Japan Tobacco Inc

TSE:2914

Earnings Call Transcript 2018-Q1

[Koji Tanaka, executive]

Thank you for waiting. Thank you very much for joining the JT Group consolidated financial results meeting for the first quarter of 2018. I would like to open the meeting. First, Naohiro Minami, the Chief Financial Officer, will make a presentation for 15 minutes followed by the Q&A session. And the meeting will be about 60 minutes. I would like to start the presentation.

[Naohiro Minami, executive]

I'm Naohiro Minami, Chief Financial Officer of the JT Group. I will take you through the consolidated financial results for the first quarter of 2018. First, I will focus on the highlights of consolidated [indiscernible].

For the first quarter of 2018, please look at Slide 4. Adjusted operating profit at constant FX, our KPI increased year-on-year led by the strong performance in the International Tobacco Business and pharmaceutical business while the challenging environment continued in the Japanese Domestic Tobacco Business.

As for results by business segment, in the International Tobacco Business, pricing gains drove the growth in both of the top line and bottom line as we communicated earlier this year.

In the Japanese domestic tobacco business, profit decreased due to cigarette volume decline despite the increased sales of Ploom TECH. This result was within our expectation.

In the pharmaceutical business, royalty revenue continued to grow and made contribution to the group's profit growth.

In the processed food business, despite the increased sales of staple food products, profit declined mainly because of the higher raw material costs.

On a reported basis, operating profit and the profit attributable to the owners of the parent company declined 1.5% and 1.4%, respectively, mainly due to the negative impact of yen appreciation. Regarding the detailed analysis of consolidated and business segment results, please take a look at the earnings report, which is newly published since this quarter.

Next, we move on to the highlights of the international tobacco business, please look at Slide 5. First, let me start with the shipment volumes. GFB performed well with a volume increase of 3.1% year-on-year supported by the share gains in several key markets. Total shipment volume increased 7.3% fueled by the growth in GFB as well as a newly added brand through the acquisitions and the favorable inventory adjustment.

Excluding the acquisitions and inventory adjustments, total shipment volume decreased 2.2%, a resilient performance in light of the industry volume contraction in various markets.

Now turning to the international tobacco financials on Slide 6. As we mentioned before, we expect the international tobacco business to return to top line growth, driving the profit increase in 2018. On a constant FX basis, core revenue grew strongly 7.5% year-on-year, driven by the pricing gains in Iran, Russia and Taiwan, among others.

As for the adjusted operating profit, as shown in the above graph, pricing gains being the driver, led to the strong profit growth of 7.9% while investment in margin market and the reduced risk products continued.

Let me add that as opposed to the strong contribution to the shipment volume, the benefit of acquisitions was limited for the profit. This is because these acquisitions were made in the lower unit price market. The yen-based result impacted by the unfavorable effect of yen appreciation is as shown on that slide.

Next, I'd like to talk about the current situation of Russian and the U.K. market. Please look at Slide 7. With respect to Russia, as I mentioned at the beginning of the year, we expect that the pricing environment will improve in 2018 in light of the timing and the scale of tax hikes. In 2017, we carried out our flexible pricing strategy in order to defend our market share against the backdrop of intensified price competition. As we seized the pricing opportunities in the second half of last year, now those pricing benefits were realized in the first quarter of 2018, our GFB market share led by Winston and LD with the record [indiscernible] of 24.4% on 12 moving average.

As for the acquisition of Donskoy Tabak that we recently announced, it is expected to be completed in the third quarter of 2018. We expect this will further strengthen our geographic capabilities in the market and increase our strategic options with the enhanced brand portfolio.

In the U.K., around the time when the EU TPD2 introduced in May 2017, we faced volatility in consumer dynamics and a competitive environment and also experienced a temporary supply shortage of our fine cut product, so we lost market share and couldn't increase price more but only to a limited extent.

It has been almost a full 1 year since the regulation implementation, and now we see that the operating environment has been stabilized though gradually. Under such circumstances, our market share has increased for 6 consecutive months from last October. In addition, we took the manufacturer price increase in March after carefully considering market dynamics and reconfirmed that our key competitors followed our pricing for their major products. On the other hand, we're aware that we couldn't overlook risk, most notably related to competition and down trading. We continue to closely watch market dynamics and effectively take measures as necessary.

Now I'll give an update on the acquisitions last year.

