Japan Tobacco Inc

TSE:2914

Earnings Call Transcript 2018-Q3

[Unknown Executive]

Ladies and gentlemen, thank you very much for waiting, and thank you for attending the JT Group's 2018 third quarter investor conference presentation amidst your very busy schedule. It is time. We would like to begin the conference call.

Now we'd like to call upon Mr. Naohiro Minami, Executive Vice President, CFO and Communications to provide a 20-minute presentation. And we will conduct a Q&A session later, so we are expecting to spend the next 75 minutes or so.

So without further ado, we'd like to begin the presentation.

[Naohiro Minami, executive]

I am Naohiro Minami, Chief Financial Officer of the JT Group.

Now I will take you through the results for the third quarter of 2018 and full year revised forecast. Let me start with the consolidated financial results for January-September 2018. Please look at Slide 3.

Adjusted operating profit at constant FX, our KPI, increased by 9.2% year-on-year. This was mainly driven by the continuing strong performance in the international tobacco business as well as a contribution from the pharmaceutical business. In addition, inventory adjustments ahead of a tax-led price increase favorably impacted the results of the Japanese domestic tobacco business, and its profit decrease was relatively small.

Reported basis results were negatively impacted by FX. However, revenue and adjusted operating profit increased, as the negative FX impact was more than offset by the top line growth driven by acquisitions and pricing benefits in the international tobacco business as well as the favorable inventory adjustment and RRP-related revenue growth in the Japanese domestic tobacco business and an increase in royalty revenue in the pharmaceutical business. Operating profit also increased despite the increase in intangible amortization related to acquisitions and the unfavorable comparisons related to an one-off gain in the previous year. On the other hand, profit was almost flat due to the increase of financial costs.

Regarding the detailed analysis of business segment results, please take a look at the earnings report available on our website. Now let us move on to the revised forecast for 2018 on Slide 4.

The key assumption changes from the previous forecast include better industry volume trends, incremental pricing effects and unfavorable FX in the international tobacco business as well as higher RMC and lower Ploom TECH sales volume in the Japanese domestic tobacco business. Based on these updates, adjusted operating profit at constant FX has been revised upward. It is now forecast to grow 6.6% year-over-year. On the other hand, financial metrics on the reported basis, including profit, have been revised downward, as all key local currencies are weaker versus the U.S. dollar.

I will talk about each business segment from next slide.

First, I would like to explain the results for the Japanese domestic tobacco business. Please look at Slide 5. JT cigarette sales volume declined year-on-year, but our cigarette market share has gained growth momentum, increasing for 5 consecutive months. Regarding RRP, the national rollout of Ploom TECH in convenience stores started on 2nd of July, and both RRP sales volume and RRP-related revenue have been increasing solidly. Our share in the third quarter within RRP category was estimated at approximately 10% in the convenience stores. The increase of cigarette market share and the growth of RRP led to the recovery of total market share, a combination of RRP and RMC. We have been focusing on RRP as the growth driver; and at the same time, strengthening the undisputed #1 position in RMC, which supports the RRP growth. And this strategy is working.

Market shares might be volatile in and after October because of the reversal of the inventory adjustment, but we are committed to maximizing our sales volume and market share by offering diverse products for RMC and RRP from which consumers can choose. Having said that, RRP sales volume results did not reach our expectation, and we need to revise the initial target. This will be explained in the next slide.

For the revised forecast of the Japanese domestic tobacco business, please look at Slide 6. Let me start with a view on the Japan market. Considering the recent trends, we updated the assumptions for the cigarette and RRP industry volumes. Notably, the revised RRP market size for 2018 is now circa 21% of the total industry. Based on the industry outlook, JT cigarette sales volume has been revised to a decline of over 12% that is in previous assumption. Looking at the dynamics in October, we observed a negative impact from the September inventory movement but are not surprised by its magnitude. As for RRP, in consideration of recent sales performance, the sales target has been revised to 2.8 billion sticks equivalent from the initial target of 4 billion.

Our forecast for adjusted operating profit of JPY 202 billion remains the same. The profit target will be achieved despite the volume downside of higher-margin Ploom TECH, as the adverse impact will be offset by incremental RMC volume and cost containment.

As for the outlook for the Japanese domestic market in 2019 and beyond, we need to see how the price increases over the years and the ongoing discussion on environmental tobacco smoke regulations influence total industry volume. On the other hand, we still expect the RRP category to reach 30% of total industry volume by the end of 2020. We continue to prioritize RRP and allocating our resources to accelerate its growth.

Now I would like to explain the initiatives to accelerate Ploom TECH growth on Slide 8 -- Slide 7. Excuse me. We revised our RRP sales volume target based on 2 reasons besides the recent slowdown of RRP market expansion. Firstly, we have not effectively communicated to consumers the benefits of low-temperature heating and the new opportunities the benefits create for enjoying tobacco. To improve the communication, we reorganized and strengthened our marketing and sales force who propose of the occasions more suitable for Ploom TECH use in restaurants and sales events. In addition, utilizing the sales force, we will invite more consumers to trial events in a closed space where the users will actually feel the benefits of social consideration and convenience. The number of no-smoking Ploom TECH-only restaurants across the country exceeded 2,600. Recently, we announced our scientific assessment results about the effects of T-Vapor products on indoor air quality. We will continue to send out our scientific findings that prove low-temperature heating meet the consumers' needs.

Another factor for RRP volume revision is that current Ploom TECH lineup is still limited, while consumer preference is more diverse. The majority of Ploom TECH users are male in 40s and 50s, and we should take measures to win over the diverse consumer base. Therefore, we have decided to introduce a new white-color device and 2 new capsule flavors from the Pianissimo brand in December to capture new consumers. Two more consumables are coming in March 2019. Perhaps more notably, we will launch Ploom TECH+ for consumers who prefer richer vapor and flavor. Through these initiatives, we accelerate the growth of Ploom TECH and establish low-temperature-heating type products market. By doing so, we distinguish low temperature and high temperature. This is the key to our success.

