Japan Tobacco Inc

TSE:2914

Earnings Call Transcript 2019-Q1

[Unknown Executive]

Ladies and gentlemen, thank you very much for waiting. Thank you for dialing in for the 2019 first quarter results conference call despite your busy schedule. We'd like to now start the call as time has come.

First, Executive Vice President and Chief Financial Officer in Communications, Mr. Naohiro Minami, will present for about 10 minutes, and then after we will take questions. We are planning for approximately 50 minutes for the call.

Now without further ado, we would like to move on to the presentation.

[Naohiro Minami, executive]

I'm Naohiro Minami, Chief Financial Officer of the JT Group. Thank you for joining the conference. First, I will go through the highlights of our consolidated financial results for the first quarter of 2019.

Please look at Slide 3. Adjusted operating profit at constant FX, our main KPI, increased 5 -- 7.2% year-on-year, led by strong pricing gains in the international tobacco business and solid results in in the Japanese domestic tobacco business, fueled by cigarette pricing gains and Reduced-Risk Products top line growth.

On a reported basis, adjusted operating profit declined 6.3% due to a negative FX impact in line with our initial full year assumptions. Operating profit increased by 24.4%. This is due to the onetime compensation gain related to the termination of the exclusive license agreement for anti-HIV drug in the pharmaceutical business, which more than offset a decrease in profit from sales of real estate, an increase in intangible amortization related to acquisitions and the decrease in adjusted operating profit of the group 16.2% year-on-year driven by the increase in operating profit despite higher financial expenses due to an increase in interest expenses.

Just to make sure, I'd like to mention that the onetime profit in the pharmaceutical business was treated as an adjusted item, therefore it's recorded in operating profit but not included in adjusted operating profit.

Next, I'll explain our performance by business segment. Regarding the detailed analysis of our consolidated business segment results, please refer to our earnings report.

Let me start with the Japanese domestic tobacco business. Cigarette industry volume declined by 8.5% year-on-year, a resilient performance given in the price increases and the expansion of Reduced-Risk Products. The RRP market size increased, and we estimate it reached about 23% of the total tobacco industry volume in the first quarter. The total tobacco industry volume decline is estimated at around 5% versus last year, which is relatively moderate under the circumstances.

Moving on to our performance. Our cigarette volume declined 8.3% year-on-year, outperforming the cigarette industry volume decline. Our RRP volume increased significantly year-on-year, reaching 0.6 billion units. However, volume declined sequentially due to an unfavorable comparison with the previous quarter's higher shipment volume, supported by aggressive promotion and the expansion of the competing products in this quarter.

Despite an increase in cigarette market share, total market share declined due to the expansion of the RRP market size and a decrease in JT share within the RRP category. We estimate our share in the RRP category around 8% on an offtake basis. It was impacted by the expanded distribution of competitors' products in the first quarter and the unfavorable comparison in new customer trials, which were boosted by our enhanced marketing during the previous quarter.

Regarding cigarettes, while influenced by downtrading, our category share have been increasing steadily since January and reached 61.6%, up 0.1 percentage point, both year-on-year and versus the previous quarter.

Let me pause here and look back at our 2019 forecast assumptions. In cigarettes, we did not see any notable deviation from our assumptions. Regarding RRP, the 23% share the category recorded in this quarter is the high end of our assumptions, which, nevertheless, we do not change for the following reasons. It was boosted by new product launches by both competitors and us. These launches uplifted shipment volume, including retailer inventory and stimulated interest of consumers for both new entry and reentry to the RRP category. Under these circumstances, although our share within RRP during the quarter was [indiscernible] to 8%, we maintained our assumption related to JT RRP sales volumes. I'll review our RRP activities in a latter slide.

Moving on to the financial results in the Japanese domestic tobacco business. Core revenue and adjusted operating profit increased 3.2% and 4.2%, respectively, driven by top line growth. It's self-fueled by RRP sales volume increase and cigarette pricing gain, partly offset by the decline of cigarette sales volume. RRP-related revenue in the first quarter was JPY 12.4 billion. The marketing investment for RRP increased year-on-year. To achieve our full year target, we will strengthen the top line growth through total share gains, as well as appropriately controlling our costs, including marketing expenses.