Please turn to Slide 8. In the Philippines, after acquiring the assets of Mighty Corporation, we increased the prices for Camel, Mighty and Marvels last November and for Winston and Mevius in February this year. In addition, GFB shipment volume grew strongly through the expanded distribution network. We continue to invest in the business with a view to maximizing the synergy.

In Indonesia, where we had completed an acquisition in the fourth quarter of 2017, we now are working on the business integration with top priority.

In Ethiopia as well, we continue to focus on the capability building for the supply chain and the sales force of the acquired company that we have promoted since we initially took a stake in July 2016. We made acquisition in emerging markets such as the Philippines, Indonesia and Ethiopia from a mid- to long-term perspective, and we will foster these markets for our future growth.

Next, move to the domestic tobacco business. Please take a look at Slide 9. First, let me talk about the Japanese market. The share of reduced risk products kept increasing, and we estimate it reached about 20% of the total tobacco industry volume in the first quarter. Cigarette industry volume declined 15.6% year-on-year, mainly due to the expansion of reduced risk product. As a result, the tobacco industry volume was estimated to decline at around 2.5%. This 2.5% decline seems relatively moderate. However, it was in line with our expectation considering the tax hike will be implemented in October.

As for our performance, JT's cigarette sales volume decreased 15% year-on-year due to the cigarette industry contraction. Thus, our cigarette market share remains solid with an increase of 0.5 percentage points, partly solidifying our foundation in this category which is the overwhelming majority in the Japanese market.

Regarding the RRP, due to the Ploom TECH sales area expansion, the sales volume was 0.3 billion cigarette equivalent units and RRP related revenue was JPY 8.3 billion. In addition, the Ploom TECH share at convenience stores in current sales areas was estimated to be 3% to 4% in the first quarter. As for the financials, adjusted operating profit decreased 14.4% or JPY 8.3 billion due to the cigarette revenue decline despite the sales increase in reduced risk products.

Now I will explain the user base and potential of Ploom TECH.

Please look at Slide 10. Now we have been aware of those, but now we have further confidence in the potential of Ploom TECH through expanding the sales areas and receiving feedbacks from more consumers. As already mentioned in the past, Ploom TECH has benefits unique to the low-temperature tobacco heating technology since its reduced influence to the surroundings and creation of opportunities to enjoy tobacco products. Because of such benefits, we understand that in addition to the consumers who have fully converted to Ploom TECH, many consumers tend to use both Ploom TECH and cigarettes for other reduced risk products. So this fact suggests that Ploom TECH has the potential to be accepted by a wide range of tobacco users. And to support this, accumulated sales volume of Ploom TECH devices since its launch exceeded 2 million units in April. Ploom TECH, the low-temperature tobacco heating product is different from any other existing tobacco vapor product. We developed and established this new category with a mid-term perspective. We continue to make efforts to enhance the understanding of the benefits unique to low-temperature tobacco heating technology and to increase the number of facilities where Ploom TECH is allowed to use with the aim of maximizing the number of users.

Next, please look at Slide 11. As announced yesterday, Ploom TECH national launch will start in June and expand to convenience stores nationwide from July.

The capsule production efficiency being the bottleneck has been improving as the manufacturing machines currently in operation are running stably. Under such a circumstance, we have decided to revise the launch schedule in order to respond to those potential consumers who are waiting for Ploom TECH across the country as early as possible. While Ploom TECH national launch will start from June, there's no change to our initial sales target for reduced risk products as the supply of capsule is still under constraint. Our assumptions of Japan market also remain unchanged. It means that the operating environment continues to be challenging. However, we will aim to achieve our full year profit target of the Japanese domestic tobacco business while strengthening our sales force and increasing marketing investments to support Ploom TECH national sales.

And now I would like to explain JT's position on regulations regarding heated tobacco. Please refer to Page 12. Recently, various administrative organizations are examining the measures to prevent exposure to environmental tobacco smoke. We believe health risks of exposure to vapors generated from reduced risk products should not be argued as the same way with exposure to environmental tobacco smoke generated by conventional cigarettes. Because when using reduced risk products such as heated tobacco, there's no combustion of tobacco leaf and no generation of environmental tobacco smoke. JT supports the measures to prevent unintended exposure to environmental tobacco smoke and have been advocating to develop designated smoking areas and improving smoking manners. On the other hand, there are regulations regarding prevention on exposure to environmental tobacco smoke that treats heated tobacco and conventional cigarettes in the same way. We believe regulations regarding health risks on heated tobacco should be carefully examined based on scientific evidence. For instance, reform bill of Health Promotion Act of the Ministry of Health, Labour and Welfare allows heated tobacco to be used while eating and drinking in dedicated rooms in contrast to conventional cigarettes. We will continue to provide information to relative stakeholders to gain the understanding of our position on regulation regarding heated tobacco.

