Japan Tobacco Inc

TSE:2914

Earnings Call Analysis

Japan Tobacco Inc. Upgrades Revenue and AOP Forecasts Amid Vector Acquisition

Japan Tobacco Inc. has revised its financial outlook positively, expecting a core revenue growth of 9% year-on-year, an increase of JPY 97 billion, largely driven by strong pricing strategies and market momentum post-Vector acquisition. The adjusted operating profit (AOP) is similarly forecasted to rise by 9%, up JPY 27 billion, amid stable costs. The tobacco segment experienced a 2.6% AOP growth at constant FX. However, net profit has been revised down by JPY 8 billion due to higher financial costs and taxes. The company aims to maintain its dividend at JPY 194 per share despite changes in profit outlook.

Strong Revenue Momentum Driven by Tobacco Segment

Japan Tobacco Inc. (JT) reported impressive results in its third-quarter earnings with total revenue rising significantly due to robust pricing strategies within its tobacco segment. Notably, the core revenue is now expected to increase by 9% year-on-year at constant foreign exchange (FX), representing an upward revision of JPY 97 billion from previous forecasts. This strong performance is attributed to favorable pricing contributions and an upswing in total volume, notably in key markets including Europe and the Emerging Markets and Africa (EMA) cluster.

Vector Acquisition Enhances Market Share

The recently completed acquisition of Vector Group is a pivotal move, as it will expand JT's market share in the U.S. from 2.4% to an impressive 8.2%, effectively positioning the company within the top tier of the U.S. tobacco market. This acquisition is expected to contribute approximately 9 billion units of sales volume and is anticipated to enhance JT's profitability amid a market that remains resilient despite a global decline in tobacco consumption.

Solid Progresses in Reduced-Risk Products

JT's investment in smoke-free alternatives like Ploom is also paying off, with sales volumes increasing by 40% year-on-year to 5.9 billion units. The company aims to significantly boost RRP-related revenue by 2.5 times from 2023 levels by 2026, indicating a strong commitment to expand in this category, which is becoming increasingly critical given the industry's shift towards reduced-risk products. Currently, Ploom holds an 11.8% market share in Japan and continues to grow in other markets.

Operational Performance and Challenges

Despite overall positive trends, the company highlighted challenges including rising financial costs and corporate taxes, leading to a downward revision of profit by JPY 8 billion. AOP (Adjusted Operating Profit) is expected to grow by 6.3% compared to the prior year, but overall profit remains flat due to these external pressures. Free cash flow is anticipated to decrease by JPY 220 billion, affected by payments related to the Vector acquisition.

Outlook and Strategic Focus

Moving forward, JT plans to continue strengthening its investments in both combustibles and RRPs, with an increase in the RRP investment budget from JPY 300 billion to JPY 450 billion. This strategic focus is designed to offset the pressures on traditional tobacco products and embrace emerging consumer trends. Additionally, while the current fiscal year is expected to face some one-off challenges, the company remains confident about long-term profitability from the Vector acquisition and continued growth in the RRP sector.

Steady Dividends Amidst Strategic Investments

Despite the challenges, JT remains committed to its shareholders, keeping the annual dividend payout unchanged at JPY 194 per share. The dividend payout ratio is approximately 74%, reflecting a balance between returns to shareholders and necessary investments in growth areas. The focus on sustaining a resilient balance sheet will enable future M&A activities and support ongoing shareholder returns.

Earnings Call Transcript 2024-Q3

[Unknown Executive]

Thank you for participating in the Investor Meeting for Q3 2024 results at Japan Tobacco Inc. today. Before we start the meeting, we would like to ask you to make sure that your display name is accurate. Thank you for your cooperation. It is now my pleasure to introduce you, our CFO, Mr. Furukawa.

[Hiromasa Furukawa, executive]

I am Hiromasa Furukawa, Chief Financial Officer of the JT Group. I would like to go through our consolidated financial results for the third quarter of 2024. We would like to share with you the third quarter 2024 briefings. First, let me clarify that since the closing of the Vector acquisition took place in October, the contribution from this acquisition is only included in the revised forecast for the full year, not in the cumulative third quarter results.

Please see Slide 4. As shown on the slide, revenue and AOP increased both at constant FX and on a reported basis. AOP at constant FX, our primary performance indicator, increased 2.6% year-on-year. This solid performance was mainly driven by the tobacco business, where the robust pricing contributions outweighed the impact of increased investment towards Ploom as well as higher costs in our supply chain and in indirect expenses such as labor costs.

I would also like to mention the contribution of the processed food business to this performance, where profit increased year-on-year. Regarding FX, essentially coming from the tobacco business, the impact to AOP was unfavorable due to the depreciation of emerging market currencies and the appreciation of cost-related currencies, such as the U.S. dollar and Swiss franc, which more than offset the positive impact of a weaker yen.

