarettes that that retail price includes a federal excise tax, a state excise tax and a very significant master settlement agreement payment. And so that average price for a pack of cigarettes is a little above $7 today. When you look at a Juul pod, it sells for more like $4.50 And even with that lower price, which actually offers an opportunity for a cigarette smoker to switch and have some retail cost savings, there's the opportunity for high profit margins because, of course, at the current moment, there isn't a federal excise tax.
There are relatively few states with a state excise tax. And of course, there aren't master settlement agreements on this. So we think it's actually quite an attractive profit model, both now and into the future. And you can imagine over time that given the advantage it has over cigarettes, that can be helpful to drive their growth.
Got it. And just finally just on the guidance. So I just want to make sure that we're clear. There is no equity income sort of built in, in terms of 2019 guidance, that's because it seems like it's really more interest expense in fact and it doesn't seem like there's much of an equity income that's built into 2019 guidance. Is that the way to think about 2019?
Again, I wouldn't necessarily call it guidance, Judy. We'll be providing that in January. But you're correct in assuming we're going to carry the asset as an investment in an equity security until post HSR and we feel like there's high probability for that to clear HSR and then we would convert to equity accounting once we have the voting and the Board representation. Okay.
And Billy, just sorry, my final question. I think strategically, when you think about big investments now that you have in both beer and now JUUL sort of equity investments or minority investments, you're still keeping kind of an 80% dividend payout on your EPS, which obviously the cash impact is cash flow impact is different. So is there any kind of thought to whether this 80% payout policy is kind of the right policy in the context of having a greater EPS that's coming from equity investments?
No, Judy. We remain committed to that 80% dividend payout target ratio, and I think it shows you the nature of the cash generation of our core business.
Got it. Okay. Thank you.
Our next question comes from the line of Chris Growe of Stifel.
Hi, good morning.
Good morning, Chris.
Hi. I would like to and forgive me if you covered this already, Howard, but have you said what sort of effect vapor has had on tobacco volumes and what you expect going forward? You talked about 4.5% there on volume, I guess, in the near term. And maybe we thought of that as in relation to a 3% to 4% decline rate historically. Is that sort of quantifying roughly what you expect in terms of the vapor's effect on the category?
Yes. I mean, I think we've been having this dialogue each quarter through the last three quarters. And of course, we had because of economic tailwinds, we had the decline rate in the cigarette category below the long term 3% to 4%. And then as we went into this year, pretty persistently on a year to date basis over the last 9 months, it's gone outside of the 3% to 4% in the other direction that is sort of the latest trend. And I think that one of the impacts there is this rapid growth of e vapor.
Although I think we're going to have to get, in my view, probably another 5 quarters worth of data before you can start to make decisions on whether or not there's a persistent impact driven by e vapor. Because of course at the same time, e vapor has accelerated its growth rate. You had slightly higher gasoline prices and some other economic impacts. But certainly, it does look like e vapor has pushed the decline rate of cigarettes, at least in the past 9 months, up a bit.
Okay. And then, I'm just curious as you look at the recent sort of self regulation that Juul has put in place and obviously the FDA regulations mostly mimic that. I think you said
that you expect the category kind
of cool down a little bit. Do you still expect it to grow, I guess is the question? And I'd just be curious, how much of their sales are affected by the flavors that have been pulled off the market in C stores? Have you discussed that? Or could you give us some color on that?
Yes. I mean, I think a significant portion of their sales is within that flavor group that they've stopped shipping to retail stores. And those products are now only available to 21 plus on juul.com with enhanced age verification. But my expectation is and I think it's far too early to tell based on the data, but my expectation is that given the strong interest in Juul's products from adult cigarette smokers that they'll continue to see growth next year. But I think that's going to remain to be seen.
And then I would also tell you that I believe that one of the strongest impacts we can have on driving down youth vaping is to raise the minimum age to purchase to 21. If you look at the primary source for underage to get access to vaping products, it typically is that they give money to an adult to purchase. And when you think about it in their context, an adult could be an 18 year old who's a classmate in their high school. And we've concluded that essentially raising the minimum age to purchase to 21, in addition to the other actions that have already been taken, should have a pretty significant impact that we think is favorable to allowing e vapor to continue to be an alternative to move adult cigarette smokers to e vapor and move them down the continuum of risk.
