Japan Tobacco Inc

TSE:2914

Earnings Call Transcript 2019-Q3

[Naohiro Minami, executive]

Welcome to the JT Group 2019 Third Quarter Investor Conference.

I am Naohiro Minami, Chief Financial Officer of the JT Group. I will explain the 2019 third quarter results.

My presentation today will contain some forward-looking statements, so I direct your attention to our safe harbor statements on Slide 2. I will start by covering the highlights of our consolidated financial results through third quarter of 2019. Please turn to Slide 4.

Adjusted operating profit at constant FX, our main KPI, increased by 3% year-on-year. This is driven by AOP growth in the international tobacco business offsetting the decline in the Japanese domestic tobacco and pharmaceutical businesses. On a reported basis, adjusted operating profit declined 11.6% due to currency headwinds.

In the first half of 2019, operating profit grew driven by the onetime compensation gains related to the termination of exclusive license agreements for anti-HIV drugs in the pharmaceutical business, fully offsetting the decline in proceeds from sale of real estate assets and the increase in amortization related to acquisitions. However, in this quarter, due to the large decline in adjusted operating profit on a reported basis and restructuring costs in the international tobacco business, year-to-date operating profit declined by 7.6%. I will provide more details on the restructuring costs in a later slide.

Despite a lower effective tax rate due to onetime favorable factors, profit decreased by 5% mainly due to the decline in operating profit and higher financing costs.

Full analysis of our consolidated business segment results are available in our earnings report. Let me now review the highlights of the performance of each business segment.

Starting with trends in the Japanese domestics tobacco business, where total industry volume declined by over 6.5% year-on-year, representing an accelerated decrease compared to circa minus 4% in the first half. While the industry volume continued to be negatively impacted by the natural volume decline and the October 2018 price hike, the main reason for the accelerated decline versus the first half is the significant reduction of long-term demand in September due to more moderate price increases compared to last year. In addition, total RMC demand fell by over 9% compared to the previous year due to the impacts of the expansion of the RRP market. While downtrading continued, it remained in line with our expectations.

The RRP market size is estimated to be circa 22.5% of the total industry, which is representing a stable trend. In such an environment, share gain continued to be difficult as competitors launched new devices and upgraded products as well as device price reduction. With regards to the impact of these October price revisions, we recognize that it is necessary to closely monitor market trends for both RMC and RRP.

Moving to our performance in Japan. Our RMC sales volume fell 10.5% year-on-year due to a decline in total demand and our share. The market share within the RMC category decreased by 0.8 percentage points versus last year. This is driven by an unfavorable comparison to the third quarter of last year. Back then, our market share was positively impacted by higher long-time demand, especially for JT major brands. And in addition, in this quarter, our market share was pressured by intensified competition in the low-price segments due to downtrading. More recently, after a downward trend since June, our share increased in September versus August mainly due to occurrence of long-term demand for Mevius before the price revision.

In September, we launched Wakaba cigars and Echo cigars in the value segment. These [indiscernible] has been capturing many consumers of the former third-class products, most of which will be delisted after sale-offs. In addition, we plan to launch Camel little cigar in December in order to retain our consumer base amidst intensifying competition in the value segment.

JT RRP sales volume increased by 0.5 billion to 2.3 billion stick equivalents. And the RRP share within the category was approximately 9%. Performance of low-temperature heating products Ploom TECH and Ploom TECH+ was broadly in line with our expectations. Ploom S increased its presence in the high-temperature heating category with its nationwide launch in early August, so competition in this category has intensified. While the RRP share within the category has not yet reached our expectations, it has increased versus the previous quarter due to the contribution of new products. We intend to continue focusing on improving our share. As shown on the graph, our share in the RRP category have been on a recovery trend as of mid-October. The decline at the end of September was due to higher demand for competitor products ahead of their price increases. We will continue to monitor the situation closely in assessing the impacts of the price revisions in October, as the RRP volume in the market is still volatile especially for competitor products.

Here I'd like to introduce the latest efforts in Japan. At the time of Q2 disclosure, I explained that we needed to take initiatives towards intensifying competition in the RMC value segment. I also mentioned that we will consider expanding the RRP refills in response to consumer feedback, so let me provide you an update of the situation.

