Good day, and welcome to the Philip Morris International 4th Quarter 2019 Year End Earnings Conference Call. Today's call is scheduled to last about 1 hour, including remarks by Philip Morris International Management and the question and answer session. Media representatives on the call will also be invited to ask questions at the conclusion of questions from the investment community. I will now turn the call over to Mr. Nick Rowley, Vice President of Investor Relations and Financial Communications.
Please go ahead, sir.
Welcome and thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2019 Q4 and full year results. You may access the release on our website at www.pmi.com or the PMI Investor Relations app. A glossary of terms, including the definition for reduced risk products or RRPs, as well as adjustments, other calculations and reconciliations to the most directly comparable U. S.
GAAP measures and our business transformation metrics are at the end of today's webcast slides, which are posted on our website. Unless otherwise stated, all references to IQOS are to our IQOS heat not burn products. Comparisons are presented on a like for like basis reflecting pro form a 2018 results, which have been adjusted for the deconsolidation of our Canadian subsidiary Rothmans, Benson and Hedges, Inc, effective March 22, 2019. Today's remarks contain forward looking statements and projections of future results. I direct your attention to the forward looking and cautionary statements disclosure in today's presentation and press release, where a review of the various factors that could cause actual results to differ materially from projections or forward looking statements.
It's now my pleasure to introduce Andre Kalantzopoulos, our Chief Executive Officer Martin King, our Chief Financial Officer will join Andre for the question and answer session. Andre?
Thank you, Nick, and welcome, ladies and gentlemen. Our 2019 results continue to reflect strong underlying business performances from both our combustible and smoke free portfolios. IQOS is performing strongly across a broad array of geographies and remains firmly on track to meet our 2021 heated tobacco unit shipment volume target of 90,000,000,000 to 100,000,000,000 units. Meanwhile, our combustible business continues to perform well underpinned by solid price We achieved several important milestones in our transformation to a smoke free future. This notably included the authorization for a version of IQOS product from the U.
S. Food and Drug Administration through the premarket tobacco product application pathway and the subsequent commercial launch in Atlanta and Richmond under a licensing agreement with Altria. IQOS is now commercially available in 52 markets worldwide. Let me now take you through the main elements of our full year results, starting with volume. Industry total volume for cigarettes and heated tobacco units declined by 2 percent, broadly in line with the historical trend and slightly better than our prior forecast of around 2.5%.
Our shipment volume of the industry was driven by heated tobacco share gains of 0.6 points, which helped offset cigarette declines partly impacted by heated tobacco unit cannibalization. Focusing on the 4th quarter, I would also like to highlight that while the effect of inventory movements across the year was small, the greater shipment volume decline of 4.4 percent in Q4 2019 partly reflects unfavorable combustible cigarette inventory movements of 2 point 3,000,000,000 units compared to the prior year quarter, notably due to the European Union region and Japan. We anticipate a partial reversal of this effect in these geographies in the Q1 of 2020. 4th quarter in market sales volume declined by 3.1 percent. As previously anticipated in our 3rd quarter remarks, this in market sales decline primarily reflects the impact of recent pricing in Turkey and the Philippines.
In Turkey, our cigarette volume decline was due mainly to the impact of 2 price increases during the year taken in April August, totaling TRY5 per pack or 44%, which disproportionately impacted our share given the timing of our our basis, but the total market was weak due to a rise in illicit cut tobacco consumption. In the Philippines, tobacco consumption. In the Philippines, our cigarette volume decline mainly reflected a lower total market in the immediate aftermath of industry price increases. Though from a volume mix perspective, Though from a volumemix perspective, this was partly compensated by a strong share performance from Marlboro. Heated tobacco unit shipment volume increased by 4% to 60,000,000,000 units in 2019.
This performance including shipments of over 17,000,000,000 units in the 4th quarter, reflects broad based growth across our launch markets with notable contributions from the EU region, Japan and Russia, and keeps us well on track to deliver our 2021 shipment volume target of 90 1000000000 units. This excellent performance means that heated tobacco units now make up nearly 8% of our total shipment volumes as compared to almost nothing in 2015. We expect this proportion to grow further as our positive momentum of reduced risk products continues. Turning to our 2019 financial results, net revenues increased by 6.4%, excluding currency, driven by strong pricing from for our combustible product portfolio and growth in heated tobacco units. RRP net revenues reached $5,600,000,000 or close to 19 percent of PMI's total net revenues, with IQOS devices accounting for approximately 700,000,000 dollars or 13 percent of RRP net revenue.
As highlighted previously, this lower proportion of device revenues primarily reflects favorable geographic mix of heated tobacco unit volume, the longer lifespan of the latest IQOS devices and the impact of retail price changes in select markets. We recorded a strong combustible tobacco pricing variance of 6.5 percent in 2019, better than our initial expectations for the year, helped by a broadly rational excise tax and competitive environment. There were notable contributions from Germany, Indonesia and Russia, in addition to the aforementioned pricing in the Philippines and Turkey. This was in line with the average historical variance since the 2000 and 8 spin. On a currency neutral basis, adjusted operating income increased by 11.2%, while adjusted operating income margin grew by an excellent 100 and basis points.