In the next slide, I would like to explain the launch of Ploom TECH+. We execute a portfolio strategy with a primary emphasis on low-temperature-heating type products to acquire the leadership in the RRP category. Let me revisit the product features and our marketing approach for each product.

With Ploom TECH, we aim to expand the consumer base who prefer the light and clear flavor. For potential consumers looking for a rich flavor in addition to the benefits of low-temperature heating, we offer Ploom TECH+. I will explain the difference between 2 low-temperature-heating type products using the analogy of cigarettes. We think that Ploom TECH is well accepted by consumers who prefer low-tar cigarettes with 1 to 3 milligrams, while Ploom TECH+ can be popular among consumers of 5- to 6-milligram-tar cigarettes. This means that consumers have options to choose between the 2 low-temperature heating products as consumers of conventional tobacco products do. Additionally, we will launch Ploom S to gain market share from competitors in the already established high-temperature heating category. Both of new products will be introduced to the market by the end of March 2019, while previous communication indicated the earliest launch time line as around end of 2018 or beginning of 2019.

We strongly believe that Ploom TECH has an upside potential. And high-temperature heating category has been plateauing amid an intensifying competition. Under the circumstances, we have decided to invest more time and concentrate our full resources on Ploom TECH to form the low-temperature heating category through the initiatives such as device and consumable lineup expansion I described in the previous slide. The 2 new products will be first available through our online shop and flagship stores. We will expand the sales area according to manufacturing capacity ramp-up for devices and with national rollout within 2019. In 2019, we expect competition to be intense, but we'll enhance our presence in the RRP market by aggressively investing in marketing. After building the foundation in 2019, we will strive for 40% share within the RRP category by the end of 2020 with a portfolio of Ploom TECH, Ploom TECH+ and Ploom S.

Please refer to page 9. This is our portfolio graphic. Moving on to the international tobacco business, please look at Slide 10.

Both top and bottom line growths continued, driven by the robust pricing gains. Adjusted operating profit at constant FX grew strongly at 16.2% through the third quarter while investing in integration for the completed acquisitions in support for RRP, including the launch of Logic Compact in the U.K. Compared with the difficult business environment in the previous year, pricing gains during the 9-month period were relatively strong, resulting in a significant profit growth. We have not observed any significant change in pricing environment, so we believe that pricing continues to be the key driver for profit growth.

As for revised forecast, adjusted operating profit at constant FX has been revised upward. This is mainly driven by favorable volume performance through September due to better-than-expected industry volume in several markets, including certain key markets; as well as incremental pricing, notably in Iran where we took advantage of the opportunity. The Iranian economy experiences a high inflation associated with the considerable currency devaluation. Amid the volatile economy, we did decide to increase price, as we have confidence in our brands. Certain markets, notably in the Middle East area, still face uncertainties and need to be closely monitored. Specifically, there is a risk in procuring tobacco and nontobacco materials for production in these markets. However, the key materials necessary for production during this year have been already secured, so there should be no substantial impact on 2018 performance. Regarding the acquisition in Bangladesh, we expect it to be completed during this year and its contribution to be insignificant.

Please look at Slide 11. Business momentum is solid, but negative FX impact is expected to increase from the previous forecast. Adjusted operating profit on a reported basis is revised downwards, as all key currencies are weakening against the dollar compared to the previous assumptions. The largest impact is coming from the Iranian rial, which is partially offset by the additional pricing in the market, as I just explained.

Versus prior year, we assume a significant downside in the second half of the year. In the fourth quarter alone, we expect an unfavorable impact of circa JPY 30 billion. Especially, we estimate the Iranian rial exchange rate per U.S. -- to the U.S. dollar of around IRR 100,000 for the quarter. In fact, the Iranian rial accounts for more than half of the FX downside in the fourth quarter. We will stay alert to currency movements as well as geopolitical risks that I described in the previous slide because these factors could influence our financials in 2019.

Please look at Slide 12 next, which shows the results and forecasts of both the pharmaceutical and processed food businesses.

First, in the pharmaceutical business the 9 months performance was solid and full year revenue forecast is revised up by JPY 1 billion, while adjusted operating profit forecast remains unchanged at JPY 25 billion. In August, we announced that we initiated discussions with Gilead Sciences Inc. to terminate the exclusive license agreements for anti-HIV drugs. Currently, we don't have any additional information to be shared with you on this topic, but we'll give you an update when appropriate.

Let me now touch on the processed food business. For the January-September period, we report almost the same revenue as last year, but adjusted operating profit declined due to higher raw material costs. As for the forecast, revenue and adjusted operating profits are revised down by JPY 1 billion and JPY 0.5 billion, respectively. Additionally, as we announced yesterday, with an aim to grow top line, each operating subsidiary will hold more responsibility for strategic decision making. This will increase the flexibility and agility for the subsidiaries to operate.

Finally, please look at Slide 13.

Our consolidated performance was solid despite the volatile business environment during these 9 months. This proves that our business and profit foundations are robust and we responded to the changes in business environment quickly and flexibly. Our immediate focus is achieving the profit target for this year, but at the same time, with a mid to long-term view, we continue to invest, notably in RRP and business integration related to acquisitions, in order to realize sustainable profit growth.

Regarding shareholder return, the annual forecast for the dividend per share is JPY 150, same as in the initial projection.

That concludes my presentation. Thank you for your kind attention.

[Unknown Executive]

Thank you very much. We'd now like move on to the Q&A Session.

