Emmanuel Babeau
Chief Financial Officer at Philip Morris International
Thank you, James, and welcome, everyone. In Q1, we delivered outstanding performance that exceeded our expectations with double-digit growth in organic net revenue and operating income, as well as currency-neutral adjusted diluted earnings per share, all supported by robust volume growth. Excellent smoke-free business momentum continues with plus 25% organic growth in net revenues and plus 38% in gross profit. As IQOS operating leverage and ZYN mix contribute positively, IQOS continues to advance rapidly with growth of plus 13% in adjusted in market sales volumes and plus 21% in shipments.
IQOS ILUMA is a key driver of this progress and is now available in 64 markets representing nearly 100% of IQOS volumes outside Russia, ZYN also continued its considerable growth in Q1 with U.S. volumes up plus 80%. Importantly, this top line performance translated into strong operating income growth and margin expansion, both organically and in dollar terms. This was notably driven by accelerating profitability in both our IQOS and ZYN businesses in addition to improving combustible performance. We faced higher than expected currency headwinds in the quarter primarily due to the devaluation of the Egyptian Pound. We are taking mitigating actions including additional pricing and accelerated cost initiatives which allowed us to deliver Q1 adjusted diluted EPS above our prior expectation, despite these pressures. While the prior year quarter was favorable for certain gross comparison, this exceptional start to the year set the stage for us to deliver significantly better than expected 2024 currency-neutral growth and robust growth in U.S. dollar at prevailing rates.
Turning to the headline numbers. Very good shipment volume growth of plus 3.6% supported organic top line growth of plus 11% or plus 8.6% including currency. This reflect continued excellent IQOS and ZYN momentum as well as strong combustible pricing. Operating income grew by plus 22.2% organically versus a softer prior-year quarter, notably driven by gross margin expansion and a deceleration in SG&A growth. As a result, our organic OI margin expanded by plus 3.7 percentage points. In dollar terms, adjusted OI grew by plus 11.3% and adjusted OI margin expanded by 90 basis points.
We outperform our Q1 adjusted EPS outlook due to three main factors:
The first is the net revenue and profit impact of better volumes following the industry-leading performance of ZYN, the strong shipment growth of IQOS HTUs, including some higher than expected timing benefit and a resilient combustible delivery.
Second is the benefit of our pricing action to mitigate currency headwinds.
And third is on cost, including some timing benefit and a step-up focus on manufacturing and back office efficiencies to prioritize growth investments. The majority of the outperformance was driven by underlying business dynamic, which bodes well for the remainder of the year.
Indeed, we delivered adjusted diluted earnings per share of $1.50 representing plus 23.2% growth, excluding an unfavorable currency impact of $0.20, this includes $0.09 from the devaluation of the Egyptian Pounds, including a transactional impact of $0.06, primarily related to the balance sheet remeasurement of foreign currency payable. With increased liquidity in the Egyptian Pounds, we are now reducing our balance sheet exposure and this should be complete in the coming weeks.
Focusing now on volumes. Our Q1 HTU shipments of 33.1 billion units exceeded our outlook with robust underlying growth across geographies and higher than anticipated timing impact of shipment to Japan. The incremental phasing impact was around 1 billion units and was primarily related to Red Sea disruption. While uncertain, we assume this will normalize in the second half of the year. As mentioned previously, we believe the best indicator of underlying HTU growth is adjusted in-market sales as the closest metric to consumer offtake. Adjusted IMS volume grew nicely by plus 12.5% including the expected impact from the characterizing flavor ban in Europe. We continue to see strong IQOS momentum with excellent growth in Japan, robust underlying fundamentals in Europe and a growing contribution from newer markets such as Indonesia.
We continue to target plus 14% to 16% adjusted IMS growth for the year, with around plus 10% growth in Q2 followed by an H2 acceleration driven by the timing of commercial programs, ILUMA uptake, newer markets and a less demanding prior year comparison. Total smoke-free volume growth of 22% includes the impressive expansion of our oral smoke-free portfolio powered by ZYN, with pouch equivalent shipment volumes up by 35.8%. U.S. ZYN shipments grew by 80% to 132 million cans. Cigarette shipments declined by a modest 0.4% in the first quarter, with a notable positive contribution from Turkey as we increased share in a strong overall market.
