Japan Tobacco Inc

TSE:2914

Earnings Call Analysis

Strong Q1 Growth and Positive Outlook

Japan Tobacco reported a solid start to 2024, with revenue and profit growth driven by pricing in the tobacco sector. Total volume growth was 2.1%, with significant gains in Reduced-Risk Products (25.2% increase). The processed food segment also contributed positively. Despite foreign exchange volatility, the company is confident in meeting its full-year forecast and continues to invest in expanding its Ploom X product line. Japan Tobacco maintains its 2028 ambition for RRP market share and breakeven goals.

Introduction and Overview

Japan Tobacco Inc. (JT) had its earnings call for Q1 2024, led by CFO Hiromasa Furukawa. The company witnessed growth in several key metrics, despite some foreign exchange headwinds. Furukawa highlighted that both revenue and adjusted operating profit (AOP) saw increases when measured in constant FX terms. This was primarily driven by the core tobacco business, with notable improvements observed in the processed food segment.

Tobacco Volume Performance

Total tobacco volume, inclusive of traditional combustibles and reduced-risk products (RRP), grew by 2.1% year-on-year. Excluding favorable inventory movements, the growth was 1.3%. The increase in combustible volume was driven by strong market share and volume momentum in emerging countries, including notable rebounds in Russia and Turkey, and a recovery in global travel retail, mainly in Asia. However, declines were seen in Japan, the Philippines, Taiwan, and the U.K. The RRP segment showed robust growth of 25.2% year-on-year, primarily due to the Ploom X launches across various markets, particularly in Europe.

Financial Performance of the Tobacco Business

JT’s tobacco business exhibited robust top-line growth driven by price increases in markets such as the Philippines, Russia, and the U.K. Although total volume rose, its contribution to AOP was negative due to a shift in volume composition from high-margin markets like the U.K. Profitability was also impacted by increased investments in Ploom X's geographical expansion and higher supply chain costs. The adverse impact of foreign exchange, due to the depreciation of some emerging market currencies and the appreciation of cost-related currencies, was evident. However, AOP still exceeded initial expectations due to better-than-expected volume and pricing contributions and moderate increases in supply chain costs.

Regional Cluster Performance

In Asia, total volume decreased by 4.5% year-on-year, attributed to lower industry volumes in Japan and the Philippines, offset slightly by market share gains and higher Ploom X volumes in Japan. Western Europe saw flat total volume year-on-year, with gains in the GFB and Ploom X segments balancing out declines in market volume, particularly in France and the U.K. The EMA cluster, encompassing markets like Russia and Turkey, reported a 5.7% increase in total volume year-on-year, driven by market share gains, recovery in travel retail, and favorable market conditions in Russia and Turkey. Foreign exchange and higher supply chain costs posed challenges, but pricing contributions in regions like the U.K. and Spain helped mitigate their effects.

RRP Sales and Market Expansion

RRP sales volumes surged by 25.2% year-on-year, mainly driven by the expansion of the Ploom X. The product saw significant uptake in Japan, with growing market share in Europe as well. Since early 2024, Ploom X has been launched in Canada, Iran, Germany, Slovakia, and Spain, bringing its total market presence to 17 regions. Several more launches are planned by mid-2024, supporting JT’s ambition for a mid-teen HTS market share and RRP breakeven by 2028. Markets such as the Czech Republic, Switzerland, and Italy have shown positive reception, with steady market share growth since the launch.

Processed Food and Pharmaceutical Business

In the pharmaceutical segment, sales grew in the areas of skin diseases and allergens. However, overall revenue declined by JPY 1.6 billion year-on-year due to the absence of one-time income from licensing JT compounds in FY 2023. The processed food business was stable, supported by price revisions despite the discontinuation of some products following a portfolio review. Adjusted operating profit rose, bolstered by positive pricing contributions and mitigated somewhat by increasing raw material costs and unfavorable currency movements.

Conclusion and Outlook

JT delivered solid profit growth in Q1 2024, fueled by pricing strategies in the tobacco segment and higher-than-expected volume performance. This strong start gives the company confidence in meeting its full-year forecast. However, the volatile foreign exchange rates and uncertain macroeconomic conditions, including geopolitical risks, remain concerns. JT continues to prioritize RRP investments with the Ploom X expansion on track and maintains its 2028 ambition for the segment. The company remains vigilant, ready to update earnings forecasts in response to changing conditions.

