Good morning, everyone. Thank you for being here. I'm Pallav Mittal, Head of Global Tobacco at Barclays. I'm thrilled to have Jacek Olczak here with me, CEO of Philip Morris. Thank you so much, Jacek, for giving us this opportunity to host you. We will start with a few comments from Jacek, and then we'll move over to Q&A. Over to you, Jacek.
Thank you. Thank you for having me. I guess we are recovering from a long weekend, at least in the U.S. Some recovering just from a jet lag, so everyone should have a bit of forgiveness. The standard slide in the beginning, including the forward-looking and our cautionary statements, which as always, we encourage you to read. Earlier today, we issued a press release, revising our full-year guidance for currency only. Now we're cruising at the spot rates at a favorable currency impact of about $0.24, at $0.24.
We also give an update how we see the currency impact on the Q3 results. So we're turning into $0.01 at the current spot rate favorable. There are a few big ticket items, if you like, which are happening this year, at least for PMI. One is obviously the tax price change situation in Japan. If you remember, the prices taxes, excise tax went up on April 1. Now we're going into second stage of a tax increase and a price increase.
The prices has been registered by all the main players, including us, so we have a visibility how it's going on. I have to admit that obviously, in a country when the prices is not happening very frequently, the absolute amount of the price increases, it always creates some sort of a shockwave at the market, at the consumer level. Especially that this time we had, this year we had asymmetry between a heat-not-burn category and the cigarette category. There is one more excise increase in the near term happening as of April 1. This will touch also cigarettes and heated tobacco products.
But I think so far the market is, category is doing very well if you consider the magnitude of the changes which the consumers have to go through. So categories resuming to the growth. Obviously, there was some sort of a loading, deloading, pantry loading by consumers level. This whole thing has stabilized what we have seen over the last period before entering into October increase. I think it's all going in the right direction. The world before the full year, we're still aiming at the net adjusted basis IMS growth in Japan, obviously at the different levels that we used to have in the past.
But I think if the category goes through this magnitude of changes, so April, now October, and the next April price changes, I think it all goes well for the future of the category. If you remember, about a year ago, the category of this year, the category has exceeded 50% volume terms, not value, volume terms of the total nicotine market. Japanese market is essentially combustible cigarettes and heated categories. IQOS somehow holds the very high share of the segment, despite the fact that there were different pricing strategies, if you like, or tactics applied by the competition, and IQOS is at the high end of the market at the premium. It actually went very well.
This is an IQOS. Second thing is obviously U.S., and over the last couple of months, literally two months, as we announced, as we were guiding the market before, we have extended the portfolio of ZYN, our flagship pouch product, into the moist version and the higher nicotine. This goes under the trademark of, or under the label of ZYN ULTRA . In a very short period of time, the market has introduced more than 20 SKUs.
There is the massive effort on building a distribution, but also a massive effort to communicate this change to the consumer because from one day or another, in many accounts, all of a sudden, the portfolio rapidly expanded. Consumers have to find out what is this new ZYN, both in terms of a nicotine strength, but also the flavors. There is more thing coming into the market as we speak, but our strategy for the U.S., on the pouch market was very clear. We would like to obtain a sort of a symmetry in the market, our portfolio versus some other products, some other brands.
Also having in mind that this course historical price premium which the ZYN was carrying from the time, which essentially was by far the only player in the market. Despite the fact that we believe ZYN can carry the premium, we need to adjust the premium to something which is more manageable. We are doing this also while we introducing the new products to the market. We are doing a conversion from a 15, which is a traditional pouch count can in the U.S. market, we are going to the 20, creating some extra value to the consumers.
The lift is going to help tremendously and already is helping ZYN today, what we see from at least the last period's performance, but very much is going to support the future ZYN growth in the market here. We are very pleased with the developments. Obviously, we are all watching carefully the FDA and how this regulatory environment is playing out. Are we getting more and more clarity? Are we in a perfect situation here? We are not. Are we happy with what we have today, with all the PMTAs which the ZYN portfolio has received? Absolutely, yes, because everything adds to our clarity, and we can construct the plans more solidly going forward.