Operating profit increased 0.8% year-on-year, driven by the increase in AOP. Profit was in line with prior year, driven by the increase in operating profit and lower corporate tax, partially offset by higher financial costs. Finally, despite the increase in AOP, free cash flow decreased by JPY 159.8 billion to JPY 260.5 billion due to a temporary deterioration in working capital, including the impact of the difference between the calendars on tobacco tax payments.

Moving on to the results of each of the business segments, starting with the tobacco business. First, let's look at the volume performance on Slide 5. Total volume combining both combustibles and RRP grew by 2.2% increase year-on-year, in line with trends highlighted in the first half of the year. In the combustibles category, the EMA cluster continued to drive the overall volume growth. The strong performance was driven by continued market share gains, fueling our volume momentum in many emerging markets, positive industry volume in several markets and ongoing recovery in global travel retail, mainly in Asia. These factors resulted in a 1.8% year-on-year increase in combustibles volume, offsetting impacts from the lower combustible industry volume in Japan, the Philippines and the U.K.

RRP volume increased significantly by 22.8% year-on-year, driven by an increase in Ploom volume, our investment priority. In addition to the continued share gains in the HTS segment in Japan, volume growth was supported by Ploom's geo-expansion. Total volume progressed above expectations throughout the past 9 months, mainly due to better-than-expected industry volume trends in several markets in the EMA cluster, including in the key markets of Russia and Turkey.

Turning to the financial performance of the tobacco business on Slide 6 and more specifically, AOP. While the total volume increased, as I have just mentioned, the financial contribution of volume was negative to AOP. This is due to the geographic mix impacted by a higher volume contribution from relatively lower-margin markets, mostly located in the EMA cluster. Pricing contributions in many markets, including Russia, the U.K. and the Philippines, outweighed the volume impact and the lower product mix, mainly due to down-trading in Japan and the Philippines.

The solid top line growth was partially offset by increased investments towards the geo-expansion of Ploom, higher costs due to inflation in our supply chain and indirect expenses such as labor costs. As a result, AOP increased by 4.7% year-on-year at constant FX. As alluded to earlier, the FX impact to AOP was negative, mainly due to the depreciation of certain emerging market currencies and appreciation of cost-related currencies, such as the U.S. dollar and Swiss franc, more than offsetting the positive impact of a weaker yen.

Slide 7 reviews the performance of the 3 clusters in the tobacco business. The graphs on this slide show year-on-year changes in total volume, core revenue and AOP at constant FX for each cluster. First, Asia. This cluster includes Japan, the Philippines and Taiwan. Total volume decreased by 0.6% year-on-year, mainly due to lower combustibles industry volume in Japan, the Philippines and Taiwan, partially offset by market share gains across the cluster, including in the Philippines and Taiwan and higher Ploom volume and share in Japan.

Regarding financial results, the combination of a negative volume contribution and a negative product mix due to down trading in Japan and the Philippines as well as higher supply chain costs due to inflation resulted in a decline in both revenue and profit despite a positive pricing variance.

Moving on to Western Europe. This cluster includes Italy, Spain and the U.K. Market share gains continued in several markets, including in Italy, supported by a positive volume contribution from markets where Ploom was launched. These positive factors were unable to offset the impact from lower combustibles industry volume, particularly in France and the U.K., resulting in total volume decreasing by 2.7% year-on-year.

Turning to financial results. Revenue increased as pricing contributions in markets such as France, Germany, Spain and particularly in the U.K. offset the negative volume variance. Increased investment towards Ploom and higher supply chain costs resulted in a lower AOP. Lastly, EMA. This cluster includes Romania, Russia and Turkey. Total volume increased by 5% year-on-year, driven by market share gains in several markets. The continued recovery in global travel retail and favorable industry volume in several markets, including Russia and Turkey.

Regarding financial results, the positive volume contribution and strong pricing in several markets outweigh the increased investment towards Ploom and higher supply chain costs, resulting in higher revenue and AOP.

Slide 8 describes the performance of Ploom. Ploom volume increased by 40% year-on-year to 5.9 billion units. Ploom is now available in 23 markets as of today, including the Jordan and the Philippines, where it launched in October and will be available in South Korea from November. In addition to continued volume growth in Japan, the volume in markets other than Japan, is steadily increasing, fueled by the increase in the number of markets and ongoing marketing initiatives.

This volume performance drove an increase of RRP-related revenue by approximately 22% year-on-year. The steady growth aligns with our ambition to increase our RRP-related revenue by approximately 2.5x by the end of 2026 compared to 2023.

Slide 9 provides an update on the trend of Ploom in selected markets. As shown on the graphs, Ploom share of the HTS segment is continuing to grow both in Japan and outside Japan. In Japan, HTS share of segment reached 11.8% on a quarterly average. According to consumer surveys, the product has received higher ratings and for taste than other products. And in terms of design, it has received the Good Design Award, the only comprehensive design award system in Japan as the first heated tobacco device to receive this award. Other results are coming out that support the competitiveness of our product.