Earnings Call Transcript 2024-Q1

[Operator]

Thank you for participating in the investor meeting for Q1 2024 results at Japan Tobacco Inc. today. Before we start the meeting, I'd like to ask you to make sure that your display name is accurate. Thank you for your cooperation.It's now my pleasure to introduce our CFO, Mr. Furukawa, please.

[Hiromasa Furukawa, executive]

Good afternoon. I am Hiromasa Furukawa, CFO of the JT Group. Thank you for joining us today for the JT Group's first quarter 2024 earnings briefing.First, let me review the 3-month consolidated financial results. As shown on the slide, revenue and adjusted operating profit increased both on a constant FX and on a reported basis. AOP at constant FX our primary performance indicator increased by 3.4% year-on-year; driven by the solid contribution from our core tobacco business. The growth in the tobacco business was fueled by pricing and combustibles, which outweighed increased investment towards HTS and higher costs, including in supply chain costs.The increased profit in the processed food business also complemented the overall growth. On a reported basis, AOP declined due to the negative foreign exchange impact from the depreciation of some emerging market currencies and the appreciation of cost-related currencies. Operating profit increased by 4.6% year-on-year, mainly driven by the AOP increase as well as adjustment benefits driven by a decrease in amortization of trademark rights and increase in gain on sales of real estate. Profit increased by 8.7% year-on-year, mainly fueled by the operating profit growth and lower financing costs.Moving on to the results of each business segments, starting with the tobacco business. First, please see Slide 4 for the tobacco volume performance. Total volume, including combustibles and RRP increased by 2.1% year-on-year. Excluding favorable inventory movements, total volume grew by 1.3% year-on-year.In the first quarter, we continue to see solid market share momentum and GFB volume growth in several markets. In the combustibles category, volume growth was driven by the EMA cluster fueled by strong market share and volume momentum in emerging countries, positive industry volume with the key markets of Russia and Turkey and ongoing recovery in global travel retail, mainly in Asia. These factors plus the favorable inventory movements resulted in a 1.7% year-on-year increase in combustibles volume. This, despite the lower combustibles industry volume in Japan, the Philippines, Taiwan and the U.K. as well as the negative impact from the business model change in Sudan.RRP volume increased significantly by 25.2% year-on-year, driven by an increase in HTS volume, our investment priority. In addition to the growth of market share in the HTS segment in Japan, volume growth was supported by Ploom X launches in several markets, particularly in Europe. Overall, total volume in the first quarter exceeded our initial expectations. We will continue to monitor trends in industry volume and operating environment in each market.Moving on to the financial performance of the tobacco business on Slide 5. In the first quarter, we continued to deliver strong top-line growth driven by pricing contributions in multiple markets, including the Philippines, Russia and the U.K. Although total volume grew on a unit basis year-on-year, the volume contribution to AOP was negative. This was due to a lower market mix resulting from a reduced volume composition from high-margin markets such as the U.K.Top-line growth was partially offset by increased investments towards the accelerated geo expansion of Ploom X, higher supply chain costs due to leaf tobacco costs and other factors such as labor costs. Foreign exchange impact on AOP was unfavorable, mainly due to the depreciation of some emerging market currencies such as the Russian ruble and the appreciation of cost-related currencies, such as the U.S. dollar and Swiss franc. AOP in the first quarter exceeded our initial expectations, mainly due to higher-than-expected total volume and the related pricing contribution as well as a more moderate increase in supply chain costs compared to the initial forecast and the phasing of various sales promotions and costs.Slide 6 reviews the performance of the 3 tobacco clusters of the tobacco business. The graphs on the slide, shows year-on-year changes in total volume, core revenue and AOP on a constant FX for each cluster.Let me start with Asia. This cluster includes the key markets of Japan, the Philippines and Taiwan. Total volume in this cluster decreased by 4.5% year-on-year, mainly due to lower combustibles industry volume in Japan and the Philippines, partially offset by market share gains in the Philippines and Taiwan and higher Ploom X volume in Japan.Despite a positive pricing contribution from the Philippines, mainly resulting from a carryover effect from last year, financial results showed a decrease in core revenue and AOP at constant FX. These results were due to a negative volume variance, a deterioration in the product mix from down trading trends in Japan and the Philippines and investments towards growing our RRP share in Japan.Turning to Western Europe, which includes the key markets of Italy, Spain and the U.K. Total volume was flat year-on-year as GFB fueled