We have Mr. Naohiro Minami, Executive Vice President, CFO and Communications; Mr. Koji Shimayoshi, Deputy CEO and Executive VP, JT International; and Mr. Hisashi Ishikawa, VP, Head of Tobacco Business Planning Division, will be the respondents.

[Operator Instructions] Now questions in English, we will receive them through e-mails. We have already communicated the e-mail address, which is [e-mail], so please submit your message to this e-mail address.

So we are receiving the questions now.

[Unknown Executive]

Thank you very much for waiting. This will be the first question, from Citigroup Securities, Mr. Miura.

[Nobuyoshi Miura, analyst]

My question relates to next fiscal terms for next year. So the international business, whether you've got -- if you can tell us the current situation and also the guidance for next year in terms of profit and revenue. So more specifically Donskoy and also Bangladesh, Philippine, Indonesia. So in these respective markets, if you can give us some idea, that will be helpful. Also another, about next year's view on Iran inclusive of risks, that will be very helpful.

[Koji Shimayoshi, executive]

This is Shimayoshi from JTI. Now the acquired markets, the current situation. In terms of Bangladesh, the deal has not been closed yet, so it will be fairly early for us to comment on that right now. So apologies for that. Now for Donskoy, August onwards, it has been consolidated. So we have acquired the brands. So we have a 40% of share right now, so we have been able to strengthen our leading position in the Russian market. Now for Q3 and the 2 months acquisition, it's -- actually it's been trending much better than we initially expected, Q3 onwards. And also, 2018, 3 months will be consolidated, so 5 months’ worth will be consolidated. So it would be negligible in terms of the guidance for this year. Now for JTI as a whole, the full year contribution will start in 2019. So for the next results announcements onwards, we should be able to give you more details.

[Nobuyoshi Miura, analyst]

So Mr. Shimayoshi, what I have mentioned next year's was more about 2019, so fiscal year 2019, if you can also give us an idea.

[Koji Shimayoshi, executive]

So Donskoy, it's just been started into consolidation. It's been trending well so far. So please wait until the full year results to give you more details on next year. Moving on to the Philippines, the current situation, because the price increase had positive effects on GFB and non-GFB brands. In addition to that, for non GFB, after the price increase, the momentum has been favorable, so it has continued to contribute to profit increase. Now next year, again it is fairly early in the phase right now. So again we'd like to give you an update at the full year results, but on a qualitative basis, the Philippines, we are having a really good -- a strong feeling about that. So again, the details, we'll share with you later. Moving on to Indonesia. Now for Indonesia, kretek accounts for the majority of the market, so we need to acquire the knowledge and expertise. So profitability will be mid -- more on the mid- to long-term basis. We need to learn about the market first. So about this market, so we will need to understand and assess the features, characteristics of the market; and also try to focus on the flavor. So July onwards, we will continue to invest, for instance, in [indiscernible]. So we are dealing with this in a much longer-term perspective. And whichever the case, we need to look at this on the mid- to long-term perspective. Moving on to Iran. Next year -- as you may be aware, the 5th of November -- the new sanctions from the U.S. has been announced. So again, we need to wait and see what will become of this action in order for us to talk about next year. So we need to assess this and scrutinize this right now. So given the fact that the current situation will continue, based on that assumption, that is the basis of our guidance right now, but that would stand for the time being. So that would be its standing.

[Nobuyoshi Miura, analyst]

Now for Iran, what will be the worst case scenario? What would be the worst risk that you have in mind? And what will be the cost of countermeasures? If you can give us some color, that would be helpful.

[Koji Shimayoshi, executive]

The worst case scenario in Iran, again it's really difficult to assess at this point. So according to the disclosed information, if we were to extrapolate from there, the sanctions, the application will encompass finance and also heavy industry, energy. This will be the industries impacted by the sanctions. Well, at least that is the expectation. So as far as the tobacco industry is concerned, perhaps we will not be directly impacted by the sanctions. The likelihood is low, but as we have seen this year, we have seen some confusion in the logistics and also the impacts on the banking system. These will be some impacts that we foresee, but again we need to scrutinize the content of the sanctions. Otherwise, we will not be able to give you some more details.

[Nobuyoshi Miura, analyst]

This is a great opportunity. Can we also share about Russia and U.K.? Again the current state and also the view for next year.

[Koji Shimayoshi, executive]

Russia and the U.K. So now for Russia, in 2017, in the first half, we have seen a price competition. It has been intensifying in the first half, but second half onwards, the pricing environment has been improving. So in that case, for this year, 2018, the pricing impacts -- because of the backlash from 2017, the pricing impact is stronger than the ordinary years. So we believe this pricing impact will continue into next year. now moving on to U.K. The pricing environment, it is recovering. So in fact, last month, there has been a tax increase that has been announced. And there has been already a realized tax on to the retail price, but this is common for U.K. and Russia. We need to be cautious. And the moves of the competitors. In fact, in the U.K. we are already seeing progression of down trading, so the fine cut -- the shift towards fine cut has been accelerated somewhat. And also the competitors, they were actually lowering the price in the fine cut category, so we need to address this. So we are trying to refine our plans for next year onwards based on those situations. So just to repeat myself: Both Russia and U.K., the current operating climate should continue. So that is the assumption. That is all.

[Nobuyoshi Miura, analyst]

If that's the case, for 2019, you are saying that there will be some risks, of course, related to FX, but when you look at the pricing environment, it seems that, when you compare 2019 against 2018, you are going to expect a steady pricing environment. Is that correct?