Outside of Japan, our HTS share of segment continues to grow in highly competitive markets such as the U.K. and Italy. In the Czech Republic and Portugal, we have achieved steadily growth since Ploom was launched by quickly establishing a distribution network and implementing a wide range of marketing approaches. Although each market has its own characteristics, by sharing effectively the knowledge we have gained across markets, we will increase the opportunities to engage with consumers, improve the awareness of Ploom and pursue market share gains.

I would like to also highlight that JT's aggregated HTS share of segment in our key HTS markets where Ploom is available has reached 9% in September. We are encouraged by the current trends, putting us on track with our 2028 ambition to reach mid-teen HTS segment share.

On Slide 10, I would like to take you through the recently completed acquisition of Vector Group, starting with a strategic rationale. The acquisition will add approximately 9 billion units of sales volume in the U.S., the world's largest market by value and one of the most profitable. This acquisition will significantly increase our market share in the U.S. from 2.4% to 8.2%, and we will own 2 of the top 10 cigarette brands in the U.S. At the same time, the acquisition will expand our sales network in the market and create medium- to long-term strategic opportunities that could enhance our competitiveness in the U.S. market.

Thus, this acquisition is an investment, designed to expand the JT Group's presence in the U.S. market and is in line with the strategy of continuous improvement of ROI in combustibles as outlined in our business plan in February.

In addition, the U.S. is a hard currency market that is less affected by exchange rate fluctuations. And we believe that the stable cash flows and profit contributions from this market over the mid to long term will enable us to secure funds for investments in RRP and strengthen the financial base of the whole group.

In terms of share purchase price, the total value is approximately USD 2.4 billion, representing an EBITDA multiple of about 8x. The acquisition is expected to contribute to our profits from the first year of integration and will contribute to group's profit growth over the mid- to long term. We intend to continue to prioritize and continuously reinvest the profits generated by combustibles into RRPs, which we expect to grow.

Slide 11 provides some additional details on the Vector transaction. Through this acquisition, we are now the fourth largest tobacco company in the U.S. market. As you can see from the map on the slide, the combined business already has some market share strongholds and some visible opportunities.

In addition, the combined business doubles the number of outlets where our products are distributed in the U.S. market and strengthens our presence in important distribution channels such as key accounts. Vector has strategically positioned its brands in a low-price segment called deep discount, and this price segment is the only segment that is expanding in the combustibles' category due to down trading.

Montego and LD, which belong to this segment, have been among the fastest-growing brands over the past few years and are expected to continue to grow. We are currently in the process of formulating a concrete integration plan and business strategy. So we cannot provide additional details at this time, but we will do so when appropriate. This also applies to potential synergies, although we have already identified some early synergies related to the delisting of Vector and other cost optimization initiatives.

Next, I'll explain the results of the pharmaceutical and processed food businesses. First, the pharmaceutical business. Despite sales growth in the area of skin disease and allergens at our consolidated subsidiary, Torii Pharmaceutical, revenue decreased by JPY 2.8 billion due to the absence of onetime compensation gains from license compounds received in 2023 and lower overseas royalty income. AOP decreased year-on-year due to the lower revenue and higher R&D expenses.

Moving on to the processed food business. Revenue increased by JPY 2 billion, driven by price revisions implemented in the previous and current fiscal years as well as the steady sales growth in the seasoning business. AOP increased year-on-year due to the revenue growth, offsetting higher raw material costs. I will now explain our revised full year forecast for fiscal year 2024. Prior to presenting the revised forecast, we would like to provide a brief overview of the Canadian litigation.

On October 17, we received notice from JTI-Macdonald Corp., our local subsidiary in Canada that the court-appointed mediator and monitor in the Companies’ Creditors Arrangement Act, proceeding had submitted a proposed plan of compromised and arrangement, outlining the terms of a comprehensive settlement regarding multiple claims against JTI-Macdonald and certain of its competitors in Canada. Should the proposed plan be approved, the defendants would pay an aggregate settlement amount of CAD 32.5 billion as presented on the slide, consisting of the upfront and annual payments.

Although the proposed plan indicates that allocation of the total amount between the defendants is unresolved. JTI-Macdonald has been actively engaged in the confidential mediation and recognizes the significant progress that has been made in many areas despite a very complex process. JTI-Macdonald is supportive of a global settlement, but it does not consent to the proposed plan in its current form.

There are certain critical issues that would need to be resolved in order for a settlement plan to be workable. As a result, JTI-Macdonald has advised the court that it does not support the proposed plan, and as suggested, how the issues JTI-Macdonald has identified can be resolved on October '24. We are committed to continuing to work diligently and in good faith with all the mediation parties to try to reach a negotiated consensual compromise that is viable.