Now let me share some details regarding our RRP portfolio in Japan. In the 6 prefectures where Ploom TECH+ was launched in April, JT RRP volume has steadily increased, and the market share within the RRP category in these areas has risen to approximately 10%. Consumers of this new product consist of various tobacco product users: cigarettes, JT RRP and competitors RRP. We are offering consumers a new choice with this product. Most of the customers' feedback is positive, and some consumers already show great interest and suggest to increase flavor lineups, which we will consider.

As for further distribution expansion of Ploom TECH+, we will go nationwide in mid-June versus our original schedule of July. Regarding Ploom S, its sales panels are still extremely limited, therefore, the awareness of the product remains low. Therefore, our first priority is to make this product available to consumers and increase the awareness. Then for consumers who are aware of Ploom S, our marketing and sales activities will be deployed for them to understand the product in its superiority to gain the share from competing products.

As for Ploom TECH, its market share declined in Q1 due to the factors I previously mentioned. Looking ahead, we will strengthen our approach to consumers who share benefits unique to Ploom TECH, such as high usability, importability, a rich flavor line and a clear smooth taste.

From the second quarter onwards, we will expand our market share by leveraging our entire RRP portfolio, offering the new consumer choice.

Moving on to the results of the international tobacco business. Total shipment volume increased by 6.5% year-on-year, driven by acquisitions in Bangladesh and Russia in 2018 and share gains across most key markets. This is also supported by higher industry volume in Turkey due to speculation of price hikes and the favorable year-on-year comparison in Taiwan where the previous year industry volume was negatively impacted by price increases.

Organic sales volume, excluding the acquisitions, declined by only 0.1% from the previous year, highlighting our positive share performance and the equity of our brands. Adjusted operating profit at constant FX grew strongly by 13.3% driven by positive volume contribution and solid pricing, while investments continued notably in RRP. Pricing gains were realized notably in the markets listed on the slide.

For the remainder of the year, we anticipate an industry volume decline in several markets, including Turkey and Taiwan, as well as in Europe.

As the year-on-year volume growth will decelerate, we do not assume the double-digit profit growth to continue. Still, pricing is solid and remains the key driver to achieve our full year profit target.

On a reported basis, as expected in the initial forecast, adjusted operating profit decreased by 7.4% year-on-year due to unfavorable currencies, which outweighted our solid business performance. Negative FX impact was JPY 19.9 billion mainly due to weaker Iranian rial and Russian ruble, partly offset by the favorable FX from the yen depreciation to the U.S. dollar. For the quarterly negative FX impact going forward, we expect it to be lower in the second half.

Next, turning to the pharmaceutical and the processed food businesses. In the pharmaceutical business, both revenue and adjusted operating profit decreased due to the termination of the exclusive license agreements for anti-HIV drugs in Japan. In addition, we expect that the royalty revenue from outside of Japan will decline due to the expansion of the competing product in anti-HIV drugs.

In the processed food business, despite solid performance of staple food products, revenue decreased due to lower sales of other products. Adjusted operating profit declined mainly as a result of the revenue decline as well as higher raw material costs and an increase in logistics costs.

We started 2019 with a strong first quarter. Talking about risks surrounding our business, nothing materialized in this quarter that affected our performance. Although the deadline of Brexit was postponed, this hasn't changed the situation. We are firmly prepared with plans for various scenarios. As already announced, all of the Canadian litigations against JTI McDonald Corporation, our Canadian subsidiary, have been stayed by the March 8, 2019 court order upon JTI McDonald's application for protection under the Companies' Creditors Arrangement Act, called CCAA. Protection under CCAA allows JTI-MC to continue its ordinary course of business while seeking a coordinated solution for all stakeholders. We do not plan to deconsolidate it from our group and have not allocated related allowances so far.

Regarding geopolitical risks, uncertainties continue in several countries -- continue in several countries such as Iran and Sudan, and we will deal with these risks appropriately. We completed our share buybacks of circa JPY 50 billion on March 18 and acquired circa 18 million shares.

Based on a solid performance in the first quarter, we will execute our plan with flexibility and aim to achieve our full year target. This concludes my explanation. Thank you for your attention.

