Philip Morris International Q4 2023 Earnings Call Transcript

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Provided by Quartr
February 8, 2024

There are 9 speakers on the call.

Operator

Good day, everyone, and welcome to the Philip Morris International As a reminder, today's call is being recorded. I will now turn the call over to James Bushnell, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.

Speaker 1

Welcome. Thank you for joining us. Earlier today, we issued a press release containing detailed information on our The press release is available on our website at pmi.com. A glossary of terms, including the definition for smoke free products, as well as adjustments, other calculations and reconciliations to the most directly comparable U. S.

Speaker 1

GAAP measures The non GAAP financial measures cited in this presentation and additional net revenue data are available in Exhibit 99.2 to the company's Form 8 ks date on today's date and on our Investor Relations website. Today's remarks contain forward looking statements and projections of future results. I direct your attention to the forward looking and cautionary statements disclosure in today's presentation and press release for a review of the various factors could cause actual results to differ materially from projections or forward looking statements. I'm joined today by Jacek Orchard, Chief Executive Officer and Emmanuel Pavot, Chief Financial Officer. Over to you, Yasset.

Speaker 2

Thank you, James, and welcome, everyone. PMI delivered another strong operating performance in 2023. We achieved our 3rd consecutive year of positive volumes and a high single digit organic top line growth driven by Smoke Free Products. Smokefree Products delivered accelerated accretion to profitability in the 4th quarter as our IQOS business meaningful 2023 operating leverage, mitigating the significant drag from combustibles. I'm also very pleased to report the continued outstanding growth of ZYN, which was not included in organic metrics until mid of November last year.

Speaker 2

Importantly, smoke free products reached nearly 40% of PMI net revenues in the 4th quarter and over 40% of gross profit. For the year, smoke free gross profit increased by 19% organically, and we expect smoke free organic growth to for both net revenues and gross profit in 2024. Zwail delivered exceptional growth in its 1st year within PMI, with U. S. Pro form a volumes up by over 60% for the year and over 75% in the quarter 4.

Speaker 2

Oral smoke free is accretive to both our smoke business and the overall growth with Swedish Match contributing 50 basis points organic uplift to Q4 OI margins from only 50 days of the period. Our IQOS business continues to deliver excellent results with 15% adjusted in market sales growth for 6 week tobacco unit, reflecting broad based momentum in Europe, Japan and Emerging Markets. The rollout of IQOS Ilima is substantially complete and now present is present in the 51 markets representing over 95% the Vicos geographies by volume, excluding Russia and Ukraine. The superior experience and design of Ele. Me, Combined with the strong premium brand growth equity of IQOS and our commercial infrastructure enabled IQOS to outgrow heat not burn category despite holding a category share of over 75%.

Speaker 2

Importantly, as we have seen in Japan, the launch of Illumina is a multiyear growth driver cost expense with fast High cost Innovation. Our 2023 combustible performance was margin dilutive despite strong commercial results with very good pricing and higher category share. This reflects the significant cost pressures in the category, geographic mix from volume growth in lower margin market results more through product and the impact of IQOS cannibalization. This was also compounded by the technical impact of 3rd party manufacturing in Indonesia and Israel. While cost and currency headwinds impacted our revenues in 2023, the strengthening growth and margin profile of smoke free product set us up well to deliver sustainable growth and returns, including currency in 2024 and beyond.

Speaker 2

We reached a number of key transformation milestones in the last quarter of last year. First, IKO's net revenues surpassed Marlboro to become the number 1 international nicotine brand on this measure. This demonstrates the power of innovative smoke free alternatives to switch adult smokers away from cigarettes And to address the societal issue of combustible tobacco, it is also a testament to our organization's ability to build strong and sustainable brand equity. This also applies to ZYN, The fastest growing U. S.

Speaker 2

Smoke free brand was another outstanding performance in Q4, marked by an increase in category volume share, retail value share and overall volume. We're also proud to have reached 25 markets where smoke free products exceed 50% of our top line for both Q4 and the full year. We aim to reach 60 markets by 2,030, driving our ambition to exceed 2 thirds of group net revenue. Last, as I already mentioned, over 40% of our total gross profit was generated by Smokefree Products. With the adjusted gross margin rate on smoke free, surpassing combustibles for both the quarter year.

Speaker 2

We are encouraged by the increasing number of governments adopting tobacco harm reduction policies To encourage reduce the risk nicotine consumption instead of smoking, which is ultimately more sustainable for society. Nevertheless, a considerable amount of work remains. Sustainable growth requires a sustainable business And we continue to garner increasing recognition for our sustainability performance across the key product and operational topics for our company. PMI was included in the Dow Jones Sustainability toward the index for the first time. And for the 4th year in a row, DJSI North America.

Speaker 2

In addition, PMI was awarded Carbon Disposal Projects AAA rating for the 4th consecutive year. I will now hand it over to Emmanuel to discuss our results and outlook in more detail.

Speaker 3

Thank you, Jacek. Let's start with the headline numbers. We finished the year with Q4 organic net revenue growth of +8.3 percent. This includes plus 14% growth from smoke free products despite slower HTU shipment growth due to comparison effect and also plus 5% growth from combustibles. Pricing was a strong driver for both categories with Smoke free pricing including the impact of retail price increases on HTUs.

Speaker 3

While Swedish Match was Only included in organic metrics as of November 12, it contributed plus 0.8 percentage points to Q4 organic top line growth and grew by an excellent plus 26% on a pro form a basis. Operating income grew organically by a very good plus 8%, including a Swedish Match contribution of +2.2. As expected, Q4 margins were broadly stable organically and grew excluding the technical effect mentioned by Yaptek. This enabled our business to deliver another quarter of double digit currency neutral adjusted diluted EPS growth at +12.2%. This exceeded our prior expectations with ZYN's remarkable growth as a notable contributor.

Speaker 3

Despite this strong currency neutral result, Q4 adjusted diluted EPS of 1.36 was adversely affected by a greater than expected currency impact of 0.20 dollars This includes a balance sheet related impact under hyperinflationary accounting in Argentina, following the devaluation of the peso in mid December. As with the previously mentioned impact in Q3, this reflects the depreciation of monetary net assets denominated in Peso, which are subject to capital controls. By its nature, this does not carry forward to future periods. Turning to the full year, net revenue grew by +7.8 percent organically, representing the 3rd straight year of high single digit growth. Similar to Q4, this reflects continued excellent IQOS momentum and strong combustible pricing.

