Good day. Welcome to the Philip Morris International first quarter of 2020 earnings conference call. Today's call is scheduled to last about one hour, including remarks by Philip Morris International management and the question and answer session. In order to ask a question, please press the star key followed by the number one on your touchtone phone at any time. 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 Rolli, 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 2020 first quarter results. You may access the release on www.pmi.com or the PMI Investor Relations app. A glossary of terms, including the definition for reduced-risk products, RRPs, as well as adjustments, other calculations, and reconciliations to the most directly comparable US GAAP measures, additional heated tobacco unit market data, and/or 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 forma 2019 results, which have been adjusted for the deconsolidation of our Canadian subsidiary, Rothmans, Benson & Hedges Inc., effective March 22nd, 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 for review of the various factors that could cause actual results to differ materially from projections or forward-looking statements. Please note we now also include additional forward-looking and cautionary statements related to COVID-19. It's now my pleasure to introduce André Calantzopoulos, our Chief Executive Officer, and Martin King, our Chief Financial Officer, both of whom will be available for the question and answer session. André?
Thank you, Nick, and welcome, ladies and gentlemen. These are unprecedented times for all of us, and I hope everyone listening and their families are safe and well. I would also like to express a deep appreciation for the life-saving efforts of medical, social, and other frontline workers during the COVID-19 pandemic. Our main focus at this time is on the health and well-being of our employees, their families, and the communities in which we operate. We have implemented stringent policies and measures to minimize risks for those who continue to work in our facilities and offices. For all our employees, including those working from home, providing guidance and support is also essential. We recently announced a new set of guiding principles to reassure employees of the company's commitment to job security throughout the global pandemic period in three areas: employment stability, financial stability, and special recognition.
The strength and spirit shown in these challenging times by the people that make up our organization is a real inspiration to me and the Philip Morris International management team. I would like to take this opportunity to thank them for their outstanding efforts. Indeed, our people continue to generate ideas on how they and PMI can contribute skills and resources to the wider societal effort. Ongoing and planned initiatives in more than 60 countries include providing protective equipment to trade partners, support to care communities, procurement support to purchase items essential to fight against COVID-19, and financial support to institutions and non-government organizations working to end this crisis. In addition, our employees in many countries are volunteering to help elderly, low-income, and other at-risk populations, and some of our factories are producing hand sanitizer and masks for their local communities.
Lastly, but very importantly, we have also taken steps to ensure the continuity of our supply to our customers and consumers and to support our suppliers through this challenging time. Let me now comment on the overall impact of COVID-19 around business and outlook before I hand over to Martin, who will cover this impact and the performance in the quarter in more detail. We started the year with a very strong first quarter, with minimal disruption to business performance and continued structural growth momentum. While we have had a number of temporary shutdowns at different manufacturing facilities and some additional complexities in our route to market, we have activated contingency plans where required to ensure sufficient inventories and consumer access to our products.
Aligned to a healthy balance sheet and liquidity position, our ability to generate cash will allow us to continue investing in our business, retire maturing debt, and pay dividends. Turning to the outlook, the inherent uncertainty in the global economic picture makes forecasting much more challenging than usual. With social isolation measures placing day-to-day life on hold for much of the world's population, this temporarily impacts our operating environment. The most direct effect is on duty-free sales due to reduced travel, with additional impacts from delayed IQOS user acquisition and regulatory price enforcement in Indonesia. In total, this is likely to have a negative impact on our 2020 currency-neutral performance, with recent exchange rate movements a further drag. Our visibility on the duration and extent of lockdown measures across the world is extremely limited. We are withdrawing our annual forecast and replacing it with quarterly guidance, where visibility is relatively better.
Martin will talk through the key moving parts in our EPS guidance for the second quarter, when the most impact is likely to be felt. We are confident the strong momentum from IQOS user acquisition shown in recent quarters will start to resume as restrictions ease. In the meantime, our digital and commercial engine allows us to serve our existing adult consumers, maximize the conversion of adult smokers under the prevailing circumstances, and tailor our investments as required to optimize costs. There is also considerable uncertainty as to the magnitude of the economic consequences of the current situation and the speed and shape of the recovery, including the impacts on disposable incomes and employment. While it's too early to fully assess potential effects on market dynamics in terms of consumption and down-trading, we have to assume there will be some impact.
We also sense, in certain developing countries, difficulties in ensuring business continuity for some smaller general trade players, which may lead to localized out of stocks. However, as in previous times of economic and social turbulence, we expect to show resilient performance through these challenges. Martin?
Thank you, André. I'll start with a headline summary of our first quarter performance, which was very strong in terms of like-for-like ex-currency growth before any pandemic impact. We estimate COVID-19 effects, primarily distributor and trade inventory movements, accounted for 2 points of net revenue growth, 110 basis points of adjusted operating income margin, and 6.8 points of adjusted diluted earnings per share growth. Heated tobacco unit shipment volume grew 45% to 16.7 billion units, reflecting continued broad-based share gains. Total combined shipment volume decreased by a modest 0.6% on a like-for-like basis, benefiting from inventory movements. Currency neutral net revenues grew by 10%, reflecting the volume growth and positive geographic mix of HTUs, in addition to a strong combustible tobacco pricing variance of 7.7%.
This robust revenue growth, combined with a positive margin mix, scale effects of higher HTU volumes, cost efficiencies, and cost phasing, drove a 510 basis point increase in our adjusted currency neutral operating income margin and 30.1% growth in currency neutral adjusted diluted EPS. This excellent start to the year with encouraging progress in both our combustible and reduced-risk product businesses is particularly important as we consider the impact of the COVID-19 pandemic. While we expect our core existing operations to continue performing well, there are three main areas of expected impact from temporary changes to our operating environment, in addition to the impact of currency movements, which I'll come back to. The first, and likely longest in duration, is on duty-free sales due to severely curtailed global travel. For context, PMI duty-free, with a market share of 37%, contributed almost 4% of our 2019 net revenues.