market share gains in most markets and Ploom X volume growth offset declines from lower industry volume, mainly in France and the U.K. Excluding the favorable inventory movements in France, Italy and Spain, total volume decreased 3.5% year-on-year. Core revenue and AOP grew as the pricing contributions mainly in Spain and the U.K. offset the negative volume variance, mainly in the U.K., increased investment towards Ploom X and higher costs, including in the supply chain.Moving on to EMA, this cluster includes the key markets of Romania, Russia and Turkey. Total volume increased 5.7% year-on-year, driven by market share gains in several markets, a continued recovery of global travel retail, mainly in Asia and favorable industry volume in Russia and Turkey. These factors more than offset the negative impact from business model changes in Sudan. The cluster reported an increase in both revenue and AOP at constant FX, driven by the robust volume and pricing contributions mainly in Romania and Russia, which more than offset the investment towards Ploom X and higher costs, including in the supply chain.Turning to RRP on Slide 7. RRP sales volume increased by 25.2% year-on-year to 2.5 billion units. This performance was mainly driven by the growth of Ploom X in Japan. RRP volume is also increasing steadily in markets outside of Japan and is affected to grow further as we expand the number of markets in which Ploom X is deployed. Since the beginning of 2024, Ploom X was launched in 4 additional markets, namely the Canada, Iran, Germany, Slovakia and Spain. Ploom X is now available in 17 markets. We are planning 4 additional launches by the end of June, including Serbia, Ukraine, by the end of May and Latvia and Montenegro in June. These efforts put us on a track towards achieving the 2028 ambition in terms of mid-teen HTS share of segments in HTS key markets and RRP breakeven.Slide 8 provides an update on the progress of Ploom X in several markets. As shown in the graph, Ploom X market share in Japan and overseas is growing steadily, including in newly launched markets. In Japan, the largest HTS market globally; Ploom X continued its positive trend amid increasing competition in the HTS segment. In the quarter, Ploom X share up segment grew to 11% and reached 11.3% in March. In Italy, we have strengthened our distribution and expanded nationwide since last November. Post a nationwide expansion, our segment share has been growing steadily, reaching 1.5% as of March 2024. In the Czech Republic and Switzerland where we launched in June and September last year, respectively, our segment share has constantly increasing since last launch.As you recall from our Tobacco Investor Conference last year, our launch strategy in HTS focuses initially on large urban cities. This means that our segment share performance tends to be higher in these cities. For instance, in [ Geneva ] our segment share reached 4.1% in March. We continue to aim to reach nationwide expansion in each launch market at an early stage. In other markets, our segment share continued to improve gradually since launch. And we have received positive feedback from both our customers and business partners, confirming we are off to a good start.Next I'll explain the results of the pharmaceutical and processed food businesses, starting with the pharmaceutical business. Although sales in the area of skin disease and allergen grew at our subsidiary, Torii Pharmaceutical. Revenue declined by JPY 1.6 billion year-on-year due to the absence of onetime income from licensing patented JT compounds received in FY 2023. AOP decreased year-on-year due to the higher R&D expenses in addition to the lower revenue.Moving to the processed food business. Revenue was broadly stable year-on-year, mainly driven by the positive impacts from price revisions, offsetting the impact of discontinuation of some products as a result of the product portfolio review. AOP increased was driven by the positive pricing contribution from the revisions implemented in the previous fiscal year, offsetting the increase in raw material costs and unfavorable currency movements.In closing, please see Slide 11. To summarize the first quarter results, we delivered solid profit growth with tobacco pricing as a main driver. The stronger-than-expected tobacco volume performance also contributed to the business performance, further complemented by the profit growth in the processed food.This robust start of the year gives us confidence in achieving our full year forecast announced in February. On the other hand, foreign exchange rate have remained volatile. In addition, the business environment remains uncertain due to the macroeconomic factors such as geopolitical risks, including the situation in the Middle East. The total industry volume evolutions trend to our supply chain costs, just to name a few. We continue to closely monitor the situation and update our earnings forecast if and when necessary.Regarding RRP, our investment priority, the geo expansion of Ploom X is on track with our plan. And we confirm that the announced 2028 RRP ambition remains unchanged. We continue to collect and utilize customers' feedback to further improve our product and marketing strategy.This concludes my presentation. Thank you very much for your attention.