Just for your reminder, if a settlement is ultimately approved and implemented, all pending smoking and health-related litigation, including all healthcare cost recovery claims in Canada should be resolved. We will continue to provide updates at an appropriate timing as the situation progresses.

Now I will move to our full year consolidated revised forecast. As mentioned at the beginning of this presentation, the revised forecast includes the pro rata temporis contribution of Vector. We have made upward revisions to consolidated revenue and adjusted operating profit both at constant currency and on a reported basis. Core revenue at constant FX is revised upward by JPY 97.5 billion from the previous forecast due to upward revisions in the pharmaceutical and tobacco businesses, including the contribution of Vector.

As a result, core revenue at constant FX is now expected to grow by 8.2% year-on-year. AOP at constant FX is expected to be JPY 29 billion higher than the previous forecast due to upward revisions to AOP in all business segments, resulting in a 6.3% increase compared to the previous year. On a reported basis, revenue and AOP including the impact of FX rates have been revised upward by JPY 54.5 billion and JPY 36 billion, respectively, compared to the previous forecast.

Operating profit is revised upward by JPY 28 billion from the previous forecast, as the upward revision to AOP more than offsets adjustment items related to the Vector acquisition. Profit has been revised downward by JPY 8 billion from the previous forecast to reflect increases in financial costs and corporate tax as well as costs related to the Vector acquisition. Free cash flow is expected to decrease by JPY 220 billion from the previous forecast due to payments related to the acquisition of Vector, offsetting the upward revision in AOP.

In the following sections, I'll explain the revised forecast by business segment, starting with the tobacco business. Regarding the impact of the Vector acquisition on the revised forecast, total volume, core revenue and AOP are reflecting the performance of Vector at the same level as before the acquisition. Total volume, including combustibles and RRP has been revised upward to reflect better-than-expected industry volume in several markets and a solid market share momentum. As a result, we now expect an increase of approximately 1% year-on-year.

Next, I'll explain the financial forecast. Core revenue at constant FX is expected to increase by 9% year-on-year, an upward revision of JPY 97 billion from the previous forecast due to strong pricing contributions and favorable volume performance as well as the inclusion of Vector. AOP at constant FX is also expected to increase by 9% year-on-year, an upward revision of JPY 27 billion from the previous forecast, driven by the revised top line growth and contained supply chain costs, while we strengthen our investment towards Ploom and combustibles.

Slide 17 explains the revised forecast for the pharmaceutical and processed food businesses. The forecast for revenue in the pharmaceutical business has been revised upward by JPY 1 billion from the previous forecast due to an expected increase in sales at Torii Pharmaceutical. AOP has also been revised upwards by JPY 1 billion from the previous forecast due to the increase in revenue as well as scrutiny of R&D expenditures.

Moving on to the processed food business. Revenue has been revised downward from the previous forecast, reflecting the recent sales trend of frozen and ambient processed food businesses as well as the seasoning business. Forecast for AOP has been revised upward by JPY 0.5 billion due to efficient cost management, including SG&A, despite higher operating costs such as raw material costs.

Finally, please see Slide 19. As we have explained, the strong pricing contribution in the tobacco business drove the group's top line growth in the first 9 months of the year. In the tobacco business, top line growth led to year-on-year increase in AOP despite accelerated investment towards Ploom.

This strong performance was further supported by the solid performance in the processed food business, resulting in a 2.6% increase in consolidated AOP at constant FX. The revised full year forecast for AOP, both at constant FX and on a reported basis has been revised upward, driven by the strong business momentum in the tobacco business as well as the contribution from the Vector acquisition, resulting in an increase versus the previous year. Although the operating profit forecast is revised upward, profit is expected to be flat compared to the previous forecast due to the increase in financial costs, corporate tax and costs related to Vector acquisition.

As explained, we are extremely confident in the strategic rationale behind the acquisition of Vector and on the mid- to long-term contribution from this acquisition to the profit growth of the JT growth -- JT Group.

Finally, I would like to discuss shareholder returns. The dividend payout ratio based on the revised forecast is approximately 74%, which is in line with our shareholder return policy. Therefore, the annual dividend per share forecast remains unchanged at JPY 194. Should a loss occur related to the Canadian settlement, we will examine its impact and consider adjusting it from the dividend calculation defined in our shareholder return policy. This concludes my presentation. Thank you very much for your attention.

[Unknown Executive]

Thank you, Mr. Furukawa. Now we would like to start the Q&A session. Let me introduce you the speakers who will answer your questions today. Hiromasa Furukawa, CFO of the JT Group and Nobuya Kato, JTI Deputy CEO. Now we'd like to show you how to ask questions. We're afraid we don't accept questions in this English line. If you have any questions, please send an e-mail to [e-mail]. We will introduce your question accordingly. Thank you for your understanding.