Speaker 3

In 2023, Swedish Match, led by Zvienn, grew pro form a ex currency net revenues by plus 20%. Operating income grew by +3.7 percent organically, reflecting a challenging first half, followed by strong growth in H2. We delivered expansion in both adjusted gross margin and operating income margin in H2, driven by the strong progress of smoke free product. With the impact of accelerated devices from the Illumina rollout in the base and return to Cifre to Japan, the effect of growing HDD volume and ongoing cost optimization are clearly visible. As expected, ORI margin organically contracted 150 basis points for the full year, primarily due to acute cost and supply chain headwinds in H1.

Speaker 3

As flagged in prior quarters, Full year margin include 40 basis point headwind from the accounting treatment of 3rd party manufacturing in Indonesia and Ukraine, primarily reflecting the Indonesia excise tax gross up of around $250,000,000 growth in both net revenue and cost of sales. While headwinds in combustibles have not fully abated, our smoke free business is delivering excellent profit growth And our organic result will include the strong contribution from Swedish Match going forward. We successfully mitigated inflationary pressure and supported investment with efficiency. Across our total operating cost base, we delivered an incremental $100,000,000 in gross cost efficiency in Q4 And $2,200,000,000 for 20 20 1, 20 23 overall surpassing our $2,000,000,000 target. We target an additional $2,000,000,000 over the next 3 years.

Speaker 3

These positive factors allowed us to deliver very strong currency neutral adjusted diluted EPS growth of +11 percent ahead of our prior expectation. Adjusted diluted EPS of $6.01 includes unfavorable currency of 0.63 dollars primarily reflecting the Japanese yen, Russian ruble and specific Argentine peso dynamic I just explained. We include a slide in the appendix to this presentation with more detail. Focusing now on volumes. We comfortably achieved a 3rd consecutive year of shipment growth, driven by a +15 percent increase for HEICO's HTUs in addition to a resilient combustible performance.

Speaker 3

Our smoke free volumes made up over 20% of total PMI in Q4 and with continued mid teens or better growth expected year, we are very well positioned to continue growing volumes over the mid and long term. 2023 HTU shipment volume of 125,300,000,000 units were at the lower end of our targeted range due to delayed launches in Saudi Arabia and Taiwan, combined with lower than expected underlying growth in Russia and Ukraine. For IQOS HTUs, we believe the best indicator of underlying growth is adjusted IMS as the closest metric to consumer offtake. For the full year, adjusted in market sales volume and shipment growth were in line at plus 15%. In the 4th quarter, HTU shipment growth of plus 6% reflect trade inventory buildup in the prior year quarter and the plus 14% adjusted IMS growth is therefore a more reliable measure of continued strong growth momentum.

Speaker 3

Excluding Russia and Ukraine, Adjusted in market sales grew by more than plus 17% for the year. For context, Across the 2 years before the war billion in 2022, these markets made up 23% of HTU shipment volume and exceeded the company's growth rate by a notable margin. These smoke free volume growth rates exclude the excellent development of our overall nicotine portfolio driven by ZYN with shipment volumes up by plus 23% in Q4 and plus 17% in 2023 on a pro form a basis. Cigarette shipments declined by a modest 1.4% in 2023, outperforming the international category decline of 2.4%. Turning to profits, organic operating income growth stepped up in H2 to plus 10%, following the exceptional headwinds of H1.

Speaker 3

We believe this is more representative of the underlying momentum of our business and in line with our 24% to 26% CAGR target range of +8 percent to +10 percent. Focusing now on some key drivers of our full year operating income. Smokefree gross profit grew organically by an excellent plus 19%, expanding gross margin by 3 40 basis points. This reflects part of the operating leverage of IQOS I already mentioned, With a notable contribution from Swedish Match overall nicotine in the last 50 days of Q4 with organic operating profit growth of over 50%. With small free commercial costs also increasing by less than net revenue, this clearly bodes well for 2024 as we continue to benefit from scale effect and manufacturing optimization.

Speaker 3

Despite very strong pricing, there was only marginal organic growth in convertible gross profit. This partly reflects the negative geographic mix I already mentioned with greater volume decline in higher margin market like Japan as adult smokers switch to smoke free product and better volume trends in lower margin geographies where smoke free products are small or not available such as Turkey. There were also significant inflationary pressures on leaf, direct materials and other manufacturing costs. Cost increases on leaf, where inventory cover multiple crop years and wedges are likely to carry over into 2024 and should ease thereafter. Moving now to Swedish Match, which delivered outstanding performance in its first year as part of PMI, with adjusted pro form a currency neutral top line growth of plus 26% in Q4 and plus 20% in 2023.

Speaker 3

When we announced our offer for Swedish Match in 2022, We targeted a return on investment in excess of our cost of capital within 5 years. With the growth of VIN surpassing our expectation, We now expect to achieve this well ahead of time. ZYN delivered another remarkable U. S. Performance with plus 78 volume growth in Q4 and plus 62% in 2023.

Speaker 3

Internationally, we have launched or relaunched ZYN in 10 markets as planned as we continue to focus on building a truly global brand. US Cigars posted robust 2023 results, growing net revenues and profit. This was driven by strong pricing following an increase in partially offset by volume decline, which reflect lagged competitor pricing and comparison effects. ZYNX's excellent U. S.

Speaker 3

Progress continued in Q4 with plus 15% sequential growth in 12 months volume shipments. Impressively, category volume share grew for the 3rd consecutive quarter to 72.8%, an increase of plus 5.4 points year on year and plus 2 points sequentially. Retail value share also grew during the quarter to 77.4 highlighting ZYN's premium positioning and superior brand equity. This accelerated growth again reflects a growth step up in nationwide store velocity and gradual distribution expansion as the category gained strong traction We'll add a nicotine user for its convenience and pleasurable experience. Now focusing on IQOS, Starting with user growth.