[Operator]

Thank you very much, Mr. Furukawa. Now we would like to start the Q&A session. Let me introduce you to the speakers who will answer your questions today. Hiromasa Furukawa, CFO of the JT Group and Nobuya Kato, JTI Deputy CEO. [Operator Instructions] The first question comes from Mizuho Securities, Mr. Saji.

[Hiroshi Saji, analyst]

I have one question, which is about Page 6, EMA in the tobacco business. For Russia, Turkey and Iran, that comprised this segment or cluster. You've done quite a lot of pricing in Russia in '23. And total volume has been increasing even after pricing. So can you talk about its sustainability? And also for Turkey, I think total volume has been growing by approximately 20%. So I'm sure there's inflation. But when it comes to affordability, it seems that trends continue to be risk. But I was wondering about its sustainability. So Russia and Turkey in the EMA cluster and its performance trends and its sustainability is my question.

[Hiromasa Furukawa, executive]

The question was about the EMA cluster. And Russia, Turkey, Iran and the increase in industry volume as well as how long it can be sustained. Mr. Kato will take your question.

[Nobuya Kato, executive]

Mr. Saji, this is Kato speaking. For total volume in Turkey, Iran and Russia, it has been firm. In each of the markets, volume continues to be firm and the reasons vary by market. For example, in the case of Russia, total volume has been firm, not just for the first quarter this year, but even after tax increases and pricing last year, it has been relatively firm. And it has remained that way for Q1 this year as well. So it's really hard to pinpoint one single reason, because there's, various reasons. But one major reason is because of illicit products. Products have been growing, but its growth rate compared to several years ago, has been decelerating over the course of the past 2 years. So that has led to a relatively firm industry volume. That is our view.So for Turkey and affordability that you were asking about in your question, well, that's one of the reasons why total volume continues to be firm. So for other consumer goods, prices have been increasing and tobacco products have been seeing their prices increase as well. But in the past year or 2, compared to other consumer goods for tobacco prices, relatively, it's more affordable on a comparative basis. So relatively, affordability has been favorable, leading to firm volume.So for Iran, it's similar to the trends in Russia, where the inflow of illicit goods compared to before, has been falling leading to a firm volume. So regarding the sustainability of this firm this, because we're still in Q1, we need to continue to closely watch the trends. But earlier, I talked about affordability in Turkey.But it's not just limited to Turkey. But the economic circumstances in each of the countries and how they are likely to change is something we should watch out for because we need to look at the -- how it's going to have an impact on consumer behavior. And for each of the markets, tax increases as well as price increases. The timing as well as the degree of the increases is likely to affect the purchasing volume by consumers.But any case, during the middle of the fiscal year, we would like to continuously watch the trends closely. That's it for me. Thank you.

[Hiromasa Furukawa, executive]

Just one thing for the prime driver for EMA. I guess you're not really seeing any signs of negativity in the trends. For total volume, it's a matter of closely watching the trends going forward. However share gains continue to be brisk. So at this point in time, we are not anticipating any major negative factors. For the brisk share gains and its momentum throughout the course of the fiscal year, we do expect that this will be ongoing. We are getting good response.

[Operator]

Now we'd like to take the next question. Mr. Morita of Daiwa Securities, please?

[Makoto Morita, analyst]

This is Morita of Daiwa Securities. Do you hear me?

[Hiromasa Furukawa, executive]

Yes.

[Makoto Morita, analyst]

I have one question. I'd like to ask about the dividend. After the beginning of the year, it has been covered by the media for the 55% of the dividend and also the return from our foreign company has been covered as well. And there has been raised some questions. And I do believe that, that would be sustainable.But this is the dividend policy of 75% is sustainable or not? That is my first question. And also just today, up to '26, this 75% of the dividend will be sustained. It was a comment provided. So going forward, do you continue to stick to this 75% of the payout ratio? Or if the environment changes, is it possible to change that number? So for the mid to long term, I'd like to know your thoughts about the dividend.The question is about the dividend. With regard to the 75% of the payout ratio is that sustainable and after '26 and onwards, is that sustainable going forward and that is covered by Mr. Furukawa.