In the previous slide, I have explained JT's position regarding regulations on heated tobacco. So I would like to explain JT's Ploom TECH characteristics specifically here. Please look at Slide 13.

Ploom TECH is a category of tobacco infused vapor products with low-temperature heating technology, and there are no burning nor high-temperature heating of tobacco. Ploom TECH tobacco vapors show the following 2 characteristics: first, there is approximately a 99% average reduction in the levels of potentially harmful constituents measured in the Ploom TECH vapor compared to conventional cigarette smoke; secondly, we believe there is no substantial health risk combined standards associated with the use of Ploom TECH's since its use does not affect surrounding air quality based on our study results. In fact, our studies have shown that there is no significant difference with and without the use of Ploom TECH in the indoor air concentration of 3 potentially harmful constituents detected in Ploom TECH vapor; and four, substances defined in the Japan act on Maintenance of Sanitation in Buildings. The study results have been published in scientific articles and peer-reviewed academic journals, and you will be able to find the content on our JT Science website. So please visit our website.

So lastly, before we go into the Q&A, please look at Slide 16. Our results on the first quarter of 2018 were broadly in line with our expectations. In the international tobacco business, we expect that the pricing returns to be the profit driver, and we have got off to a solid start towards this full year target. In the Japanese domestic tobacco business, we continue to maintain and enhance the dominant position in cigarettes and to strengthen the manufacturing capacity as well as the sales force and marketing investment towards Ploom TECH.

In the pharmaceutical business, we forecast the royalty revenue to increase and make contribution to the group's profit growth. As for Processed Food Business, we continue to strive to achieve the annual target. Despite a challenging operating environment, we will execute our plan with flexibility and aim to achieve our full year target. This concludes my presentation. Thank you for your kind attention.

[Unknown Executive]

Thank you very much. Now we would like to go into the Q&A. The gentlemen answering the questions will be Mr. Naohiro Minami, Executive Vice President and Chief Financial Officer of Communications; as well as Mr. Hisashi Ishikawa, the Vice President, Head of Tobacco Business Planning Division.

[Operator Instructions]. When we take your questions, the MC will call out your name. Please limit your questions to one question per person due to time restrictions. In terms of questions in the English language, we are receiving it on -- through e-mail. Please submit your e-mail to [e-mail]. Now we are receiving your questions. Thank you very much for your patience. I would like to introduce the first person. This is from JPMorgan, Tsunoda-san.

[Ritsuko Tsunoda, analyst]

I'm Tsunoda of JPMorgan. I didn't expect to be the first question. So I'd like to ask about the prospects for the domestic market. At this result, you didn't revise the plan for the full year. But for the RMC, the [indiscernible] 17.5% decline that the first quarter decline was moderate. But still, you didn't change the forecast. And of course, there'll be the impact of the upcoming tax hike. And also that the Ploom TECH will be developing farther, and then there will be the cannibalization impact by the RRP. So for the RMC, assuming this -- I think there'll be some trade-off with the RRP and RMC. Then, when you see the increase of the RRP, then the industry contraction of the RMC, how is it going to be developed in the next year and onward? And the RRPs present review about 23% for this year. But in 2020, 2 or 3 years down the road, when the RRP, how RRP will be growing? And then vis–à–vis, the industry decline of the RMC, how much will be the decline on the RMC?

[Naohiro Minami, executive]