It also enjoys higher unit margins relative to the global average, given the skew to premium brands such as Marlboro and HEETS. Consumer offtake trends exited March with declines of over 80%, and we expect similar trends to continue until travel starts to recover. Due to the premium skew of our duty-free sales, we assume that only a portion of the volume will be recovered by our own brand portfolio in local markets, usually at lower margins. The second impact is on the rate of IQOS user acquisition. Lockdown measures and other restrictions hamper our ability to engage adult smokers. Our IQOS retail touchpoints are currently closed in a number of markets, and even where open, retail footfall is significantly down. Our investments in digital capabilities over recent quarters are now coming into their own, and we are reallocating further commercial spend to digital where required.
Our commercial sales experts and coaches, although very limited in terms of physical consumer engagement, have a number of tools at their disposal to conduct virtual guided trials. However, based on trends since lockdown measures were introduced, we expect our rate of user acquisition to be on average around 50% lower than previously anticipated for as long as widespread restrictions continue. Variations by country also make the mix difficult to project. To be clear, we believe this is a delayed rather than lost growth, and we expect the strong underlying momentum witnessed in recent quarters to pick up as restrictions ease. Importantly, given our digital capabilities, we do not expect customer retention or conversion rates to be affected.
For illustrative purposes, each 1 million users acquired have an annualized consumption of around 5 billion Heated Tobacco Units, and using pre-COVID market mix, including device sales and cannibalization effects, would generate on average over $350 million in net revenues and over $200 million in incremental contribution. Accordingly, the timing of plans for IQOS VEEV, our improved e-vapor products, and the licensed KT&G products later this year could be delayed depending on how events unfold. The last main area of impact is in Indonesia. As explained previously, 2020 was already a year of catch-up on excise tax and pricing. A positive structural element of the new excise tax was a larger percentage increase at the mid to low segment of the market, with a new minimum retail selling price due to come into effect on April 1st.
However, the government has now said the enforcement of the new minimum price is delayed until June due to COVID-19 restrictions. The prolonging of unfavorable price caps is an added headwind for the risk of down trading, the timing of price increases, and for our market share. While the effects of pandemic-related measures on our operating environment, such as travel restrictions, are tangible, there is greater uncertainty as to the social and economic impact on consumer purchasing behavior during the crisis. In developed markets, like the EU region or Japan, which tend to have strong social support programs, we have so far observed only a limited impact. There have been instances of pantry loading in certain markets around the introduction of restrictions. However, these have been generally short-lived in nature and had a minimal impact on Q1 performance, with distributor and trade inventory movements being the bigger influence.
In certain developing markets, the high prevalence of daily wage workers, lower resources for social support, and thus greater fragility of incomes create more vulnerability. We observed some initial signs of down trading and reduced daily consumption in some countries. The most significant for us are Indonesia and the Philippines, the latter of which has the added dynamic of being a stick market. We have to assume these trends will temporarily continue while pandemic-driven restrictions last. As André mentioned, given less developed route-to-market infrastructure, we also sense potential difficulties in certain emerging markets for some smaller general trade outlets, which may lead to temporarily localized out of stocks. Our own manufacturing and distribution operations continue to function well despite current challenges.
This is made possible by the incredible efforts of our supply chain and market teams, who have implemented a number of contingency measures with regard to production and customer supply. On average, inventories of our products remain healthy, with over two months for Heated Tobacco Units, over three months on IQOS devices, and over one and a half months for cigarettes, including distributors. After the one-week suspension of production at our Bologna HTU facility in late March, all our HTU factories are currently operating with sufficient capacity. Around 20% of our cigarette production capacity is currently affected by temporary shutdowns. However, we do not currently foresee any out of stocks in major operating income markets. One watch-out is Argentina, where we will be facing out of stocks if the factories do not reopen soon.
Given investor focus on the liquidity of listed companies in the current environment, I want to highlight our robust position. We continue to have ample liquidity sources through the ongoing cash generation of our business, cash on hand, and access to commercial paper. Our $7.5 billion revolving credit facility remains undrawn. Our balance sheet remains strong, with a well-laddered bond portfolio and net debt of 1.9x adjusted EBITDA as of March 31st, 2020. We repaid $3.6 billion of maturing bonds during the first quarter and distributed a total of $3.6 billion in dividends to shareholders in January and April. We also expect that strong cash flows will exceed cash requirements, including the funding of dividends to which we remain fully committed. Our ability to invest appropriately in our business and retire debt is fully intact.
However, further deleveraging of our balance sheet at prevailing exchange rates may be somewhat delayed versus our previous expectations. It's also worth mentioning that our cost efficiency programs continue, and that we remain well on track to deliver over $1 billion in efficiencies by 2021. These programs are also flexible, and we are reprioritizing activities as events unfold. Related to this, we expect to reduce capital expenditures to approximately $0.8 billion for the year, with the reduction unrelated to RRP investments. We turn now to guidance. As covered in our earnings release, we have withdrawn our previous reported diluted full-year 2020 EPS forecast of at least $5.50, which, absent COVID-19, our business was well on track to deliver.
However, as we stand today, there's simply not enough visibility on the duration or extent of lockdown and social isolation measures and their wider consequences to provide a sufficiently reliable full-year earnings estimate. Given comparatively better short-term visibility, we are therefore introducing quarterly guidance, one quarter forward in its place. As previously flagged, we already expected a weak second quarter, notably due to an unfavorable prior year comparison, market dynamics in Indonesia, and cost phasing. We also expect the biggest quarterly impact of the COVID-19 pandemic on our business to occur in the period, which we additionally factor in. Consequently, we expect Q2 2020 reported diluted EPS to be in a range of $1-$1.10.