[Unknown Executive]

The first question comes from Mr. Saji from Mizuho Securities.

[Hiroshi Saji, analyst]

I have a question related to Vector, the acquisition. So 8.2% is the market share, inclusive of the ex-JTI. So both JTI and Vector, I do believe the performance is better than the previous year. My question relates to margin. So you mentioned about the market being the highest margin. So what we can see for 2023, OP margin was around 23% or so. So it wasn't that high in terms of the margin, but with deep discount. They have exhibited their strengths was in the deep discount category. So in terms of margin, so given the fact that U.S. is a high-margin market, what is the potential upside in terms of the margin? And what are the drivers? Because about JPY 48 billion of OP, I think, 7% is the -- that 7% or so of contribution that it may have. So what sort of impact would it pose for the JT Group as a whole?

[Unknown Executive]

Thank you very much for that question. The question was related to Vector's acquisition. What will be the impact in terms of the margin, how much of the margin increase could we have? So Mr. Kato would answer your question.

[Nobuya Kato, executive]

Mr. Saji, thank you very much for your question. This is Kato. In terms of Vector, so it is in the U.S. market, so we do believe the market is fairly high and profitability. And for the global tobacco business, this would lead to improvement of the ROI. So specifically, what sort of margin accretion do we expect to have? I do believe that was the question that you posed. Unfortunately, as far as the individual markets are concerned, we cannot actually comment on the margins or the margin contribution.

We cannot actually touch upon those markets. So regardless of Vector or not, we don't disclose those information by market. So for the actual numbers, we cannot comment. I hope you would understand. But needless to say, we have a clear target to improve the combustibles' ROI. And we do believe this acquisition will lead to that. So for the global tobacco business, the margin should improve through the acquisition of Vector's Group, and that is exactly the rationale behind this.

Also another point I'd like to highlight in terms of the current state and also the future state. I would also like to give you some color. So in the U.S. combustibles, if you look at the volume, it has been on the decline, that is for the market, industry-wide volume. However, all the players, inclusive of Vector have been able to exhibit the pricing strategy. Therefore, in the mid- to long-term basis, we do believe the pricing strategy as well as the margin should be able to secure by each of the players regardless of the industry volume decline.

And we do believe this will continue. Also, in addition to that, this is slightly different from FX constant basis, but the acquisition of Vector, so this is the profit generation in terms of hard currency. That is another point we'd like to highlight so in the soft currency market, the profit we generate. In comparison to that, the U.S. dollar basis, hard currency basis, we can also generate profit. That would also have a positive impact on the reported basis number. It will give us a stable basis in terms of the profit contribution. That is another important factor we'd like to highlight.

[Hiroshi Saji, analyst]

May I, just additional question. So value and super value, the U.S. tobacco market, I do believe it accounts for 30% of the U.S. market. So within this category that is growing, so will we see more below price competition or perhaps the margin would not actually rise as initially anticipated. I think there is a risk that may be of concern. What is your expectation going forward?

[Unknown Executive]

Thank you for that additional question. In terms of risks, I think whichever market we go to, risks exist. So as you mentioned, for the deep discount category, whether we can really capture the pricing element or perhaps the competitors might have a stronger deep discount. Therefore, the things will not turn out we initially expected. So we do perceive that as a potential risk.

However, Vector, traditionally, they have been able to increase their market share and at the same time, have been able to gain that pricing as well as the profit as well in the past. They do have the track record. So let's just say, for 1 quarter or for 6 months basis, so for that short period of time, we may see some stall in terms of the growth. That may be a possibility. However, as far as the mid- to long-term basis are concerned, a deep discount, the category should grow. And within that category, Vector as well as JTI combined together, we can at least maintain the market share, and at the same time, capture that pricing element. We do expect to proceed in that direction.

[Unknown Executive]

Thank you very much, Mr. Saji. Let me introduce the next person. Mr. Morita from Daiwa Securities.

[Makoto Morita, analyst]

This is Morita from Daiwa Securities. Can you hear me?

[Unknown Executive]

Yes, we can.

[Makoto Morita, analyst]

I have a question about your balance sheet and your M&A strategy going forward and use of cash. So if you didn't do the Vector acquisition, net cash this -- it was a matter of whether you can become net cash -- in a net cash position this year. So going forward, as you continue to pay dividends, if you don't have any major investments that you're going to make, cash is likely to build up. So regarding your M&A strategy, is that going to be your priority going forward?

You did Vector this time around? And if you are, what kind of entities are you going to target? So is it going to be more about investing into your business than doing share buybacks? Is that your intention when it comes to use of cash, can you sort that out for me?

[Unknown Executive]

Thank you for the question. Based off our balance sheet, our M&A strategy, is it going to be a priority on business investments more than share buybacks. Mr. Furukawa will take your question.