Let me now walk through the drivers of our Q1 net revenues. As I mentioned, volumes grew by a remarkable 3.6%, including oral. Pricing contributed 5.5 points of growth primarily from combustibles, as well as pricing of around plus 3% on HTUs. Smoke-free category mix added plus 3.1 percentage points to the top line, reflecting the higher net revenue per unit of IQOS and, to an even greater extent, ZYN. Oral smoke-free product overall boosted our organic net revenue growth by plus 2.2 points, showcasing its role as a meaningful accelerator. [Technical Issue] to report a positive contribution from our VEEV e-vapor business which, while still small in the context of the group, delivered good revenue growth.
As in 2023, there was a negative geographic mix within our combustible business as lower margin markets, often without smoke-free products, grew faster; and smoke-free products accelerated cigarette decline elsewhere. The positive category mix impact of smoke-free products, [Technical Issue] and pricing are the three enduring engines of our transformation and growth.
Focusing now on the key dynamic of our Q1 profit delivery, smoke-free gross profit grew by an impressive plus 38% organically, on top line growth of plus 25%. This reflects the very strong performance of U.S. ZYN and the growth and scale effects of IQOS, including manufacturing productivities. This strong underlying acceleration was amplified by only a few percentage points due to HTU shipment phasing.
Gross margins expanded substantially for both heat-not-burn and oral nicotine, and by a striking 600 basis points organically for smoke-free overall, which made up close to 39% of total gross profit, an increase of plus 6 percentage points versus prior year. Combustible organic gross profit growth was notably improved and exceeded our expectation at plus 2.3%. Gross margins were also better-than-anticipated, leading to an improved full-year outlook. Resilient volumes, strong pricing and manufacturing productivities more than offset the continued cost pressures in the category, geographic mix, and the impact of IQOS cannibalization.
As previously flagged, cost increases in leaf, wages and certain other inputs carried over into 2024, and these should ease next year. We were also impacted by around $30 million of costs from implementation of the EU Single-Use Plastics Directive, primarily on cigarettes. A key feature of Q1 was strong operating income margin expansion. Gross margin increased organically by 150 basis points and by 80 basis points including currency. This reflects excellent expansion within smoke-free products, their growing weight within our business at higher margins, and the better-than-expected evolution of combustibles. These factors, combined with productivity savings, significantly outweighed the unfavorable technical dilutive impact of third-party manufacturing in Indonesia, which equated to 30 basis points in the quarter.
For SG&A costs, currency-neutral growth of only plus 1.4% drove plus 220 basis points of organic margin expansion. This benefitted from our resource allocation and prioritization programs, including the delivery of approximately $160 million in gross cost efficiencies across COGS and SG&A towards our $2 billion target for 2024-2026. Although the Q1 margin impact of SG&A cost evolution including currency was small due notably to Egyptian Pound transactional currency, we continue to target SG&A progression below top line growth for the year. We expect higher organic SG&A increases in the remainder of 2024, notably reflecting investment spend phasing, which was favorable in Q1. The combination of these factors powered a remarkable 370 basis point expansion in our organic operating income margins, and plus 90 basis points including currency. This exceeded our expectation and we are now raising our full-year operating income growth outlook, as I will come back to.
Taking another lens on adjusted OI margins by geography, we see broad-based global momentum with all regions delivering strong organic progress. In dollar terms, margins expanded in every region except the South and Southeast Asia, CIS, and Middle East Africa region, mainly reflecting the transactional currency impact of the Egyptian Pound and the technical dilution in Indonesia. [Technical Issue] excluding these factors, this region grew margins at a very similar rate to the Group.
Moving [Phonetic] to IQOS. With ILUMA now widely-launched, PMI HTUs continue to strengthen their position as the second largest nicotine brand in markets where IQOS is present. PMI HTUs now exceed the 10% market share milestone on the prior basis excluding Indonesia, which we now include following broader commercialization in the market. Our HTUs are the number one nicotine brand in 11 markets, and as shown at CAGNY, IQOS net revenues have surpassed those of Marlboro.
Focusing on IQOS in Europe, Q1 HTU share increased by plus 0.9 [Phonetic] points, also crossing the 10% regional share milestone for the first time. While still early in many markets, the growing availability and uptake of ILUMA is a key driver and we are seeing a strong acceleration in a number of historically slower growth markets. Adjusted IMS volumes continue to exhibit robust sequential growth and reached a record high of 12.6 billion units on a four-quarter moving average. This reflects year- on-year progression of 9.4% in Q1, with excellent growth in Greece, Portugal, Germany, Spain, U.K. and the Netherlands. Growth was slower in certain Central European markets such as Poland and Czech Republic, where increased economic pressures and price-sensitivity are visible.