[Unknown Executive]

If I may go into detail a little bit more. From 2017 going into 2018, the pricing environment recovered for us. So growth rate wise, this year is going to be higher than average. So from '18 going into 2019, when you look at things from a growth rate point of view of profits, it's not going to be as strong as this year. That's what we're anticipating. Whatever the case may be, at JTI -- mid- to high single-digit growth is what we're striving for in the JT Group. And JTI is the driving engine. We have challenges such as geopolitical risks locally, but on a JTI-wide basis, based on pricing, we would like to achieve a good track record. And that is of which we are formulating next year's plan, but please wait until the fiscal year-end results meeting for details.

[Unknown Executive]

Let's move on to the next question, from Goldman Sachs, Yamaguchi-san.

[Keiko Yamaguchi, analyst]

This is Yamaguchi from Goldman Sachs. I have a question about the domestic tobacco business. With regards to that revision in your outlook, you have done a revision before as well and revised down the outlook for heat-not-burn, and for RMC revised it up. In the first half, you were saying that new products are going to be launched in the second half, so the RRP contribution is going to reach 23% or 24%. That was your prior estimate. Why did you revise this down this time around? Can you give us the reasons why? And for your new outlook for heat-not-burn in Q4, it seems that the volume is going to be quite small. Compared to last Q4, it's not going to grow by double digit even. It's not going to reach double digit. So can you give us the details of that? That's my questions.

[Unknown Executive]

Ishikawa will take your questions.

[Hisashi Ishikawa, executive]

For the RRP share, originally, at the beginning of the year, we were saying that it's going to reach 23%, then after, we've revised it down to 22% in Q2. Currently, it's at 21%. We have been conducting analysis on this for RRPs and understanding the benefits of it and then making a purchase. It seems that the number of customers who are actually trying out RRP has been plateauing lately, but this is also uncertain at the same time. Going forward, with regards to how the market is going to develop, we are doing some research on that. And we are looking at this in a range. Before, in the world of RMC we had higher accuracy in projecting the market out, but going forward, we believe a range is more important when we make projections. For Q4, I just mentioned that there's a plateau in the market and the growth rate has been slowing down somewhat, but whether it be JT or competitor new products, there will be launches and active sales promotion expenses. Spending is probably going to be accelerating. And with that as a backdrop, although currently growth may have slowed down, but -- we believe that high-speed growth can be reignited. Then after, from 2019 onwards, when we look out into the future, our discussions around passive smoking is one difference we're going to see in the environment. So when it comes to T-Vapor products, they will be handled in a different way compared to RMC. And we are also expecting intensification of competition in 2019. So at this point in time, when we look out on to the future, when you look at the RRP share, by the end of 2020, there may be a chance that it may reach 30%. So this scenario is unchanged, but of course we would like to look at this from a range point of view as we follow the trends in the market. Furthermore, with regards to Ploom TECH and how it's doing: So 4 billion stick equivalent was the initial outlook. This time around, we reduced it down to 2.8 billion stick equivalent on an RMC basis. With regards to this, like mentioned earlier, the market has slowed down somewhat. And moreover when you look at the current business conditions when it comes to customers, the benefits of our products of Ploom TECH has not been well communicated sufficiently. And we have been able to cater to the diverse preferences of the customers. So this is something we would like to put emphasis on through a variety of measures going forward. One thing I would like to add is that, because of last-minute demand, we are going to see a reactionary fall in Q4. So when you just look independently at Q4 results, this may be misleading, but going beyond that, in the low temperature category we would like to ensure that we will establish that category with Ploom TECH and ensure that we deliver Ploom TECH to our customers so that we can establish a good low temperature category. And that is our most important challenge. That's all from myself.

[Keiko Yamaguchi, analyst]

I'd like to confirm a few points. With regards to the reactionary fall from the last-minute demand in Q4, were there last-minute demand for RRP as well?

[Unknown Executive]

To your question. Yes, we do believe there was last-minute demand for RRPs as well. However, it's right after we started nationwide sales. And currently, we are in a growth stage, and that's when last-minute demand occurred. So we're not really sure what is base growth and what is last-minute demand growth. It's hard to accurately separate the 2. However, on a qualitative basis, we do believe there was last-minute demand for Ploom TECH as well, on top of RMCs.

[Keiko Yamaguchi, analyst]

I just have 2 more brief questions. You said 30% on a snapshot basis and you said that it's very hard to accurately make projections, but what is the range you have in your mind with regard to your new products as the market slows down? Steadily launching the products is important, I believe, in order to reach your market share. And because you didn't have a variety of products in the past, I think you should rush to launch the products, but you were saying that you're going to postpone the launches. And why we -- why -- is the reason you're doing that?

[Unknown Executive]

First of all, with regards to the 30% outlook and our range behind it, I would like to refrain from giving you the exact range numbers on a quantitative basis. However, one scenario is that achieving 30% by the end of 2020. Under the scenario, we would like to have that range in our minds and plan our business out flexibly based off a variety of scenarios. To that end, although I will refrain from talking about the actual range, we're going to look at an upside scenario as well as a downside scenario, and we are preparing for both. One more thing, with regards to your next question, around new products: With Ploom TECH+ and Ploom S, we introduced some visuals around the new products in our presentation today. Let me give you our perspective or our thoughts on these new products. Going back to basics or where we started, in the RRP category we would like to ensure that we extend our leadership in this category in the future. And by the end of 2020, we would like to reach 40% share within the RRP category. That is our goal, so in what way are we going to achieve this goal is the question.

Our basic way of thinking is that we would like to mainly focus on low-temperature T-Vapor products to establish RRP portfolio in achieving this target. As we've communicated from before, when it comes to low temp, the characteristics are different from high temperature. Especially when it comes to odor and convenience, low temperature products have an advantage over high-temperature RRP. So we think low-temperature products have a high potential in the market.