[Hiromasa Furukawa, executive]

This is Furukawa speaking. Mr. Morita, thank you for your question. I'd like to make several points. So regarding our balance sheet and our view on the balance sheet, this might be redundant, but in the past, there were some times where there were financial economic risk in the world, but we were able to continue to sustain and steadily run our business.

So even if an economic crisis were to happen, we want to ensure that we can continue on with our business. So we need to have a balance sheet that is robust. And of course, it's not just about robustness. Based off that notion, if there are any attractive investment opportunities, we would like to enable a balance sheet that will give us flexibility to pursue those opportunities. So that's our basic way of thinking.

So based on this notion, our thoughts on M&A, as you asked in your question, is our stance hasn't changed from before. We believe it's a good way to grow by acquiring external assets. It is -- if it has good significance and if it makes sense, economically, we would like to continue to pursue acquisitions. So that stance hasn't changed. And currently, we did the Vector acquisition, but regarding additional acquisitions, HTS combustibles will -- are positioned as the most important category. We have been concentrating our managerial resources there. Therefore, of course, our stand remains the same regarding acquisitions or M&A as well.

We would like to go after these types of categories. And what's available wise, we are thinking about a variety of things is all we can say. But for example, we're focusing on HTS or RRP, and in this regard, IP, technology and start-ups maybe of our interest, although they may not be that significant in size. On the other hand, for combustibles, productivity, efficiency, profitability, investments will be made, that will enable us to enhance those types of KPIs.

As for share buybacks that you mentioned in your question, I just wanted to kindly remind you where we stand on that. For shareholder return, dividend per share continues to be our focus and central to our shareholder return policy. So we would like to continue to strive to reach the payout ratio we target, and in accordance with our growth or sustainable growth, we would like to ensure that we strengthen and enhance what we return back to our shareholders.

Of course, for share buybacks, we need to consider a variety of factors. So the financials of that given year as well as the business environment that we're in as well as free cash flow and medium- to long-term perspective on balance sheet as well as net income as well as how we're executing our business measures. So those are factors we will consider in determining the size and if we're not going to do share buybacks. But once again, DPS will be central to our shareholder return policy and M&As will be our focus as well.

[Makoto Morita, analyst]

One more thing I would like to confirm is regarding the robustness or soundness of your balance sheet, I think it's a matter of balance, but net cash, 0, are you striving to reach that level or status?

[Hiromasa Furukawa, executive]

Well, we don't have one single KPI that we're working towards. But I'm also not saying that we're not managing against nothing. So we do ensure that we are aware of cost of capital. And we confirm that our investments exceed cost of capital from a return standpoint. So we don't have one single KPI that we abide with, but we will look at the conditions surrounding us. And we would like to maintain a situation where we can consider numbers of options. And we will think about the financials that we are at, as we can consider the investment opportunities.

[Makoto Morita, analyst]

So you're not persistent or adamant about reaching net cash 0 status that you can tolerate not being net cash in a net cash position -- positive net cash?

[Hiromasa Furukawa, executive]

Well, sometimes, if you have a rigid target, you might not be able to pursue opportunities. So we're not adamant about reaching a positive net cash position.

[Unknown Executive]

The next question comes from JPMorgan Securities, Fujiwara-san please.

[Unknown Analyst]

This is Fujiwara from JPMorgan Securities. Can you hear me?

[Unknown Executive]

Yes, we can.

[Unknown Analyst]

So I do have one question related to acquisition of VGR, Vector Group. So through this acquisition from the combustibles cash flow would have much more debt. So in terms of RRP's investment, I do believe there's a possibility you may accelerate the investment into RRP. So through the acquisition of Vector, would they actually pose an impact in terms of RRP investment?

[Unknown Executive]

The question was related to the acquisition of VGR, whether that would accelerate the investment into RRP. So Mr. Kato would like to answer that question.

[Nobuya Kato, executive]

Mr. Fujiwara, thank you very much for that question. As you rightly mentioned, through the acquisition of Vector, the cash as well as profit will be on the increase. And we would like to allocate those for the RRP investment. In terms of the profit, that is generated from Vector, that would not be directly invested additionally into RRP. That is not the case.

So in fact, at the beginning of this year, we have the 3-year, the business plan 2024. And RRP investment, JPY 300 billion level has been increased to 1.5x to JPY 450 billion. We have already announced that the investment amount would be increased. So the RRP-related investment, we have already upgraded. That is the current state. And based on that, we would need to also secure the source and the resources to allocate investment and that was definitely one of the rationale for the acquisition of Vector.

Now for the RRP investment, we would like to refine and update the amount. And if there is a need for additional investment, we would need to have flexibility in securing the source for the [ investment ]. So from that perspective, the Vector acquisition was important. So to conclude, through the acquisition of Vector, the profit would not necessarily be directly led to the RRP investment. So it would not be as is to answer your question.