Speaker 3

We estimate there were 28,600,000 IQOS users as of December 31, representing growth of 1,200,000 users in the quarter and plus 3,700,000 for the full year, It's a nice acceleration compared to 2022. This includes notable progress in Japan and Europe, in addition to a broad range of other geographies. Illumina is now available in essentially All major markets outside Russia and Ukraine, with over 70,000,000 estimated adult users as of December 31, 2023. This reflects the switching of existing IQOS user and the acquisition of Adel Smokers. We expect Illumina to drive continued strong IQOS user growth in 2024 and beyond.

Speaker 3

Considering the seasonal and volatility in reported user estimation, we plan to report this metric on a semi annual basis going forward. With the addition of ZYN to our portfolio and the smaller but growing ZYN e vapor business, we also intend provide a more holistic view of our total smoke free user base to investors. Moving now to IQOS in the Europe region where Smokefree Product made up more than 45% of Q4 net revenues. Our Q4 adjusted HTU share increased by +1.2 points to 9.6 percent of total cigarette and HTU industry volume. A key driver is the growing uptake of Illumina, which is available to around 90% of IQOS users in the region after 8 further launches during the quarter.

Speaker 3

In the EU, 11 markets making up nearly 30% of regional IQOS volumes adopted the delegated directive to implement a characterizing flavor ban on heated tobacco product and implemented Clean Share policy in October. While still early days, we estimate only a small impact on offtake as consumer adjust as well as on trade inventory levels. Indeed, adjusted IMS volume continue to exhibit Very good sequential growth and reached a record high 12,400,000,000 unit on the 4 quarter moving average. This reflects double digit year on year progression of plus 13% in Q4, despite the lack of growth in Ukraine. We expect the remaining EU market to adopt the characterizing flavor ban in 2024 and estimate a full year consumer adjustment impact of around €2,000,000,000 unit on both shipment and IMS, representing less than 5% of regional volume and less than 2% of total PMI.

Speaker 3

This is consistent with other past favorable restrictions such as the EU ban applied to combustible in 2020. Based on the initial data from market that have enacted the ban, our fundamental view remains the same. We do not expect a meaningful change in the structural trajectory of the category and indeed expect Europe adjusted IMS progression to be broadly in line with a group growth rate in 2024. Europe is also an important geography for innovation. Livia 0 Tobacco HTUs were launched in the Czech Republic in mid October through limited channels with an encouraging initial response.

Speaker 3

We plan a broader Czech rollout later this month and further market launches this year. In Japan, the It Nut Burn category now represent close to 40% the total industry with IQOS driving its growth and reaching over 8,500,000 adult users. In Q4, the adjusted total tobacco share for our HTB brand increased by 3.1 points to 27.6 percent with Oftex shares surpassing 34% in Tokyo. Adjusted IMS volume increased by plus 14.5 percent year over year for 2023 and plus 13.4 percent in Q4 alone, reaching a record high of almost €10,000,000,000 unit on the 4 quarter moving average. Such interesting growth in a market with already high category penetration is a clear testament to the sustainable potential of IQOS around the world.

Speaker 3

To a more normalized take in the Q4 as compared to a tough prior year inventory comparison following the substantial completion of the transition Back to C4H8 in Q3. In addition to strong high growth share gain in developed countries, we continue to see very growth in low and middle income market. This slide highlights a selection of Q4 key city of Tech shares across markets Eastern Europe, Africa, Asia and Latin America. Egypt continues to impress with Kero Oftech share up plus 3 points to 9.4 percent, also noting encouraging result elsewhere in the region such as Morocco and Lebanon. Indonesia also saw notable progress in its capital city, especially given limited commercialization.

Speaker 3

We continue to see dynamic of spec drilling growth across these important future markets with the city shares toward the right of this chart an indication of the exciting potential. While we have already covered the margin dynamic on combustible, Our 2023 commercial performance was very robust with organic top line growth of plus 5.5%. This reflects both strong pricing with notable contribution from Germany and Indonesia and positive share performance within the resilient international category. Our cigarette category share grew by plus 0.1.224 and plus 0.2.2023 with notable contribution from Egypt, Poland and Turkey. Although, flattered by competitor supplied constraint in Egypt, which may normalize in 2024, we again achieved our ongoing objective of stable category share excluding this effect, despite the impact of IQOS cannibalization.

Speaker 3

This remains key as our leadership in combustibles helps to maximize Switching to smoke free product. This convertible share performance combined with structural growth of IQOS led to an increase of plus 0.6 points of international cigarette and HTU share for the full year. As mentioned previously, our superior share of Smokefree product give us a formidable platform for sustainable share gains with superior unit economics. Before we turn to the 2024 outlook, Let me briefly reflect on our strong delivery over the past 3 years in spite of a number of substantial headwinds. The performance was clearly positive compared to our currency neutral 20212023 target of more than 5% organic top line and more than 9% bottom line growth, supported by overall growing volumes.

Speaker 3

For the next few years, We target a similar strong volume delivery, a +6 percent to +8 percent organic net revenue CAGR and a step up in organic operating income growth to +8 percent to plus 10%. We target an adjusted EPS CAGR of +9 percent to +11 percent ex currency growth at constant 2023 corporate tax rate, including an increase in net financing costs, which skewed towards the 1st year of the period in 2024. Okay. This brings me to the outlook for 2024, where we expect a strong acceleration in smoke free performance across IQOS volume, smoke free net revenue and gross profit. We forecast the highest ever absolute increase in HTU adjusted IML volumes to deliver plus 14% to plus 16% growth in percentage terms despite the inclusion of an estimated impact of around €2,000,000,000 unit from consumer adjustment to the EU characterizing favor ban I mentioned earlier and essentially no offtake growth in Russia.

Speaker 3

For shipment volume, we target more than 140,000,000,000 units, subject to the usual inherent volatility of shipment timing, new market launches and potential supply chain disruption such as the ongoing situation in the Red Sea. While shipment growth rates naturally follow adjusted IMS over time, there is a possibility of some lower inventory level compared to 2023, given the substantial completion of Inuma launches and opportunities for working capital optimization. We expect continued excellent U. S. In volume growth to around 520,000,000 cans.