Okay. And just one follow-up if I could. One more question, which would be, as you think about a 5 year view or 10 year view or even longer view of Juul's growth, I mean, there are limitations to growth internationally, whether it be nicotine regulations in the EU or just availability of the product in some markets like Japan or Israel, Malaysia, whatever. Is international a much larger market than the U. S.
You believe in some long term outlook for Juul?
I mean, here's how I think about it. And you're exactly right to say let's think long term because as we think about it at this investment, we think 10 to 20 years out. And our belief is that in the U. S, over time, e vapor is going to continue to rapidly grow and it's it along with heat not burn is going to become a really attractive alternative to adult cigarette smokers. And so I think that you're going to see a significant opportunity for harm reduction.
Now again, change in the tobacco business doesn't come in 2, 3, 4 years, tends to happen more over 10 or 20 years. But I think when you look 10 years out, you're going to see a significant growth of heat not burn and e vapor, which are the inhalable alternatives to adult cigarette smokers. Then I think that's going to drive 2 things. Number 1, I think it's going to drive countries that have not had a regulatory system that was open to e vapor to consider whether they should loosen those restrictions. Because I think by then, the FDA will have received PMTAs, will have received MRTPs, and I think the science will be clear.
And I think that will drive a change to the e vapor opportunity around the world. And then I have to say for the countries that already allow free access to e vapor products, I think you would note that in most cases, a company like JUUL can't take their U. S. Product and introduce it with different packaging in the other country. It requires an adjustment to the product to meet the regulatory requirements in the country.
And frankly, we view that as a benefit to Juul's success overseas because with access to technical capability and the product design capability that they have, we think nobody is better positioned to customize a product to meet the regulatory requirements overseas and to satisfy the needs of adult tobacco consumers in those international markets. So I have to say that I think ultimately the Juul opportunity internationally is going to end up being as large or larger than the
Okay. Well, thank you for
that color. I appreciate it.
Thank you.
Our next question comes from the line of Adam Spielman of Citi.
Hi, thank you very much for the opportunity to ask a question. I gather that you're just simply not going to give us any financial details on this on JUUL. I'm working just so you know on $700,000,000 of revenue for the last 12 months. But I guess the real question is when will you? Because you made a very big investment and I'm just sort of intrigued to know when you will allow your investors to actually find out what this asset looks like?
Well, I think as you can imagine, we just closed the deal this morning. So we haven't had a lot of time to talk to JUUL about additional disclosures. And I think, of course, we're going to account for this as an equity security in the short run. But once we start accounting for it based on the equity interest, certainly their income will flow through our financial statements. And I think we are also cognizant of the fact that if we can get agreement with JUUL to provide some more financial disclosure that that would be helpful to investors and that's something we'll work on.
Okay. And just you've said that it will be sort of positive for DCF and the reason that you're willing to pay the price you are is because it looks good on a DCF basis. Can you just sort of highlight some of the assumptions you've got in there? Thank you.
Sure. I mean essentially what we did was we made an estimate of how the e vapor category would grow both in the U. S. And overseas and obviously made assumptions for what Juul's market share would be in their respective markets. And then using their existing margin structure and projections on what future margin structure would be, we ultimately forecast free cash flows and discounted them back at frankly at a fairly high discount rate to reflect the risk of the business.
And what sort of size do you think the e vapor market will get to in let's say 5 or 10 years?
Yes. I think we had a number of scenarios. I'm not going to share that number today, but we do think that e vapor represents a strong growth opportunity both in the U. S. And overseas over the next 10 years.
We do not believe that this growth that it's seen this year is going to return to more flattish performance like the category had in the prior 3 or 4 years.
Okay. That's very clear. And then just turning to the cost cutting, the $500,000,000 or $600,000,000 There's a big chunk of money if you look at your controllable costs. And I was wondering, I'm sort of mentally thinking you won't be doing much R and D in future and perhaps you'll be dialing back some of the sort of buy downs. Is that the sort of things you'll be thinking about or where should we expect that to fall in broad terms?