On the combustibles, which are doing on the face value, a bit better than one could expect from the past. But if you zoom in into which markets, et c, the combustible volumes are doing better than expected, I think there is a very strong correlation, the markets which do have some sort of a significant penetration of a smoke-free product versus the markets which do not, for very much regulatory reasons, our consumers can't enjoy the access to the smoke-free product. So clearly, these better combustible volumes are coming mainly from the markets where SFP, smoke-free products, are not allowed or not marketed, are not commercialized.
And it somehow also reflect the underlying dynamics, the demographics, et c, population growth, GDP, and some other factors which we all know. But having said so, yes, the category is doing a bit better than we thought. From our side, nothing wrong with this one, but our focus was and is and will be on the smoke-free product and opening the new markets and obviously U.S., which is a very big, very great opportunity in front of us, but also the markets in which we already have a significant position. I mentioned Japan, but very much European Union. There's also the pockets of geographies when the unit profitability is more attractive than the rest of the world. And that's from me. I guess you will have some questions.
Sure. That's some very good context, and we will go into the details on IQOS, ZYN, and combustibles one by one. But if you could just start high level, and as IQOS and ZYN and smoke-free penetration continues to increase, what we have seen over the last few years is you have had low double-digit, low teens EPS growth. Do you think that growth is sustainable over the next few years as you expand into the market?
Yeah, that's our midterm algorithm, and I do believe it's an attainable algorithm, and obviously, the quarters may differ, et c. But if you take a bit longer outlook for us, I think we can deliver in these ranges. Now, this is all based on the major shift which has happened at PMI over the last good few years. Okay, we started the smoke-free implementation of the smoke-free strategy about 11 years or so ago, as we remember Japan and then the Italy. But the very important is that we brought the whole company volumes into the growth, and actually, we're shooting for a six consecutive year of a total volume growth.
So I think we start delivering a much better quality of the revenue growth that we used to have when we were very much the combustible cigarette, the cigarette company. We all know the algorithm in the past. There are a few things which we retained, and the current past and the current performance proves that we still command quite a pricing power, if you like. There is a pretty solid pricing coming from a combustible cigarette year-over-year.
But also there is some pricing coming from a smoke-free product, very much from the heated tobacco products category. Obviously, to the different extent because the dynamic is different and the strategy is more into go after penetration, grow the segment, maintain leadership, or establish a leadership position in the segment. So you need to balance the share aspirations, volume growth aspirations, and the price somehow in this equation. But the both categories, combustibles and the smoke-free products, are contributing to the pricing variance in addition to the positive volumes. This is very good.
If you look down from the top line, the rest is, we know that this is not the extremely CapEx or COGS, if you like, heavy category. The margins at the gross level are very attractive, and the rest is essentially the reflections of a strategy of how far we want to go and open or penetrate or, as I said earlier, grow the leadership or solidify the leadership in a category. This is very much, if you like, discretionary marketing type of a spend, which depends on the elections we make in a given period, may go up, may go down.
So I feel pretty confident that the earnings at the bottom line is going to grow, and we're going to hit our algorithm. Also we don't try to be a Feel that the algorithm is somehow too much of a straightjacket, which would impair the company's ability to react to the market situation, opportunities, challenges on a much shorter period of time. And this is how we play this whole thing.
Right.
I should mention one more thing, because I talk about the pricing and I spent some time explaining Japan. So yes, we have this tax increase price, sorry, excise-driven price increases, high magnitude. Japan has changed the system of taxations. We call it the equalizations to the CC, the combustible cigarettes. But in exchange, actually, heated tobacco category is gaining now a price productivity, which is equal to the cigarettes.
Because in a past system, despite the fact that the category was enjoying lower taxation per units than the cigarettes, the price productivity was actually not very incentivizing the addition of the pricing to your growth mix. So essentially, as of now, the price product-- Essentially, it means that for a given unit of the tax changes, we don't have to increase the prices so much, or if we increase, more is retained to the company.