This forecast assumes unfavorable impacts of $0.12 per currency at prevailing rates, reflecting the devaluation of many of our operating currencies vis-a-vis the US dollar, notably including the Russian ruble, the Indonesian rupiah, and Mexican peso. $0.10 for inventory movements, primarily reversals from the first quarter. $0.09 for loss duty-free sales, net of domestic sales recapture, assuming no recovery in global travel in the period. $0.05-$0.15 for the delay in Indonesia minimum price enforcement and other COVID-19 related factors, including temporary reductions in daily consumption and down-trading in certain developing markets. These assumptions also reflect ex-currency net revenue declines of approximately 8%-12%, with the expected decline being wholly attributable to COVID-19 related impacts, including on device sales. Let me now run through some of the main elements of our first quarter performance.
We estimate the total international industry declined 2.9% in the period. However, we recorded a total like-for-like shipment volume decline of only 0.6%, with cigarette declines of 3.8%, largely offset by the impressive 45.5% growth of heated tobacco units, with notable contributions from the EU region, Japan, and Russia. Excluding the net favorable impact of estimated distributor inventory movements, our total in-market sales volume declined by 3.7%. Inventory movements reflect two main factors. Firstly, the prior year comparison where shipment volume in Q1 2019 were below in-market sales. Secondly, net distributor inventory buildup in Q1 2020 to mitigate the risk of COVID-19 related disruption. Importantly, our HTU in-market sales volume increased by 3.9% sequentially, versus the fourth quarter, reaching over 17 billion units in what is typically the lowest volume quarter of the year.
This strong performance means that heated tobacco units now make up nearly 10% of our total shipment volume as compared to 8% in 2019 and almost nothing in 2015. We expect this proportion to grow further as our positive momentum on RRPs continues. Turning to our financial results. Net revenues increased by 10%, excluding currency, driven by pricing and combustibles, a favorable comparison versus Q1 2019, and growth in heated tobacco units. We estimate the COVID-19 effect of higher trade inventories and, to a lesser extent, consumer pantry loading contribute around one-fifth of the growth in revenues, operating income and EPS. We recorded a strong combustible tobacco pricing variance of 7.7%, with no significant impact of COVID-19 and notable contributions from the GCC, Germany, Mexico, the Philippines, Russia, and Turkey.
Adjusted operating income increased by 25.5% ex-currency, while currency neutral adjusted operating income margin grew by an excellent 510 basis points. This strong margin expansion was driven by RRP scale effects and favorable geographic mix for HTUs. Additional drivers include pricing and combustibles, cost phasing, and the underlying impact of cost initiatives. Adjusted diluted EPS increased strongly, growing by 30.1%, excluding currency. With regard to currency, we should point out that the unfavorable impact of $0.13 in the first quarter includes $0.07 of transactional impact occurred in March, primarily from the revaluation of euro or dollar denominated payables in certain markets such as Russia, where the local currency has seen a significant devaluation. Such effects would only recur in future quarters if further sharp devaluations took place.
RRP net revenues reached $1.6 billion, or close to 22% of PMI's total net revenues, with IQOS devices accounting for approximately 10% of RRP net revenues. Turning now to market share. Our total international share was slightly lower at 27.9%, with higher share for heated tobacco units, which reached 2.9%, offset by lower share for cigarettes. The share of our cigarette portfolio declined by 1.1 points, reflecting continued adult smoker out-switching to IQOS, a lower share notably in Argentina and Indonesia due to price gaps with tax-advantaged local competitors, trade inventory movements in Pakistan, and an unfavorable prior year comparison in Turkey.
Let's turn to Indonesia, where industry volumes declined by only 0.6% in the first quarter due to trade loading effects, which are likely to reverse in the second quarter. Pricing was taken on all main premium and mid-price brands, with PMI price increases since October of 2019, representing approximately 85% of the weighted average pass-on of the 2020 excise increase. Our share declined despite a recovery in premium A Mild, due to smaller price gaps with directly competitive brands. These gains were outweighed by our mid and low price brands, which lost share to super low price manufacturers who are tax advantaged due to smaller scale. It follows that the delay in the enforcement of the minimum selling price extends this temporary share headwind. The prevalence of daily wage workers in Indonesia also introduces some uncertainty as to the effects of social restrictions on daily consumption.
As such, we have to assume the total market decline will be higher than our previous estimate of 6%-7%. Turning now to RP performance, we estimate that there were 14.6 million total IQOS users as of March 31st, representing the addition of more than 4 million adult users since the same time last year. We further estimate that 73% of this total, or 10.6 million IQOS users, have stopped smoking and switched to IQOS, with the balance in various stages of conversion. This reflects widespread user growth momentum across all key IQOS geographies, including Japan, Russia, and the EU. The overall share performance of IQOS HTUs continues to see excellent progress. Indeed, in international markets where IQOS has been commercialized, IQOS HTUs were again the third largest tobacco brand in the first quarter, with 6.6% share, increasing from 5.5% in Q4 2019.
This was achieved despite not having full national distribution in a number of markets. In the EU region, first quarter share for HEETS reached 3.9% of total industry volume, with an estimated 0.2 points due to consumer pantry loading. On a sequential basis, share growth was also very strong, increasing by 0.7 points, with in-market sales volume 13% higher compared to Q4 2019, despite a typically lower quarter. I also refer you to the appendix, where we show shares by key EU market and global key cities. IQOS continued its strong performance in Russia, with HEETS share up by 3.5 points to reach 6.5%. On a sequential basis versus the fourth quarter of 2019, HEETS share increased by 1.5 points, while in-market sales increased by 3%. With limited social restrictions in Russia in the period, there was minimal estimated impact of pantry loading.
In Japan, our total reported share for Heated Tobacco Units increased by 2.1 points to reach 19.1% in the first quarter, supported by the launch of IQOS 3 DUO and line extensions in our Marlboro HeatSticks and HEETS lineups. On an adjusted total tobacco view, including cigarillos and adjusted for trade inventory movements, the share of our HTU brands increased by 1.1 points versus the prior year quarter, and by 0.6 points sequentially to 17.7%. Q1 2020 adjusted in-market sales volumes for our HTU brands grew 6.2% compared to an adjusted total tobacco market, which declined by around 1%. This helped drive growth of the overall heated tobacco category to a first quarter total tobacco share of over 24%.