Speaker 3

We have also accelerated our capacity expansion plan to support this further significant step up in volume and to manage inventory level, which are naturally affected by the recent level of growth. Such a strong outlook for IQOS and ZYN means we expect to deliver an acceleration in organic smoke free top line growth compared to 2023, reaching close to 15 $1,000,000,000 in net revenue at prevailing exchange rate. This supports a total PMI forecast of plus 6.5 2 +8 percent organic net revenue progression, including the 4th consecutive year of total volume growth and mid single digit combustible pricing. We also forecast an acceleration in smoke free Gross profit growth from the organic plus 19 percent delivered in 2023 as IQOS profitability expands and the excellent economics continue. We expect Smokefree to again drive the lion's share of Our forecast organic OI growth of +8 percent to+9.5 percent, notably given the enduring cost pressure and negative geographic mix in combustible I just mentioned.

Speaker 3

This naturally implies organic margin expansion, even factoring in the ongoing technical dilution impact of third party manufacturing in Indonesia. We expect a meaningful organic improvement in overall gross margin, excluding technical impact and a very limited currency impact on adjusted OI margin. This forecast includes notable capability investment in the U. S. But as mentioned at Investor Day, we still expect to deliver strong double digit operating income growth in this market.

Speaker 3

As flagged at the last year in Investor Day, we anticipate an increased net financing expense this year as debt is renewed at higher rates. We forecast a range of $1,300,000,000 to $1,400,000,000 as compared to $1,100,000,000 in 2023. We also assume a higher effective corporate tax rate due to Russia's suspension of certain double tax treaties and earnings mix. The tax and interest factors combined impact our currency neutral adjusted EPS growth projection by around 2 percentage points. Accordingly, we forecast currency neutral adjusted Diluted EPS growth of plus 7% to plus 9%.

Speaker 3

This translates into an adjusted diluted EPS range of 6 point $3.2 to $6.44 including an unfavorable currency impact of $0.11 at prevailing rates. This notably includes a net favorable impact of EUR0.13 related to the revaluation of monetary balances in hyperinflationary economy in 2023 skewed to the second half comparison. Moving to the shape of expected 2024 performance on a quarterly basis. We anticipate good double digit growth in adjusted IMS SGD growth every quarter, supporting the full year forecast of plus 14% to plus 16%. We forecast a strong Q1 overall with HTU shipment volume of €31,000,000,000 to €32,000,000,000 and continued strong volume growth from ZYN.

Speaker 3

We expect organic top line and operating income growth to be broadly consistent with the full year outlook, which implies organic margin expansion as with the full year. We project strong Q1 currency neutral adjusted diluted EPS growth of plus 7 to plus 10%. This translates to a range of $1.37 to $1.42 including a negative currency variance of €0.10 at prevailing rates, with currency comparison improving in the second half as we lap the Argentina impact of 2023. Our business remains highly cash generative. However, the $9,200,000,000 in 23 operating cash flow was lower than expected.

Speaker 3

This was due to currency effect on net earnings, including the Argentine peso devaluation, other year end currency impact and higher than expected working capital needs. In 2024, we target between $10,000,000,000 $11,000,000,000 in operating cash flow at prevailing exchange rate and subject to working capital requirements. We continue to prioritize investing in innovation and the growth of our smoke free portfolio. In 2024, we expect capital expenditure of around $1,200,000,000 including the ZYN capacity expansion I just mentioned. Deleveraging remains a key priority for us.

Speaker 3

And as expected, our 2023 net debt to adjusted EBITDA ratio was around 3x given the 2023 purchase of the remaining Swedish Match minority and the final U. S. IQOS payment to Altria. We target much better progress of 0.3 to 0.5 times deleverage in 2024, driven by continued EBITDA growth and strong cash flow generation. We continue to target a ratio of around 2x by the end of 2026, with buyback to be considered once confirmed we are on track.

Speaker 3

Finally, our commitment to our progressive dividend policy is unwavering and in line with our long term commitment to return cash to shareholders. I will now turn it back to Jacek for concluding remarks.

Speaker 2

Thank you, Emmanuel. Let me now take a moment to cover our key Strategic priorities for 2024. 1st is supporting the sustained growth momentum of IQOS with continuous innovation. This includes leveraging the rollout of ViloMark to maximize user growth, while innovating further on top devices and consumables. 2nd is to continue the strong TUHs growth of ZYN, supported by targeted commercial investment, long term capacity expansion our organizational infrastructure, which will also support IQOS.

Speaker 2

Outside the U. S, we intend continue developing our integrated multi category offering to add our e coating users with further launches of ZYN and we will revamp our viv e vapor portfolio. Of course, 2024 will be a landmark year for IQOS in the U. S. While the ultimate launch of IQOSI Luma is the main priority, we continue to prepare for the 1st CT test of the IQOS 3 blade products starting in Q2 this year.

Speaker 2

The small scale pilot launches will allow us to with different aspects of commercialization and support our drive for at scale commercial success once Illumina is authorized. We have no update on the expected PMTA timeline, the patent settlement agreement announced last week allows for commercialization of both blade and induction products while mitigating risks of patent related disruptions and enables us to leverage the scale, optimize cost and flexibility of our global supply chain. In combustibles, we continue to target the stable category share over time despite the impact of IQOS cannibalization, while taking judicious pricing actions to drive a positive profit contribution. Our capital allocation priorities are crystal clear. Will continue to invest in the growth of smoke free products and our commitment to dividend remains stable.

Speaker 2

Following the acquisition of Swedish Match, the leveraging remains our key balance sheet objective. We aim to continue our excellent progress on sustainability initiatives, including those related to product impact, such as new access prevention and post consumer waste. Finally and importantly, We remain committed to transforming the tobacco harm reduction landscape by providing superior alternatives to adult smokers who would otherwise continue smoking and advocating for science based regulations. We will be expanding further on many of these topics Let me now conclude today's presentation. Overall, our business delivered a strong 2020 foot performance in the face of notable cost headwinds driven by structural smoke free momentum.

Speaker 2

The continued excellent performance of IQOS and the remarkable growth of ZYN strengthen their position as leading brands with excellent equity. Combined with our unrivaled commercial and innovative capabilities, We have a powerful platform to expedite our smoke free future as we broaden our portfolio and reach the adult smokers. We expect 2024 to be a year of accelerated growth for smoke free products and remain confident in our 2024, 2026 growth targets. We have exciting opportunities in the U. S.