This margin expansion was driven by RRP scale effects and favorable geographic mix for the heated tobacco unit. Additional drivers include pricing in combustibles and the impact of our cost initiatives, where we are firmly on track to reach over $1,000,000,000 of efficiencies by 2021, helping to finance growth investments behind RRPs. To this point, we implemented all of our $400,000,000 planned incremental RRP investments in 2019, with the net increase in spend partially offset by higher efficiencies realized as part of our overall cost program. Adjusted diluted earnings per share increased strongly, growing 9.9%, excluding currency, and exceeding our prior forecast of around 9.5%. As explained in our 3rd quarter results, the lower currency neutral growth in adjusted diluted earnings per share compared to adjusted operating income reflects higher non controlling interest and a higher like for like tax rate.
Our strong operating cash flow of $10,100,000,000 increased by $600,000,000 benefiting from a number of working capital initiatives and the timing of certain cash costs related to our Berlin factory optimization. Capital expenditures production efficiencies. Turning now to market share. Our total international share grew by 0.1 point to 28.4 percent with lower share for cigarettes, including the impact of cannibalization, more than offset by higher share for heated tobacco units, which reached 2.2%. The share of cigarette portfolio declined by 0.5 points, reflecting continued adult smoker outreaching to IQOS, particularly in the European Union region and Japan, coupled with lower share notably Argentina, Indonesia, Korea and Turkey.
Further, despite this outreaching, Marlboro share of the cigarette category increased by 0.3 points to an all time high of 10%, driven by Indonesia, the Philippines, Saudi Arabia and Turkey. IQOS is now commercially available in 52 markets, representing 44% of the total international market, where our weighted average geographic coverage within these markets is approximately 60%. This follows the addition of 8 new markets in 2019, including Hungary, Sweden, the United Arab Emirates, the United States, and the 4th quarter launch in Mexico, initially focused in select areas of Mexico City. In the later part of the year, we took another important step in our journey towards a smoke free future with the launch of IQOS 3 Duo, which is now available in all of our international IQOS market, supported by our new Simply Amazing brand campaign. The Simply Amazing campaign focuses on everyday relatable moments and emotions by showcasing to adult smokers who would otherwise continue to smoke
smoke the benefits of switching to IQOS.
This latest addition to the IQOS family was designed with enhanced features to help adult smokers switch more seamlessly from cigarettes. IQOS 3 Duo allows 2 consecutive users without recharging the holder, while its charging time is significantly faster compared to IQOS 3 and IQOS 2.4 plus We've seen positive initial effects on rates of conversion and consumer satisfaction from the rollout of Duo, which offers us from the rollout of Duo, which offers us encouragement on consumers' response to innovation as we start 2020. We continue to nurture a strong pipeline of future product improvements and innovations for the core IQOS platform. Turning now to a more detailed discussion of RRP performance. We estimate that there were nearly 14,000,000 total IQOS users as of year end, representing the addition of 4,000,000 adult users over the course of the year.
Based on our current momentum, we expect this rate of acquisition to 10,000,000 IQOS users have stopped smoking and switched to IQOS with the balance in various stages of conversion. This reflects widespread user growth with highlights including a near doubling of users in Italy and Germany, a near troubling in Poland, very strong growth in Ukraine and the addition of 1,700,000 users in Russia to reach a total of 2,500,000. Let me now take you through the performance of IQOS in 20 19. The overall share performance for IQOS heated tobacco units continues to see excellent progress. Indeed, in international markets where IQOS has been commercialized, IQOS heated tobacco units were the 3rd largest tobacco brand in the 4th quarter with a 5.5% share, increasing from the number 4 position in the 3rd quarter.
This has been achieved despite not having full national distribution in a number of markets as mentioned earlier. The continued excellent growth of IQOS reflects progress across a broad range of markets. Our commercialization approach starts with a focus of the key city on the key cities within a market, building adult smoker awareness, trials and conversions. On this slide, we see the strong offtake share momentum in a number of key cities. This gives us further encouragement as to national level as we see increases in both our geography reach and rates of consumer awareness and trial.
In the EU region, 4th quarter share for HEETS reached 3.2% of total cigarette heated tobacco unit industry volume, an increase of 1.5 points or near doubling compared to the 4th quarter of 2018. On a sequential basis, share growth accelerated in the quarter, increasing by 0.7 points. In market sales volume also grew 16.1% compared to the Q3 2019. This growth reflects continued strength across a broad range of markets as detailed in this slide. It is worth noting that IQOS is only present in geographic areas, representing approximately 57% of industry total volume in the region.
The quality of consumer acquisition is also high with conversion rates and registration rates improving over time. IQOS continued the basis versus the Q3, percent to reach 2,900,000,000 units. HIT share growth in the quarter was consistent with the pace of adult smoker adoption and our geographic expansion. We are now commercializing IQOS in cities, representing 2nd quarter. In Japan, our total reported share for heated tobacco units increased by 2.4 points to reach 17.6% in the 4th quarter, supported by the launch of IQOS 3.2 and line extensions in Marlboro HeatSticks and Heat's lineup.