Minami speaking. For the long-term prospects, including this year, 3 years from now, RRP and RMC, how they will be developing? And what will be the normalized development used to be confirmed? And after having those numbers, I would like to have the finding. And given that, certainly, when we look at both the RRP and the RMC, that market contraction of the RMC, at this moment, the decline is a bit weak. And that can be said for the 3 month period. However, as we have been telling from the beginning of the year, for the 2020, our assumption for the management is that the RRP will be about 30% of the total tobacco category although there might be several [indiscernible] years. And that should be within our perspectives. And that assumption remains unchanged at this moment. So returning [ to ] the key comment, other companies and our service in the 3 years, that high temperature and the low-temperature product, and those, the various versions, we think the low-temperature product, and with that, we'd like to erase that worry. And also, we're going to have the improvement of the product and also the sales force improvement. So under such circumstances, at this moment, after 2000 and onward, what will be the demand of the RMC? That would rather be appropriate. We wouldn't be able to comment on the 2020 RMCs, the market contractions. So assumptions of the planning is 30% of the RRP, and we think that category we're going to take 40% of share. And looking at the -- all of the domestic tobacco business, which includes both of the RRP and RMC, we'd like to improve the product portfolio. And also, we'd like to -- the price leadership to maximize the profit. And I'm not talking about the short-term profit, but that through the portfolio, both of the RRP and RMC, we'd like to expand the product lineup and also we'd like to expand the profit pool. So that might not be the direct answer to your question, but that shows our ideas and observations.

[Ritsuko Tsunoda, analyst]

I understand that it's very hard to draw the line between the RRP and the RMC, but market contraction, the combined of these 2 so far, that trend decline has been around 2% to 3%. Should we think that should be the range that we need to procure? And also, that BMI showed the forecast and that was downward revised. But regardless, you stick to the previously presented number of 23%. Do you have any background for your thought?

[Naohiro Minami, executive]

First, for the RFP for this year, that every company has the product launch in various areas. And also -- and that includes nationwide launch of Ploom TECH in our case, and also that first promotion at the storefront and also pricing, for example, the cash back campaign at the stores, various -- so there are various initiatives taken by each company. And then, that would affect the -- our prospect. So in October, we're going to see the tax increase. So because of that, at this moment, when we have the 2 sensitive forecasts for the RMC, I don't think that that is the right option us to go. So for our target, 200 million pack or the 4 billion sticks that we like to stick to that number and continue to pursue that number, and we are the follower in this category, and this is our highest priority for your comment. And for your first point, we need to look at the -- our revision, how it will be developing. It needs to be confirmed, and the smoking place, I'm not talking about the [indiscernible] but the smoking places would affect the smoking volume. And also for the preparations [ wide ] that there will be increasing aging trend, and that is probably discussed in the Social Security discussions, and also declining birthrate, that is the unchanged trend of the 20 or 30 years. So under such circumstances, our major target, consumers that the people over 20 years of age up to 65 years of age, the working population, that demographically, that those populations will be declining. So we need to be watchful for that trend. Therefore, at this moment, sorry to say that after 2000, how did we decline? We cannot give you the straight answer to you, but we wouldn't be excessively optimistic, but we wouldn't be excessively pessimistic either because -- partly because of our sales force and also we listen to the consumers' voice in the field. And as we have been saying that we are going to maximize the profit pool. That includes the RRP, and that is our key initiative.

[Unknown Executive]

Thank you very much, Mr. Noda. Next, we are going to take the second question which is from Mizuho Securities. Saji-san.

[Hiroshi Saji, analyst]

I'd like to ask about the Ploom TECH status as well. One thing is, well, regarding the concerns, I want to ask you what is your awareness regarding this? I understand that you've been able to sell about 1 million units up to now, but I understand the share of the convenience is still as low as 3% to 4% which has not grown so much. And I agree because when we look at the Ploom shops in the streets, we don't really see people gathering around the product. It is a concern to me as well. So you did mention in your presentation that there are many users who use Ploom TECH alone, but there're also people who use it together with different devices or cigarettes as well. But it is not the main product actually. This is the way I see it. And because it's not the main product, it's not moving fast enough. This is one of my hypotheses. But what would you say to this kind of phenomenon is 1. Now the second point is related to their concern. PMI is saying, for the core users, which is about 50 years old, the conversion rate is not that fast. They have mentioned that in their calls -- conference calls. So I was wondering as you are already in the phase of selling this, what are some of the concerns that you have and what are your thoughts for the next phase?