Speaker 2

And internationally, which we are fully dedicated to capture as we progress towards our ambition of being sustainably smoke free by 2,030. Finally and importantly, Our strong growth outlook and highly cash generative business underpins our ability to leverage while returning cash to shareholders. Thank you. And Emmanuel and I are now happy to answer your questions.

Operator

Thank you. We will now conduct the question and answer portion of the conference. Our first question will come from Bonnie Herzog with Goldman Sachs.

Speaker 4

Hi, everyone. I actually wanted to ask a high level question on the year. You originally guided FX neutral EPS growth in 20 3% to 9%, yet you really did finish out the year a lot stronger reporting 11% currency neutral EPS growth. So As you look back, what were some of the key areas of outperformance versus your initial expectations? And then as you think about this year, you're initially guiding that 7% to 9% FX neutral EPS growth again.

Speaker 4

Just trying to understand how conservative this may be, especially considering your 9% to 11% mid term growth target?

Speaker 2

So Bonnie, with regards to 2023, I think the momentum of Which we have in the category as in Japan is really worth simply doubt. And despite the fact that IQOS occupies a very sizable part of the segment, mean, we capture well above our segments. I think we capture about 80% of the entire segment growth in Japan. So this is very strong. Japan is on the forefront of a smoke free transformation.

Speaker 2

We're approaching this year kind of anniversary of IQOS in Japan. And if I just look over the last few weeks how categories continuously the expansions in Japan. Think in the Tokyo area, the smoke free products now about exceeded the size of the cigarette category. So if IQOS continues after 10 years participating in this phenomenal growth, this is really our single out. Here we've been And as we indicated very much, we've been very keen and very pleased that we could conclude the acquisition of Swedish Match adds the important element of our portfolio of alternative to smoking the pouches and obviously creates a very good opening for us in entering the U.

Speaker 2

S. Market and as in Peru is growing, is growing above the expectations. What is very important as we hear from time to time quite likely conversations about Some unintended consequences about the use of the products. I am so pleased that both IQOS and his win actually Delivering of as they were designed for, I. E.

Speaker 2

Going after adult smokers in the U. S. About 21 years, we are all familiar with the CDC data Less than a 2% UBSH, just the same is for IQOS and International. So we have a good my view is we have a very good sustainable growing 2 fabulous propositions in the smoke free product and we also trying to be a very I focused from a financial perspective with regards to the E Rate. So right now, the role this through to 2024, I think Japan is on the good momentum.

Speaker 2

Within the U. S, this continues this momentum. Europe is doing very strongly, very well. Yes, we have this distortion, maybe potential headwind, which I think We very clearly indicated the $2,000,000,000 potential impact from that flavor ban in the year. But other than that, these key geographies and these key geographies also are very important from the margin perspective expansion.

Speaker 2

They really are on the positive side. And I don't want to sound negative on the rest of the world. However, one thing, Vijay, I know that On occasions, there might be some conversations around the growth trajectory of IQOS and so on. And you remember here at Investors Day, I've been very clear. We're running IQOS in the 10 consecutive years of a fabulous growth despite the fact We essentially lost any growth access to any growth in Russia and to Ukraine.

Speaker 2

And historically, I mean, Russia alone was delivering and depends how you know in each period of pickup, but easily about the 4,000,000,000, maybe even 5,000,000,000 per annum growth of the category. So I think we need to look at this trajectory from this perspective, which makes me even more confident about our priorities.

Speaker 4

Okay. Thank you. That was helpful. And then I did want to ask a little bit more on margins. Just hoping for a little bit more color on your margins in Q4, especially in Americas where they were negative.

Speaker 4

I'm assuming, I think you called this out, a key driver of this is your investments ahead of the IQOS relaunch in the U. S. In May, so in the context of this, how should we think about operating income growth in Americas this year? Will it continue to be negative. And then for the full year of 24 year, just total company, your guidance is For FX neutral revenue growth and operating income growth does imply operating margin expansion.

Speaker 4

So could you maybe touch Your expectations for gross margin and OpEx in the context of that?

Speaker 2

Yes. Emmanuel can chip in with more details. I think in the Americas segment, There is more the impact of the devaluation in Argentina, which drove the margins down rather than the U. S. Market, specifically about the U.

Speaker 2

S. Market, yes, there is the increased investment also to continue supporting ZYN growth is an expansion, but also in preparing Swedish merger international in the U. S. Organization for being able to handle IQOS soon and obviously, head of the organizations, is up to the opportunities and challenges of the U. S.

Speaker 2

Market. So there is a there are some investments which are already flowing through the P and L even ahead of the High cost per sales target of the commercialization. Emmanuel, do you want to

Speaker 3

Just to complement To answer your question, Bernie, in complement with Jeff Flake was saying on what is behind the higher than expected performance for 2023, Clearly, I think you described the very strong dynamic on the volume on the commercial dimension, if you want. But we've been very pleased as well with the development of our margin on our smoke free product. And we are today seeing the margin both on IQOS And on ZYN being above the average margin on CC, we are making progress on the profitability of the IQOS product, And we have some price increase in Q4 overall. So that was the plan dynamic, But it is happening, maybe even a bit better than what we're expecting, and we expect that to continue in Q4. And in that perspective, I mean clearly the U.

Speaker 3

S. Is a fantastic market. We've described the fact that the margin of ZYN in the U. S. Is best in class among our portfolio of product.

Speaker 3

And therefore, make no mistake, even if indeed we're going to continue to invest in the U. S, the U. S. Is going to be super nicely accretive in all parameter of our P and L at the level of the, of course, revenue growth, but also at the level of The margin evolution and the level of the operating income and reflect the fact that we talk about double digit growth and very strong double digit growth. U.

Speaker 3

S. Is a very powerful contributor to our financial performance.

Speaker 4

Okay. Emmanuel, if I may just clarify something then for this year, you are expecting gross margin and possibly op margin expansion based on your guidance, It implies op margin. Yes,

Speaker 3

we do absolutely, Billy. Yes.

Speaker 4

Okay. All right. Thank you.

Speaker 3

Thank you.