Lastly, following the 2019 launch of IQOS in the U.S., through our commercial arrangement with Altria in March, we submitted a supplemental PMTA for the IQOS 3 device to the FDA to further support the efforts to convert U.S. adult consumers who would otherwise continue to smoke. FDA's review of the company's modified risk tobacco product applications for the IQOS tobacco heating system, which is separate from this PMTA application, continues. Let me now hand back to André for closing remarks. André?
Thank you, Martin. In summary, the continued strong underlying momentum in our business, especially the impressive growth of our Reduced-Risk Products, is again evident in our first quarter results. The world has clearly now changed, with considerable uncertainty as to the development and duration of the pandemic and its economic and social consequences, including those which impact our operating environment and our consumers. Our business has historically proven remarkably resilient, and we believe we can deliver a solid performance under the current challenging circumstances. Importantly, we remain confident in our structural midterm growth prospects and, when these headwinds have passed, expect to resume growth consistent with our 2019-2021 compound annual x-currency growth target of at least 5% net revenue growth and at least 8% adjusted earnings per share growth. Crucially, our organization, liquidity, and balance sheet are strong.
We'll continue to protect and support our employees, serve our consumers, and reward our shareholders, which clearly includes our strong commitment to our dividend. We remain resolute in our strategy for a smoke-free future and are convinced that we'll emerge stronger from this crisis. Thank you. Martin and I are happy now to answer your questions.
Thank you. We will now conduct the question-and-answer portion of the conference. In order to ask a question or make a comment, please press the star key followed by one on your touch-tone phone. Our first question comes from the line of Pamela Kaufman of Morgan Stanley.
Hi. Thank you for the question. I hope you are all doing well. Hi. I was hoping to get an update on where you're seeing the most significant impact on new IQOS user growth in 2020, and if there are any markets that are surprising you in terms of the resilience of IQOS performance in the current backdrop. Separately, are you seeing a negative impact on IQOS usage among existing users?
Okay. Let me take a minute to give some context here on what we're going to discuss during the call. Okay. The first thing is that we do not see any structural business fundamentals kind of problem. It's more delays, slowdowns, as you mentioned, in the acquisition, and one-offs during the duration of the pandemic. The second thing, we have assumed that in this quarter, because that's what we can see, we will have lockdowns continuing essentially through the end of April and the vast part of May, with some gradual recovery during the month of June, and then it continues. Okay? That's important to remember when we discuss the context. What we observe, with a high degree of certainty, is the duty-free impact, because there's no traveling essentially worldwide.
The second thing we've seen, to your point, Pamela, is a slowdown in the acquisition of IQOS that varies market to market, obviously, because some have stricter restrictions and others much less. We have big differences, I would say, between Japan, who are almost operating with normality, with some slowdown, and Europe, where we have more slowdown as physically our coaches cannot engage with people and our stores are closed today. That's why I'm saying, on average, we are around 50%, sometimes higher. Okay? I find this, given the circumstances, that the people are confined at home, to be very resilient, actually. Especially since, as I said, stores are closed and the coaches cannot physically interact with people. That's the right thing to do. We see a much bigger increase and a high sale through our digital channels.
As Martin said, we're gearing more and more resources from the other channels, obviously, to those. That's for acquisition. For retention, we don't see any problem. Actually, in certain markets, we see people increasing average daily consumption and retention rate, and some of dual use being reduced during this period. There is no issue from that perspective. We don't have also an issue regarding the sales of IQOS heated tobacco units in the market. I don't know if I answered your question.
Yes. Thank you.
Just to add to that, Pamela, we're also not seeing any drop-off in conversion rates.
Yeah. Absolutely.
We're holding conversion rates. In fact, they're looking quite strong. The underlying business in retaining consumers and converting consumers is going great. Obviously, your ability to have the face-to-face interaction is a little bit slowed down, but we're switching as fast as we can to more digital channels.
Thanks. How should we think about the balance between your planned cost savings realization from this year and the investments that you're making in the business to drive IQOS adoption? Are there delays in your cost-savings plans? I guess, how are you thinking about changes in timing of your investments and what you're investing behind?
The first principle that we've undertaken is that their investments need to align to the new situation. In other words, we are, if anything, putting more money into those aspects which will help us recover momentum and get back to growth as soon as the lockdowns end. Hence, the focus on where we can add some investment around digital and around the programs, which will have a bigger impact later. Clearly, we've gone through our projects as well to see which ones are hampered by our inability to operate right now and need to be re-timed and move some of the spending further later in the year or even into the next year.
We've also looked again at our list of projects to prioritize the ones that maybe had not as good a return and try to mitigate some of the impacts of what we're seeing from the COVID-19-related. Overall, our cost savings are on track. If anything, we will accelerate some as we can. Then our investments part is also lining up to the new situation and giving us the biggest bang for our buck. We are looking long-term and looking towards the growth momentum that we can attain as we come out of this.
Thank you.
Our next question comes from the line of Adam Spielman of Citi.
Hello. Thanks. Thank you very much. I have three questions, if I may. The first one is about illicit and cross-border. I'm a little bit surprised. I would've expected the clampdown on borders and transport to result in much reduced illicit cigarettes and also legal cross-border. I would've thought that would be quite a positive impact in Q2 and Q3. You haven't mentioned it, I guess, am I wrong or is that a positive impact? How should we think about that? That's the first question.
Okay. Again, Adam, some of these things we try to lay out are based on observations. You are right, our markets report some reduction in illicit trade for the reasons you mentioned. Now, we cannot cautiously take the European Union as 10% illicit trade and say this is going all disappear and appear in the domestic market. We may see some, and reasonably so, but I'm not sure we have take this all in the numbers because we are just three weeks, essentially, in the month of April. I prefer to remain a bit cautious. You are right. We are observing this, and we should see some impact.