As we have previously mentioned, total industry and share metrics in Japan are currently somewhat distorted by the low price significantly preferential tax treatment, though the tax comes significantly preferential tax treatment, though the tax council of the ruling party has recently announced the closing of this gap over 2 steps in October 2020 October 2021. While the growth of this category is likely to be temporary, we plan to enter with a Philip Morris brand in the current quarter to capture our fair share. On a total tobacco view, including cigarillos and adjusted for trade inventory movement, the share of our heated tobacco unit brands increased by 1.5 points versus the prior year quarter and by 0.6 points sequentially to 16.9%. 20 19 in market sales volumes of our heated tobacco unit brands grew 4.2% compared to a total tobacco market, including cigarillos, which declined just over 3% after adjusting for the estimated impact of trade inventory movement. This helped drive growth the overall heated tobacco category to a 4th quarter total tobacco share of almost 24%, including and adjusted for trained inventory movements.
In Korea, there remains a lingering impact on the heated tobacco category of the consumer confusion caused by the Korean FDA's 2018 communication on TAR. The category also remains highly competitive, particularly in the area of non menthol flavors and related new taste dimensions that are also present in the cigarette category. His share in the 4th quarter declined by 2.2 points or by 1.4 points on an adjusted basis. However, on a sequential basis, 4th quarter adjusted share was essentially stable and our segment share continued to grow supported by IQOS 3 Duo and recent launches that expanded the flavor line up. While we're encouraged by this trend, we still have a lot of work to do to reinforce the heated tobacco category's benefits and build upon IQOS' leadership position.
A key development in 20 19 was the launch of IQOS in the U. S. Through our commercial arrangement with Altria. The first IQOS retail stores opened in the initial launch markets of Atlanta, Richmond, marking a historic milestone and providing better alternatives to the 40,000,000 men and women in the United States who continue to smoke. While it remains early days in the lead market commercialization, we're excited about this significant opportunity.
As a reminder, IQOS is currently the only hit and burn product on the market authorized by the U. S. Food and Drug Administration through the PMTA pathway as in the coming months, which will further support the efforts to convert U. S. Adult consumers who would otherwise continue to smoke.
Building on the on the reach the optimal capacity to deploy at scale. As a result, we plan to a faster acceleration of commercial rollout through the second half of twenty twenty. It's worth pausing briefly to consider the dynamics of of of geographies, with 10 markets making up around 70% of the approximately 25,000,000 international adult users, which despite numbering almost double that of heated tobacco, contribute less than half its retail value. This reflects the heavy existing SKU to open tank system, a low degree of product differentiation and a low rate of full conversion relative to heated tobacco products. Of these ten markets, 7 also have a meaningful limit on nicotine concentration.
Address these dynamics and will be able to leverage our existing RRP commercial infrastructure and capabilities to drive consumer trial and repurchase. In summary, we are optimistic that IQOS MESH will deliver a superior experience and drive further growth in our business over time. Lastly, in terms of the commercialization
Lastly, in terms of the commercialization outlook
on RRPs, we also recently announced a global collaboration agreement with KT and G for the commercialization of their multiple products, providing a wide array of brand, taste, price and technology choices to adult smokers. The capabilities we have built around RRPs in term of commercial infrastructure and know how, technology, scientific substantiation and regulatory engagement are best in class. These capabilities can be leveraged to broaden our strong portfolio and innovation pipeline to further drive category growth, including partnerships with others when it makes strategic and economic sense to do so. KT and G has a range of smoke free products, which we see intend to apply a market by market approach to deployment. The agreement will run for an initial period of 3 years with the intention to expand the market footprint based on commercial success.
While we don't disclose the financial terms of such arrangements, this is a royalty based agreement. Products sold under the agreement will be subject to careful assessment to ensure they meet the regulatory requirements in the markets where they are launched, as well as PMI's high standards of quality and scientific substantiation of their harm reduction potential. We are now working towards the first launch as late as this year. There are no current plans to commercialize KTHG products in the United States. With this agreement and our own IQOS MESH launch in 2020, we have an active and exciting year ahead.
Turning to 2020 reported diluted earnings per share to be at least $5.50 at prevailing exchange rate compared to reported diluted earnings per share of $4.61 in 20.19. On a like to like to like for like basis and excluding an unfavorable currency impact of approximately $0.04 at prevailing exchange rate, this forecast represents a projected increase of at least 8% versus pro form a adjusted diluted earnings per share $5.13 in 20.19. In terms of quarterly phasing, we expect earnings per share growth and net revenue growth to be particularly strong in the Q1 and notably softer in the second quarter 2020. The Q1 will benefit from the timing of pricing in the Philippines and a favorable comparison with the Q1 2019, which included the absorption of substantial excise tax increases in Turkey. Conversely, performance in the Q2 will likely be impacted by both the comparison to a strong performance in the Q2 2019 and the most pronounced effect of the tax driven pricing in Indonesia.
It's also worth noting that the higher weighting of growth to markets with significant non controlling interest seen in the second half of twenty nineteen will continue into the first half of twenty twenty due to annualization effects. Let me now explain the dynamics in Indonesia in more detail. As we said in December, the industry faces a typical year of catch up on excise tax and pricing. The 2020 excise tax took effect on January 1, implying a weighted average excise tax increase of 24% industry wide, with a 40 6% increase in the minimum bundtroll price. While the potential tax pass on is relatively steep at 14% of the weighted average price.