Operator

We'll go next to Gaurav Jain with Barclays.

Speaker 5

Hi, good morning. Two questions from me. One is just to clarify the Argentinian peso impact. So you have a $0.19 impact this year, which is linked to balance sheet revaluation. And on the slide, you are using the Argentinian Piso rate, which is equal to the spot rate.

Speaker 5

So there shouldn't be any further balance sheet revaluation down, which means that there is an automatic $0.19 benefit to EPS. Isn't that the way the math works?

Speaker 3

Look, of course, we cannot speculate on any further duration of the peso. The reality is that The amount in dollar term has been significantly reduced by the last devaluation. So a further devaluation would impact to a much lower amount. Now I don't know whether more devaluation could come. Frankly, we're not able to anticipate this kind of thing.

Speaker 3

What you have to take into account is that the basis has been in fact, has basically with the devaluation in December. So any further devaluation would apply to a lower base in Argentine and Peso?

Speaker 5

Sure. Maybe I'll ask it separately. And my second question is around Zen. We are hearing a lot of statements. We had a statement by Chuck Schumer, a lot of investors are concerned, they think that regulation is coming on ZYN, flavors will get banned.

Speaker 5

How do you plan to get ahead of this entire potential controversy that could emerge around ZYN?

Speaker 2

Yes. So as we observed over the last few weeks, we've had a lot of conversations around the ZYN in Social media and generally Internet and media, I think, look, ZEN is in the U. S. Market for 10 years, okay? And if you look even on the CDC, latest data on the U.

Speaker 2

S. Under age usage, etcetera, it It stays right below 2%, which is the lowest from any product, Neutrokin and also other products where there's some age restrictions are applied. I think we know a lot about the Swedish Match marketing practices and we were taking this And we were taking this very seriously during the acquisitions of Eurovision website 1. We have said that the alignment with Swedish Match was not only that they were pursuing the smoke free projects already, but also that they have a very Responsible and a disciplined approach to the marketing as we are on Web IQOS with Kitmat Veranti International. We had reached out to the few people who have been the most vocal in this conversation, Senator Schumer, but also to FDA.

Speaker 2

And I think the facts are different that sometimes it We're trying to build their positions in the media. So the product is helping adult smokers with Very strict with age verifications. Obviously, when it comes to the conversations among the adults In the social media, that's going a little well, it's going from speaking in a territory where we don't have controls. And it's not via Zynga and it's paid to ambassadors or Whatever this is being called in a social media. So we think what we're doing is put the right product from the Potential of a reduction of the harm and where the product is based on science positioned on the risk reduction continuum.

Speaker 2

It's frankly speaking, it is the best nicotine alternative to any other nicotine product, very much obviously versus the cigarettes. We have a pending PMTA with FDA, but I think the science is very strong and very conclusive on the site. So I feel very confident From the very beginning of our transformation, so is Swedish Match. We put the market team in very much a protection of the youth That is very, very high on our agenda. So I think it gives me the confidence that as I said earlier to Bonnie's question, We have a progress, phenomenal growth on the products, which are delivered in a very sustainable manner to adult smokers.

Speaker 5

Thank you so much.

Operator

We'll go now to Pamela Kaufman with Morgan Stanley. Good morning. Good Morning. I have a question about ZYN as well. It's seen phenomenal growth in the U.

Operator

S. Can you Talk about what's driving the acceleration in growth in ZYN in the U. S? And are there any particular regions where you're seeing stronger growth? And just on the ZYN guidance, it implies about 35% growth in U.

Operator

S. Shipments, but that seems conservative given the strength that we've seen. So is there anything that would temper ZYN's growth outlook relative to what we're observing?

Speaker 2

Yes. So there's an issue to remember from our Investors Day, the profile of the ZYN when it comes toward the Smoke over the adults are coming from there is any sourcing very nicely from a combustible cigarette, Obviously, sourced from the oral categories, including the tobacco containing pouches, the Swedish snails and similar products, But also resulting from the e vapor category. So it is being recognized by the growing number of adults the convenience of usage of a ZYN. It is another way of looking at ZYN. It is a natural Innovation or extension of the Swedish news product, the tobacco containing pouches.

Speaker 2

Obviously, as we know of them, Some people were not maybe comfortable of having a tobacco in the pouch. There are some optical hygienic type of maybe constraints, etcetera. And Zoom is something which is looks cleaner and is white, doesn't which might have been for or might be for some consumer create some resistance. So this is what I can say. I think the product has a good trajectory.

Speaker 2

The market is a large market in the U. S. The well developed Evate category, obviously, we're still a very sizable combustible cigarettes category And also many other oral tobacco phones, so it's a nice sourcing for ZYN, which is appealing to these audiences. With regards to your comments, we avoid the number of accounts for the customers which are reporting to our guidance for next year. Great.

Speaker 2

We very well familiar with brands in the U. S. Can any surprise us to the positive? Yes. Okay.

Speaker 2

But guidance is built on the number of the assumptions, right? I mean, it's global business, multi category And there are some headwinds, which were very today. I'm not sure whether they will all materialize, but I think it's the matter of is that this part of the year or the beginning of the year to single them out and be prudent. But there are also some upsides and the tailwinds, which we have whatever of. The year unfolds, we will come to the Q1.

Speaker 2

I mean, As of the year, you build the confidence as you go through the year.

Speaker 3

Yes. And, Uptan, to clarify the guidance here, we are coming with The growth year on year, that would be similar than the one we've been experiencing in terms of total volume growth, I'm looking at the percentage a year, versus 'twenty three and 'twenty two. So these are similar volume growth. It's reflected to be between the growth rate. We'll see whether we have seen going even higher than what we

Speaker 2

are forecasting for the time being.

Operator

Okay. Thank you. That makes sense. And a question on the patent settlement with BAT. Can you elaborate on the implications of that?

Operator

I know you've been investing in manufacturing capabilities in the U. S. For IQOS. How does the settlement influence your ability to import into the U. S.

Operator

And does it change your manufacturing strategy?

Speaker 2

Well, it actually allows us now to book or connect in the U. S. To the new supply chain, which is on the international supply chain from day 1, which is operating With all the benefits of economies of scale, etcetera. So obviously, as that mitigating type of a we have been implementing in parallel the alternative manufacturing in the U. S, but that obviously It's the satisfactory, first volumes.