Okay. That's very helpful. Next question is on Indonesia. Obviously, the minimum price was going to be imposed on April 1st. You've now talked about perhaps a delay till June, but I notice you don't give a specific date. Is it possible, or how likely do you think it is for this to delay further, if we see really quite a nasty recession in Indonesia?
Well, Adam, generally what we know is the government said that because they cannot send inspectors out to inspect physically outlets because of the COVID, they have to delay, and they gave a date that is June. That's not any firm date in June. If they get out of the situation of restrictions earlier, I assume they would do it earlier. If it continues, it may continue a bit longer. That's why we have uncertainty in this whole As a matter of principle. I don't know, Martin, you want to add something?
That's exactly right. It's a matter of when they can get out there and start inspecting. It's not a matter of not wanting to do it. It's purely for their issue with their inspectors.
Now, in Indonesia, we have this. Obviously in Indonesia, is in the category of these developing markets. Martin mentioned in his remarks, and myself, that you have a lot of casual labor. Many people work on a daily salary, essentially. If they can't work, clearly their consumption has to adjust to the situation. We have to assume here that we may have some impact also on consumption coming from COVID-19. Other Southeast Asian markets can be infected. Africa as well. We observe this phenomena, and we had to make a forecast in our numbers of what that impact is going to be. You all appreciate it is rather difficult. If I take, for example, a market we know very well, like the Philippines, this confinement clearly has some impact also in daily consumption. Also, it's a very broad trade with very small players.
Sometimes they run out of stock. If we take markets with stick sales also, if we have an average stick sale, an average consumption of sticks of nine per day, you go to eight, that's a 10%-11% impact temporarily on the market. Now, how precise to be on this? I don't know. That's why we gave a broad range in these areas. I think some will happen. People are not gonna be immune to the confinement. That's why we try to bake some numbers in, and I think it's reasonable to assume it at this stage. If it's better, it's better. Third question.
Following up on that, André, I hear I'm now talking about Europe, which is obviously much more profitable for you. I hear some people saying people at home will smoke more. They're anxious, they're bored, they're not traveling. They'll end up smoking more. I hear other people saying they'll smoke less because of their concern about the impact on possibly catching this disease. Do you have a view as to sort of what individual consumption will do? I'm thinking more developed markets than EMs now in the lockdown.
Well, in the developed markets, we don't see any impact on consumption. You appreciate it's early days, and you don't have data on a granular consumer research. All of the elements you outlined are correct. Technically, people staying home have more opportunities than when they're in the offices, for the people that work in offices. We shouldn't forget in certain countries, you are with family and children, so also you have to be a bit more respectful, so one may compensate the other. That's why we don't see any change in the pattern at this stage. We all need to appreciate, guys, that I think we've been through many crises and difficulties, but having people confined at home and not going out is not a situation we've ever faced, and some adjustments may happen in the daily consumption. I don't think that's structural or anything else.
We know that markets recover in cigarettes after crisis. This, I have no experience, to be very surgically precise. Everything you described is correct. We also saw in some countries, as I said, more IQOS used at home. Okay. Because people are more respectful of families and children and so on. That's where we are today. In the developing markets, as I said, okay, we also need to know, in some cultures, smoking in front of parents and some women may be more reluctant to fully consume. That's compensated, obviously, as you say, by some opportunities more. All in all, that's the best estimate we can make today. I'm trying to be as transparent as possible on what we know at this stage.
Thank you very much. Final question, just very quickly. In the spirit of transparency, I know you're not giving EPS guidance for full-year, but can you at least say what the FX impact would be? Should we just take the $0.13 in Q1 and the $0.12 you've guided to for Q2, and then put another two quarters of $0.12? Is that how should we think about the FX for full-year on EPS?
Yeah, Adam, that's pretty close.
Perfect. Thank you.
Q2 estimate of $0.12. It'll be roughly that in Q3 and Q4 at prevailing exchange rates, $0.11, $0.12, something like that.
Perfect. Thank you very much. That's all from me.
Our next question comes from line of Vivien Azer of Cowen.
Hi, Vivien.
Thank you. Good morning.
Very well.
Good. I'm glad everyone's well on your end. Thank you for all the detailed commentary. I just wanted to double back to, André, some of your comment on down-trading. Obviously, this is market-by-market commentary, I'm just curious, in any market where you've seen it pretty apparently, has it happened faster than, say, like the last financial crisis, or if it was an Asian market relative to a SARS or any other kind of market disruption that you've seen? Thanks.
First of all, the only down-trading we can say we've seen is a continuation of what's happening in Indonesia due to the price gaps. Okay. Here is my assumption that some may happen. On one side, you say some people, if they have less disposable income for a period of time, and I'm still referring to developing countries, they may down-trade for a period of time. On the other side, we know in periods of uncertainty, especially the current one, people go for trusted brands from safe sources, and they tend to trust the known brands. That's contradicting what I said previously, and you need to find the right balance. That's the same thing as about illicit trade. There's not only availability of illicit trade, there's also no trust in the sources of illicit trade that may reduce it.
There is this tendency to buy what is essential and what is trusted. Okay. I assume some down-trading. I'm not saying I've seen it. Okay.
That's helpful. Thank you. As you think about the quarter-to-quarter guidance, Martin, that you're gonna be offering, implicit in there, it seems like you guys are taking an appropriately conservative approach around volumes due to the impact on consumption. Can you comment at all around the underlying assumptions around price elasticity embedded in your Q2 EPS guidance? Thanks.
Yeah. When you look at the second quarter, for example, we already had expected a pretty weak second quarter due to the dynamics out there on how we were wrapping pricing in Turkey, for example, where you had big market gains before in the previous comparable period, against a 40% price increase that we've had since then. We were looking at Mexico with a different timing on the price increase and the way the trade inventories were working being a pretty big headwind. We already looked at Indonesia. We knew that the big impacts were coming in Q2. The Q2 guidance we're giving is actually, if you unpick it's actually what we had expected before. It's purely the COVID related.