[Hiromasa Furukawa, executive]

Thank you very much for your question. This is Furukawa. My thought for the dividend, our dividend policy remains unchanged. And this is the first answer. And also, as you have mentioned, our payout ratio of 75%, plus/minus 5% is a range we have provided. And we continue to achieve that payout ratio. And we have been saying that and that remains unchanged going forward.And there was the Nikkei report. And it is rather hard to communicate precisely. But we have not specified the time frame. And in future, the business mix and also there might be some exceptional changes might happen. And we will be open to those changes. But the basic policy, we continue to remain unchanged.And for the second part, I assume that you are talking about the capital reserve reversal. And that is being covered by the media article. And because of the Japanese Corporate Act that our, distributable amount is constrained. There is one assumption.But talking about the consolidated JT Group, then we need to think about the -- our gap between these consolidated one and also Japan 1. And of course, there is one option for us to think about the reversal coming from the international. So there are several options available for us.So there might be some constraint coming from the regulations or the constraint. And we are not specifying any changes that may happen to us. That's all from us.

[Makoto Morita, analyst]

That's very clear to me. And additional question, '26 and December and onwards, '27 and '28, I understand that you cannot comment specifically for those few features. And unless there is any major change in the environment, then, don't you have to have any needs to change that commitment of the 75% payout ratio? Why do you review that payout ratio '27 and onward? What will be the background assumption?

[Hiromasa Furukawa, executive]

That might be one of the factors we need to consider. But at this point of time, we can say that we don't have any plan to change. And also going forward, in the future, of course, we are not sure what may happen. And basically, we are going to aim at the competitive payout ratio, so at this point of time there is no factor for us to be, communicating to you.

[Operator]

Our next person is from Morgan Stanley MUFG Securities, Ms. Miyake.

[Haruka Miyake, analyst]

This is Miyake from Morgan Stanley. For Q1 annual results, I would like you to sort out the drivers. Compared to your expectations, I think you said that you're off to a good start, especially volume was firm was the way I understood it.So from a pricing point of view, did you exceed your expectations? Can you sort that out for me? And for the positive inventory correction, when you exclude that impact, did you also mean that you were off to a good start.

[Hiromasa Furukawa, executive]

Thank you very much for the question. Against expectation, volume was firm. But we're able to be with pricing. And even if I exclude the inventory adjustment impact, did you still exceed expectations? So Mr. Kato will take that question.

[Nobuya Kato, executive]

Ms. Miyake, thank you very much for your question. So for Q1, I think your understanding is right for volume or there are some markets where industry volume was firm. But we also had a market share gain momentum as well in some markets, so overall, sales volume was pretty good.And also regarding even without the inventory adjustments and your question around whether we were able to see good results. Even if we didn't have the one-off volume impact from inventory adjustments, we were able to see positive volume. And for pricing and your question around whether we exceeded expectations, mainly in Europe, U.K., France and Spain, whether it'd be timing or by amount, we were able to see pricing that exceeded expectations.So volume and pricing or top-line momentum was positive. And for pricing, if I may add a few more comments at the beginning of the year. We had a pricing plan at approximately 70% of the plan has been secured as of Q1 this year. Also, you didn't ask about this, but regarding costs, if I may refer to cost a little.Mr. Furukawa talked about this in his comments about supply chain cost wise increased year-on-year. However, compared to our initial expectations, it was a little bit moderate. For material prices, negotiations turned out to be favorable. So we made self-efforts to improve our cost base. So costs were also moderate compared to our initial expectations. So that also contributed to our positive profits.

[Haruka Miyake, analyst]

I did want to ask about costs, too. So that really helps.

[Operator]

So I will take the next question, Mr. Fujiwara of Nomura Securities, please.