Speaker 2

We do obviously result in the increased or elevated cost both on the Devices and acoustics and it will take a while until U. S. On a standalone basis would close at the same level of the benefits of the cost if you like as we had on international. So for us, it So it clears the path for IQOS, both late and Illumina. So we're bringing a lot of or removing, actually, I should say, uncertainty from today and going And IQOS, because it is U.

Speaker 2

S, it's just another market, which we added to the geographical family of IQOS presence from day 1 will have an access, as I said, to the pipeline of the products and the economy cost benefits as any international market. So for us actually is clarity and acceleration, which we gained through this agreement. And obviously, as we all know, the patent litigation territory has a high degree of uncertainty. And we're running a very sizable business. We were to have even more sizable business.

Speaker 2

We're very in addition now over U. S. And that clarity and the visibility Going forward, it is very important, which I believe is also important for investors too.

Operator

Thank you. I'll pass it on.

Speaker 2

Thank you. Thank you, Dan.

Operator

We'll go next to Faheem Bey with UBS.

Speaker 6

Hi, guys. Good afternoon. Thank you for the questions. I have a couple as well, please. Firstly, you're guiding for another impressive year of mid teens heat tobacco end market sales growth, you've highlighted Europe will be within that range.

Speaker 6

Historically, Europe's done slightly better. What markets make up the sort of difference to help you to still get to the mid teens growth, if you could allude to the larger markets. And within that, are you assuming any contribution From Taiwan, Saudi Arabia, you mentioned. And what should we expect for the U. S.

Speaker 6

As well, please?

Speaker 2

So maybe I start with that U. S. I mean, the U. S, we will do the test market 3 point what we call IQOS 3.0 of late product, which is literally for us the high cost and We're looking forward to get the more visibility from FDA with regards to the PMTA MRTPA for diecasiloma, which would allow us to accelerate the broader, more national type of the commercialization. So what we have assumed in 2020 In terms of the volume contribution of IQOS from a U.

Speaker 2

S. Is very minimal. We're more treating this as Testing the engine, commercial, consumer, pricing type of a solution rather than lower the current version of the product at the full scale. We have assumed we made some assumptions with regards of opening the markets in the IQOS today is not allowed. The trade that's on the list is obviously Taiwan.

Speaker 2

Okay, that's and our assumptions and we might be Right or wrong, but these are the assumptions that we made. These are the issues on the speed of some regulatory decisions and laws being passed and etcetera. And with regards to you, look, I mean, Although I believe and the histories have shown with the flavor type of regulations in the different categories, in the different places that Over a period of time, they don't have much of an impact to it at all. But we're going in a period that some markets, the markets So we'll be implementing these regulations. So I think I think we need to be cautious that there might be some distortions.

Speaker 2

I mean, we put in a guideline and we were very transparent with 2,000,000,000 potential with headwinds, which we typed in in a volume outlook for IQOS. But we all have materializes, not materializes because it is a matter of prudence, so we should talk about this. Other than that, the underlying IQOS growth, if I look at the share reposition in essentially all European market is pretty strong. Despite the fact that very much in Central Europe, There is maybe more of the pricing competition from our Hypnotem participants, but we also have There is stronger price competition. It's really strong price competition, I should say, but on the devices and the consumer base in Japan.

Speaker 2

And over the period of time, IQOS navigates with this highly Sometimes aggressive competitive pricing environment very well. So that's essentially where we are. Germany grows Nicely. Italy continues with a very strong growth momentum. I think that the major driver is Spain.

Speaker 2

We make the We started making the significant progress. So That's it from me. Yes.

Speaker 6

Thank you. And then just one other question, please. So you're expecting a smoke free acceleration in 2024, but that's not translating into group net revenue growth acceleration in 2024. Are you expecting a softer performance in combustibles in 2024, is that the discrepancy?

Speaker 2

Yes. I mean, this is the plan that is So, moment in time, at the beginning of the year, the blended outlook for the group revenues, combustibles, oral and obviously heat matburg, The few others smaller things. Look, we have managed last year to deliver a very strong pricing variance. I think again, it's fair to assume that that level of the pricing variance May not be repeatable this year, but there is obviously a pricing potential, which we're basing in the or included in the guidance. Look, for some of these things, we need a little bit more visibility to start increasing our confidence.

Speaker 2

I said the late that As I compare what FieldMark is delivering now, a number of the years when we leave their revenue top line about 7%. And remember very well the times when we started transformations where we were at 3% to 5%. Now I think quality what counts for us and this is what we pay a lot of attention that we not only we want to lift in a sustainable matter The revenue growth, but obviously importantly, the quality of the revenue growth. So now having a 3 years total group volumes To start with above, while no decline, not even a flat but growing, then we start overlaying the desired pricing, then managing to focusing to avoid the risk of some down trading, etcetera. I think that's The 7% is the over the top 7% revenue growth is the pretty From a qualitative perspective, not just from the nominal growth perspective, I would think that is all the pivot.

Speaker 3

Just to add to what Jeff has just been saying, indeed, please take into account that 2023 was exceptional when it comes to price is close to 9% on the convertible portfolio and we don't intend to repeat that. We are guiding to mid single digit price increase for 2024. So of course, that will have an impact and make a difference on the growth of our revenue on the convertible business.

Speaker 7

Thank you very much.

Speaker 2

Thank you.

Operator

We'll go next to Cowen Elliott with Bernstein.

Speaker 8

Hi, good morning. Thank you for the questions, guys. I just wanted to start with disposable vaping products. We've obviously seen these products have huge success in the U. S.

Speaker 8

In 2023 and the U. K. Also driving us a steeper volume decline for combustible cigarettes in those markets. Obviously, your combustible cigarette business in those two markets is not huge, it's non existent obviously in the U. S.

Speaker 8

So not a huge impact on your business so far. But my question is why do you think we haven't seen equivalent for these products in the markets that are big markets for your business and the EU in particular? And do you think this could be a threat to your business in 2024?