Well, basically, it would give you a wider options to explore them. So different ways to explore the cash usage then.

[Unknown Executive]

The next question is from SMBC Nikko Securities, Ms. Takagi.

[Naomi Takagi, analyst]

Can you hear me?

[Unknown Executive]

Yes, we can.

[Naomi Takagi, analyst]

I have a question about the litigation case in Canada. At the end, you were talking about this case. And if losses were to be incurred, dividends may be adjusted. I think you said that. So can you explain that a little bit further for me? Meaning dividend impact wise, does that mean you may have to cut dividends? Or are we supposed to account for any negative impact on dividends? And in the future, a Canadian subsidiary, the settlements I heard are going to be paid from their profits, but in your dividend policies going forward, is this case going to have any impact whatsoever or not?

[Unknown Executive]

The question was about the litigation in Canada, and specifics around dividend adjustments. And based off future profits, the impact on dividend policies, Mr. Furukawa, our CFO, will explain.

[Hiromasa Furukawa, executive]

Thank you for your question. This is Furukawa speaking. At the end of the presentation, yes, we talked about should a loss occur, we will consider adjusting dividends. I'm sorry, it lacks specificity, but there's a reason for that because for Canada, in the draft of plan of compromise and arrangement, although the amount has been disclosed, we haven't reached an agreement yet. As regarding how we're going to divide the damages has also not been decided either, the settlement amount. Nothing has been confirmed.

And we are not able to see a rationale amongst -- towards what's been proposed. If we are able to reach an agreement in some kind of way for the arrangement and if it takes effect, the actual amount size as well as the payment timing will be confirmed. And then for the first time, we'll be able to set forth the specifics. However, because if it were to be incurred, it's going to have a substantial impact, our payout ratio target is 75% by 5 -- plus 5% or minus 5%, we wanted to think about that there may be a chance we may have to consider making adjustments, but nothing has been decided yet.

But in accordance with the results, we would like to consider making the adjustments, if necessary. So it continues -- I continue to lack specifics, but that's because nothing has been decided, but we do have on our minds that we may have to make adjustments in accordance with the losses.

[Naomi Takagi, analyst]

So when you say adjustments, the meaning behind that, are you trying to make adjustments or consider make considerations so that you won't have to have that much impact on your dividend payments, right? And also, is it going to take much more time? What is the future time line, if you can share anything?

[Hiromasa Furukawa, executive]

Well, unfortunately, regarding future developments, I am not able to say anything definitive at this point in time. However, as I touched upon in the presentation, for JTI-Macdonald, our subsidiary, there's still some important challenges that still needed to be resolved and sorted out. So the plan itself has been disclosed. However, there are still some details that need to be worked upon. And it's not just us. There's probably opinions from other plaintiffs as well. So unfortunately, we are not able to give you any details.

[Naomi Takagi, analyst]

One more thing is hypothetically, let's say that if you lose the dividends from Canada, which I think is about 4% of total. And from other countries, if you make sufficient profits on a group-wide basis, the dividend pool can be greater. So can we work off that mindset?

[Hiromasa Furukawa, executive]

Well, of course -- we hope to do so, of course. But once again, as I said before, the details are yet to be decided. Therefore, the scale of impact needs to be confirmed first. So unfortunately, I'm not able to say a big yes to your question, but of course, we hope that is the case. And our company, we want to sustainably grow and ensure that we are able to continue to grow through steady profit growth.

[Unknown Executive]

I'd like to introduce the next question from Goldman Sachs Japan. Mr. Miyazaki, please.

[Takashi Miyazaki, analyst]

So this is Miyazaki from Goldman Sachs. I do have one question. My question relates to dividend. So AOP, you have revised up the guidance. But the profit, there's been a downward revision. So I think the dividend has stayed flat, no change. But you mentioned how you intend to sustainably grow. But it seems as if the profit outlook is somewhat weak. So shall we look at it, it cannot be helped because it's a one-off issues? Or are there any possibilities for improvement? So how do you actually perceive the revision of the guidance?

Also towards the next year, so the VGR, could we expect that to be a full contribution purely next year onwards? Or would there be some amortized or depreciated assets? So the net profit for 2023, even if it is flat for next year onwards, is there a possibility not the full amount may be contributed? So if you can share with us your outlook in terms of the dividend as well as the profit, the bottom line.

[Unknown Executive]

So this is the downward revision of the profit for the full year guidance, what is our valuation? And also next year onwards, what is the profit level for Vector? And also the general level of the profit. So our CFO, Furukawa-san, would answer that.