Sure. I think I would start off by acknowledging the fact that we're going to compete in the e vapor category going forward exclusively through Juul. So all of the expense we had related to our Mark 10 and Green Smoke products and all the regulatory work we were doing, that is essentially expense that will go away. And then I think incremental cost reduction I think represents us really looking across the entirety of our business platform and identifying opportunities to reduce costs. I can tell you we plan to continue to vigorously compete in the U.
S. Cigarette market as well as the smokeless market and the cigar market. We've had, we believe, strong performance from those businesses this year. And we expect even after the cost reduction program, we'll be equipped to continue to perform well in those businesses over time. But if you think about it, if you look at the investments we've made in e vapor over the last few years, both at Newmark and the support that our ALCS organization has provided them, Essentially, that's now cost that can go away because we'll be achieving that through Juul at higher margins and with greater volume and growth.
Okay. Thank you very much. And then there's sort of one other question, sort of perhaps relating to the first one. Traditionally, companies often say, well, the ROIC of an acquisition will make the WACC, the equivalent of the WACC in, I don't know, 3 or 4 years. Do you have a figure for that sort of calculation?
Are you asking what we expect the return on invested capital to be?
Well, so yes, I suppose I am asking that because it and as I say, it's a very big investment and it's the opposite of transparent. It's about as opaque as it could be frankly.
Yes. I'd refer back to the investments we made on UST and on John Middleton. And we do expect to get an attractive return on invested capital. I don't have a timing or an amount on that, but I hear your desire for greater transparency and we'll go to work on that.
Okay. Thank you very much indeed. Thank you.
Thank you, Ed.
Our next question comes from the line of Todd Duignan of Wells Fargo.
Good morning. Thanks for the question. Good morning. I wanted to see if you could tell us a little bit about your financial policy going forward. For the past decade, you've had leverage of under 2x debt to EBITDA.
And now according to my calculations, it's going up to about 2.8 times on a pro form a basis. Can you tell me if we should expect that to be coming down in the near term? And if so, if that's going to be by way of EBITDA growth or debt reduction or a combination of both?
Yes, Todd. I think the debt to EBITDA you had modeled there, even if I just take it over the last 12 months. So if you think about us ending the 2nd quarter with a 1.3%, think about it about doubling. And so from that standpoint, we started with an extremely strong balance sheet. And even after these acquisitions, we have still a very strong balance sheet.
From a standpoint, we don't have a specific number in mind. You've seen us in the past, debt to EBITDA comes down through time. We would anticipate that, that would Some of that's going to be EBITDA growth and then some of that, as I said before, when we have excess cash generated by the business, you've seen us either do share repurchase or selectively reduce debt, and we will follow that same process.
Okay. That's helpful. And this morning, S and P downgraded your credit rating to BBB Flat. Fitch and Moody's have yet to weigh in. But can you tell us, do you target a specific credit rating either like high BBB or simply investment grade?
It's a little bit more than investment grade. I would say we definitely want a solid investment grade and we feel like the BBB flat and we've been here before is a solid investment grade.
Okay. That's helpful. Thank you.
Thank you.
Our next question comes from the line of Priya Ori Gupta of Barclays.
Great. Thank you so much for the questions. I think just to follow-up on a couple of points that Todd asked. So Billy, as you think about that BBB flat rating, would you have any aspirations to potentially bring that up to high BBB over time? And then just secondly, with regards to your use of free cash flow, I know you've recommended you've indicated that you plan to be consistent with the past.
But typically, we've seen other companies prioritize debt pay down over share repurchases, at least over sort of the more immediate term following a leveraging acquisition? How should we think about that here? And why not speak to something that gives us that clarity at this point? Thank you.
Sure. I think the first question, do we have a specific rating in mind? I really believe it should be you should consider us saying that we want to be solid investment grade. It's important to us. We usually enter the commercial paper market towards the end of April beginning of May with the MSA payment and then we're out in June, but that investment grade credit rating is important to us both from a long term and a short term perspective.
As far as free cash flow, from a standpoint of how we think about it, it's exactly the way I described it. We certainly have small capital expenditures that we fund for the business. It's the 80% dividend. And that usually in a typical year leaves about $1,000,000,000 to $1,500,000,000 in free cash flow and then we put that to use in the best way possible for our shareholders and debt holders. And so we'll go through that analysis each year and inform the investor of how we see that year play out.