[Naohiro Minami, executive]

Thank you. This is Minami answering your question. So first of all, in regards to this announcement regarding the convenience store sales and the share being 3% to 4% right now, let's take the example of Tokyo. You have a point because the numbers are volatile by week. The speed of the sales changes, because depending on the area where this product is sold, if it becomes nearby, in other words, for people who used to buy in the convenience stores, would be able to buy it in their nearby store. When we have more and more stores standing in more regions, people have more choices, so -- as to where they can buy their products. So this is one of the phenomena that you can see in regards to the initiatives that we are taking. Now to your question about our concerns, the turnover -- turn rate in the convenience stores. Now there are people who completely convert to Ploom TECH. And when you compare that, how they use it compared to people who are dual users, the situation is different and they would consume less if you are dual user. But if you are a dual user, that means that they are also consuming other products. For example, cigarettes or other products from our competitors. That means there is more opportunities and occasions and scenes in which the consumers choose to smoke their products and they select their products depending on the occasion. So in that sense, we believe that there is potential for this product as the market continues to expand in this way. So therefore, to this concern, which you've raised as an issue, we share the same understanding. We often say people smoke within very small slots of time, and people do switch a little bit to Ploom TECH and then go back to their original product. And so we understand that this churn rate is based on these dual users and people shifting from one product to another. Furthermore, we can say that we need to focus on the characteristics of this product which is the low-temperature heating technology. These features that are high-temperature heating technology does not have, it releases you and liberates you from some of the difficulties and constraints that you may have with high-temperature heating products. So the benefit of low-temperature heating technology needs to be spoken to the consumers and communicated very well with some hands-on experiences for people to relate to. This is the kind of story and communication that we need to continue going forward to make Ploom TECH more penetrated into the market. To do this, we need to take time and make sure that our consumers actually feel this as their own experience. And ultimately, get their understanding that low-temperature heating technology has some benefits that high-temperature products do not have. To the second point about Ploom shops that do not have enough customers, well, maybe Mr. Ishikawa can follow up more details after me. But one thing is when it comes to convenience stores sales expansion, it creates a dramatic increase in locations where people can purchase Ploom TECH from. And it is true that a lot of the consumers are shifting from Ploom TECH stores to the convenience store, and there is nothing more than convenience stores where you can get a volume of sales. But when it comes to the benefit and having the consumers experience it, the Ploom TECH special stores or any retailer who cooperates with Ploom TECH's experience is the place where we can take the time and energy to carefully communicate the benefits of this low-temperature heating technology. So it is true, the phenomenon that you've mentioned is happening, and we see the same trend. So I don't want to say roll sort because that would be rude to our sales stores, but we'd like to make sure that we use Ploom stores and the other retailers in their own strength.

[Hisashi Ishikawa, executive]

I, Ishikawa would also like to add to what Mr. Minami mentioned. In terms of Ploom TECH, as was just mentioned, this is different from the other T-Vapor products because it is heated with low temperature. It is a new category and building a new category is exactly what we have been wanting to do, and we are executing that as we speak. So the Ploom TECH product's characteristics, for example, there is no tobacco burning odor, there is the clear tobacco taste to this kind of product. So these are the benefits that we need to have the consumers understand to raise awareness. This is extremely important as of today. So from this perspective, communication to our customers is very important because that is what will help drive the customers into the Ploom TECH stores. We will continue the deployment of this product and the communication going forward, but we will take various initiatives, for example, enriching the number of accessories or also dealing with customers and providing much more aftercare so that we can actually deepen the communication with our customers. And through that, we'd like them to understand Ploom TECH so that we can ultimately maximize the number of users. If I may add another point to the communication initiatives that we are taking, understanding the importance of this, we actually have been evolving our sales force as well. What I mean specifically is we are trying to find new places where people can smoke Ploom TECH, going to companies to actually explain the product and also sell it to employees. These are some of the face-to-face direct communications that we are trying to do with our customers. We have a new team that does this so that we can focus more on communication with our customers and be more agile in expanding our products into the market.

[Naohiro Minami, executive]

Minami again. If I may add one more answer to your question regarding PMI. They have their sense of issue that there's a shift regards to their main target -- in regards to their main target, 50s, but we don't necessarily narrow the target in terms of age like that, because it's a matter of preference and the choices that people make. As we roll out our products nationwide going forward, we would like to see how people use these products in metropolitan areas or depending on the demographics of the population, how differently people use this, and we will gain more experience when we expand our products into other geographic areas, and we will learn as we do this. Now having said that, what we can say, and this will be a repeat of what I've mentioned already, but it's about the maintenance fee, the maintenance aftercare that we provide, and we'd like to make sure that this product is activated even more. So in that sense, we believe that we can give a very good product that will be selected after the consumers go through the consideration of which product to choose. I'm not going to directly answer your question regarding competitors though. Thank you very much.

[Unknown Executive]

Thank you, Mr. Saji. I'd like to move on to the next question. Mr. Miura of Citi, please.