In the context of a 2 year percentage increase is broadly in line with historical levels. The tax increase and the higher bundle price should also give us the opportunity to address the price gaps which impacted our 2019 share performance. So far between October January, we have announced pricing of 8% on a weighted average basis or approximately 60% of the pass on. To date, some of our competitors are lacking on pricing and will require a larger catch up to comply with the new minimum retail price that is effective April 1. We should also highlight the one time impact on our pricing variance from the lack of any excise tax increase in 2019.
With minimal pricing taken in the 1st 9 months of last year, we will not benefit this year from the usual annualization effect of increases taken in the prior year. This exceptional dynamic effectively creates a one off drag on our 2020 pricing variance of over $200,000,000 In line with our prior comments, we expect the total industry measuring 370,000,000,000 units in 2019 to decline by around 6% to 7 percent in 2020, with the highest impact likely in the second quarter as the new minimum retail selling price takes effect and the new has worked their way through the trade. With the resumption of pricing this year, we expect market dynamics to improve in 2020 one. Our 2020 guidance reflects certain key assumptions. The most significant, as we just noted, is the pricing rollout in Indonesia, which at this stage, we assume to dilute our combustible pricing robust and it's supported by a generally rational excise tax environment.
In combination with the projected total market decline of 6% to 7% in Indonesia, at this stage, we cautiously assume currency neutral percent currency neutral earnings per share growth. One of the reasons for this confidence is the positive margin outlook, while our efforts to deliver over $1,000,000,000 in annualized cost efficiencies by 20 21 are bearing fruit, led by important initiatives related to productivity, cost category management, a project based organization model and other cost efficiencies. In 20 20, we expect cost efficiencies to fully offset expected net incremental RRP investment. With the growing scale and geographic reach of our RRP business, additional investments now primarily reflect variable costs linked to new consumer acquisition and existing user retention plus new market entry. Consequently, the cost per user is improving with an expected decrease of 25% in our acquisition cost per user in 2020.
We expect the increasing leverage of our commercial platform to contribute to an increase in currency neutral operating income margin of at least 100 and 50 basis points in 2020. Moving to the industry volume backdrop, our estimated total market decline is around 3% to 4% for the year. While this is weaker than the historical average of 2% to 3%, this very much reflects the temporary situation in Indonesia, which represents around 11% of total industry volume. An additional factor comes from the present growth of the cigarillo category in Japan, which is not included in the cigarette total market calculations. As shown on the chart, we assume 6% to 7% market decline in Indonesia is an expected effect of around 0.7 points on the global industry, with a further 0.3 points from the growth of cigarettes in Japan.
Where while there are the usual puts and takes elsewhere, together these two temporary impacts fully explain the deviation from the historical average with underlying fundamentals remaining unchanged. An additional upcoming development included in our industry forecast is the Tobacco Products Directive ban on menthol cigarettes in the European Union, effective May 2020. Menthol and menthol capsule variants make up for around 10% of consumption in the region. And while we do not expect a significant impact on the overall industry volume decline of 1% to 2%, there is a further opportunity for IQOS given that MENSORHEETS variants are not covered by the ban. We expect PMI shipment volumes the of approximately 2.5% to 3.5%.
We expect our shipment volume trends to be slightly better in the second half compared to the first half due to the dynamics already mentioned in Indonesia and Turkey. While we are not providing a specific 2020 target for heated tobacco unit shipment, we expect continued broad based growth and remain well on track to meet our shipment volume target of 90,000,000,000 to 100,000,000,000 units by 2021. We anticipate a full year effective tax rate of approximately 23%, consistent with last year and relatively stable net interest expense compared to 2019. We are targeting 2020 operating cash flow of approximately $10,500,000,000 subject to year end working capital requirements and currency movements. This Berlin factory restructuring.
Together, these two factors account for an expected unfavorable cash impact of $350,000,000 We project total capital expenditures this year to be approximately $1,000,000,000 Summing up a strong year, we made very significant progress in our transformation to a small $600,000,000 in RRP net revenues, making up almost 1 5th of our business. Importantly, RRP revenues are increasingly accretive to our profits as evidenced by the strong margin growth seen in 2019 and expected in 2020. IQOS continues to perform strongly with 35% growth of heated tobacco unit in market sales volumes from an increasing number of markets where close to 10,000,000 adult smokers have already stopped smoking and switched to IQOS. We project the number of new users over the course of 2020 to be significantly higher than 2019 and at a cost per user that is lower as the large RRP infrastructure investments over the past several years are mostly complete. We're also focused on maintaining the leadership of our combustible tobacco portfolio, which is delivering robust performance and price and power.
Despite the temporary headwinds in Indonesia, are confident in our 2020 guidance and remain well on track to deliver our 2019 to 2021 compound annual ex currency growth targets of at least 5% net revenue growth and at least 8% adjusted earnings per share growth. Finally, we are confident in our strategy for a smoke free future and are convinced that our current and future RRP portfolio continues to provide us with the single largest opportunity to accelerate our business growth and generously reward our shareholders over time. Thank you. Martin and I are now happy to answer your questions.