Okay. That's helpful. So should we assume sort of the mid-2s is a level that you're comfortable maintaining in terms of leverage? And if we think about that free cash flow absent through share repurchase and debt pay down at this point, are there any other needs that you could potentially have particularly related to some of the growth in dual or promo?
Yes. I think if understanding your question, yes, we're very comfortable where we landed with S and P. We'll see we've been in contact with the other two agencies and I think you'll see their releases later today. From a standpoint of significant needs in the future, no, we don't forecast any significant needs at this point. But we like to have that free cash flow and that nature of the core business generates significant cash flow.
That's why we remain committed to the 80% dividend target payout ratio and still see excess cash being generated above and beyond that.
Great. Thank you so much.
Our next question comes from the line of Stuart Hajinke of Vanguard.
Good morning and thank you for giving me the opportunity. A couple of questions for you. One very specific and one a little bit more general. The specific one is what interest rate have you incorporated into your projections with regard to the debt that you're going to
be incurring? And then
the more general question is, as you think about JUUL, your relationship with them, can you talk about how you're going to be working with them to transition presumably going to be looking to transition your combustible customers to the JUUL products?
Yes. So I'll take the first part related to the interest. On the short term basis, remember we financed this through JPMorgan in the term loan. The terms there on a drawn basis are about 100 basis points above LIBOR. So if you think I know LIBOR is moving around today, but if you think about where it closed last night, about 2.5 plus the 100 basis points would be 3.5.
We do look to in time, latest often through the long term debt market. And we just like Howard said, we ran a range of scenarios with input from the rigging agencies of where we saw the ultimate rating landing out. So we've ran a range of those scenarios and feel comfortable with the comments we made early as far as accretion in full year 2 with that range of assumptions on interest rate.
Yes. I'll take the second part of your question. I think the way we think about it is we ultimately believe that the adult tobacco consumer decides which products they're going to ultimately purchase and enjoy. So I believe that ultimately our role is to work hard to make sure our products and brands are appealing to consumers in the categories in which they have interest. And as interest becomes stronger in new product categories, we work very hard to either organically gain access to those leading products or through acquisition.
And I might give you a recent example. The smokeless tobacco category, if you go back about 10 years when we made our acquisition of UST, had become a very important category where adult cigarette smokers were switching into. It actually got up to a pretty persistent 5% to 6% a year growth rate because of that inflow of adult cigarette smokers to smokeless tobacco. And we concluded that in order to economically benefit from that, that we should buy UST, which we did, and that growth rate persisted several years after that. I think e vapor today has pushed smokeless out of the sort of the leading spot for being a place that adult cigarette smokers are trying new products and potentially switching to.
Okay. I appreciate that. And maybe a follow-up on that. Can you talk about from your perspective the different, I guess, profit dynamics between you taking a portion of Juul's earnings and with the growth in that? And then if your customers transition over to Juul, you're obviously losing the earnings from that.
So how do you think about that relative difference in contribution to Altria?
Sure. That's a fairly complicated calculation, but I'll try and simplify it. At its simplest level, if Juul was just a domestic company and it was growing by attracting adult cigarette smokers, which I think it largely is, And given that we have a 50 share of the cigarette market, you might think about, well, if the margins were the same in the 2 categories, if we had a 50 share of the cigarette market and Juul was drawing equally from all the brands in the market that you could get to sort of a breakeven situation at a 50% economic interest on Juul. Of course, life is not simple that way. And so in the end, you have to also factor in the relative margin of these two products and the relative margin trend over time.
And you also have to factor in the fact that our 35 percent economic interest is not just in the U. S, it's also in the overseas market as well. And so when you factor that in, I believe that over time, Juul's margins are going to grow to a nice level. That is going to be a benefit to us. I believe that over time as their international market grows, we more than offset the difference between a 50% economic interest and a 35% economic interest in the domestic market by income that comes from overseas markets.
But a lot of that depends on how the future works out. We've gotten comfortable that there's upside to us from this investment. But as I hope the example points out, there's a little bit of complexity in that.