[Hiromasa Furukawa, executive]

So this is Furukawa. Thank you very much for the question. So in terms of this year's guidance, so the profit downward revision by JPY 8 billion. As mentioned already, because of the financial cost, we do expect a large loss. So in terms of the actual content, it is really the loss related to FX and also the corporate tax. The corporate rate will be on the rise. Therefore, the tax payment would also increase. These are one-off factors.

Also the VGR, some of the costs related to the existing borrowings, this is also a one-off factor. Now for FY 2025 onwards, how will this pan out? So it really depends on the FX situation and also the transaction and also the tax system situation. So we cannot actually comment with confidence at this moment for FY '25 onwards. Now would there be any sort of amortization or depreciation for Vector? There could be some intangible assets amortization, but we are conducting a PPA in terms of the valuation. So with next year's plan, we do hope that we can clarify some of these aspects.

[Takashi Miyazaki, analyst]

Just as an additional question then. So financial costs, financial profit loss deterioration, you mentioned that. So the one-off factors that pushed down the profit. So you mentioned some of the costs related to repayment of the debt, and what are the acquisition-related costs? So what is the underlying the profit we may expect? Of course, you're still in the midst of PPA at this moment. But at this moment, you must have expectation of the profit generated by Vector on top of the JT Group. If you can give us some color of the expectations going forward.

[Hiromasa Furukawa, executive]

As for the individual figures, unfortunately, we cannot comment. But with the VGR acquisition-related cost, so the existing borrowings related costs, that will be a one-off factor. And beyond that, so through bridge loans, we also borrow the funds related to acquisition. So you made some interest related to that. But again, this is a bridge loan. So that is a short-term basis. So of course, depending on the refinancing, this may change.

So inclusive of Vector Group, we would need to clarify what is our outlook of our business. And that should be outlined within the business plan for next year onwards. And we are still in the midst of formulation in conjunction with Vector. So once that is finalized, we would like to communicate those in an appropriate manner.

[Unknown Executive]

The final question is from Morgan Stanley MUFG Securities, Ms. Miyake.

[Haruka Miyake, analyst]

This is Miyake from Morgan Stanley MUFG Securities. On a constant currency basis, AOP has been revised upwards, you have the Vector consolidation impact as well. So factor-wise, that's contributing. Can you talk about which factors are contributing by what degree? And for the existing business upward revision part, it might be top line related and also cost related, meaning you didn't have to spend as much as you thought. So can you also elaborate on that as well?

[Unknown Executive]

The question was about this fiscal year's upward revision of AOP, Vector impact and company impact and existing business upward revision and its details. Mr. Furukawa will take that question.

[Nobuya Kato, executive]

Ms. Miyake, this is actually Kato, not Furukawa, and I'll take your question. So as you rightly said regarding the actual amount and contribution, we are not able to give you that number -- the numbers. But for the Vector acquisition and its impact, we closed on October 7th, and we have been -- it has been contributing to AOP ever since. The scale of it, although we cannot communicate the actual amount, the conventional level of profit that Vector was making is being accounted for, for the period ever since its consolidation.

And for organic -- the organic business contribution, additional investments, cost increases have occurred, but top line upward revision also has been made. And supply chain cost compared to our assumptions was relatively moderate, which has been a positive on AOP. So those are the major factors.

[Haruka Miyake, analyst]

For the upward revision of top line, I would think that it's EMA that's better than expected. So recently speaking, for top line and profits compared to your original plan, are there differences in how much progress the regions are making?

[Nobuya Kato, executive]

Well, like you rightly said, when it comes to volume, EMA has been contributing. However, when it comes to pricing for other EMA markets, we have been seeing good contribution. However, overall, the contribution from EMA is relatively higher.

[Haruka Miyake, analyst]

So when we heard about the second quarter, you were saying that EMA has a risk of a slowdown. But I guess -- and you were saying that it hasn't slowed down then. But considering Russia, Turkey, what are their conditions right now? And what's your outlook next fiscal year? Should we expect some changes to happen?

[Nobuya Kato, executive]

Yes, as you rightly remember at the Q2 earnings call, because total volume was brisk in Russia, Turkey and Iran, we were communicating that our outlook is that we're expecting a deceleration. In reality, when you look back at the third quarter, we did not really see a deceleration and we continue to see brisk trends. And for the fourth quarter, we'll have to determine how the trends are, as we consider next fiscal year's plan. But as you know, for next fiscal year's plan, we have just started to formulate the plan and we would like to share it with you and set it forth next year in February.

[Haruka Miyake, analyst]

So we're not at an inflection point or anything right now. No changes?

[Nobuya Kato, executive]

No, top line momentum continues to be brisk. And we believe that in this good shape, the trends are likely to continue on next year. That's how we feel now. So we're not expecting any major risks or changes at this point in time. Thank you.

[Unknown Executive]

So with that, we would like to conclude the Q&A session. So we would now to conclude the investor meeting for Q3 2024 results at Japan Tobacco Inc. today. So thank you very much for your participation.

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