Thank you. We will now conduct the question and answer session of the conference. Our first question comes from the line of Michael Lavery from Piper Sandler.
Thank you. Good morning.
Hi, Michael. Good morning. Good morning.
Can you touch on IQOS and some of what's going on in really sort of 2 different ends of the adoption curve, I guess. On the one end, you see a market like Hungary, for example, that has 4 share points plus in just a year out of nowhere, but then you're also talking about the lower costs of acquisition per user that you've mentioned in the past comes from scale and growing word-of-mouth. I guess I'd love to just understand both dynamics a little bit more. One is how are you driving some of the rapid adoption in select markets? And then second, what are some of the key drivers of your efficiencies as they get a little bit more mature?
Yes. Well, I guess as a learning organization, every time we launch in a new market, we apply what we learned from the previous one. So the time when we start growing faster is shorter and shorter. And I think we showed a chart like this recently, and we'll explain that in CAGNY next week. So it's a learning organization, the deployment of more digital skills that makes that every new market we open starts growing faster than the previous one.
And that's fact of organization knowledge. Now as we have also the infrastructure in place, clearly, the cost per user will decrease and does decrease this year in 2020. We have to invest a little bit more money in retention, I would say, although the cost of retention will also go down as we have more people. But clearly, the cost of acquisition is higher. So it makes sense now that we have enough people in our CRM base to invest a bit more there because losing a consumer that have acquired is much bigger loss than not acquiring someone by definition, okay?
And also because now we have the digital infrastructure, we can start enlarging beyond over time the offering, beyond accessories and just special editions and normal products to more things that can help us build a different type of business over time as we have data on consumers and so on. So I'm optimistic that although we will continue investing, Michael, incrementally in the RRP, So we grow the number of users. This cost per user is going to go further and further down. And obviously, we retain more consumers. So that's all on the positive side.
And that's how I see it, if if I was clear.
No, that's very helpful. Thank you. One just quick follow-up related to that. When you look at the evolution of IQOS usage of consumers, you've shown the charts that pretty consistently show around 70% of users who fully convert. But obviously, you're also adding new users constantly as well who have obviously just gotten started.
What amount of time does it typically take for somebody to transition and maybe related to saying it kind of a different way for users that began using the product, say, a year or 2 ago, is the amount that's fully converted more like 75%, 80% or 85%? How should we think about that dynamic?
Well, for the new users, clearly, on average we say 2 weeks to a month depending on the individual. Sometimes people take much more time to fully switch, okay. They start using product immediacy obviously because they bought it. Now regarding retention over time, it's fairly stable, I would say. And I think with the new programs we have in our CRM, we will increase this retention.
Now, dilution of consumption because people buy other devices typically vastly cheaper from competition and they try a few products. But if I compare markets where and I think we can further enhance this retention as we now deploy a much better CRM program during the year. So I'm pretty happy with what we have. We can improve from here.
That's great. Thank you very much.
Your next question comes from the line of Robert with UBS.
Hello. Three questions from me. The first would be outside Korea and Japan, are there any markets where IQOS volumes have declined sequentially? And then on the flip side, are there any markets where sequential growth has accelerated?
Okay. I mean, except for Korea, I would say we have growth in every market, okay. Korea is a particular phenomenon because there is a confusion of consumers around the heat not burn category that is not dissimilar to what happened in many markets on the e vapor category. And that happened at the beginning of last year in June, when the Korean FDA, although they found a very significant reduction in the toxicants of heated tobacco product compared to cigarettes, very similar to what we have communicated, they kind of confuse consumers by saying yes, but the tar of this product is very similar to cigarettes, although we're comparing apples with oranges, because there's 2 different parts. The one is water and glycerin and the other is bad chemical.
So this has stalled the category, by the authorities in Korea that that's not the right thing to do with consumers. And the alignment we have now much more with KT and G. After the agreement, I think that will help grow the category. But except for Korea, I don't see any other place where we have an issue.
Great. And then just in terms of the margin expansion. So if we think about how much of your 2020 expectation is driven by, say, cost saves, pricing and IQOS? Is it fair to think that the impact of IQOS is offset by cost savings and the incremental increase is pricing or how should we think about that?
Yes. The margin expansion is driven by a number of factors. First of all, it's partly mix in that we're growing very rapidly now in the EU, which has very good margins on IQOS heated tobacco units. The second piece is, as you point out, our cost saving initiatives have stepped up significantly. At this point, the investments that we're making behind RRP are now fully offset by these cost savings initiatives.
And that's where you get the big benefit from margin expansion. And the cost saving breaks down into a couple of buckets. In the operations area, we have various productivity, especially as we get better and better at producing the consumables for heated tobacco units with scale, better uptime on the equipment, lower waste. We're improving the footprint across the whole manufacturing area. You saw the factory optimizations we've done in the last year, which begin to pay off in 2020 beyond.
And we also have initiatives across all of our spending categories to find effort started to pay off really last year, effort started to pay off really last year. You saw our margin expansion. Last year was very strong at 1.7 percentage point increase. And then this year, we're committing to at least 1.5 percentage increase. And this is something that we will continue to focus on in the out years going forward as well.