Regarding the initiatives for the RMC value segment, as I touched upon in a previous slide, we launched Wakaba cigars and Echo cigars. And we'll launch Camel little cigars in December. Camel little cigars will include 2 regular types and 1 menthol, aiming to fulfill a wide range of consumers' needs, retailing at JPY 360. Today, November 1, we introduced 4 new refills for Ploom TECH+ in convenience stores nationwide. Mevius Gold provides a powerful rich vapor using a special ingredient characterized by the scent of the tobacco leaf, the [ note tails ] and the back of the throat and rich taste.

New flavored refills are also deployed following several consumer requests. Going forward, we will continue to develop products that meet consumer needs by [ speeding up ] the process between identifying their needs and implementing new initiatives.

Turning to the financial results in the Japanese domestic tobacco business. Core revenue and adjusted operating profit decreased 1.9% and 4.3%, respectively, due to a large volume decline in RMC, as I mentioned previously, and unfavorable comparison of sales volume for Ploom TECH devices. Last year, device sales volume was relatively high following the nationwide launch in July. These were partly offset by RMC pricing gains and increase in RRP refill volume.

Next, moving on to the international tobacco business. Total shipment volumes grew 18.5 billion units versus the previous year, representing an increase of 5.8%. This is mainly driven by the contribution from last year's acquisition in Bangladesh and Russia; as well as share gains, mainly from GFBs, across many markets. Please note that the contribution from Russia -- from the Russia acquisition was [ that ] important at the end of July. Our organic volume performance was resilient, declining only 0.4%, with notable growth in Europe driven by share gains in France, Germany, Italy, Poland, Spain and the U.K.

In RRP, we are moving forward with the global expansion of Logic Compact. Compact is now available in 17 markets as of end of September. In addition, ahead of the U.S. FDA deadline, we have filed several PMTA submissions in August regarding the Logic portfolio. These filings were pre reviewed and accepted by the FDA in September for a substantive review.

Lastly, regarding the current active discussions with the U.S. related to youth vaping and vaping illnesses, I would like to point out that, as a responsible company, we call for appropriate regulations to be implemented and, more importantly, enforced. While we continue to work with regulators towards the implementation and enforcement of appropriate regulations, we remain confident in our responsible marketing practices, our age verification procedure as well as with the quality and safety of our vaping products.

Moving on to the financial results in the international tobacco business. Adjusted operating profit at constant FX grew a robust 10.2%, driven by strong pricing, while investments continued in recently acquired businesses and in RRP. Pricing gains were realized in many markets, notably in Germany, Iran, the Philippines, Russia and the U.K. And in regards to Russia, as expected, pricing gains improved in the quarter as we ran the course for the excise tax hike from July 2018.

On a Japanese yen basis, reported adjusted operating profit decreased by 12.0% year-on-year due to negative FX impact offsetting a solid business performance. While in line with expectations provided in the second quarter, the total negative FX impact was JPY 74.7 billion following the depreciation of the Iranian rial, Russian ruble and also a weaker U.S. dollar against the Japanese yen.

Next, turning to the pharmaceutical and processed food businesses.

In the pharmaceutical business, both revenue and adjusted operating profit decreased mainly due to the termination of the exclusive license agreements for anti-HIV drugs in Japan and lower overseas royalty income. In the processed food business, despite solid performance of staple food products, revenue decreased due to lower sales of other products with lower profitability. Adjusted operating profit increased mainly due to pricing, improved product mix and cost reductions despite an increase in materials and logistics costs.

Now moving on to the revisions to the full year forecast for the group.

Consolidated AOP at constant FX remains broadly in line with the previous forecast despite the downward revision in the Japanese domestic tobacco business.

Now let me detail the AOP revisions by business segment. AOP of the Japanese domestic tobacco business has been revised downwards due to a lower sales volume assumption for RRP. For the international tobacco business, currency-neutral and reported core revenue have been revised upwards. However, the AOP remains unchanged, as incremental revenue will be reinvested in the business. In the pharmaceutical business, AOP has been revised upwards, driven by better-than-expected results during the July-September period. In the processed food business, AOP remains unchanged, while revenue has been revised downwards, reflecting successful efforts to improve profitability.