Right. Going into some of the details and starting with IQOS, clearly it is on top of investors' mind in terms of the growth story. In 2026, we have seen a couple of transitory headwinds, call it the flavor ban in Poland, the excise tax increase in Japan, as you were highlighting. Going forward, in the second half of this year and then 2027, do you think it is fair to assume that you get back to the 15 billion sort of incremental sticks every year? Is that a fair expectation to have?
Yeah, we try to guide the market more from how we see the total volumes of the company rather than be very specific. As we know, in many countries, we have now what we called the multi-category strategies. We don't stay shy of introducing a VEEV, the electronic cigarette, into the IQOS users portfolio. I think we feel very positive on the total volume trajectory. Now, IQOS, always in the history of IQOS, you go back again to what has happened over the last 11, 10 years, there were always some headwinds. Okay. There were the flavor bans, very much in the European Union.
Majority of the countries has gone through this whole thing. I think one of the largest countries when we had the exposure in the flavors was Italy. And yes, Italy went through the couple of months or quarters of a bumpy road, and you look at the growth rates of Italy today, if you wouldn't know that there was a flavor ban, you wouldn't notice this from the volume performance, both for the category and for IQOS. Poland is one of the large flavor market and the last market from the large markets in the EU, which has to go through this transition.
Based on what we have observed in other European markets, yes, there will be some sort of a shorter-term headwinds, but I don't think it's going to change the attractiveness of a category in the mid or longer term. Yeah, excise. Look, the taxes, we are in the nicotine industry. In the past, we called it just the cigarette or tobacco industry, but-
Right.
...we need to broaden this whole thing. It's not that we like the taxes, but the taxes are something which doesn't keep me awake for too long. In a sense, we've seen so many tax changes country by country, year- after- year, that this is something built into the way we managing the business. What we always were saying, and I think this is true also in a smoke-free category, that there is an ability to manage the taxes through the prices as long as they are becoming a sort of a regular event and over some sort of a moderate level of increases.
Now, from time to time, you always have one country, one government, which tries to do something unorthodox and, like Mexico recently, and you have a period of years of no tax changes, some price changes driven by manufacturers. No tax changes, and all of a sudden, tax doubles. That's the shocking type of, is the sticker shock at the consumer level. Then we need to somehow moderate the impact by maybe partially absorbing or maybe taking some price increases ahead and then catch up later on.
I mentioned Japan again because that's the most recent event. With these massive tax changes imposed on a heat-not-burn category, after our pricing, which we announced as of October 1, we essentially pass through plus. There's a margin improvement in the market. I think we had that capacity, and I mentioned how IQOS and the category is performing. I think we're going in the right direction. The rest of the market is still, if my numbers are right, in a quite a significant absorption. But we manage with IQOS to pass it through.
Right.
The headwinds are there. I'm not saying that the waters are flat, and they are pretty choppy waters on occasions there. But we operate on a truly global basis. As always, you have markets which you are having very nice surprises, the market reactions, the fiscal regulatory, and there are some markets which might have some hiccups, and we just have to go through this whole thing.
Right. If I can just ask on the Japanese heat-not-burn market. I think this year you're still expecting the market to grow, despite the excise tax environment. Then from next year, tax increases for cigarettes and heat-not-burn will be pretty similar. So do you expect strong growth to return to heat-not-burn IQOS in Japan from next year?
Well, there will be some volume impact, right? Today we have this misbalance that heated tobacco products took the price, cigarettes there. Obviously cigarette is the only sourcing, if you like, pool of consumers going into the heated tobacco products. So, there is a temporary price disincentive to go and instead of paying whatever yen per a pack of cigarettes, I have to pay a bit more for a pack of TEREA. Okay, we have a cent here, [50 PM lower, but still it's an upper part of the market. But I think all these things should somehow wash out or iron out once we all have App, assuming whatever pricing rate will happen in April.