Yes. Regarding pricing, I would say, as I explained, we foresee pricing to be a bit below this year than 2019, but it's essentially due to Indonesia, okay? Because if we took 2019, we had annualization of pricing from 2018 in Indonesia, which at this stage, we assume is not going to happen. Obviously, 1, there was no real pricing in 2019, so we have no annualization in 2020. And we have to be a bit cautious about pricing and how it rolls out in Indonesia as there is a pretty steep increase.
But we assume that this situation will resolve during 2020. So in 2021, we have annualization of pricing in Indonesia and come back to normal.
Okay? Excellent. Apologies. Just one follow-up on
Well, IQOS margins are higher than cigarettes, okay. So that's basically clear and a lot of the margin improvement is coming as Martin explained from IQOS essentially.
Okay. Thanks very much.
Your next question comes from the line of Vivien Azer from Cowen.
So you guys sound very constructive on the momentum on IQOS that is clear. I was hoping that you could comment on your key competitors commentary this morning for the RRP category in Japan specifically. They maybe have a different view than you, specifically saying that they're looking for more moderate, growth to capture 25% of industry volumes, as competition intensifies. Can you comment on that?
I think it's very difficult to comment at this stage what is going to be the precise growth of the category. Maybe I see it higher than them, but we see both growth and that's the important part. And I think we are well positioned with all the initiatives we have to capture the largest part of the growth. So we'll see as the year unfolds, where exactly we end. But the key thing is that we remain focused.
IQOS still has the lion part of the segment share and the momentum is positive and and we're increasing segment share and overall market share. So that's the key thing to retain.
Just to follow-up on Japan, can you offer any color on what your HTU mix is between HEETS and Marlboro at the end of 2019?
I don't have the exact numbers in my head, but I would say the cannibalization is stable. We had a little bit of down trading, I would say, after the price increase, because Marlboro increased prices more than HEETS. But now it's back to stable, and they are both growing, but Balboro is growing again.
I think, Vivien, we haven't given the exact split, but I think it's safe to say that Marlboro's share, Marlboro HeatSticks' share ended up being more than we originally expected. We thought that HEETS would be a bigger component by now and Marlboro HeatSticks has held up better than we expected given the pricing. On the other hand, Heat did its job of expanding the category and making the offering available to a broader array of consumers that were more price sensitive. So we're satisfied with its performance. And overall, it did its job.
However, more heated tobacco users opted to stay with the Marlboro Heat 6 than we originally planned, which is positive, of course, for our margin and for the profitability.
Sure. Absolutely. No, that's a great outcome. Last one from me. Andre, I appreciated your commentary on some of the e vapor concerns that are spreading seemingly to the EU.
That's certainly consistent with what we heard from one of your competitors yesterday. Are there any principal markets, that we should be watching out for in particular where consumer concern or confusion around e vapor risk is taking hold most dramatically?
Well, I think the maximum was after the unfortunate cases in the U. S. With the lung disease and deaths that were spun by some people in the wrong way, as you know. I think this is getting better, but we're not there out yet because there are still people that spread confusion despite all the efforts. Myself and others are making to explain that this had nothing do with the vapor category and more with misuse with cannabis, oils and so on.
Our perspective on this was, in any case, our plan on e vapor was to build the capacity and go into the bulk of the market that is the European Union towards the year end, okay, because then we have capacity at scale. We had planned a couple of markets earlier on a try basis. I think it's better not to put oil in the fire, especially since we will put the e vapor under the IQOS brand. So to minimize confusion, I prefer that we let a little bit time fly. We build capacity and it doesn't move in reality our plan for the European Union, which was towards the end of this year.
So that's my perspective. And I think that it's about time. There are more voices here to stop misleading people. And I was reading the recent Q and A by the World Health Organization,
misleading and I would say
malicious statements in misleading and I would say malicious statements in there that some of the top advocates in public health came out and say, this is unacceptable. So they modified their version, but they're still misleading. So I think short term that may appear not a good thing, but long term, the more people say insane things, the more credibility they lose
and
the more the alternatives will become more credible because they lose their credibility. And I think we are in this phase now, who are frankly speaking, you see more and more of this nonsensical thing and more and more voice saying, let's stop this, have a reset now of the situation and stop talking seriously because these alternatives are better for people who would otherwise smoke. But as far as the commercial part is concerned, that's it. That's what I said and I explained just now. Hope I'm clear.
Very clear. Thank you so much.
Your next question comes
ask one quick question there before turning to IQOS? And the question on Japan is whether in your pricing variance, you're baking in any assumption for the around the tax rise that we're obviously going to get in October this year? So that's the first question.
Well, any pricing is all in the guidance, obviously, Adam. So we always hope there is an opportunity in Japan when there is a tax increase to get pricing. We make some assumptions. We see how much they materialize or
not. Perfect. Very clear. So the real question, the core question is obviously around IQOS. And so one, so thinking about the European to begin with, the European Union to begin with.
In Q3, you had 0.1% quarter on quarter market share growth. And then you've had a much higher really strong growth in Q4. And I was just wondering how you should think how we should think about EU market share progressing going forwards, whether there's any sort of seasonality in that and how you think we should sort of smooth out those two things, Slight disappointing in my view in Q3 and then a really strong performance just in Q4. Okay.