All right. Thank
you. Our
next question comes from the line of Jennifer Maloney of Wall Street Journal.
Hi, Jennifer.
Hi. How are you?
Good.
I wanted to ask you about the do you expect to help JUUL with their applications? And do you anticipate helping them improve their relationship with the FDA moving forward?
Yes, I would say that I have to tell you that Juul has a highly capable team today across their business. And I think that includes their FDA regulatory group. But what we have essentially offered to Juul is to help them in any area that they have interest in receiving our help. And it would not at all surprise me if we collaborated with their regulatory team on their FDA filings, Purely by the fact that we've been regulated longer under regulation of the cigarette category and the smokeless category, We have years of experience and literally 100, if not 1000, of interactions with the FDA that we would be happy to provide perspective on.
And one follow-up, if I may. Do you have a sense of what kind of revenue you'll get from the service agreement?
Yes. I think that it's probably too early to tell on that. We have a cost plus arrangement with them and we know they have interest in a number of areas, but we haven't nailed down how much service they'll take. But certainly that is an opportunity that allows us to benefit by taking some of our leading infrastructure and having some of the cost paid by Juul. And frankly, we believe that as we grew out of the combustible cigarette category into smokeless and into machine made large cigars and now into e vapor that having that broader set of businesses to have supported by our Altria Client Services and AGDC sales organization allowed us to keep a much larger scale organization and more capable service infrastructure that benefits all of the brands, including our core cigarette business.
I forgot to ask, have you gotten any indication from the FDA about whether they're supportive of this partnership?
We have not. We communicated the occurrence of it, but we've not gotten any perspective from them on that.
Okay. Thanks.
Our next
question comes from the line of Vivien Azer
of Cowen and Company. Thank you.
Thank you so much for the follow-up. And Company.
Thank you so much for the follow-up.
Thanks again for the follow-up. I know everyone's very, very focused on Juul, but I didn't want to miss the opportunity to just ask about, the Cronos deal. So, 2 quick ones. Just any background on how long you guys have been working on cannabis, number 1. And number 2, any points of differentiation that made Cronos particularly attractive?
Thanks.
Yes, I would say that we began working very hard on Cronos around late August, early September. And you may recall, we communicated kind of a more open perspective on the cannabis sector in early September. And as we got engaged in really understanding the investment opportunity, investing understanding the potential future growth rate and assessing the likelihood that the U. S. Market may become federally legal, we became quite convinced that this was an attractive global opportunity that had rapid growth potential.
And then of course, we were influenced by the fact that if you take the domestic companies off the table because of the sensitivity we have to only operating in businesses that are federally legal. We were aware of the fact that there were actually not that many leading companies to invest in and we really wanted to have the opportunity to take our pick of what we thought was the best player. And after really meeting with most, if not all of the major players, we concluded that Cronos was the right company. We like their management team. We like the work they've done around investing in intellectual property.
We like their branding strategy. We like their position in the Canadian market and also some of the distribution they've built in other medically legal cannabis markets like Germany and Poland.
Terrific. Very exciting. Thank you.
Thank you very much. Thanks for hanging in there.
Our next question comes from the line of Gerry Gallagher of Deutsche Bank.
Good morning, guys. Thanks for taking my question. I've just got 2. The first one goes to the buy up from the current 35 percent position. It wasn't entirely clear for me.
Could you just clarify, is that subject to the 6 year time frame as well? Or does that have a different time line attached to it?
Yes. We have a standstill that I think is in effect for the foreseeable future. I don't know that it's time bounded.
Is there any color?
So if we wanted to buy beyond 35 percent equity interest, that would have to be adjusted or changed by the Board of Juul.
Okay. And then the second question is around the returns point. Maybe I could just ask the question as simply as I possibly could. Could you tell us what cost of capital you applied to the transaction? And when your return on invested capital will exceed that cost of capital in terms of years from now?
Yes. I think as Howard mentioned earlier, we ran a range of scenarios related to this investment because there with any assumptions, you have a range of those. And so as Howard mentioned earlier to Adam, we'll be sure to provide that clarity. We understand what you're asking and we'll be sure to provide that clarity as we move forward.
Okay. Thank you.
Thank you.
And at this time, I would