With that as a backdrop, what shall we do now is the question from that point of view. First of all, we believe that the low-temperature category should be well-established through Ploom TECH. And that is our most important target. And we are analyzing the current situation. And as we mentioned in the presentation, there are 2 challenges we are facing. One is the customers. When it comes to the low-temperature category, their awareness towards the benefit is not as high. And the second point is there is many numerous preferences of the customers that we have not yet been able to respond to. So first of all, we need to communicate the benefits of the low-temperature RRP products. And then to the diversifying preferences of the consumers, through Ploom TECH, we would like to respond to them. That's what we'd like to first do with the low-temperature category.

To give you a little bit more detail, so with regards to communicating the benefits of low-temperature RRP, it's less odor, a higher convenience. This is one of the large benefits that Ploom TECH provides. In the past, in our sales activities as well as communication with our customers when we reflect upon what we did, we really think that we have to have the customers actually experience the benefits. So that is why we would like to reinforce our sales organization so that we could better communicate with the customers and talk about the benefits of the low-temperature RRP and offer opportunities to experience the product in reality. For example, inside cars or in other closed space, we would like to communicate how great Ploom TECH is when it comes to less odor properties. And we are planning some events going forward. At the same time, research is something we would like to actively do in order to prove the benefits of low-temperature products.

And catering to the diversifying needs of the customer, in December, we are going to launch a white device. It used to be black for Ploom TECH. However, in order to cater to the diversifying preferences of the consumers, a white color version of Ploom TECH is going to be launched in December. And it used to be about Mevius. The customers in their 40s and 50s who are male, Ploom TECH appears to be popular. However, we would like to address a wider range of customers. That is why we decided to launch Pianissimo from December 2. Through Ploom TECH, we would like to better establish the low-temperature category. And if that becomes more solid, if our RRP portfolios centered around the low-temperature category becomes stronger, we would like to then move forward. We do have a Ploom S pipeline. But currently, we will be focusing on the low-temperature category.

Finally, for Ploom TECH+ and S, as we said, we will launch the products until March 2019. For those customers who are looking for a richer vapor and flavor, we will have Ploom TECH+. And in the higher temperature category, we will have Ploom S, would compete with the high-temperature products of competitors. And we would like to basically take away share with Ploom S. That will be our next stage. By 2019, centered around low-temperature RRP, we will have a stronger portfolio. And in 2020, we would like to achieve our target that I mentioned earlier. I'm sorry for running long. That concludes my comments.

[Naohiro Minami, executive]

This is Minami. I would just like to just say one word. You mentioned about the 30% share that we're aiming towards. So it is important to simulate with a detailed analysis. But of course, in terms of assumption, we do assume that it might diverse from 30%. So the question is how can we actually look at it from both RMC and RRP, so we can actually grow the profit and achieve the single year target? So we need to shift towards that attitude. So up until this year, we have some issue with capacity constraints and also some issues with the launch of our products. But next year onwards, we should be able to have the full set of weapons -- products to compete in the market. So we'd like to look at this for RMC and RRP. Based on certain assumptions, if there are any changes, we need to be proactive in capturing those, so we can translate that into profit. I think that would be more and more important as management goes. So apologies for the long explanation.

[Unknown Executive]

Let us move on to the next question from Mizuho Securities, Mr. Saji.

[Hiroshi Saji, analyst]

So I have one question about the heated tobacco. So 1 billion is the current number, including the loading -- inclusive of loading. So where exactly are these products coming from? And also related to that, this is about RRP, so next March onwards, you have this low-temperature heated products of Ploom TECH+. You've talked about a 1.3 or a 5.6 -- 5 mg of tar. You've mentioned that explanation. That was very helpful. But perhaps we could have Ploom S. Why did you not launch these products? And also another question. Up until 2020, if the market is going to drop to the same way, I think it would turn to about 150 billion. So it's about 30% of that, we're looking at 45 to 46 billion sticks' worth equivalent. And you have mentioned that JT market share is 40%. So you're looking at 18 billion or 16 billion to 18 billion in terms of sticks equivalent. So you'd have to increase the sales by 13 billion in comparison to this year's 1 billion. So 2019, you would like to maximize the sales volume RRP at the earliest ways possible. I think that is the target. But is this target still valid for next year? Because do we expect to see the RRP to grow at accelerate pace as you have initially mentioned in your target? Does that still stand?

[Hisashi Ishikawa, executive]

So this is Ishikawa. I'd like to answer your question. So in terms of the total volume, we are consistently analyzing the number. So we don't -- we cannot disclose a quantitative data, so I'd like to give you the qualitative data right now, so in terms of RMC as well as for the T-Vapor combined together. So in terms of the heated tobacco products, this is inclusive of JT, we have a larger proportion from here. But of course, the reality, the consumers who have been smoking the competitors' products are migrating over to Ploom TECH. And that is the reality. And this is a rather complex year. So in terms of low-temperature heated products, our consumers tend to prefer this more. So in terms of switching, it is not as if it's switching in the RMC. It's more the dual use that we are seeing. So they should say dual use between RMC and Ploom TECH. And also within the heated tobacco or T-Vapor category, they are doing dual use of multiple products. So it is really complex in terms of the situation. But we are closely watching the situation and scrutinizing it.

[Unknown Executive]

And the next question about Ploom TECH+, as mentioned already, we would still continue to focus on Ploom TECH. That will be the base products. So we would come up with different colors. And of course, we'd have new products from Pianissimo brand. So that will be the direction going forward. And in terms of these products with more richer flavor and vapor, we have Ploom TECH+. So Ploom and Ploom TECH+, Ploom TECH+ has a stronger, richer flavor and vapor. So that is equivalent to 5 to 6 milligrams of tar of RMC. Now the conventional existing Ploom TECH, it will be equivalent of 1 to 3 milligrams of tar in terms of RMC. So it's preferred by consumers who prefer this amount of tar.