In broad strokes, okay, there is seasonality in summer pretty although IQOS was very marginally affected by the whole situation of e vapor in the U. S, it was just the moment in the quarter. We had a bit of a slowdown in September, I would say, but we recovered as of October, November. And I think we're entering 2020 with a pretty good momentum. Number of users is increasing.
As I explained, I think the mental is an opportunity for us at the towards the second half of the year. So I'm very optimistic about the momentum and outcomes in the European Union.
And so just to summarize, I think you're saying you expect to get more new users in the EU in 2020 than you did in 20 19, partly because of a medical issue, but also the CRM that just the whole momentum is so good?
Yes, that's what I'm saying.
Hey, Adam, I would also just sorry,
I'm not going to add
on the IQOS heated tobacco unit share in the EU, there is seasonality there.
If you
look at, for instance, in 2018, you see the same basic dynamic where the increase from Q2 to Q3 is relatively small with a bigger increase from Q3 to Q4. And then again in 2019, you see the same dynamic. In addition, this year, we had even more pronounced effect that Andre mentioned with the other news flow. But this is back to the seasonality piece. Cigarettes in EU are going to be higher because it's warm weather, people go outside and they could use it more and then lower in the winter months, whereas IQOS you could use much more easily frequently without any worry as far as what the weather outside is.
So you don't see the volume changes quarter to quarter as much as you do on cigarettes. So it's really the cigarette seasonality that's driving these share numbers to be impacted.
Overall, I would say, Adam, we see a significant increase in the number of users overall across the market, okay? And I think it's also due to the fact that we're getting scale, getting momentum. We see more word-of-mouth happening in the markets and the tools we use now are more scalable. So I hope we will see this accelerate.
And then quickly, turning to Russia, which obviously a very large market and you're getting share very fast. Roughly speaking, well, in Q3 last year, you had roughly 1% market share. You've now got 5%. So in 5 quarters, you've gained 4 percentage points of market share. I guess the question is, do you think that rate of growth can continue?
Or would you expect it to slow slightly?
Well, first of all, we need to compare comparable things, okay? We are still growing in cities where we started before. There is some obviously expansion in there that helps and we still have scope for expansion. Now it's pretty clear in my mind that at a certain stage, we will need probably a second price point in the portfolio in Russia, because in certain cities, we will be getting the essence of the premium and somehow a large part of the more, I would say, wealthy part of the mid price segment. I don't know that we will need this in 2020, but we have to plan at least for 20 21, okay?
And that's how I see it. So we don't see a slowdown, but we need to prepare for reaching the limits in terms of affordability over time in the big cities. Now in the cities we just started, clearly, we have more runway in front of us.
Okay. Thank you very much.
Your next question comes from the line of Pamela Kaufman from Morgan Stanley.
Hi, good morning.
Hi, Paula. Good morning.
So over the last several years, you've quantified a level of incremental IQOS investment in each year. How much incremental investment do you anticipate in 2020 relative to 2019?
Well, in my view, it's going to be a bit less than 2019. And it's all variable. At the end of the day, it all depends on the number of new consumers you acquire. So I would say, it would be between 3 $1,000,000 and $350,000,000 depending on the number of new users that we have, because there are certain costs that are purely variable. But as clearly said, all this is offset on a comparable basis by all the savings we have in from our cost saving initiatives.
So that helps clearly the margin expansion plus the geographic mix of IQOS that is helpful.
Thanks. That's helpful. And I wanted to better understand your decision to partner with KTNG and how you see their products competing with IQOS? And given that this partnership expands your portfolio to e vapor and hybrid products, do you also see a to fill the gap in modern oral?
Yes. I think at the end of the day, I said many times, I don't think we will do all the new products on our own or invent everything and we are very open to partnership. And this is a very simple principle is what can we add to the partnership. I think we have technology, we have IP that's complements, we have the scientific assessment capabilities and obviously the route to market. And in my view, KT and G has an interesting product like the Hybris product, which by the way is a peripheral heated tobacco product that vaporizes at the same time.
When we think there is potential in certain markets and certain consumer segments, their heated tobacco product is the 2nd more performing heated tobacco product and it's also hitting from the inside. And I think with the know how we have, if necessary, we can improve this product. And I think we decide market by market what are the right points for this product, so that they are complementary to our IQOS strategy. And as we discussed in Japan, for Japan, there may be some cannibalization, but from Japan, for example, we do the two price points with our own products, we didn't see much cannibalization with so much more incrementality. So that's how I see it.
For the e vapor product, we have not major the pin that has potential in these markets and that's how I see it. We also have more alignment, I would say, overall in Korea, that's important for the Korean market. And we also have access from a technology point of view to a country like Korea that is one of the centers for electronics. So I think it's a win win for both companies. It's a license agreement, the financial work for both of us.
So I look forward to working with them and expanding in the right markets, offering consumers much more wide range of products.
Thank you. And can you give an update on the impact on new user adoption in Japan from your device price reductions and other initiatives to accelerate IQOS growth in this market over the last year? Are you seeing increasing heated tobacco adoption and trial among the harder to convert later adopters?