We would have ended up, without COVID, after the first half, being right on track with our full year numbers and hitting 9.5%, 10% EPS growth, right in with what we had thought we would end up for the full year. When you go forward and say, "What are we going to do for the rest of the year?" We're going to basically be giving you each quarter, one quarter ahead, what the COVID-related impacts are and trying to adjust to new news around lockdown timings and recoveries from consumers and so forth. That's what we thought was more prudent given that the underlying business is in fine shape. We're doing exactly what we thought, it's very difficult to predict how this COVID-related piece is coming out.
We can't really give you the full year look right now, but we can give you each quarter ahead as best we predict what will happen given the latest news that we have.
Understood. Just to follow up on that, then I'll drop back into the queue. As you think about the COVID-specific related impact to 2022, are you assuming a degradation in price elasticity just given some of the potential headwinds to the consumer, to the unemployment rate?
No. As André mentioned, we have some watch-outs in there around average daily consumption, around down trading in certain markets, but it's not really a price elasticity point of view. As far as pricing goes, price timing, we have to be cognizant that in the case of lockdowns and in certain periods, it may not be wise to take some of the pricing at exactly the same timing we had in the original plan. We will have to look at the timing of pricing in certain markets. In some markets, we will likely need to delay some planned pricing. On the other hand, we will look forward out into the year and see what we can do to try to compensate for that.
It's more around timing of price increases that have to be rephased and rescheduled, and there may be, likely will be some lower total pricing during the year than what we had originally planned, just because you run out of runway. Once you give up some of the windows due to the lockdowns, et cetera, you run out of runway to make up for some of the pricing that you will not be able to take over the next, say, couple weeks, months because of lockdowns.
Exactly. I mean, all these are assumptions at this stage, but they are not relating to price elasticity in my view. It's relating to will governments allow that you take, in one or two places, a price increase in the middle of a crisis? I don't think psychologically, from a consumer point of view, is there, I think. Say that a couple of months or a month delays, okay? In the vast majority of the places, we don't see any price elasticity in the short term. In the long run, I don't know what the impact of COVID is gonna be on the world economy. If the world GDP comes down substantially for a longer period of time, you may need to revise elasticities. As you know, in cigarettes, it's very rare that we need to revise elasticities except in very big price increases.
That's very clear. Thank you so much.
Our next question comes from the line of Gaurav Jain from Barclays.
Hello. Good morning, and thank you. I have a couple of questions. One is just on your supply chain and your factory footprint, inventory levels. Do you think the current crisis changes the way you think on those issues long term?
That's a very good question that doesn't only apply to us, okay? I said it many times, resilience equals a little bit of redundancy in the system in general. Thank God we had inventories and we had action plans, to obviously build inventories as we saw the crisis arrive, and materials, and everything necessary to make it happen. Not sure that's the case for every business with just-in-time deliveries. I think that would be a learning here for everybody. As you know, in our business, as I said, we operate with fairly large inventories of tobacco by the nature of the business, and we had the capability and the flexibility to build sufficient inventory. I don't see anything that we should revise at this stage on our footprint, given the fact also that in cigarettes, we are limited by trade blocks and import duties.
We think it's rather optimal. As a cautionary principle, because I don't think COVID will disappear in one afternoon, it will come back. We have to have the caution that this may be repeated at the scale it was repeated this time, because we were absolutely not ready as humanity for that. We have to take our own conclusions of how we build even more flexibility in the system. So far, I think we've done pretty well. You don't see what is behind the scenes on keeping everything flowing. I think the guys in the company have done miracles given the circumstance.
Sure. My next question is just on IQOS device pricing. Do you think the upfront pricing will become an issue to acquire new consumers in a recessionary environment?
Well, I think we can adjust the pricing, obviously, when necessary. My view is pricing plays a role in the IQOS acquisition. As I said many times, it's also a lot about convincing people to make the step, and sometimes pricing is the excuse. If you remember the remarks we made in February, the only place we can really see the need both to have a tiered system in terms of device pricing and at a certain stage in terms of consumables is Russia, where in certain cities we're reaching into the limits of the premium consumer. We are doing this with IQOS 2.4 Plus, being at the bottom end of our range, although more expensive than any other competitor. As we always said, we maintain flexibility on this, and we can adjust pretty rapidly once we recover business. Just now, that's not our issue.
Our issue is more the limited ability to have the contact with the consumers and the point of sale.
Sure. If I can just sneak in one last one. You have given this range of $0.05-$0.15 EPS impact from the delayed minimum price enforcement in Indonesia and COVID-19-related costs and even down-trading. Should I read it that $0.05 is the impact from minimum price enforcement because that you have visibility on? The range, the extra $0.10 ranges, because of issues around down-trading and other COVID-19 costs, because you don't have visibility on those?
Well, I think we should look at this as one piece rather than trying to cut it, because I don't have a super exact science in disaggregating this. It's an estimate. As I said, even if you look at the other numbers in there, even if I take inventories, we assumed in inventories that the build-up safety stocks we've done in certain countries, perhaps in the course of the month of March, will be fully paid back. Now, it may not happen, and we also assume a reduction in inventories that we've seen in certain countries uncertain. Retailers got a little bit worried about the situation, we will not recover them during the quarter. We put probably the worst scenario in there to be on the safe side. All these are flexible fixes. I can't predict them entirely.
We tried to just say that it's to be as transparent as possible doing this thing, given the uncertainty. I will stay there because me venturing any particular number, I can only be wrong.
Sure. That's very, very helpful. Thank you.
Next question. Chris Growe.
Hi, Chris.
André, I hope you are well, and glad to hear you're safe and healthy. Just had a question, if I could, first of all. You started to see some seasonality in your shipments between 1Q and 2Q and 3Q. I'm just curious how social distancing, social isolation, those kind of things, would affect that sort of seasonal lift you normally see in the second quarter. I guess you mentioned that you're not seeing much of a change in daily consumption rates. Could that change going forward if these social isolation moves remain in place?