And if you were to look at RMC, the Japanese market tends to be more low tar and also more menthol flavor has been preferred in the Japanese market. So in fact, in RMC, the low tar segment accounts for 30% of the total. So where we'd like to focus is deleverage on the conventional Ploom TECH, so we can address this volume market which is basically the consumers who prefer low tar products. And also we would like to expand the brand from Mevius to Pianissimo. So that would be a major foundation to establish the low-temperature heating-type products. So of course, beyond that, 2019 up until March of 2019, we would have 6 milligram tar equivalent products would be launched, Ploom TECH+ namely. So those will be launched by the end of March 2019.

[Naohiro Minami, executive]

So the last question, so we cannot give you the details from the tobacco business division. So from Minami, I would like to give you more of a general idea how JT addresses this issue. So as mentioned already, so Ploom TECH itself, so we have revised down the forecast for sales volume. Also next year onward, the launch and also the sales promotion plan would be conducted on a phased basis. So that has been communicated already. So conventionally, 2019, we'll see in more of a phased basis. So from that perspective and given the current situation, we are trying to stock up the number. We would need to change slightly our perspective. But in any case, 2020 target is still the same, the target remains. So the question is how are we going to reach that target? In order to reach that, we would need to device and also refine our plans to reach the target with 2020. So that will be a more of a generalized answer to your question.

[Unknown Executive]

Let me introduce the next person, Tsunoda-san from JPMorgan.

[Ritsuko Tsunoda, analyst]

This is Tsunoda. I have one question. With regards to the profitability of the domestic tobacco business, I would like to ask my question. Mr. Minami, like you just said, up until now, it was about production and other matters. So the grip when it came to profit was a little weak. Adjusted AOP was around JPY 200 billion, but regular OP was about JPY 186 billion. Can we view this as the bottom? With regards to the negative sales volume from RMC, this impact seems to be significant. And that's the reason why profit declines are occurring. However, from fiscal year onwards in the T-Vapor category, because you're going to be active in your business development, how are you going to balance the 2 so that can lead to better profit? I think that part of your strategy is hard because it's about your sense in how you're going to develop the 2 businesses. So accounting for those, what are your thoughts about your future? Demand of dual-use users, is that going to be an advantage for you? And is profit going to be more manageable? Or do you think otherwise? So operating profit is JPY 186 billion for this fiscal year. Do you think this is going to be the bottom? And do you think we're going to see a rebound from next fiscal year? Is this scenario correct? Can you give us some implication on that?

[Unknown Executive]

So with regards to the policy of how we're going to formulate next year's plan, Minami will take your question.

[Naohiro Minami, executive]

To your point, in the past, we have communicated that we would like this year's operating profit to be the bottom year. And also going forward, as we put together our budget, placing 2018 at the bottom on a stand-alone basis for the domestic tobacco business, we would like to ensure that we have a plan that enables us to grow our earnings from 2019 onwards. And this policy stays the same.

To your point, up until now, it was about our supply issues. And up until 2017, the RRP market and the penetration -- and its quick penetration, we were rather looking at the RRP market as a linear line as we accounted for in our plan. However, from the second half of this fiscal year, we are thinking about RMC and RRP on a combined basis and how we can increase our earnings together. I think we are now better organized so that we can think about our earnings plan from this point of view. And we're going to have more feasibility into reading out into the future. That is how I feel.

So to your concern, for low-temperature RRP, with regards to the relationship with tax rate, depending on the price increases, profitability may become higher or it might become lower. However, it will be a positive when it comes to capturing people from RMC. So we need to look at things on a single year basis as well as profit growth year-after-year, maintaining that and growing our earnings. We need to look at it from these 2 aspects. And we also need to look at whether it's cannibalizing itself within our company or if we've been able to take away share from competition. In our profit plan, we need to consider all of these options and scenarios and flexibly pursue a scenario depending on the business condition. I think that will be our capability in growing the domestic tobacco business going forward. Therefore, I have went on and on. However, it's a matter of how we account for all of these things in next fiscal year's plan and ensure that we capture feedback from consumers and take action against the competition. We would like to do this in a smooth way as well as in a drastic way. And that is how we would like to consider our budget as well as our plan. So it doesn't necessarily directly answer your question, but these are our thoughts.

[Ritsuko Tsunoda, analyst]

Sorry, I have a follow-up question. Mr. Minami, in the RRP segment, when it comes to complete switching demand, do you think that kind of complete switching demand is over? Meaning in the future, for the market share, you reduced it to 21% but as backdrop to that, you're probably looking at sales volume of Ploom TECH and a downward revision of sales volume probably is the reason why you reduced the share target. And you were saying that 30% is also a fluid goal. And I understand that. But when you consider the growth rate, who are you going to capture as new customers? What kind of customer profile do they have? Is it going to be a complete switching smokers? Is another wave of these type of customers going to be captured? Or has this run its course? And is it going to be about dual-use smokers in order to grow the RRP category?

[Naohiro Minami, executive]

This is Minami speaking. I think there is 2. It's both. For low temperature, we are working off the assumption that there will be dual-use customers. And we are trying to address a wider base of customers. It's close to developing new customers because there are customers that look at RRP in one single way. And some people just look at RRP as well as maybe RRP, but it's cigarette and they don't smoke. So there are people who may be close to smokers who feel that RRP, maybe RRP, but it's another type of cigarette. But we are going to target non-smokers as well as we run promotions. So we think that's important, too. Not as if we're trying to make them smoke, but we want to have the non-smokers feel that RRP products do not have a negative impact when you're close to RRP smokers.