[Unknown Executive]

We would like to now move on to Q&A. The CFO, Mr. Minami and the Senior Vice President from the Tobacco Business Planning, Corporate, Scientific and Regulatory Affairs Department, Mr. Junichi Fukuchi will take your questions. [Operator Instructions] Mr. Fujiwara from Nomura Securities, please.

[Satoshi Fujiwara, analyst]

Hello, this is Fujiwara from Nomura Securities. I have a question about RRP. First of all, thank you for last fiscal year. RRP category share was 10%, and your share is now 8% within the RRP category, and you explained the reasons why. For Ploom TECH+, as you expand sales, your share is 10% in the 6 prefectures, and you also have Ploom S available now. So with regards to further share growth, how much of a positive response are you getting because you would like to raise awareness of Ploom S going forward, but differentiation against competition, is that really going to be communicated well to the consumers? What is the kind of progress you are feeling at this moment in time?

[Junichi Fukuchi, executive]

This is Fukuchi speaking. Thank you very much for your question, Fujiwara-san. Let me talk about the sales trends as well as our expectations for this fiscal year regarding RRP. For fiscal '19 Q1, RRP, our category share is 8%. And it was 10% back in Q4 2018. So 10% went down to 8%. And Q4 last fiscal year, it was JPY 900 million, and the cigarette equivalent basis went down to JPY 600 million for Q1. So new products attracted retry users as well as new users, including ourselves and other companies, and relatively, our RRP share went down. And we -- this year, integrated outflows to competitor products as well. Also, Q4 in 2018, we did more sales promotions and trials of customers increased, however, this dropped off in Q1 which we believe may be another reason why. For new products, on January 29, we started -- no limited sales of the new product. For Ploom TECH+ on the other hand, we have expanded sales to 6 prefectures from April 1, and we are doing well. Currently, that's been category share of JT within the RRP category is 10%. Sales volume, as well as in category share, it's not just for Ploom TECH, but in addition with the new product, we would like to have a portfolio of strategy with the 3 products and offer various options to the customers in order to gain more market share.

For Ploom TECH+, we started sales in 6 prefectures from April the 1st and we've been getting feedback from our customers. They are saying, relative to Ploom TECH, the kick was better or it tastes better that they don't have to smoke or infuse anymore. So we are getting good positive response already. In addition to that, for the high temperature of product users of competitors, we are seeing an inflow of competition, so we would like to continue on with our aggressive sales promotion efforts. As for Ploom S, at this stage, the sales of channels is limited, so that awareness amongst the customers are still low. However, for the users who have tried this product, they are saying that relative to other competitor products, the odors are low, and it's as good as an RMC. So we think getting some good positive feedback. So as we expand sales, I would like to continue the focus on marketing efforts. With regards to our sales schedule, we believe it's important to accelerate our sales, so we would like to go nationwide with Ploom TECH+ from the middle of June instead of July. And for Ploom S, we would like to go to 6 prefectures from July and nationwide from September. But we are still working on trying to accelerate this timeline with regards to expansion of sales.

[Satoshi Fujiwara, analyst]

For Ploom S and its positive feedback you're getting, I'm sure that the number of feedback is limited at this moment, but on the other hand, what about some feedback that is more constructive about improvements we can make?

[Junichi Fukuchi, executive]

Thank you very much for your follow-up question. We've been getting various pieces of feedback, one would be how long the battery lasts, as well as compared to competitor products, for example, the waiting time when you turn on the device. It's an opportunity. We are getting that kind of feedback, too. But we will consider improvements in various ways in the future.

[Satoshi Fujiwara, analyst]

At this moment, for Ploom S, you are basically trying to wrench away share from competitor products. And I guess the focus would be, are you really able to do that? But what is your feel on that? That's my last part of the question.

[Junichi Fukuchi, executive]

Well, the odor is less compared to competitor products, and maybe its flavor is realized really well and it tastes well. So we would like the consumers to understand this advantage through our communication.

[Operator]

I'd like to introduce the next person, this is from Mizuho Securities, Saji-san, please.