Reported AOP is also expected to be broadly in line with the previous forecast. Operating profit has been revised downwards due to the restructuring costs in the international tobacco business, partly offset by an upside in proceeds from sales of real estate assets. Profit has been revised downwards due to downward revision of operating profit and a negative impact of onetime increase in the estimated average annual effective tax rate. Despite the downward revision of the profit, we expect that sustainable generation of free cash flow will continue.

Next, let's move to the forecast for the Japanese domestics tobacco business. JT RRP sales volume assumption has been revised from 4 billion to 3.3 billion stick equivalents considering lower-than-expected performance of Ploom S since its nationwide launch in August. Despite improved consumer awareness for Ploom S, the slower performance is due to more severe competition than expected, lowering the levels of trials. In addition, retention is below our expectations. In order to increase trials, we are now considering initiatives to promote the device sales. In addition, as one of our initiatives to improve retention, we will work on expanding the refill lineup, which now has a limited variety compared to our competitors. Lastly, to enhance our competitiveness, we will strive to improve devices based on feedback from consumers.

For RMC, its industry volume outlook has been revised upwards from a decline of over 6.5% to over 6%, reflecting better-than-expected results in the July-September period. Consequently, our sales volume assumption has been revised upwards from a decline of circa 8% to circa 7.5%. The forecast for RRP market size remains unchanged at approximately 23%, and the forecast for total industry volume also remains the same at a decline of approximately 4% from last year.

Let's move to financials. Core revenue and AOP have been revised downwards due to the lower RRP sales volume assumption. We will invest in marketing as planned and will not compromise investment to support the RRP sales volume growth from next year on. We will also continue to pursue cost efficiencies.

Talking about the Japanese domestic tobacco business for next fiscal year and beyond. Financially speaking, and we recognize that it's quite challenging to turn around our performance in the short term, we will primarily focus on maximizing market share and sales volumes. In the October 2019 price revision, we kept the refill price for low-temperature heating products and raised JPY 10 for high-temperature heating products. This is a top line investment aimed at maximizing the volume of RRP for the next fiscal year. In 2019, we expanded sales of 2 products, Ploom TECH+ and Ploom S, to nationwide; and thus are steadily expanding our RRP product portfolio. In order to further expand our market share, we will first work on enhancing our refill lineup. And in the future, we'll also work on device upgrades in response to the consumer needs.

Next, let me explain the forecast for the international tobacco business. Total shipment volume growth is revised downwards from 5% year-on-year to 4%, reflecting lower-than-expected volume from certain emerging markets. On the other hand, currency-neutral and reported core revenue are revised upwards taking into account the stronger pricing gains. However, no change is made to adjusted operating profit both at constant FX and reported basis, as the incremental revenue will be reinvested towards accelerated expansion of RRP where the environment is rapidly changing.

Now I would like to spend some time to talk about the transformation in the international tobacco business. Following the changes impacting the tobacco industry, our international tobacco business will be transforming. To fuel long-term growth, we must increase speed and agility, improve service quality, enhance our competencies and empower employees. With that in mind, we have designed a 3-year plan that will maximize future growth opportunities in a sustainable yet agile manner. This will result in termination notices for up to 3,720 employees, pending the outcome of consultations. In parallel, 3 new global business service centers will be set up in the Philippines, Poland and Russia, with the creation of 1,300 new positions.

The full implementation is planned by the end of 2022. The expected financial impact includes restructuring costs of USD 172 million booked in the third quarter 2019 and anticipated annual cost savings in excess of USD 200 million upon completion of the 3-year plan in 2022.

To summarize our third quarter year-to-date results. The group AOP at constant FX grew mainly driven by pricing gains in the international tobacco business. Full year target for the group AOP at constant FX remains broadly in line with the previous forecast despite the downward revision in Japanese domestic tobacco business. And we will continue to aim for year-on-year growth in AOP at constant FX. Profit has been revised downwards due to the restructuring costs related to the transformation of the international tobacco business and a negative impact of the onetime increase in the estimated average annual effective tax rate.

The expected annual dividend of JPY 154 per share remains unchanged.

As we work on our business plan 2020, there will be no change in our intention of aiming for sustainable profit growth over the mid to long term. In Japan, as we recognize it's challenging to turn around financial performance in the short term, we will make investments to maximize our market share and volume. Given the current severe business environment, some investors have voiced the concern about dividend reduction. In developing our business plan 2020, we acknowledge maintaining or increasing dividend per share is the key to shareholder return.