Speaker 2

You mean the threat to our business coming from There are a number of factors, right? So one is that I think that the category of these products is Being disposable is not disposable. It's very much focused in terms of the offering and innovation, frankly speaking, into the flavors, right? And we very often forgot that the color of the smokers market by market with literally few exceptions Very much on the what I would characterize as a traditional tobacco type of experience, flavor, etcetera. So this creates sort of a more dual consumption or occasional consumption.

Speaker 2

But I think for some snorte, and we know it from our experience of IQOS, it actually triggers curiosity to try, but at the same time triggers the bottleneck in terms of full time type of switching Adoption. That's the one of the factors, okay? And there are obviously other factors that are playing.

Speaker 8

I guess, I understand that, Yasser, but why hasn't that it seems like in the U. S. And the U. K, that like in the U. S.

Speaker 8

And the U. K. That hasn't been an impediment to these products' success over the past 12, 18 months?

Speaker 2

That is also the focus, right? Because U. K. Was on the forefront as was U. S.

Speaker 2

As I remember historically of the forefront of this category, Partially, I guess, also attracted by the underlying margins in the CC category. So Obviously, people are going with alternatives to the places, which create some sort of That underlying margin opportunity with the relative freedoms also to talk about this product. As you know, Europe very much, but also in international, some countries, these products are not very, let me put it at very warmly welcome. So Let's leave aside the hardware action principles, but some other opinions and appeals at play. We know that when we enter the e vape category, But we're trying to be very disciplined or focused, I should say.

Speaker 2

It's very easy to enter into this category as a result of too much of the to sustainable profitability. And we don't want to defocus the company from some other opportunities which we pursuing, which in other views are more sustainable and also the good path for the margins and the underlying profitability. When we enter with this product, Italy, Czech, a few other markets and then our products despite the fact that we're relatively late From a category system perspective, I mean, we have gained double digit shares in this market in the Speed or span of less than a 12 months or so. So it also tells you there is a lot of lack of loyalties in those. There's a lot of Yes, I know that we see the volumes, but there's a lot of trial.

Speaker 2

I should not very category and the pouch is judged by Performance in the U. S. I mean by definition the consumer is more loyal, more focused, more disciplined

Speaker 8

Okay. Thank you. And I have a follow-up that is related, but maybe a slightly more philosophical question. In a number of markets and especially the U. S.

Speaker 8

Related to some of these disposable vaping products, we've been seeing this formation of I would describe it as like a dual tiered market that's been forming with big legacy players such as yourselves who are sort of forced video on ZYN last week, I would imagine. But at the same time, we also have a secondary set of smaller new businesses who seem to be doing basically whatever they And often illegally, but having great success within the marketplace and attracting lots of consumers. And so I guess my question is, Do you think that this dual tier structure that seems to be forming in a number of markets structurally impairs the attractiveness of your business and your brands, but when it seems like you're just being forced to play on a playing field which is not level?

Speaker 2

Well, look, obviously, companies like others It's not even thinking about doing something which would be against crossing the line of regulations or even I would say, societal expectations. So obviously, I mean, our ability to compete is, I believe what you're asking, grossly different some other operators or participants in the market, especially people who don't have a 10 years or 15 years outlook, but it's essentially hit and run almost type of operation. And I think we know what has happened, a lot is happening in the U. S. Yes, I understand some discipline in the market is now underway, but Thank you.

Speaker 2

Speaking is a long overview because there is a lot of, pardon my language, but the mass created in the market by the fact that Regulators, law enforcement and other design for this designated for these agencies were a bit slow. And I think it's frankly speaking, the replica, which we have for many years and still in some places have on cigarettes market, then the phones of illicit type of participations in the market is not only marketing practices, but also products, product standards, all of this phase creates completely wrong distortions in the market that they expense of the legitimate tobacco category manufacturers. And also, it diverts the conversation. So I mean how further we can progress and have reductions and it diverts them into the things which relatively easily should be fixed.

Speaker 5

Okay. Thanks, Jasmine.

Speaker 2

Thank you.

Operator

Our final question will come from Matt Smith with Stifel.

Speaker 7

Hi, thank you, Yossi and Emmanuel. Wanted to ask a follow-up question about investment levels embedded in the 2024 outlook. If we consider the expectation for gross and operating profit margin expansion on an organic basis, can you talk about the areas where you're seeing a step up meaningfully in incremental investment? Last year you called out $150,000,000 of explicit investments including $75,000,000 or so in the U. S.

Speaker 7

It would seem like the growth in ZYN would allow you to step that investment level up while still being able to achieve your double digit profit expectations in the market?

Speaker 2

Yes. So, in the line of hand, obviously, we target Adjusted the life growth above our revenue growth. So obviously, Assuming some improvement in the margins, but on the other hand, I think we will have enough of the resources support that revenue growth. So it is if we were to completely stop investing, obviously, the expansions on OI growth would be much more significant, margins expansions would be much more significant, but we are it is not what is in our strategy. So I think once you operate at scale and we do, right, because ZYN has the scale in the U.

Speaker 2

S. And The revenue is very substantial over there. It is by the U. S. By the market stand out and the revenue which we generate from a small crude but also combustibles On international, we've got sort of a revenue growth rates.

Speaker 2

I think we have a room to provide for the investments to support today's and tomorrow's growth, while also allowing for the or driving the margin expansion. We also have provided here some inflationary pressure. And I think especially on the combustible, I we assume that the 2024 is sort of the last year of this extra Organized, I believe, the inflation of a pressure and as of 2025 in other words, we should start We're seeing easing on the COGS pressures and this is about dilute and some other materials. And I think Every incremental IQOS and every incremental zone is obviously requires proportionally less of the investments, the different cycles and the trend series. So I mean, the scale offers going forward this opportunity for supporting the margin.

Speaker 7

Thank you, Jacek. I can leave it there in personnel.

Speaker 2

Thank you.

Operator

That concludes today's call.

Speaker 1

Before closing our call, I'd like to remind you that we'll be presenting at the CAGNY Conference on February 21, and we hope you'll be able to join either in person or virtually. Thank you again for joining us today. If have any follow-up questions, please contact the Investor Relations team and hope you have a great day.

Speaker 3

Thank you all. Speak to you soon.

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Earnings Conference Call
Philip Morris International Q4 2023
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