But it's the first time that the cigarettes will go up, so I think a consumer thinking will somehow incorporate this into their decisions. What I'm saying is despite the fact that there was this massive imbalance, price increases on the heated products compared to cigarettes, I still see how the category is performing so far. I'm assuming nothing will be broken in the second part of this year. The next year the situation is even better.
From a total overall consumption level, I believe the loss of elasticity somehow will kick in. We need to now see how much they're going to impact the heated category versus CC category. I think again, from a financial performance perspective, not a volume performance perspective, as Japan has a pretty attractive fiscal multiplier, how much you can retain from a given price increase into the company's margins. I think on the revenue, we should be fine.
Right. Before we move into nicotine pouches, just on IQOS ILUMA in the U.S., is there any update in terms of the PMTA timeline? Because last time, I think when you were talking to the market, you said it is pretty close. Any update on that would be great.
No. In the past, public events like this one, I make this, not a mistake, but I was offering timelines and I was always wrong, so I refrain from referring to any fortune-telling with regards to when we can hear, when we can get authorization for ILUMA from FDA. I guess the long weekend was also on the federal level, so I guess the agency was not working over the long weekend. So let's leave it like this. I think clearly, in my view, it's shorter, it's sooner than later. The file is with FDA for the long time. I know that there are the conversations, discussion with FDA, but until we have PMTA, then you can't do anything.
Our focus is on executing the same strategy I mentioned, what we have launched into the market over the last two months. That's quite the impressive portfolio enhancement. Now we are busy with putting ZYN back on the growth trajectory, recover the share, at least to some extent, and we're busy with this one. IQOS, we are ready. We are ready because we have all this international experience, et c. So it's more of the questions as of when we can bring it to the market. I still believe that heated tobacco product, IQOS in particular, as the undisputed global leader, has the room to play here.
I still confirm that I see it over a period of time, heated tobacco products can take, say, a 10% of the combined cigarettes and the heated product. This is what we've seen in other markets. So it's not that I am trying to develop here some different unique scenario. It's essentially the average sort of a performance IQOS has achieved, if I group all the markets in which IQOS is present today. By the way, the U.S. is the most developed, if you like, nicotine market. If you'll take into considerations all the product categories and emanations which you have.
Okay, some are so-called illicit, some are licit. Okay, that's more the issue which is on the regulatory side, very much on a vape, to the much, much lesser extent on the pouches because the legal market is more developed, thanks also to some FDA decisions. But I think, when IQOS will come to U.S., frankly speaking, IQOS will be category on its own. Right. I think that that advantage is stealing from this opportunity, stealing from the IQOS. I think whenever we'll get these authorizations, we are ready to go and introduce IQOS ILUMA to the market. Remember that we have authorization for IQOS, but-
Right.
...due to all of this latency of FDA, et c, or the long-lasting process, we ended up in the situations that technology for which we have IQOS version based on the technology, which we have the full-fledged authorization and nothing technically stop us from launches to the market, is the technology which we essentially retired on the international.
Right.
Normally in the consumer goods space, you would expect U.S. to be a leader at par or a step ahead on innovations to the market. Now we ended up in a reverse thing. For us, to be very frank, doesn't make sense to go to the previous IQOS and got it here if we still have in view that IQOS ILUMA, the latest roll come. By the way, IQOS ILUMA will also not last forever.
Right.
We are already gearing up for, without disclosing too much of the details, we are gearing up for the next big thing from IQOS. We cannot afford recycling on a global basis, a very past technology, a past technology, and the latest modern technology. For sure, internally, it is extremely difficult.
Moving to nicotine pouches and starting maybe looking at the big picture. I think at Q2 results, you were saying the category growth is 20%-30%, but when we look at recent data, it has slowed down to mid-teens. How are you looking at the category in terms of the growth rate in the medium to long term? I am sure people are focused in the very short term, but in the longer term, how do you think about the growth rates in the category?