This is the end of my presentation. Thank you for your attention.

On Slide 16, I would like to add. We talked about the JTI cost reduction estimations. I would like to give more accurate descriptions. I mentioned USD 200 million. $200 million is the accurate figure.

[Unknown Attendee]

Thank you very much.

We'd like to now move on to Q&A. CFO, Mr. Minami; and Senior Vice President of the Tobacco Business Planning, Corporate, Scientific and Regulatory Affairs, Mr. Fukuchi; as well as Deputy Chief Executive Officer Koji Shimayoshi will take your questions.

[Operator Instructions]

[Operator]

The first question is from Mr. Miura from Citigroup Securities.

[Nobuyoshi Miura, analyst]

I am Miura from Citigroup Securities. First, the shareholders and the message around maintaining your dividends. I felt something really passionate, so I hope you could -- we look forward to make sure you do that, but I have one question for myself with regards to your restructuring efforts. Although the international business is growing, you have made a bold decision to make operations more efficient, and I think that's positive. On the other hand, what about Japan? With the domestic business, I think you're in -- [ hells deep ] in challenges right now. And the fixed cost per person is pretty inefficient. So when we look at the status, are you thinking about restructuring in Japan or cutting fixed costs? What is your point of view? And especially for head office costs, are you planning to take any action in your domestic business? And if so, can you provide me with the details?

[Junichi Fukuchi, executive]

I am Fukuchi. Thank you very much for your question. So for the Japanese business as well as rationalization efforts, there is nothing we can share with you right now. As you know, when you think about our history, we have focused on creating the organization that can sustainably grow. And we have reviewed accordingly and consistently in Japan, an organization that is relevant over time. The policy stays the same right now. However, currently, the 3 RRP devices are now in place, so now it's a matter of how we can grow sales events. So evolving our sales force is what we are working on.

And also, grasping customer needs and implementing that into our strategy quickly is something we are also trying to do. So we're trying to change the way of our work style. So that's one of the reasons why we have decided to transfer the location of our head office. So as we now have the 3 RRP devices in place, it's a matter of how do we respond to consumer needs at a higher rate and speed. And this is our declaration and this is something we're working on. So just repeating myself: For Japan, currently there is nothing we can share with regards to rationalization efforts. As for costs, obviously we are a manufacturer, so on a daily basis, cost cutting is something we are always working on, whether it be fixed or variable. And because we are a manufacturer, we would like to continue to focus on this matter. Especially, it's not just RRP but also for RMC, I think there is space for us to cut more costs, so we'd like to ensure we do that as well. That's all from myself. Thank you.

[Nobuyoshi Miura, analyst]

For RMC -- I understood your answer very well, but for RMC [ it seems ] like you're considering something. But when your business is down so much -- well, how are you viewing this for RMC?

[Unknown Executive]

Thank you very much for your follow-up question. Whether it be RRP or RMC -- we are not considering any rationalization efforts for RMC. It's more about fixed cost-, variable cost-cutting efforts that we should be doing, anyway, as a manufacturer. And this is -- applies to both RRP as well as RMC.

[Nobuyoshi Miura, analyst]

And I'm sorry. I have another question. You were talking about speedily responding to consumer needs -- but I am a smoker. I have to admit I am a smoker. And when I go to the smoking area, as the data shows, the majority of the people are IQOS or glo smokers. And when it comes to -- and then it's Ploom TECH. And it seems like share of competition has remained steady, so in order to break through and gain more market share, what do you think is necessary? Because you have a full line of the products now and it seems that Ploom TECH gadget is not doing that great. I think you really need to do more element of marketing. So what are your thoughts?

[Unknown Executive]

Thank you very much for your follow-up question again. For RRP sales, I'm sure everybody is interested. And so if I may take some time to walk you through about RRP sales, about current performances as well as current challenges we're facing as well as how we're going to do about the business, if I can walk you through. Is that all right?