[Hiroshi Saji, analyst]

I want to ask about Russia. The volume, ex acquisition effect, is about 9.8 down, which is drastic, I believe. But against that, I understand that last July and this year, it seems like you've been hiking the price, but still there is down trading. According to the document regarding Winston, it seems like the share is still at 16% which seems to be stagnating. So I'm interested to ask about the environment surrounding the downtrading in Russia and also, on the very bottom, it does say it is contributing to profit for international tobacco business, but still I don't think that the proportion of the Russia contribution is the same, at least when I look at the quarter 1, it looks like the contribution is declining. So I was wondering how I should perceive the development of this part of the business going forward from quarter 2 and on? And also, Logic Compact is in the Russian market right now, and the product composition is about 5% in the RRP in this fiscal year, I think you said. Fukuchi, you can also talk about that as well, please.

[Junichi Fukuchi, executive]

Yes, thank you very much, Minami would like to answer this one.

[Naohiro Minami, executive]

In terms of pricing, I think I will explain this. First of all, in the Jan-March quarter, we have increased the prices for the products. There is one extraordinary point that I'd like to raise for this year. And that is Russia always -- we've always experienced a tax hike in January, but in 2018, the timing has slided from January to July. So for quarter 1 FY 2019, it has gone back to a normal timing, so there was tax hike. So with this in mind, basically, we have transferred 2 tax hikes worth of price transfer onto our products. This is what we did. So the pricing that we've been able to acquire in Q1 compared to the usual level has less effect which could not be avoided. So that is 1 point. And also, last year, in July 2018, when you think from there, in order to transfer the tax hike onto our pricing, we hiked the price a little bit faster than our usual pace. So in terms of the total demand, it was about minus 8%. But having said that, to your point about the downtrading, we had calculated that. But the reality is that the downtrading is happening a little bit faster than we had expected. So our sales share looks stagnant because of these reasons, we believe.

[Junichi Fukuchi, executive]

I see. Consequently, in terms of Q1, Jan, March top line in Russia with constant FX is the pricing is that which is lower than usual did not offset the tax hike. So that's why we have less profit here. Now this decline in the profit though, as I mentioned in the beginning from 2020 and on, will return to the ordinary level because the tax hike will continue to happen in January every year like it has been the case. And also the tax hike amount in Russia will be milder compared to 2019 in 2020 according to the information that have today. So that makes this year extraordinary in various ways.

[Naohiro Minami, executive]

I see. Now speaking of the future, in the Russian market, we are determined to continue to increase our profit growth going forward. So we'd like to maintain our position as the price leader. And even strengthen that position. This is one of our priorities going forward. So in that sense, the acquisition of Donskoy, and also we'd like -- is an investment that we made, but we'd like to continue to execute more investments, as needed. These are some of our plans included in our efforts and initiatives going forward. Speaking of Logic Compact, it is true that initially the RRP category in Russia in the full year will be low single-digit growth in -- low single-digit in the market. So the announcement from our competitor, specifically PMI, I think the market is -- market conditions are within our expectations. So against this backdrop, Logic Compact has started its sales in February in Moscow, but in terms of the initial delivery, it is progressing smoothly and steadily. But when it comes to the volume and area, these are still limited. So in terms of our performance going forward, we still have yet to come up with a more concrete projection right now because it is still too early. Therefore, in terms of the future business, in this regards, I would like to stop with my comment here.

[Hiroshi Saji, analyst]

I'd like to confirm 1 point regarding Russia. I guess the difference between Russia and Japan is that there is purchasing power in Japan. But when it becomes expensive, the situation is different in Russia. I think you said something about RRP in Russia. But maybe the device price or the unit price of Logic Compact, how much ruble is it actually, specifically?

[Naohiro Minami, executive]

Yes. For Logic Compact, the devices per unit, RUB 1,300. And then the refills, a pack of refills, is 2 pods, which includes 2 pods is 299, almost RUB 300. We have to evaluate the fact that there are 2 pods in a pack and also the fact that the device is RUB 1,300. When you compare with a regular pack product, it is actually drastically expensive, in some cases maybe tenfold more expensive. That is the pricing that we sell these products at.

[Operator]

Here's the next person, from JPMorgan, Ms. Tsunoda, please.

[Ritsuko Tsunoda, analyst]

This is Tsunoda from JPMorgan. I also have a follow-up question regarding Russia. In your appendix, you have some details around total industry volume as well as your total demand. But is this talking about the RMC business only?

[Junichi Fukuchi, executive]

Yes. We're just giving up the numbers for RMC.