Yeah. I guess we are looking at the same numbers. Everyone is torturing Nielsen and the similar numbers left, right and center. I still believe that the category is growing 20%+ . Now, the few weeks of different trend does not really, I think, changes the fundamentals. As you could see, more products coming to the market. I talk about other brands, but I guess, well, I know there are some other introductions into the market. Pouch market, unlike unfortunately vape market, is not competing with this massive so-called illicit product very much because the legal part of the market is well-developed.
Products are being introduced on the ladder of the nicotine strength to the upper end and to the lower end. I think there is more choices for the consumers and some flavors as well. The market is pretty well-structured. Second thing is, if we are looking continuously on the sourcing to what is into the category, the U.S. has the three pretty sizable pools of sourcing, which I think are fueling or supporting the category growth.
One is something which is obvious, which is other oral tobacco products, not maybe the largest category, but still existing here. This on its own gives the support to the growth. But we know that the e-vape users and obviously combustible cigarette users are coming to the category. What is different is that each of this sourcing group of consumers will come with a different pattern of consumption. Obviously, for people who are coming from the oral tobacco categories, they will try to convert into pouches at the higher daily consumption rate. Right?
The consumer, if you like, switching from oral going to the pouches will give you more support into the unit volumes. Vape and the cigarettes will tend to incorporate pouches as a part of their daily repertoire. Now is the whole journey, how quickly they will, starting with one or two pouches per day, how quickly over a period of time they will go to six, seven, or maybe more even pouches per day. The only reference point which we have at this stage, which doesn't matter, is a strong or weak point, but is the only point which we have is a daily consumption in Sweden.
How Sweden can be replicated in U.S., we don't know. But this is the only data point, which the whole industry, the market has, which is well above what you have today on a daily consumptions here. To sum it up, I still believe it's a strong 20%+ the growth of the category. Yes, on a weeks or whatever very shorter periods, they may look like a slowdown or acceleration. I'm not that much overly excited. I think oral category has the future for a variety of reasons.
The only bottleneck or headwind, if you like, to the category is that is extremely different ritual from a inhalation product, doesn't matter smoke-free or combustible. And people have to, consumers have to adjust, but in exchange, they essentially receiving much, much less restricted freedom of the usage of the product, which I believe is very important for the consumers of our category. Now, this takes time. Price is very attractive compared to the other categories in the market. This is not an affordability, if you like, per se, challenge. I think the longer-term future of the oral category, it's absolutely great.
Right.
What will happen in the shorter term, the variety of different factors which can play the role.
Just on ZYN ULTRA, it has been now two to three months since you launched. Anything that you can add in terms of the incremental growth that it is providing and any cannibalization of the flagship ZYN brand?
Yeah, it is two months, but it does not matter. It is a new product in the market. As I said, 20+ SKUs went into the market. You need to build the distributions, put it on the shelf, and most importantly is that unlike a classical portfolio development that every period or so, consumer is noticing that there is one or two more SKUs coming into the market. It is 20+ SKUs, it is quite a lot to absorb. Ultra is delivering as we have been assuming, in a sense, this gap on the above the 6 mg, which was ZYN before ZYN flagship.
We used to call it flagship, but this ZYN flagship is 3 mg and 6 mg. Now we go into the 9 mg and 11 mg. There will be other additions. We also are looking into extending the portfolio to 1.5 mg. I think now the spectrum of nicotine strength will above addressing the people who are coming to the category because they tend to, obviously, most of them, tend to rather go with the lower nicotine strength. And once they increasing their daily consumptions and being more familiar with how to use the pouch, they will trend to go up.
We also see that some people are going up with the nicotine and over a period of time, if their consumption changes, either increasing the number of units per day, they will try to go down with the nicotine. So I think the ZYN ULTRA was well received. We also have extended for the flagship. We added a few flavors, which is somehow I call it the whole strategy brings into the symmetry as much as possible to what is the dynamics in the marketplace. And they start yielding results.