[Satoshi Fujiwara, analyst]

This is Fujiwara of Nomura Securities. I have one question about RRP, HTS and the share. I'm referring to Slide 8 and you started off very good. And compared with the other peers that Ploom X, I'd like to know more about the feedback of your Ploom X compared with other peers and also in other countries, what is the share dynamics. Of course, at the time of the launch, of course, that might have affected you. But after that, I think there is some difference in the shares increased momentum, so in some countries where the share momentum has been very rapid. And in some others, it has been more moderate. So we'd like to know the background of that difference, please.

[Hiromasa Furukawa, executive]

The question was about HTS share compared with the other peers. What is the feedback of your product? And also what is the background of the momentum of each market? And Mr. Kato will take your question.

[Nobuya Kato, executive]

Mr. Fujiwara, thank you very much for your question. For the Ploom X, the customer vis-a-vis our competitor's product, having collected in various markets. And I'd like to share you the results. And also, of course, there have been some variance by the market. So I'd like to comment specifically.With regard to the consumers' feedback for the Ploom X, generally speaking, it has been very good vis-a-vis the competitors' product. And to be more specific, that the vapors volume is sufficient and also heating time and heating speed was relatively good.And also most favorite factor was that the usable time power in it is that 5 minutes without any disruption and you can have a number of parts during that time. And that point was highly appreciated by consumers. And also price wise, of course, the price varies by market. But it is generally regarded as the affordable price.So in that regard, we have received a good feedback as well. And in each market, the launch time varies. And in Japan, we have launched earlier than the others. And we have been increasing the shares steadily. So among the feedback from the consumers, they are the good appealing point. And we have been looking at the consumers' preference. And we were trying to respond to those needs by the consumers.And by market, there are some different colors, as we have mentioned. And after the launch, the time varies and also competitive environment varies by the market. And I think that that had been linked to the difference in results as well.And as shown by the slide in Czech and Portugal, it was more than 4%. And we had a very good result in this market. And as a background, as I have mentioned before, that the product appreciation itself feels very good. And also after the consumer tried our product, we need to encourage the consumers to try our product.And also the recognition level needs to be enhanced as well. And I think that is one of the keys to increase our sales. In Portugal and Czech, as I mentioned, the improvement of the recognition happened due to our approach on one-on-one basis with consumers. And so that, for example, we have set up the pop-up shop or the shop in shop to increase more opportunities for the consumers to try our products and also increased the recognition level. And I think that that was successful.And in the very high level of the share with Lithuania, let me make a comment about that. In Lithuania, the people tend to be tech savvy. And they love to have the innovative product. So they are more acceptable for the new product. That is a part of their national feature. And that is well reflected in the growth of the Ploom X product share.On the other hand, in Italy, the share seems to be a bit slow. And let me comment on that as well. In Italy, the tobacco stick sales, is only possible at the traditional tobacco new store. So that is not the key account, but so-called the tobacconist sales are possible. So in order to appeal to consumers and also in order to build a strong brand, we need to take time. And that is part of the reason why the growth has been little slow.That said, in Italy, first, we have limited area for sales. But from the second half of the last year, we have expanded it in the nationwide sales. And after that, the product recognition has been up and also the share gain has been continuing as well.And I'd like to emphasize one point; generally speaking, we said that we had a good start off. And as shown by graph, months by months, in every market and some market are not covered. But SOS is in the category has been steadily increasing. And the speed or the share level, of course, varies by the market. But we have been achieving the steady growth. And that is a very encouraging sign for us. And also that is one of the reasons why we are confident that we have been making a very good start. That's all for me.

[Hiromasa Furukawa, executive]

Thank you very much for your very in-depth explanation and shares a strong momentum. You seemed to have a very good confidence. And so from the trial to the switching, you are having this smooth switchover from the trial to the purchase and then retention. That is the usual flow of the consumers. And after the trial, that the purchase ratio and after the purchase, the retention ratio itself has been very good so far. So first, we are putting a focus on the recognition and the trial. We are making more effort on that part. And although that might take some time but we'd like to improve that. And that will lead to the increase of the purchase.

[Operator]

[Operator Instructions] It seems that there are no other questions. So we would like to end the Q&A session. Now we would like to conclude the meeting. Thank you so much for your participation. And please make sure that you disconnect.[Statements in English on this transcript were spoken by an interpreter present on the live call.]