[Nobuyoshi Miura, analyst]

I'm Miura of Citigroup. The announcement of JT for T-Vapor, the disclosure was rather confused. In February, the nationwide was delayed from June to September and after 3 months that you are headed in, that you're going to have the -- or launch in June. So what is the reason for that confusion of the launch timing. And also, you have put up the schedule but the full year Ploom TECH sales volume, JPY 4 billion, remains unchanged. And I have a big question mark for that approach. That number guidance is very confusing. So what is the development behind that, and why have you come up with that timing? So that -- in order to avoid misleading, please give us a comment.

[Naohiro Minami, executive]

Minami speaking. We fully understand that point, your point. So we need to make the detail, the communication clear. For the full year number of 4 billion or the 200 million packs, that is mostly based on the manufacturing capacity. And that is the biggest factor to support this number. And of course, we are heading for the nationwide launch, and we are planning our schedule for this year and mid-speed machines, which has started to operate from last year. And also, at the end of the year, the construction is completed. And this year -- we begin to have the operation this year. That is about the high-speed machines. There are 2 types of the machine. And looking at the nationwide launch, the stable operation of the high-speed machines so that it can meet the -- our demand, we need to ensure the supply capacity and that is our top priority. And under such circumstances, this basic structure didn't change, especially for the high-speed machines, the stable operation with the good quality and certain efficiency. Well, we still have some issues and that is a point we are working on, and this is the current status. And with regard to the medium-speed machines, we haven't come to the max. But with the certain level of yield, now we can have the operation. And after 3 months' experience, after making various efforts, we have achieved that certain level of yield already with the medium-speed machines. So on the consumer side, we need to have the linear increase of the manufacturing capability to be in line with the demand growth, and that is the habitual of the picture that we need to pursue. But still, since we have the current decision as such, so we need to have the rather agile approach, pleased approach at the beginning of the year that the height of that stair, that there were some gap between the reality and fun, so we need to have certain inventory. However, currently for the medium speed machines, for the currently assumed demand, I think we can meet our demand level with the medium-speed machines to some extent. So we are coming closer to the linear growth. And then that -- although we have been achieving the numbers and the [indiscernible] but it is coming closer to in the linear growth. Then, we understand that the confusion has been close to the market and also consumers. But our approach currently is to take the measures as soon as possible. And that's the reason for the -- put up the schedule.

[Nobuyoshi Miura, analyst]

So to be more specific, at the end of April, the Ploom TECH capacity -- how large is the Ploom TECH capacity as of the end of April and also time schedule at the end of June or the end of our December that 1 million? Can you give us some comment with visibility with some timeframe?

[Hisashi Ishikawa, executive]

Ishikawa speaking. As of today, I cannot comment on the specific number. But today, the operation has been stable, more stable than our plan. So for the medium-speed machines, that stable operation -- because of stable operation, the mid speed machines that we are able to decide to put up the schedule for the nation. And also that we have the plan of the 10 billion prior year of the capacity, and the target we are moving steadily. But the key factor is in the second half of high-speed machines. Whether we can have the smooth operation of that high-speed machine is one of the key factors. So it's really up to the mid-speed machines that operation is very stable. But for the high-speed machines, we need to make part of our effort to enhance the speed and also the stable operations. And then, with regard to the target of the 10 billion for the capacity that we'd like to achieve that number. Thank you.

[Nobuyoshi Miura, analyst]

So simply put, that 5 billion capacity will be achieved this year, but is it achieved at June or is it the number as of today? Which is the case?

[Unknown Executive]

Basically, at the end of June, we are going to achieve that number. And that plan remains unchanged.

[Nobuyoshi Miura, analyst]

So with that, 4 billion sticks sounds very conservative. And what's the reason to stick to the 4 billion sticks?

[Hisashi Ishikawa, executive]

Installation is over but how we can improve the efficiency is our key factor. So we cannot expect to see the linear growth.

[Nobuyoshi Miura, analyst]

Let me confirm. As of June, that -- you're going to have the capacity of 5 billion for the full year?

[Unknown Executive]

Yes, we have been proceeding in line with that forecast.

[Unknown Executive]

Thank you, Miura-san. Now we'd like to shift to the next question. Fujiwara-san from Nomura Securities.