Certainly, we see some. I think the IQOS address this also in general to avoid all these promotions and promotional money. We think that's the right price of the product. And we always prepare the portfolio for the next generation that will always come at a premium. So we always reduce the previous version price in view of the forthcoming new version.
And as I explained many times, we have a strategy say that there say that there is enormous reduction reaction just because we reduced the device prices, it helps, but there is a whole mix that works. We see actually more reaction in Russia, where disposable income is really an issue by having still a 2.4 plus on the market and IQOS 3, where still a lot of consumers buy the 2.4 because they're more price sensitive market. I think the answer is not only pricing, is much more resolving constantly the consumer pain points that are a barrier to entry in the category that's why we're working on the current versions and the forthcoming one. So that's a little bit the philosophy we apply.
Thank you.
Your next question comes from the line of Chris Growe from Stifel.
Hi, good morning.
Hi, Chris.
Hi. Just had a question for you and a bit of a follow on from an earlier question. As you said, your cost per user and acquiring users in IQOS is going down. And I guess I'm interested in that that's, acquiring users in IQOS is going down. And I guess I'm interested in that scale effect you have in RFPs.
You're obviously going to spend more money this year, but I think at the same time, I'm just trying to understand how you can leverage that infrastructure you have as you think about the launch of Platform 2 or Mesh.
Is a lot
of the same or are a lot of the same resources being used for that? Are those I assume they are figured as part of that $300,000,000 to $350,000,000 you cited for this year as you think about the launch cost of those new products?
Well, obviously, these new products, if they go through our infrastructure, which means our own retail, 3rd party retail, that is kind of franchises, our own digital platforms now that are put in place, our coaches, obviously you can use the infrastructure you have in a much more efficient way. So I would say that still investment during the year is still on IQOS Hypnot Verg. And we assume even when we roll out a bit more massively P4, it's going to be on a per user basis much cheaper compounded by the fact that we don't have to explain the category to people. We just need to explain to people what the difference is and what the benefits of mesh are compared to existing e paper products. So there is no category explanation effort behind.
So it will be much cheaper in my view, less expensive than the hit not burn product.
Okay. Yes. Thank you for that. And then I just one other follow-up question. And this gets to a question a bit of a question earlier in your response, but you have seen this a number of markets in the EU where IQOS market share has really accelerated.
And we talked in the old couple of few years ago about in Japan when you got over that 2% to 2.5% threshold, you start to see market share really accelerate. Are we at that point in the EU? Do we see that in the Q4? Because some of those market share increases are quite notable. Are we at that stage is my question and are you seeing that in more markets or do you expect to see that in more markets in 2020?
Well, we hope we see it in more and more markets in 2020. As I said, we expect the number of users to grow, which means compared to we had 4,000,000 users, we expect much higher number than that. So I call this acceleration on a same market basis, okay? Look, at the beginning of the year, I will feel good about the 4th quarter. We have good momentum going into 2020.
We'll keep you up to date on how we progress. And that comes at a much lower cost. So I think we're building it pretty nicely.
Okay. Thank you for your time.
We have time for one final question and that is from Gaurav Jain from Barclays.
Hello. Good morning. So my question is on the Canadian subsidiary. So can you tell us where we are with the RBH creditor protection negotiations, which are happening?
Well, they are progressing, but I cannot give you more details, okay? Still there is a stay of all litigation and there are discussions to resolve the issue. Once we have something concrete, I can give you more details, but things are progress.
Sure. A follow-up on the IQOS Mesh launch. So would you consider applying for a PMTA considering Altria changed some of the language around their JUUL agreement, if JUUL is not allowed in the market for a year and other things?
I think we have a lot of plans for P4. So one day we will probably apply for PMTA in the U. S, but we still have to finalize a few studies on P4 before we have the same type of file as we had for IQOS. But that's important also for many other countries. And in due time, we'll discuss on if and when we want to enter the U.
S. Market. The FDA is going to be very busy in the U. S. Over the next few months on all the PMTAs.
I don't think that's the last quarter
and for the full 2019? Both in the last quarter and for the full 2019?
I'm sorry. The in market sales versus the shipments were in your were sell in versus sell out were approximately equal. If anything, actually, the IMS was a
little bit more than the shipments.
So there was no inventory change on
the year. Yes. It's in line with what we said from the beginning of the year.
Sure. Thanks a lot.
Okay. Thank you.
That concludes the Q and A session of today's call. Presenters, do you have any closing remarks?
Yes. I would like to thank you all for joining, first of all. I would say we had a pretty good 2019. We're entering 2020 in a very good shape. We outlined one unusual thing that is in Tunisia.
We think we'd see how this unfolds. We prefer to be cautious about this at the beginning of the year. And just something that is in the air just now, I mean, this whole issue around the coronavirus, we have no problem today. But clearly, if that continues, there may be some impact on travel and persists for a very long period of time, like everybody else, we may have some issues with device supply. Now that's not a continuation of this, like in any company is not baked into our guidance, but we all hope this is going to be soon resolved.
So we put it behind. So thank you again and I look forward to a pretty good 2020.
Thank you very much. That concludes the call. If you have any follow-up questions, please contact the Investor Relations team here in Switzerland. Have a great day. Thank you.
That concludes today's conference call. You may now disconnect.