Well, there is this component which we also are addressing as we speak, which is this price premium and a conversion from 15- 20, creating that value to the consumer, which I think should be another nice tailwind, if you like, to the ZYN performance. So majority of the things which we are doing post the FDA now authorization, we have strings in our hand, and we can start pulling them accordingly. There is the increased investment behind the ZYN.
Oh, by the way, we launch now the ZYN campaign, When It Clicks. So we also try to add to the classical support of a brand for the promotional type of events, very much at the store level. We are also trying to add more emotional brand-building components into this whole thing. It is all obviously calls for the increased investment at this period of time in the U.S., and this is what is happening. It is going to happen in the second half of the year, but it is all baked into the guidance, et c, which we have given to the market.
Right. Just quickly on combustible, which is still 60% of the business, and in your comments, you highlighted robust volumes over the last few years in Europe and then in some other emerging markets, Türkiye, Egypt, Indonesia. Any particular market that you would call out as we look into 2027?
Look, there are still a lot of, if you like, the wide spaces in a sense that category is not allowed. It is not only heat-not-burn, and the sizable market size, meaning this underlying size of a combustible business, is obviously India, it is obviously Türkiye, it is obviously Vietnam, and there are many others. We have been successful in opening the markets, very pleased with the performance in Taiwan. Okay, volume, size, it is much smaller market financially from the unit economics, margin profiles, et c, extremely attractive.
Taiwan for us was this great opportunity that we had a very small presence in a combustible business. So we also do not have this additional sort of a headwind for the cannibalizing cigarettes while going to SFP, but it is doing very well. We have few months ago opened Argentina. Okay. Also very attractive market. Obviously, the margin profile is different than Taiwan, but wide space is wide space. These larger markets like Türkiye, India, Vietnam, obviously is China, okay, but let us leave China aside. This is in front of us, okay.
Right.
Now from a wide spaces, if I take the size of the market, unit economics, et c, by far, most of our attention is on the U.S. We are in this unique situations that unlike companies are going from the U.S. and are trying to search for a growth in some other markets outside. In a case of a PMI, we have this particular case that we have a growth on international, but unaddressed till today opportunity to large extent is the U.S., which is by far in the nicotine space, not only, but in the nicotine space, is the most profitable from unit perspective, but from the absolute size perspective, is the most attractive. Obviously, we're betting that, we're assuming that the U.S. is and will be a significant contributor to the growth to the growth of PMI.
Right. Just quickly on capital allocation. On our estimates, you are approaching your leverage target of around 2x by the end of this year. In terms of your capital allocation priorities, is a share repurchase mix in your list for 2027?
Yeah. Look, the focus near term, we'll have discussions with the Board next week, actually. Sorry, next week. I think the focus will be, not that I think, I know. The focus will be on the dividend, and then shortly after that, I guess we'll be start having conversations about the buyback. What brought us, absolutely they would leverage the company, post-acquisition, et c. But we also entered the territory, which some of you may remember. There was, unfortunately, but it was a period in a PMI performance when underlying business on the underlying basis was doing, in my view, extremely well.
But unfortunately, because of our exposure to all the different currencies and a continuous strength of the dollar, this was eroding on a reported basis, a big chunk of our profitability. This obviously sent some shock waves, which also we had to adjust our capital allocations in the past and stop the buyback, et c, in order to protect dividend.
We've been very clear to the market that dividend for us is by far the highest priority when it comes to returning cash to shareholders. Obviously, absent any other ideas what to invest into, what behind, and I am not talking OpEx, U.S., et c, because this is absolutely manageable for us. Yes, the buyback is like a next page of a conversations, what we do and at which moment and how much, et c. But nothing for me to confirm or to announce today.
Right.
Dividend is the most preferred form of returning dividend and dividend growth, obviously, the most preferred way of returning cash to shareholders.
Right. I think we are running out of time, so we will call it a day here. Thank you so much, Jacek.
Thank you.