[Satoshi Fujiwara, analyst]

I'd like to ask about overseas international business. So in the first quarter, I understand that you're able to grow your top line due to pricing. But when you look at the profit, the pricing effect is about JPY 100 million. It used to be about JPY 200 million every quarter when we look at the past results. So when we look at the past -- the environment of the business, of course, there are risks. But I'd like to ask about the effect of profit by the pricing. Will it be as strong as it used to be in the past or what do you think?

[Unknown Executive]

So in terms of this term, this fiscal year, the JPY 100 million effect or, yes, JPY 100 million effect in the first quarter, when you compare it to the full year of today, actually, there is not enough effect. I think you would understand that we can grow a little bit more from here on. And the reason why I mentioned this is, for example, in the U.K., in this quarter, it's just that the mix and the volume have negative trends right now compared to last year. And then, because of the pricing that we did at the end of the first quarter, we will have some effect of that from the first quarter and on. And also, when we talk about the country of Russia, in 2017, Q3, Q2 was when we had the discount of the baseline. So there was no special pricing effect compared to that sort of year. This year, we will have the pricing peak in the second quarter or third quarter in reaction to what we did last year. But this is about last year. We reduced it below the baseline and it's kind of like a relative effect compared to the previous year. Now we are not going to be able to get the effect and increased profit just because we do pricing. We cannot do that in a forceful way because we have a mature market right now. Russia -- these places are still -- in the state of recovery right now. So when we think about the future, the pricing effect, to your question about whether this pricing effect can be achieved or not, is exactly what we need to consider. And in an environment where the market is already quite mature, what is our positioning in such a market, and what kind of pricing that we can achieve? To manage these answers to these questions will be key. And furthermore, while we can obtain some pricing effect, we need to make sure that we build our foundation in the emerging market simultaneously and make sure that we're able to run our business like we do at JT in the emerging markets. We have to have this continuity between these initiatives so that we can continue to gain profit in our international business. This is the concept that we have.

[Satoshi Fujiwara, analyst]

I'd like to add one more question if you can answer this one. In terms of Russia, which you just referred to. When we look at the transition of the share, I understand that, as the first quarter, it is stably improving. But when you look at the quarter-on-quarter it is declining a little bit. JT I understand is at best right now, but I think maybe you have more leeway for growth here or not?

[Unknown Executive]

In terms of the competitive landscape, last year, in the second half, we did a price hike 3x. So we have RUB 9, which we increased, but depending on the competitive situation, depending on the -- some other brands of our competitors, they have not followed with the price increase and they've only raised their price by about half compared to us. So because of this difference, and I mentioned earlier that we are still on the trend of recovery right now, and you can see that in this example as well.

[Unknown Executive]

Thank you very much, Mr. Fujiwara. Next, we would like to take the question from Goldman Sachs, Yamaguchi-san, please.

[Keiko Yamaguchi, analyst]

Thank you. Yamaguchi speaking. Let me come back to the RRP. In the first quarter, that market share, that category, is about 20%. But -- and do you think that there is a gradual growth from January to March? And that's my first question and I have another question as well.

[Unknown Executive]

Yes, as of our December results, the 18% and in this January to March period, or others level, it has increased to 20%. So that expansion continues in our observation and that is the basis for our assumption.

[Keiko Yamaguchi, analyst]

Thank you. And then with the launch of your product and competitors' product, then the volume will be increasing. The competition will be intensifying. In October, there will be the tax hike. And then if you increase the -- Ploom TECH's vendors, the price might higher than the Mevius. So that would be a rather difficult option for you to take. And you said that you're going to have the active reaction. So with regard to the advantage at the Ploom TECH, how are you going to ensure that the competitive advantage of the Ploom TECH given you're going to have the tax hike?

[Unknown Executive]

As we have correctly pointed out, Ploom TECH -- talking about the Ploom TECH, unfortunately, as of today, that we have the proceeding competitor's product, and we are lagging behind. So unfortunately, we don't have the price leadership with that product. And under such circumstances, competitors like ourselves, we have consider how they're going to have the pricing for the RRP as well as the RMC, and that will the part of their in-depth strategy. And then, on our side, basically, with regard to the tobacco, the tax increase will be passed on to the consumers. But for the RRP, at this moment, with regard to the competitive environment, we are rather cautious because of the competitor's product. And for the RRP, for 5 years, there will be the new -- shifting to the new tax scheme of both -- combing both of the specific and ad valorem tax scheme. However, that said, vis-à-vis the RMC that the tax rate of the RRP is different. And also, that would be affected by the certification of the RRP, but that is a variable part. And of course, we would pursue the cost reduction further and also for the further product development. But we need to ensure the profitability with the mass production. So as I have been commenting, the tobacco product as a whole, including both of the RRP and RMC that we will maximize the profit pool in future. That is our intent.