So whether it's complete switch-overs or whether it's dual use, I just wanted to say that Ploom TECH's goal is expand the consumer base. So it doesn't matter if it's complete switching or dual use, we would like to capture new customers. That is the most important thing for us. And I think competitors, they are saying this as well. But it seems that they're running a lot of research around this matter as well. And their new product, they're trying to aim for trial customer. And it seems that they're offering steep discounts so that they can capture new customers. And we're aware of what kind of promotions they're running. So it's just -- it really depends on each of the companies' strategy. And you'll need to look at the results and how much refills they were able to obtain.

So for the follow-up question with regards to Ploom as a share source is that a lot about taking away market share from competitors. You're basically aiming switching customers. I think it will be hard to capture new customers in this segment of RRP. To that end, we are competing in the market, so we basically need to win. So of course, new customers are in our view. Like RMC, we would like to basically grow our share in the pie. So we would like to capture our customers by growing our share, basically.

[Masahito Shirasu, executive]

The next question from Daiwa, this is Morita-san.

[Makoto Morita, analyst]

This is Morita from Daiwa Securities. I'd like to ask about your dividend policy. So judging from what I've heard on the cost and FX basis, you expect to grow the profit. But it seems as if the ex FX impact is quite steep. So it has been going on for some time, so it has impacted the dividend policy. So let's just say, next year, let's just assume that you're able to grow the profit on a constant FX basis, but you would have a lingering effect on the negative FX impact in the first half. So will you continue to be able to grow the DPS in line with the adjusted OP? Would you still be able to do that next year onwards?

[Unknown Executive]

Again, we still need to explore this. We are still planning for this, so we cannot give you the details right now. As we have mentioned from before, on a single year basis, the profit and loss on a single year basis would not be the sole factor to decide the dividend or DPS. So every year, we do a rolling plan and looking into the next 3 years' outlook for the adjusted OP. And we look at the initiatives and also depending on the confidence of the management of achieving those targets, those will all be taken into account. So for instance, this year is really a tough year, but we were able to grow the DPS from JPY 140 to JPY 150. So in other words, we need to look at this on a more of a mid-term basis when we consider our dividend policy. So no change in our general policy.

Having said that, so we have this 3-year rolling plan. So we can only assess that, we cannot give you these details unless we formulate the concrete 3-year rolling plan. So starting now into the end of the year, we would have the more of a detailed numbers, figures coming in from different businesses. And those will be compiled together into the business plan. And also we need to consider the likelihood, the probability of us achieving those targets. So we would like to ensure that we can grow the profit on a group-wide basis. So that would be our main target. And we will make sure that we achieve the target. So that would be the main part of our discussion. So we will engage in a fairly solid discussion, taking all those items into account. So that is all we can share with you right now.

[Makoto Morita, analyst]

So based on what we have heard as KPI, you have adjusted OP growth at constant FX. I think that is the basis of the dividend policy then. Am I interpreting this right?

[Unknown Executive]

As a company, we need to -- so we have the international business, so we have to make sure that whether we are muscular, we are strong enough to grow on a mid- to long-term basis. So no change in our perception that forms the basis of management. But of course, there are various risks, for instance, geopolitical risks, those would also need to be taken into account. So we need to take more of a comprehensive approach to address this issue. So looking into the next 3 years, we would need to decide on our actions. We've done that last year. And we will continue to do that this year as well.

[Unknown Executive]

Let's move on to the next question, Ms. Kawasaki from UBS.

[Satsuki Kawasaki, analyst]

This is Kawasaki from UBS. I have a question about your international tobacco business. With regards to earnings internationally, although you have been hit negatively by FX, your third quarter constant FX profit growth has been quite firm. So your plan for the fourth quarter, when I look at the plan, all of a sudden, compared to Q4 last year when you had [indiscernible] expenses, when you take that out, it seems that, at constant FX, AOP basis, growth is flat. Are you accounting for any type of risk? Considering the pricing environment for Q3, are you thinking that something is going to change? And are there any implications for next fiscal year if that is the case? That's my main question. In accordance -- together with that, going back to the first question that was asked today, new consolidation for the fiscal year, there are some M&A companies that you've acquired internationally. But how much of integration costs is going to be incurred this fiscal year? What are you assuming? If you can give us some guidance on that, that would be great.

[Koji Shimayoshi, executive]

This is Shimayoshi from JTI. First, going -- addressing your first question, profit growth in Q4. You were saying that it looks fairly low. First of all, looking at Russia pricing gains in 2018, there are 2 factors associated with pricing gains. In 2017 first half, price competition was quite fierce. However, from the second half going into this year, we have started to do pricing gradually. So from beginning of the year going to Q3 on a year-over-year basis, the pricing gains were quite substantial. And every year, our tax hikes are continuing. But for this fiscal year, it slided from January to July.

Compared to Q2, the fundamentals in Russia has not really changed. So on a year-on-year basis, Q4 is what you have seen. The KPI, we are going to be spending more in Q4, which is another factor. However, this is all in line with plan. So it's not as if the business environment is going to deteriorate substantially. We are not thinking that is going to happen. Moving on to the second question, for this fiscal year and the consolidated companies and their integration expenses, which I believe was the second question. Is that correct?

[Satsuki Kawasaki, analyst]

Yes.

[Koji Shimayoshi, executive]

Donskoy Tabak was the consolidation. As mentioned earlier, profit contribution in 2018 is limited because 5 months' worth of consolidation and the profit contribution is going to be offset by the integration cost. But for the actual line items, I would like to refrain from speaking to them. That's all.

[Satsuki Kawasaki, analyst]

My follow-up question is how the integration expense for companies that were acquired last fiscal year, are there no additional integration expenses associated with those acquisitions?