We continue to evolve our portfolio in these markets under the recently-launched ILUMA system to drive further growth. Excluding Ukraine, where growth was absent, adjusted in-market sales grew double digits. As anticipated, the 11 markets so far affected by EU characterizing flavor restrictions saw an impact in line with our total region estimate of around 2 billion sticks for the year. Consistent with similar past situation, we observe an initial consumer adjustment followed by a reversion of growth rates to previous levels. We have not seen meaningful shifts towards e-vapor or competitor heat-not-burn products, and we expect the structural growth of IQOS to fuel continued HTU progression over the rest of the year.
The strong fundamental progress in the region is highlighted by the expansion in key city offtake shares. Very strong gains in cities with already high IQOS adoption, such as Lisbon, Rome, Athens and Budapest, demonstrate the potential for further growth at the national level. The recent acceleration in London, Madrid, Munich and Amsterdam is also very promising for the IQOS brand in these markets and for Europe overall.
In Japan, the adjusted total tobacco share for our HTU brands increased by an excellent plus 3.1 points to 29.3%. Adjusted IMS volumes increased by plus 13%, maintaining the rapid progress of recent quarters. Such impressive growth in a market with already-high category penetration is a clear testament to the sustainable growth potential of IQOS around the world. In connection with IQOS' strong brand equity and commercial footprint, we are fostering growth through continued innovation on both devices and consumables.
In March, we launched the latest IQOS device ILUMA i, in direct channels with national expansion ongoing. We remain laser-focused on innovation. Our innovation in consumables has included a number of new variants and taste experiences on the premium TEREA brand. As shown by the offtake data on this chart, this has helped TEREA to continue growing Japan share at the same time as mainstream-priced SENTIA. This successful strategy of broadening consumer appeal with different price tiers while reinforcing and growing the premium line-up is a good illustration of how our IQOS business is evolving across markets as the category continues to grow.
The potential of the category is clearly demonstrated by the performance in Tokyo. As shared at CAGNY, heat-not-burn category volumes surpassed combustibles in January and have continued to grow since then. Led by Japan and Korea, the East Asia and Australia region reached almost two-thirds smoke-free net revenues in Q1. While somewhat flattered by shipment timing, this clearly demonstrates the path forward for the broader company as we strive towards our ambition of becoming substantially smoke-free, surpassing two-thirds by 2030.
Outside of Japan and Europe, we continue to see very promising IQOS growth across the globe, including low and middle-income markets, as highlighted by key city offtake shares. A notable call-out is Indonesia, where we have expanded commercialization to targeted areas in new cities and introduced TEREA clove variants catering to Kretek taste preferences. We have witnessed an uplift in user growth, and now have over 150,000 estimated IQOS users in the country. Our city offtake share in Urban Jakarta is one indicator of this, with plus 1.6 percentage point growth to 3.4% in a growing total industry. We are also pleased to report the reacceleration of IQOS growth in South Korea following the introduction of ILUMA.
TEREA recently became the number one HTU brand as measured by national c-store offtake, and in Seoul IQOS market share grew by 1.8 points to 12.8%. Egypt continues to stand out with Cairo offtake share up plus 1.3 points to 9.1% despite recent pricing, and we also see promising results in Malaysia, Morocco, Lebanon and the Balkans. While not shown on this slide, Saudi Arabia also had a promising restart with Q1 national offtake share of 1.3% following the resumption of IQOS commercialization in late-2023. In a similar vein to some of our European markets, the November launch of ILUMA in Canada has coincided with an acceleration in key city growth, as shown here by Toronto. While still early days for ILUMA and in a very restrictive regulatory environment, this is clearly a positive development.
Moving now to ZYN, where excellent U.S progress continued in Q1 with plus 70% sequential growth in 12 months rolling shipments. Impressively, category volume share grew for the fourth consecutive quarter to 74.3%, an increase of plus 6.9 points year-on-year and plus 1.3 points sequentially, despite a $0.15 per can price increase in March. Retail value share also grew to 79.3%, highlighting ZYN's premium positioning and superior brand equity. This accelerated growth again reflects a broad step-up in nation-wide store velocities and gradual distribution expansion as the category gains strong traction with adult nicotine users.