[Keiko Yamaguchi, analyst]

So the manufacturing site increase will be happening. And then with regard your offset, the margin decline is due to the tax rate. And so the high-speed machines operations. So that production site will be more important, is that what you indicate? That the fixed cost reduction and minimizing the fixed cost on the side of the manufacturing side.

[Unknown Executive]

Of course, we will do that. But in addition to that, the time of the specifications of the product. But we need to ensure our profit and also for the existing product. How we can improve the cost structure will be important for us as well. And as a result -- then, as a result, we think we will see the improvement of the profitability as a whole for the -- our developed product.

[Keiko Yamaguchi, analyst]

So 5 years in a row, your tax increase will be higher on you. I think that is because of the current base tax rate is lower on you.

[Unknown Executive]

5 years in a row. Would you repeat the question again?

[Keiko Yamaguchi, analyst]

That the tax increase on you for the Ploom TECH will be higher than the competitions for 5 years in a row. So for the Ploom TECH, I think it will be rather hard for you to achieve the higher profitability under such a situation.

[Unknown Executive]

Well, I don't take that opinion because that -- of course, there will be some cost side and also that we will consider the impact on the environment. We are very particular with the Ploom TECH. And then, the leeway for the further improvement of the Ploom TECH, we still think that there are many more things for us to make the product improvement with the Ploom TECH.

[Unknown Executive]

Thank you, Yamaguchi-san. We are receiving many more questions, but due to time constraints, we'd like to take the final question. Morita-san from Daiwa Securities. Morita-san, please.

[Makoto Morita, analyst]

Hello, I'm Morita. I want to ask about Ploom TECH as well. Mr. Minami, you mentioned that there's much more room for growth. I understand that there's much leeway and high potential. But if you can give us some color on the degree of this. For example, when we look at the fiscal year '18 goal of 4 billion sticks, is there an upside possibility for this? Or when we look at the share maybe, we can say that for the first quarter, we only have 3 to 4 quarters as you say. But how about -- as of the end of January, you said 3.2 billion. So when I look at these numbers, it seems like the potential does not look at much as you say. So how should we perceive the potential of Ploom TECH?

[Naohiro Minami, executive]

So to give you some numerical color on this, the number of 4 billion sticks is based on the installation that we are doing right now, and if we improve the efficiency going forward, we believe that 4 billion is pretty much the maximum number that we can achieve. So that's why the numbers that we announced in February about the manufacturing capacity, we also said that after we improve the efficiency, we can do 20 billion. So in terms of the share also, I guess I would be repeating what I mentioned earlier because I mentioned in January that we have these 3 -- 3.3 the number for Tokyo Metropolitan area. But this is just Tokyo. And at that time, we only had e-commerce for the other 3 sectors in Japan. You can say in reverse that people in Tokyo, or at least the population that resides in Tokyo during the daytime, was consuming this number. But after that, we have expanded the sales to the Greater Tokyo area so we can say that there's a volatility depending on where the person is. And within and outside the borders of Tokyo, there's volatility now because we're expanding our sales geography. Having said this, when we look at the whole nation of Japan, we're looking at approximately 20%. This is our assumption. And compared to that, Tokyo Metropolitan area should be, in the category of RRP, higher in the category share. This is our assumption and also related to the population of smokers in this area. So that's why the shares do go up and down. But we can say for sure that for those users who already bought a device and people who smoke with the device are increasing, so we have more number of users all in all. So that's why going forward, as we approach the national deployment of this product, the potential of Ploom TECH needs to be exercised, and we would like to report to you the progress of our expansion.

[Makoto Morita, analyst]

Well, if you can give us some prospect for the next fiscal year, when you have some more numbers regarding the share or sales volume so that we can get more hint.

[Naohiro Minami, executive]

Yes, going forward, we will continue to report this to you based on the sound volume and also the revenue from that. So we look forward to your feedback against that going forward.

[Unknown Executive]

Thank you very much, Mr. Morita. With this, we will like to close the Q&A session. And with this, we would like to close this meeting for the first quarter results for FY '2018 by JT. Thank you all for your participation. Now please hang up.