The Q3 result itself, we are at 2.3 billion sticks. So the plus 500 million sticks year-on-year, 9%. But for the full year estimate, the original plan was 5 billion sticks we have announced earlier, but as of Q2, we have reduced that to 4 billion sticks. This time, in the Q3 forecast, we have said 3.3 billion. This is how we have revised. Now when we look at the market situation once again: The RRP market in Japan probably will continue to grow mid to long term. And we have not changed our idea, but we have shown a slight growth in 2019. But still, in the bigger picture we can say that we are plateauing, so how can we expand our share right now is what we're trying to think about right now. We have new devices launched from competitors in the second half of this year and the competition is intensifying. So against this backdrop, we are right now trying to market our 3 devices. Our whole suite has been completed now. There is no change in our strategy. We want to create the new market for the low temperature and also cut into the high temperature market too.

So looking at the current performance. A challenges that we are facing is becoming quite clear. Ploom TECH, Ploom TECH+ in the low temperature; and Ploom S, the high-temperature product, we would like to talk about the situation for these three. So in the low temperature category, Ploom TECH, first of all. We've explained this in a previous call. This is for dual users, light users, but these people did not adopt this product as much as we wanted them to. But it does have its unique benefits, less odor and easy handling. The strong core users desire is still there. So the number is still the same in the Q3 estimations and we're broadly in line with that. We would like to make sure we narrow down on the target customers and do our sales promotion in a more efficient way so that we can fortify our core customer base here.

Next, regarding Ploom TECH+. One of the reasons why people quit the Ploom TECH was because of the lack of the amount of vapor. Ploom TECH+ has improved this. And therefore, for customers who have adopted this, we have had very solid voices from the customers saying that it is better. So looking at the plan that we put together at the beginning of this fiscal year, we are still broadly in line with our plan. Hopefully, we can continue to cater to various customers' needs, and that's why we launched 4 new SKUs in November. Anyway, this category has a very unique property of low-temperature heating. And it can provide a very unique value to this market, so we would like to prioritize investment into the sales force. And we've said that we are evolving our sales force. So we'll do that as well so that we can improve the awareness from our customers and also at the same time try to increase the nicotine kick a little bit more. And they're also talking about improvements in the device as well, so that's why we're very eager to work on the refill and the device to cater to the customers' needs.

Moving on to the high temperature category. So the competitors have established this market, and we really need to cut through this market to get customers back from this market. So that is the role of Ploom S. So we have made this number down from 4 billion to 3.3 billion, but the main reason is because Ploom S has not been doing as much as we wanted it to see -- wanted to see it. So we now think that it will take more time to achieve the original plan, and that's why we downward revised our numbers. With product awareness, we have been able to achieve approximately 60% in the first 2 months, but the actual trial rate and the retention rate is below our estimation. But from the customers who already enjoy this, they say that the aroma, the taste is satisfying.

The taste of Mevius and the aroma of Mevius is appreciated, but we need to continue to work on penetrating the device and also continue to listen to customers' voices to increase the kick, if possible, or change it in some way so that the customers can smoke more sticks. So we would like to answer these voices so that we can expand our presence in this high-temperature heating product market. So again that was a long-winded explanation, but we want to say in summary that we're starting to see a clear layout of our challenges that we need to conquer going forward. And we need to do this in a speedy manner and make sure that we address this completely.

[Operator]

Next is Ms. Tsunoda from JPMorgan.

[Ritsuko Tsunoda, analyst]

I'm Tsunoda from JPMorgan. I have a question too with regards to the Japanese domestic tobacco business. First of all, with regards to your domestic tobacco business strategy, the trend is downtrading that you've mentioned. For RMC, price increases will be ongoing, retail prices will continue to rise. And as we see this trend, I don't expect downtrading to come to an end for long, but what are your thoughts around this? And your company, this time around, in the heated tobacco business, Ploom TECH, Ploom TECH+ natural price increases have not come through. And I'm concerned that this might be negative, which means, the downtrading in RMC, we're going to see a margin in deterioration there. And also for the heated products or RRP, you're going to see margin deterioration as well next year. And with that, I'm concerned that it might weigh on your domestic tobacco business. So it seems that your priority is going to be on sales volume. But for RRP you decided to forgo a price increase, but do you have any intention or possibility of changing your pricing strategy? In the domestic tobacco market, can you give me your pricing outlook? And if there's any opportunity for you to reestablish your pricing strategy.