[Ritsuko Tsunoda, analyst]

In Russia right now?

[Junichi Fukuchi, executive]

IQOS, Heat are seeing increased market share, it seems, and also JUUL in the vapor category. It seems to have gained some momentum. That's what I've been hearing. So everything combined.

[Ritsuko Tsunoda, analyst]

How is industry volume like? What are the trends? And with this as a backdrop, when it comes to the decline in RMC business, when exclude your acquisition impact, it seems that it's going down quite substantially. So in Russia, for e-cigarettes as well as heated cigarettes, I was wondering how you see the negative impact that it has had on your business.

One more thing regarding Russia that I'd like to ask about is about margins. The acquisition you made has strengthened the lower end category. So for your Russian business and its OP margins for profitability, is the profitability deteriorating? What happened to your shift to premium strategy? In the previous briefing, you were talking about measures against JUUL, which is Logic Compact, and the management was reinforcing the fact that you have a price advantage over them. So for competitors with heated tobaccos and e-tobaccos, they are actually setting for the strategy where they focus more on premium. But whether it be for RMCs or for logic, in the case of your company, is your strategy skewed more towards the lower end categories because that's the impression I get. So I was wondering about your price strategy, as well as the margin impact and how you view the profitability of Russia going forward.

[Junichi Fukuchi, executive]

Well, let me answer your question. There aren't statistics available on this matter. So we can only give you information in pieces. First of all, for RRP, with regards to last year, the net sales value, it was about 3% of total. And this percentage is growing right now. To this end, on a cigarette equivalent basis, this is hard to say. So at the beginning of the year, we did say indeed that the impact on Russia's sale volume, for one, can be the government has continued to increase prices and for years have continued to increase share prices so that they could obtain their margins, and that has led to lower demand. So that's the first thing. And the second factor is illicit trade. It reached about 8% last year, but this year, it might exceed 10%. Finally, with the emergence of RRP products, so that's what we were talking about last year. So part of the decline of total demand is accounted for by RRP, meaning RRP is increasing. So that's something we can say on a qualitative basis. However, on a cigarette equivalent basis and the impact that is weighing on total industry demand, we can't really communicate those numbers at this point. We don't have them available. So we could only give you the numbers on a net sales value basis. I hope that answers your question.

For Logic Compact and its margin, of course, when we launched products, we obviously price our products so that we can obtain a certain level of margin. So as a matter of course, when you focus on the cannibalization, you will price products, meaning price your products a little bit higher so that you could secure a good margin, of course, depending on the market. We can't really say we price it in this sort of way because it differs market-by-market. However, in a market where the unit prices are on the higher end, all the profitability will be higher. And if the unit prices are up trending right now and still has space to grow, on a relative basis, the margins will be slightly lower. So under this big principle, I hope you can look at how we're doing. But even if we were to cannibalize our business, we would like to still ensure that we are able to generate our profitability, and that's the way we price our products, and it's the [ patient ] of cannibalization. Furthermore, for margins in Russia and due to Donskoy's impact and their low-end priced products as well as the downtrading trends that are happening right now. With regards to what's happening, to be honest and to give you a straight answer, firstly, with regards to Russia, whether it be premium or prestige, we still believe that we don't have sufficient amount of products to go upscale, which means that the trends of downtrading will lead to margin deterioration. So this is quite obvious. On the other hand, as you've pointed out, the brands under Donskoy are in the value segment. So if we talk about what's happening currently with regards to profitability compared to JTI brands that are in -- comparing to Winston and upwards, the margin of the Donskoy brands are lower. However, the Donskoy brands were acquired because we wanted to secure value brands, so that we can become a price leader in Russia and then have their presence in the overall price portfolio and also to benefit from a profit point of view. So that's why we decided to do the acquisition. Of course, our distribution network may not be sufficient in some regions, so we would like to ensure that we continue to deliver our brands to those regions as well. So when you consider our objective and so forth, going forward, we do anticipate that further downtrading may happen, and competition is going to continue to strive for higher market share. We don't know if this is going to happen on a one-off basis or if this is going to be ongoing. But in any case, we do believe a competitive landscape, it will persist. But we would like to gain more area scale and also have a good portfolio in place so that our margins can be secured, as well as the absolute value of profits can increase in Russia. So we do believe our investment for the acquisition was important.