Well, notoriously, the first quarter of the year is the lowest consumption quarter in every tobacco product. Okay? Even if we look at the in-market sales of IQOS, we have to put them in this context by definition, okay?
Yep.
That's why that, in my view, they're even better than somehow the numbers show in absolute terms. Okay?
Sure.
Now, what is going to happen in the second quarter, other than what I explained? I can't say. We don't see in most of the markets any change in average daily consumption, except for the developing markets that have the specific things that I mentioned. We have not measured it. It's very difficult if I pick a market like Philippines, okay. Yes, there is some sales decrease just now. It is possible that is part of the average daily consumption because it's a stick sales market and people have less money. It's also possible that in some areas we had some temporary out of stocks because it's a cash economy with a lot of retailers going to wholesalers to buy. Until the whole system recombines and starts working properly, it takes some time. I could attribute the lower sales, if you wish, to only average daily consumption.
I have to assume people that don't have a job for a period of time, and they cannot have the daily salary, they will buy less for a period of time. My example, I say, okay, if the average daily consumption is nine cigarettes, stick sales, and you go to eight, it's a big decrease for a month or for weeks. Okay. That's how I see. If we assume we come out of the crisis gradually as of June, we should see the situation coming back. Okay. Probably the economy that can recover faster is the cashable economy because it would just The limitation of people to move and do business as usual. Once that resumes, I assume we will recover this. The question is it temporary? As I said, and we don't know how temporary is the temporary.
It's not unlikely worldwide that we'll see an ease by governments because now the health systems start getting to a point they can handle an increased number of cases. We may have another slowdown in six months. God knows, okay?
Okay.
That's why we said, we give quarterly reviews. As we advance, if we have any set of data for the shareholders' meeting that is forthcoming, we'll give you an update as well. We're learning as we speak.
Sure
I don't see any fraction with that's all I'm saying.
Yeah. Thank you for that insight, André. It was very good. I do want to ask very quickly about your outlook for the second quarter. You talk about IQOS devices, device sales being down. You do have a lot more users year-over-year. You don't expect to accumulate a billion users as well, I get that, but I'm just trying to understand what would cause your device sales to be down in the second quarter. Is that just a function of less incremental users, or are there any returns or that kind of thing going on as well?
Well, it's primarily due to lesser acquisition during the period. Okay? As I said, as the device life expectancy increases over time, we'll have lesser replacement. Clearly, during this period, our focus has been, and we repurposed part of our sales experts. If there is a problem with a device, we repurpose the people to do the delivery and service the consumers. We don't have an issue from that side, and I think we're doing a pretty good job from that point of view. It is essentially related to lower acquisition, as we have assumed this, if it happens.
Okay. I just one quick follow-up, which would be just to understand, embedded within your guidance for the upcoming quarter, for Q2, presumably are lower costs as well, whether it be less travel and lower maybe SG&A costs, that kind of thing, as well as obviously, you've changed your IQOS investment plans here as well. Is that sort of incorporated in the guidance as you frame that, and you've got a lot of cost savings coming through as well? Can you frame those factors that are helping support Q2 earnings on top of the negative effects you have coming through?
Yeah. The Q2 number range we gave you is all in, includes our best estimate for phasing of cost and spending, including the additional focus on digital and some of the other areas where we can invest now to help us retool and be able to recover more quickly. That number's all in. It includes things like, yes, lower travel, other cost-spending categories which just aren't happening because people are working differently. It's all in there.
Yes.
Thank you.
Our next question comes from the line of Michael Lavery from Piper Sandler.
Hello?
On IQOS, and I think you even touched on digital demonstrations.
Can you start from the beginning because you broke at the beginning of the question. Could you repeat your question, Michael? You were breaking up at the beginning of your question.
Oh, yeah. Sorry. You mentioned, using more digital for IQOS, and I think you even touched on digital demonstrations, and I guess I just would love to understand maybe how creative and flexible you can be there? Do you mean a case where you deliver or loan a device to the consumer to try it at home, or is that just watching someone do it online, or how should we think about how robust your digital interaction can be?
Yes. We do loan devices, obviously with super-extreme sanitary measures for the devices are new. Then we do the guided trial by digital means. The coaches or the sales experts are operating from home and teaching the consumers. Currently, the consumers may have a bit more time, so it's much easier to do it than in normal times as well. That's how we operate. I think I was surprised that we maintained such high levels. It may be a blessing, I would say, because that helps everybody, consumers on one side, and our organization to move more and more into digital and learn in this crisis that you can do a lot of things from remote, as we are learning and operating from some better way. That's a good thing.
Maybe we can further increase the sales this way, which over time will allow us to optimize the infrastructure costs that we have.
Okay, great.
We have gotten a boost, I would say, in a direction we were going in any case.
Okay, great. No, that's helpful. Just one more on IQOS. You mentioned in Russia and the EU that you already had lower device prices in this past quarter. Can you just describe what actions you've taken there, and are those temporary or permanent price resets?
I'm sorry. I'm not sure we changed our device price. We had some promotion.
I think it's more of a comparison year-over-year.
Yeah. Okay.
Because we had some adjustments on device prices in the second half of last year, which we're now comparing and lapping to the first quarter of last year when those adjustments hadn't occurred. When you come into the second half, I think you'll find the device pricing much more stable versus the prior year.
Yeah.
Oh, okay. Great. Thank you very much.
Our next question comes from the line of Robert Rampton of UBS.
Hello. Thank you very much for taking my questions. I have two questions. The first is looking at your 2Q20 revenue assumption. Can you let us know what the assumption was before? I think you mentioned that 1H would have been 5% ex-COVID-19, which I guess would have implied 3% for 2Q. Is that thinking correct? Thanks.