[Junichi Fukuchi, executive]

It is Fukuchi again. Thank you very much for your questions. So you talk about downtrading as well as RRP and our pricing strategy going forward. First of all, as you know, we had consumption tax hikes recently, and that excise tax hike is going to continue for the next 2 years. And for RRP tax hikes, it's going to continue for a while in the next several years, including this year, next year as well as the year after next. So with the tax hikes in place, how are we going to do about our pricing strategy? So that's the question.

So based on where we are, the customers, we believe that they will continue to prefer lower-priced products for a while because prices are going up overall. And because our market share is #1 and we would like to secure share, we would like to ensure we are able to obtain share going forward as well and also respond to customer needs by offering products that are relevant. And Wakaba, Echo little cigars were launched in September for this reason. And from December, Camel little cigars will be launched too. So we would like to continue to scrutinize customer needs as well as look at domestic market trends and implement a variety of measures.

As for RRP, we are #3 in the market, and that is how -- the reason why we are taking the current pricing strategy. Of course, pricing is a very important element or factor, but when you consider where we are and our current situation, we believe it's important to focus on growing volume at this moment so that we can change where we stand position-wise. And that is why the current pricing strategy is where it is, so -- and put priority on growing sales volumes. Of course, for next year onwards, at a time of a tax hike, it will depend on the competitive landscape that we face at that point in time, and we would like to make decisions accordingly. So the pricing strategy that we currently have doesn't mean that we're going to continue this forever. And I'm not saying that we're going to continue to raise prices either at this moment, but we do understand the importance of pricing strategies, so we'll look at competitive landscape as well as market trends. That's all from myself. Thank you.

[Ritsuko Tsunoda, analyst]

So that means, I guess, in terms of profitability, it seems like the group is weak there. I guess, more than the process, you need to capture the volume. I guess your strategy is focusing more on volume over profit for domestic business. Is this stance unchanging?

[Unknown Executive]

Thank you for the question. In terms of the RRP business. So the customers buy the device and then they buy their refills later. So in order to have a certain level of business in this tobacco business, we need to have these customers buying a certain level of volume. Otherwise, the business will not make sense. So we need to make sure that we reach a certain level of volume, first of all. Yes, that is the priority. And the price is set based on this kind of precondition. And on top of that, in the future, the RRP, compared to RMC, should have an appeal in how much profit we can gain from this. So investing in this RRP category will help us get the return in the future. So that's why we're focusing on this part of the business.

[Operator]

Next question is Ms. (sic) [ Mr. ] Saji from Mizuho Securities.

[Hiroshi Saji, analyst]

Can you hear me? Okay. My question is with regard to the Japanese domestic tobacco business. Next year, from April, the Health Promotion Act is going to be enacted. So RRP currently have got 23% of the market and is stagnant with that at this point in time, but next year, when the act comes, is enacted, what kind of impact do you think it's going to have on the overall tobacco market? And for you, what kind of impact do you think you're going to receive? And what kind of strategy do you have to address this?

[Koji Shimayoshi;Deputy CEO and Executive Vice President Business Development and Corporate Strategy of Japan Tobacco International, executive]

This is Koji. Thank you for your question. So to your point: The revised health promotion law is going to be enacted next year, in April, and you are asking about its impacts. We do believe that to a certain degree there is going to be some impact. And currently, at restaurants people are talking about making the restaurants smoking free. And also the media is covering companies that have decided to go smoke free, smoking free. So it's not really just April that's going to be the milestone where the act is going to be enacted. We do believe that recent trends in society will have an impact on us overall. And also, from April 2020, if restaurants are going to prohibit smoking from April next year, and -- what kind of implications it may have on our business is hard to say at this point of time, but for smokers -- and first of all, I mean, you need to think about where you're going to smoke. They might be smoking at home or at their office. That will be the majority. And I think the majority of their smoking is happening at those locations stick-wise. And I think the number of cigarettes they smoke at the restaurants is not as much, but of course, if restaurants prohibit smoking, I do believe we will be impacted to a certain degree.

We do need to monitor what will happen and watch it closely. And of course, we're not just going to be closely watching, but up until now, there has been -- we have been working on establishing smoking environments. So consulting activities to separate the smoking areas is what we would like to also continue to do. As for RRP in particular, in the law, people are now able to create a room dedicated to smoking heated products, so whether it be Ploom TECH or Tech+, I think it will be a valuable experience to communicate the benefits of these products, so it's a matter of how we can leverage this opportunity in establishing dedicated smoking rooms for heated tobacco products. So going back to your question, we do believe there is going to be an impact to a certain degree, but it's hard to quantify at this moment [indiscernible] all from myself.