With regards to our lower margins due to downtrading, we are not going to just watch this happen. Obviously, we will take countermeasures. That is also my reply.

[Ritsuko Tsunoda, analyst]

The follow-up question is from the current margin levels, are you going to strive to increase margins by, for example, for the reinforced RMC business due to the acquisition. Are you going to continue to invest into your brands?

[Naohiro Minami, executive]

Well, in Japan, we are struggling on that front as well. But we basically want to be the price leader, which means that when it comes to pricing of RRP products, we're expanding our products. It is a matter of what kind advantage we are going to associate the products with on a relative basis and we understand that's very important. So we need to have an established position for RMC, which, in turn, will have a positive impact on our presence in Russia overall, including our RRP business. So we basically would like to build a foundation for the Russian business.

[Operator]

I'd like to introduce the next person. This is from Daiwa Securities, Morita-san.

[Makoto Morita, analyst]

I'm Morita. Earlier in your explanation, Mr. Minami, you talked about geopolitical risks, and I would like to hear more about this geopolitical risk. You said that you were taking various initiatives, I was wondering specifically what kind of initiatives. And also the currency, foreign exchange is changing right now. So I was wondering what kind of actions are you taking in terms of the currency impact? Also when we look at the real term base, excluding FX, what is the situation in Iran? Turkey? And finally, what kind of risks should we keep in mind other than foreign exchange? Please let us know in terms of the high geopolitical risk areas.

[Naohiro Minami, executive]

Thank you. This is Minami. I'd like to answer that one. In terms of geopolitical risks, we will continue to take measures. Yes, I did say so. And when we take measures, we have to think about this in short-term and also longer term. First of all, in short-term, we have some incidents that may happen at a high ratio. For example, Russia and other areas, when we have the Crimea conflict and also recently Iran as well, the same can be said. In other words, we need to make sure our business is sustainable. What should we do now in short-term? One is we need to manufacture tobacco and distribute it. And in order to do that, how can we lay out the logistics and how can we guarantee that our manufacturing will be done. This is really the basics of the basics, and make sure that our operation is done smoothly and make sure that we get a certain volume per month. And also, look for opportunities for manufacturing end markets.

Let's take Iran for an example. We have the international sanction led by the United States. So there are various restrictions and regulations that we need to comply with. But still, we need to make sure that we get the cash circulating. So what kind of options do we have to take these measures? These are all the questions that we have to answer in short-term. With long term, and it depends on how long, long is, but we're not trying to sound responsible, but there are things that we just cannot control. And one is the market portfolio. How can we optimize our market portfolio? Really it is the question that we have to find an answer for. Another point would be the acquisition decision or business expansion decisions that we will make in the future. But what kind of calculations the business models we will build when we make these decisions? These are all kind of theoretical, and we have to find the right answer in these regards. So these are some of the thoughts that we would like to -- we must consider when we think about the tobacco business and the portfolio and make sure that we find a vision as to how we'd like to run our business, and this is all very textbook answer, I understand. But this is what we can say for now.

Next, in terms of real term basis. What we need to have in our perspective. Regarding Iran, in terms of foreign exchange, obviously, it's 2 sides of the coin was really. In the country, we have to -- in the country, there are inflations that we need to think about. This creates some effect. For example, we need to exert our power against the backdrop of an inflation, for example, pricing, how can we price well? And this is precisely about August last year when the currency changed drastically, and the inflation also accelerated substantially. And we were able to guarantee good pricing at the time. It's not just in terms of the pricing, but as the business operator in such a market, we need to build a brand equity that can undergo these kinds of changes, and we were able to do that successfully. So in that sense, in terms of real term basis, the short-term risks, how much are we able to sustain our business, keep it going, in other words, in short-term? We have various initiatives that we have done, and we are prepared also when something happens if there is some kind of an event. We are questioned of how well our business foundation is -- have been built until that day. Now in Turkey, we have the media, the press, about the foreign exchange deterioration in this morning's paper. To this point, in terms of Turkey, there is the relationship with the United States that we need to take into consideration. There is a lot of tension and nervousness here, but we believe that these signs of changes need to be understood well so that we can make our decisions about the actions that we need to take. In that sense, the JTI Global explanations that I made in the beginning is relevant. Turkey is in the inflation environment right now, and the government intends to control the inflation. Now this is my anticipation, but the interest rate political decrease is one of the actions that the government took because they have this intention. So there are these policies and also frictions, and these are things that we really need to perceive with prudence in making our business decisions. For example, should we do it now or should we postpone it? Should we go for short-term profit or maybe we should look at it in a longer term? These are some of the careful decisions that we are making. In real terms, this is really what is important. And I understand that this answer is a little bit vague, but this would be my comment.