Yeah. Q2 absent COVID impacts, revenue would have been pretty much flat, up a little bit. The impacts of these other volume events that I mentioned, like Mexico comparison, Turkey comparison, impact of Indonesia, were already going to pull our combined volumes down minus 5.5% or so, 6%, and therefore the net revenues would have been just a little bit positive. Not much, but a little bit positive. Almost flat, right? What you're seeing now with the COVID-related impacts layered in is, it is already built on a fairly weak quarter base that flagged already going back to CAGNY in the year-end call as well.
Just very clear.
That's the first quarter, so you have to look at the two in context. That's why I made the comment that if you average the first two quarters, absent the COVID impacts, we were right on track with our guidance, and frankly, a little bit ahead.
Got it. That's very clear. Then, I guess longer term, thinking about 2021, 2022, should we start to expect excise tax increases and maybe governments closing the tax gaps as they look to raise revenue?
Look, we haven't seen any of those things today, obviously. I think governments will look for money, but they also know that regular tax increases are the best way to maximize revenue. Frankly speaking, if we look at the packages the world is pledging to deploy, I don't think cigarettes will cover even an infinitesimal fraction of this. Now, this is nothing too much. This is pretty clear. We have no signs today of anything of this nature. Okay. That's all I can see at this stage.
Okay. Thank you very much.
Operator, the next question comes from Bonnie Herzog of Goldman Sachs .
Thank you. Hi, everyone.
Hi, Bonnie. Hope everything's okay over there.
Yeah, everything's okay with me. Hope for you guys, too. I just wanted to clarify something that you said a lot earlier in the call. You touched on this, but I wanted to clarify in terms of recruiting new users for IQOS, that if you're able to touch consumers virtually and converse with them, you're not seeing any reluctance from them to convert to IQOS in this environment. That's the first clarification. Assuming your recruitment efforts for new users of IQOS remains pressured for the rest of Q2, as you discussed, just trying to understand how you see this impacting your core cigarette business.
Well, I think to your first question, I haven't heard of any difference in the, what we call the adoption funnel. Once a person is contacted, typically with very high purchase rates, because very often the people that come to the stores or the digital assets are people that are aware and frankly convinced. Obviously, the ones that come to our digital channels now are the most convinced. Actually, maybe we're higher. I don't have the numbers we can come to you than we used to be on average before, which is normal. Now, cigarettes is a bit more difficult to predict. Generally, I see for IQOS, the momentum is there, and once we carry through, the direct contacts also to people will get back to on target, because I don't see any change in the momentum.
I'm very impressed, actually, that during this period, we are where we are in terms of new consumers switching to IQOS. If you look at cannibalization rates, obviously, there would be less cannibalization if there are less acquisition of IQOS. If that lasts a couple of months, I don't think that will dent any of the two. Okay. The rest is all the macro/micro things I discussed during the call. The temporary reductions in average daily consumption in some places, and then obviously, depends on where the world is going to end this crisis. We will see if there is any longer-term recessionary impact, because as you know, cigarettes are very resistant to recessions in general. It's more a question of what are long-term perspectives, which today is very difficult for any of us, frankly speaking, to evaluate. Okay.
We don't see any change in the dynamics, I guess.
Okay, that's helpful. Then I may have missed this, but should we assume that your IQOS HTU volume target of 90-106 is still reasonable by 2021? I know there's a lot of uncertainty, but are you still leaving that target out there?
If the restrictions last for the quarter.
I think we're still okay. If they last for a year, obviously, we need to delay the whole thing by a certain period of time. I think the underlying trajectory is there. Okay. For the moment, I think that's how I see it.
Okay. Then just a final quick one from me. In terms of marketing spend, you mentioned on the call that you guys are adjusting and investing more dollars in areas where you think you're going to get the biggest buck, if you will, probably digital. I'm curious about the total dollar spend in 2020. I think you had targeted incremental, was it $300 million-$350 million this year? I'm just curious if that amount has changed at all given everything.
Just now, this investment in quarterly basis is a bit slowed down, obviously, because we don't have all the opportunities available. Obviously, we have flexibility because it is variable. At this stage, we need to see when we come out of the crisis and if we need to double up a few hundred resources for a period of time in order to catch up and if that makes sense from an investment point of view. We have flexibility there. If there's no opportunity, we will not spend all this money, and obviously it will move to next year. That's how I see it. Just now, it is a slower spending, obviously, because as you said, despite the incremental investment in digital that is reallocating money.
Okay. Thank you so much.
Thank you, Bonnie.
That was our final question on the phone for back-to-back managers. Any additional closing remarks?
Okay. Thank you all for joining the call. I understand these are exceptional circumstances for all of us. I would like to say that we don't see any problem in our business fundamentals. Actually, they remain very strong. I believe all of these things are temporary, but temporary is the uncertainty. We try to be as transparent as possible, and give you as much granularity as we can. I think overall, as far as PMI operations are concerned, we are in fairly good shape given the circumstances. I hope that we move out of the crisis as soon as possible, so we resume business.
Overall, I think the outlook for me for the longer term remains the same, is very positive, and we're very committed short-term to make sure that our operations continue, our employees are safe, and I think we've done well there because that's what will make our business stronger when we come out of the crisis. We'll keep you up to date. As I said, I have the shareholders meeting. If there is any news, we'll let you know. Bear with us on this period of uncertainty.
I have one final comment, André, if you permit me to. I want to let everyone know this is Martin's last earnings call as Chief Financial Officer. As I think most of you know, he'll be taking on a new role as CEO of PMI Americas. I think I speak for everyone at PMI, the organization, certainly the finance organization that works with him on a day-to-day basis, to thank him for his service, his commitment, and his good sense of humor. We'll miss that, but we also look forward to welcoming Emmanuel Babeau as our new CFO as of May 1st, and joining us on these calls in the future. Congratulations, Martin, and best of luck to you.
Thank you very much, Nick.
That concludes our call for today. Thank you very much. If you have any follow-up questions, please reach out to the investor relations team. Thank you. Stay well, stay healthy.
Thank you, ladies and gentlemen. This does conclude today's call. You may now disconnect.