[Hiroshi Saji, analyst]

Well, RRT (sic) [ RRP ] ratio, you have forecasted it would go up much higher, in the past, but that is not the case. In reality, it is stagnating. So -- but you are going to continue with the same growth strategies. And you will center that in your strategy, I understand, but will there be any timing where the momentum will change? I actually feel that this Health Promotion Act will be one of the milestones in this change in strategy. Do you have any comments on that?

[Unknown Executive]

Yes. Thank you. The reason why customers choose RRP. So Mr. Shimayoshi talked about this in the previous call for Q2 results. He mentioned that some of the reasons include encouragement from others around you or difficulty in finding smoking rooms, but anyway, these are reasons why people choose RRP. So we believe that the change in the smoking environment will help the RRP market to grow as a tailwind and not only that, also the society's overall perspective about what smoking is and also the pricing element. There are various other levers that will change the environment. So as a conclusion, we do estimate that the RRP will continue to grow. There is high probability that, that will happen. And we actually can look at the Health Promotion Act as one opportunity as well.

[Operator]

Next question is from Nomura Securities, Mr. Fujiwara.

[Satoshi Fujiwara, analyst]

This is Fujiwara. I have a question regarding shareholder return. In today's presentation you talked about dividend cut risk and that we don't have to be concerned about it, but in this quote you talked about maintaining or increasing dividend, so I was wondering what maintaining means. Because it was all about growing dividends in the past, but now you are saying that there may be a probability that dividends might stay the same. So I think there's a change, if you want, so can you share your view on that? Also for shareholder return, you were saying that we don't need to think about dividend-cutting risk, but as you are facing increased challenges in the domestic market, with regards to funding your dividends through free cash flow, if you start to feel challenges there, is there a risk that dividends actually may be cut? So can you give me a medium- to long-term perspective?

[Naohiro Minami, executive]

This is Minami speaking. We included the word maintaining intentionally because there were communication with various investors as well as looking at reports. I'm not talking specifically about us but the market overall. When it comes to dividend cuts, there is a concern, and I think people are starting to become apprehensive about dividend cuts of corporations. So with regards to the question around are we going to cut dividends: We basically wanted to wipe away the concerns that investors may have. Of course, the ultimate dividends will be decided by -- at the BOD, but as we are going to formulate the plans for next year, this is an aspect that we would like to focus on. And this is we communicated this message with you because it is the best we could do at this moment. Fundamentally, we would like to continue to focus on growth. So this underlying thought process has not changed from the past. However, as we've always communicated, for AOP, for net income, when you think about the future, I am sure there is going to be ups and downs, but our priority is going to be to grow AOP as well as net income. And that is what we are still driving for.

And in the latter half of your question you were talking about funding dividends through free cash flow. And if free cash flow starts to decline, what's going to happen? If that were to happen, we will need to assess the situation. And if this kind of situation were to be ongoing, that would mean that the phase we're in as a company are changing. So basically, we have to reassess on how we are going to allocate our resources overall. Now currently the management's point of view is that for international tobacco business it's still going to drive the way for the company's growth. And as for the domestics tobacco business, it's true that over the short term it will be hard to do an immediate turnaround. And we do believe we need to well communicate this because it reflects reality.

And over the medium to long term, we would like to ensure that the current conditions do not persist by having a good plan in place and having good execution in place. So the transformation plans are what we have for the international business right now in order to raise the base of our profits and also to change our work style and change our business model and so that we can speedily respond to market needs better than before. And also, for the domestic market Japan, like we've been saying today, we would like to ensure that the current conditions do not persist, and that is why we currently have measures in place. And we are currently trying to have a process where we speedily react. So that is our point of view.

[Unknown Attendee]

We are receiving many more questions, but now it is time to close the conference call. Therefore, we would like to take the very last question. From Daiwa Securities, we have Morita-san.

[Makoto Morita, analyst]

I'm Morita. May I?

[Unknown Attendee]

Yes.