[Makoto Morita, analyst]

If I may add another question, I understand that you are running your business with dedication. But in terms of cash flow management, Mr. Minami, do you think that you have good control of risk management in this regards as well?

[Naohiro Minami, executive]

To your point, as we have mentioned in our financial report, in markets like Iran and also Canada where we have the litigation, these 2 markets together comprise about JPY 40 billion worth of cash, which is under restriction of usage. So we are restricted to use this amount of cash. We cannot use it. So this is well under our radar. And we have managed -- we are managing our cash fully with these kind of points that we need to take into consideration. Furthermore, when it comes to foreign exchange, using it in U.S. dollar or using it in euro, we, of course, have to take into account the depreciation when we translate the currency. But the execution costs also we have in mind, are there any other options? We have to think about that. The decision is always difficult. But when we look at the current short-term circumstances, we think it's very important to think about improving the efficiency of our investments. Looking at each market's economic growth, this may be a discussion digressing a little bit from geopolitical risks, but it's really about getting the local currency base growth. And by doing so, we can offset the FX risks. We'd like to reflect this kind of thinking into our plans and execution, at the same time, grow the volume, the shipment volume in each market. These are some of the very basic steps that we need to take repeatedly in the market to improve our business presence there. Excuse me for the digression, but I hope this answers your question.

[Operator]

Here's the next person, from Morgan Stanley, MUFG Securities, Miyake-san.

[Haruka Miyake, analyst]

This is Miyake. I'm actually off focus, but I have a question about the pharmaceutical business as well as the food business. Can you give us a broad perspective how you view these businesses? Regulatory pharmaceutical in the pharmaceutical business, as well as the license income in the pharmaceutical business, it is expected to come down in the future. So you were once starting to diversify, but how are you going to treat these businesses going forward?

[Junichi Fukuchi, executive]

I'm sorry, I couldn't hear your question. So I'd like to summarize your question one more time. So you were asking about our pharmaceutical and food businesses, and what kind of strategy we have for the future and how in the portfolio we are going to manage these businesses.

[Haruka Miyake, analyst]

Yes, exactly that was my question. I'm sorry, I wasn't audible.

[Junichi Fukuchi, executive]

With regards to the pharmaceutical business, first of all, it's true that for the anti-HIV drugs and the exclusive license agreement, it has been terminated and over the -- the negative for short-term profit. So in the pharmaceutical industry, of course, this is something that can happen. If this is going to be whether it be a patent cliff or a termination of the license agreement. But in any case, with regards to the pipeline we have in the pharmaceutical business, with regards to the drugs that are currently in the market, long-term profits and cash flow can be expected, and we also have the early stage, late stage developments and compounds that are currently in the pipeline. And what's likely to happen to them in the future, are our key aspects of the pharmaceutical business. So with regards to what has happened most recently, this license agreement -- or I'm sorry, of the assumption that the license agreement based income was going to continue, we were basically putting together a business plan based off that assumption. However, a great piece of the pie of sales is now going to drop off. On the other hand, through our negotiation, we do believe we have been able to win over our compensation income due to the termination of the agreement. So when you consider our product life cycle, we were able to generate sufficient value from these products. But on an ongoing basis, what are we going to do? Up until now, revenue, as well as earnings, is going to decline due to the termination. So it's a matter of how we're going to make up for it based off the current pipeline or existing products that are already in the market. So we are going through a review process in a speedy manner. So with regards to the out-licensing model for the pharmaceutical business, whether be for drug discovery of a new drug development, the rule that is going to play in the JT Group is not going to change. However, because a critical part of our sales is going to drop off, with regards to how we are going to make up for that, is currently being discussed at the group level, as well as at the company-wide level. As for the processed foods business. It's true that last year we retained our growth in earnings trend. Until then, however, we started to see a drop-off in earnings. And also for Q1 this fiscal year, on a quarterly basis, profits declined. But on a full year basis, we would like to go back to the increased earnings trajectory for processed foods. The imminent challenge would be to have competitive products in the market and to develop them, which is quite obvious, but the impact on the P&L, meaning managing the P&L, will be important, too. And as mentioned in the presentation, raw material costs increased and that weighed on profit especially for natural resources. So when we design our products or when we do procurement, we need to control those factors or to lower the impact it has. And this is irrelevant to the food industry, but logistic costs these days has increased and are staying high and we're expecting further rises. That needs to be absorbed to a certain extent because society is calling for price increases, and we need to accept the terms to a certain degree. So that means we need to make logistics more efficient or do joint delivery with the other companies, and we need to consider what the options are. And when we decide what to do, we need to put that into action swiftly. And in the Japanese market, we hope to become more competitive or increase our presence. That will be our utmost priority. So once our capabilities are there and established, currently, we are partially working on the international market by region so that our products can be expanded in sales. But after we take care of Japan, we would like to start focusing more on the overseas markets. So I'm sorry for going on for a long time, but basically over the medium to long term, the 2 businesses will contribute -- contributing to profit growth. Thank you very much. And our policy is the same.