[Naohiro Minami, executive]

This is Minami that will answer your question. The acquisition timing, of course, it depends on that as well. So last fiscal year, we acquired companies in Philippines, Indonesia as well as Ethiopia. For Indonesia, Ethiopia, most of expenses have been incurred this fiscal year. From that point of view, for Donskoy, I don't remember the details right now, but the consolidation started from August for integration expenses. Actually, the integration plans are currently being formulated. That's what I recall. So expenses might be incurred during this year and next year, but I haven't yet looked at the details. However, when you look at past integrations and our track record, typically we have a 100-day plan for integration. We put together that plan. And then after, we reinforce the business platform. And we also make the company stronger.

This is Minami, I'm sorry once again. Earlier, I talked about customers and promotions, and I was saying that non-smokers. But I was inaccurate in my response. So I just wanted to make sure that my comments are conveyed well. What I wanted to say is our marketing targets are basically existing smokers. What I wanted to say was that for Ploom TECH or the RRP category, especially in Japan, one of the reasons why people offer RRP is because of social consideration. So for those people who don't smoke, I just wanted to say that we would like to communicate to them so that they understand what Ploom TECH is all about. Because they might think, "Well, RRPs, I don't know how they work." So we basically wanted those non-smokers to have an opportunity to experience the impact of RRP. We have no intention of recommending the RRPs to them or smoking to them. So I'm sorry if this was misunderstood.

[Masahito Shirasu, executive]

We have received many questions. But because of time limitation, this would be the final question. So I would like to introduce the next question from Morgan Stanley MUFG, Miyake-san.

[Haruka Miyake, analyst]

This is Miyake. So in terms of low-temperature products, that would be your first focus. And also you mentioned about the importance of differentiation. So I think this is a great opportunity. Could you also elaborate on Ploom S? What are some of the differentiating factor vis-à-vis the competitors? As you have mentioned in the Q&A, ultimately if you want to acquire the share, so Ploom S will be necessary to capture the consumers as well away from the competitors. I think the competitors are launching their new products as well. But what do you exactly feel is the strengths, the advantage of Ploom S as opposed to others?

[Masahito Shirasu, executive]

So Ishikawa would like to answer your question.

[Hisashi Ishikawa, executive]

Your question was related to Ploom S. So in terms of details, we should be able to give you more at the appropriate timing. So we can only limit to what we can share as of now. So hopefully, you can bear with us. So in terms of Ploom S., so this is a heated tobacco category product. So indeed, this is a direct competition to the existing incumbent products out in the market. So in the heated tobacco category, we are a latecomer into this particular category, so we'd like to make sure that we acquire share away from the competitors. So that is our basic policy. So what is the kind of product in terms of consumables? So it's different from Ploom TECH or Ploom TECH+. It is a stick-type consumable. So it is heated between 200 to 300 degrees centigrade. So it is quite close to cigarettes in the way you enjoy the tobacco product. So the mode of smoking is quite similar to cigarettes. So we are a latecomer in this category.

But because of that, we do watch what is the current situation with the existing competitors' products. And we try to explore what are some of the points that the consumers want to be improved. So we have been analyzing those. And we can now leverage on our strengths in our Ploom S products. Where we are focusing on is really the taste and also the smell and also the ease of maintenance. These were exactly the kind of points that the consumers have been requesting. So leveraging on our technology and expertise, we have made such improvement in this product. So going forward towards the launch of Ploom S, we have been conducting some premarket survey as well. And actually, the results have been quite encouraging. So we believe and we are confident that our quality is -- it's really good to excel over the competitors’ products.

[Haruka Miyake, analyst]

You mentioned about the low-temperature products. You talked Ploom TECH and Ploom TECH+, the difference between those is the difference in the tar amount. What about Ploom S then? So what is the tar amount roughly that you're looking at in terms of the target consumers?

[Hisashi Ishikawa, executive]

Now to that regard as of now, I would like to refrain from commenting on that. But in whichever case, as far as Ploom S is concerned, at the appropriate timing, we would like to give you more detail. One point that I could add, we talked about the flavor, the importance of flavor. So we are confident that it has an excellent flavor that is well enough and high-quality enough to be able to compete against the competitors' offerings.

[Haruka Miyake, analyst]

So Ploom TECH, you are introducing Pianissimo. Are you also looking into introducing other brands aside from Mevius from Ploom S. So is my understanding correct? Are you looking into deploying other brands as well from Ploom S just as you have done with Pianissimo?

[Hisashi Ishikawa, executive]

As of now Mevius would be the key brand we have in mind. So for Ploom TECH, as mentioned, we'll be deploying to Pianissimo December onwards but going forward, Ploom TECH+ and also for Ploom S. So we need to consider what other brands we could deploy. But of course, we like to listen to the voice of customers and also the performance in the market to decide as to which brands we're going to deploy.

[Haruka Miyake, analyst]

So what about the overseas deployment, it is still out in the future then?

[Hisashi Ishikawa, executive]

For Ploom S? Is that your question on future Ploom S?

[Haruka Miyake, analyst]

Yes, or Ploom TECH+, what is the timing of deploying those overseas outside of Japan?

[Hisashi Ishikawa, executive]

Now for Ploom S, this is specifically to the Japanese market, well, it will be the prime focus because it is under the most stiff competition. So Japan will be the first place to launch. Now in terms of international market, again we need to prioritize the supply first in Japan and also watch the competitive climate in the overseas market. So that is the current state. Now for +, we need to look at the capsule capacity and the production capacity. We have sufficient capacity. So the Ploom TECH+, we are eagerly looking into overseas opportunities, given our capacity.

[Unknown Executive]

With this, we would like to end the Q&A session. With this, we would like to end the JT Group 2018 Third Quarter Investor Conference Presentation Meeting. Thank you very much for participating. Please do not forget to hang up.