[Makoto Morita, analyst]

In terms of the overseas RRP situation, if you can just give me a simple explanation. Just for the main countries, if you can explain the current situation. In the time of, I don't know, past 6 months or past 12 months, what kind of changes have you seen? And also your future prospects for the next 2 or 3 years, please.

[Koji Shimayoshi;Deputy CEO and Executive Vice President Business Development and Corporate Strategy of Japan Tobacco International, executive]

Yes. Shimayoshi from JT International. I'll be answering your question. The current situation and the forecast regarding overseas RRP business. First of all, currently the global RRP market is in the following conditions. Now the key players, including us, core revenue, when we add this, the biggest market is Japan, about USD 4 billion; and then America, USD 3 billion. JUUL is the main product. Then on the other hand, we have Korea, Russia, U.K. These countries follow. The key players for revenue, Japan, have -- these countries enjoy about 1/10 of the business we see in America and Japan. This is the current status. Now in this situation, let's take Russia as an example. We have IQOS. In Russia, that is penetrated to a good extent, about 4%. Our share is 4% right now.

Now looking at JTI's efforts. For example, speaking of T-Vapor, we are investing resources mainly in Japan, and we would like to invest resources into the international market going forward too. For Logic's compact, we have been investing thoroughly in this product this year. Next name, we have TPD2 in Europe. Paper rolled cigarettes menthol type will be regulated. Now some of the customers will be moving because of this, and for them, we are providing Logic Compact, for these customers in Europe. In the beginning of the fiscal year, we were planning to launch this in 13 markets or more within this year. And as of October 10 -- October, we have been able to launch in 18 markets. And we have 3 more months for the remaining year. And we will have to continue to make more launches in more countries, ultimately achieving double the number of countries compared to our plan that we announced at the beginning of the year. This is the kind of countermeasures we're going to take against the regulatory changes. On the other hand, speaking of the most important market, Russia, U.K., Taiwan, I'd like to briefly explain the current situation.

Taiwan, the RRP market. The market is not open because of the regulations, but if the regulation changes, we will be able to move very quickly with our products portfolio. As soon as the market is open, we would like to play the game very quickly. U.K., most of the market is E-Vapor. And within the E-Vapor, we have the open-tank type. This is really the major type that is in the market, but ours is close-tank Logic Compact. So we are shifting from open-tank to close-tank gradually. So we believe for this product we will be able to maintain our current share, and we are as we speak, although the market size is modest. So that's why we have launched Logic Compact in Russia. And also to fight against IQOS, I'm not going to talk about the details right now, but we will have T-Vapor in the market from next -- in next year, by the end of next year. That concludes my answer.

[Makoto Morita, analyst]

Regarding Russia and U.K. in the next 3 or 5 years ahead. You say that this market is of the scale of 1/10 compared to Japan. How do you think that will change?

[Unknown Attendee]

Yes. Shimayoshi will continue to answer your question.

[Koji Shimayoshi;Deputy CEO and Executive Vice President Business Development and Corporate Strategy of Japan Tobacco International, executive]

Currently, if there's anything I can mention, we have learnings from Japan and American markets. And we know that, when the number goes reaching a certain threshold, the business grows exponentially. So for Russia and U.K., we believe that the same will happen, an exponential growth, but that hasn't been seen yet in these 2 markets. What's more important right now is when that happens. When the market grows dramatically, are we prepared to launch our products into the market? So in that sense, we are ready for E-Vapor, and we are in preparations for T-Vapor right now. So in this way, within the next 3 years, Russia and U.K. -- well, currently we do not see signs that Russia and U.K. will grow at the size of Japan.

[Makoto Morita, analyst]

But what are these signs that you're looking for, for dramatic growth?

[Unknown Executive]

Yes. For example -- it's not a macro data. It's more micro. For example, signs would be word of mouth, buzz, viral communication, influencers. All of a sudden, we are talking about it very frequently. This is the kind of micro information that we need to rely on. Now the macro data, if we can confirm that on macro data, then it's probably too late by the time we see it reflected on macro data. So we need to pick up these information of these individuals and word of mouth. Thank you.

[Unknown Attendee]

This concludes the Q&A session. We will now end the fiscal 2019 Q3 results call. Thank you for your participation. Please don't forget to hang up.

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