[Unknown Executive]

May we move on?

[Haruka Miyake, analyst]

I'd like to ask regarding Canada, regarding the litigations that had the ruling. Putting that aside, there are some litigations that have stayed, have been held, right? Is this what you were talking about earlier?

[Junichi Fukuchi, executive]

Yes, regarding the CCAA procedures, within the domestic country of Canada, when there's a litigation that is filed, there are the processes and also the consideration of the rulings, the collective litigation in Québec. All of them have been stayed and withheld. So as I mentioned in my explanation, it is about -- well, speaking specifically, if we can go to higher court, which we intend to do, then when we have that opportunity to make an appeal, we will continue to go through the litigation. And in terms of the parts that are locked right now, we have to go through coordination and discussion through our stakeholders as well. So there is various options that we have in mind. And also we have our strategy in terms of going through the litigations going forward.

[Operator]

I'd like to take the next question. From UBS, Kawasaki-san, please.

[Satsuki Kawasaki, analyst]

This is Kawasaki from UBS Securities. I have a brief question. I just wanted to confirm some numbers. For Russia, August last year at Donskoy, I think it's hard to compare on an apple-to-apple basis, but for the March quarter in Donskoy volume, how did it change on a year-over-year basis? And Winston in Russia for the March quarter, what was the sales momentum?

[Naohiro Minami, executive]

For Donskoy's last year numbers of the owner, we don't have the details unfortunately when it comes to detailed numbers. However, for the first quarter in the integrated plan and Donskoy activities, one thing I can say is that optimizing our market inventory, we are striving to optimize cash flow. That's the stage we're in. So on a shipment basis, we are actually stepping on the brake somewhat. So that's one thing I can say about Donskoy.

As for Winston. Regarding momentum, like I've been saying earlier, the influence of downtrading is in the market. But when you look at the mid segment, Winston performance, compared to the momentum it has had in the past, it has decelerated to a certain extent. To that end, within the RMC category, Winston is #1, but from a market share perspective, on a year-over-year basis, 0.4% decline in market share was recorded. That's where Winston stands. That's all from myself.

[Haruka Miyake, analyst]

What I wanted to confirm was for Donskoy, apart from optimizing shipment inventory, because downtrading is happening, total industry volume has been down by 7.8%. And compared to that, due to the progress in downtrading, I was wondering that the decline in demand is going to be less. But because of the inventory impact, is the decline higher than the overall market?

[Naohiro Minami, executive]

It's hard to carve that part out. But from a market performance point of view, Donskoy, going forward, is something we believe we can continue to grow even more. But that positive impact is hard to see at this moment in time on a one-off basis. Yes, that is correct.

[Operator]

Thank you very much. And we have received many more questions, but it is time now to close the session. So we would like to stop taking questions. Thank you very much. With this, we would like to conclude the JT Group 2019 First Quarter Results Explanations. Thank you all very much for your participation. Please remember to hang up.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]