As outlined at CAGNY, we remain focused on marketing ZYN responsibly to prevent unintended use. We support the FDA's efforts to ensure only consumers over 21 have access to nicotine products. Swedish Match follows a robust U.S. marketing code that prohibits using social media influencers, age-gate digital platforms to 21-plus and includes partnering with We Card to help ensure retail sales only to legal-age adults.
I'd like to spend a moment now on combustibles, where our portfolio delivered robust organic net revenue growth of plus 3.7% in Q1. This primarily reflects better than expected pricing of plus 7.9%, with a notable contribution from Germany, and stepped-up pricing in Egypt. The pricing environment remains favorable, and we now forecast a full-year increase of plus 6% to plus 7%, with annualization effects lessening in H2. Our cigarette category share grew by plus 0.3 points in Q1, and this includes positive contributions from Algeria, Poland, and Turkey, resulting in only a modest volume decline in a total cigarette industry, which fell by 0.6%.
Our global brands gained category share during the quarter, with Marlboro gaining plus 0.4 points. As previously flagged, our 2023 share of segment was flattered by competitor supply constraints in Egypt, which may normalize this year. As I already mentioned, strong pricing in Q1 coupled with accelerated manufacturing productivity also resulted in a better than expected margin evolution.
Now, let me provide an update on our latest innovation and expansion plans as we further accelerate our smoke-free transformation. As I covered earlier, we recently launched IQOS ILUMA i, our most innovative offering to-date, in Japan. The ILUMA i portfolio consists of three devices offering a range of adaptable new features. This includes the new touchscreen on the device holder, which allows users to see experience-relevant information quickly and easily, as well as a pause mode so users can pause and resume their smoke-free moment where they left off.
Initial consumer feedback has been very positive. Japan was the first market to launch ILUMA in H2, 2021 and we plan to gradually roll-out ILUMA i to more geographies over time. As shown in our Japan and Indonesia performance, consumable innovation on the ILUMA platform is also critical, as we broaden offerings across markets. LEVIA HTUs, which contain nicotine but no tobacco leaf, were launched nationwide in the Czech Republic and Romania in Q1 with promising initial results. More markets are planned later this year. DELIA, our new mainstream-price brand for HTUs, was rolled out in Switzerland, Hungary, and Lithuania.
In the U.S., we continue to prepare for the first consumer pilot in select cities with the IQOS 3 system. As mentioned previously, the commercialization will be initially limited in scope and will be focused on direct activation of select legal-age nicotine users in a few cities, allowing us to experiment with different element of the commercial model. The main purpose of these consumer activation is to fine-tune our approach in anticipation of the at-scale launch of IQOS ILUMA, following authorization from the FDA. The international expansion of nicotine pouches remains a key focus, notably for ZYN as the world's leading brand. We have launched or relaunched in 11 markets so far, with more planned later this year. In e-vapor, our focused strategy for VEEV is showing very good early results. Positive consumer feedback is translating into promising repeat-purchase and conversion rates, and we are on a path to profitability in H2.
This brings me to our outlook for 2024. With unparalleled smoke-free volume momentum, best-in-class pricing and expanding margins we are raising our full year currency-neutral growth forecast. This strong pricing, combined with positive smoke-free mix and efficient cost allocation also helps us to mitigate currency headwinds and should allow us, at prevailing rates, to deliver on our objective of robust growth in dollar terms. Given continued ZYN volume progress, we are increasing our U.S. shipment forecast to around 560 million cans. We have further accelerated our capacity expansion plans to support this additional step-up. We continue to target strong growth in both adjusted IMS and shipments of IQOS HTUs, and to reach close to $15 billion in 2024 smoke-free net revenues at prevailing exchange rates.
Factoring the increased ZYN shipment forecast and a strong pricing outlook on both combustibles and smoke-free products, we are increasing our organic net revenue growth forecast to plus 7% to plus 8.5%. In addition to higher revenue growth, we expect accelerated organic margin expansion. This is strongly driven by a significant expected uplift in our smoke-free gross margin due to IQOS scale effects, ZYN mix and accelerated manufacturing productivities. It also includes organic gross margin expansion in combustibles, where we had previously assumed a negative development. In addition, we are focused on delivering further SG&A efficiencies while continuing to invest in smoke-free growth.
As a result, we are raising our organic operating income growth forecast to plus 10% to plus 12%. Accordingly, we are raising our forecast currency-neutral adjusted diluted EPS growth to plus 9% to plus 11%. This translates into an adjusted diluted EPS range of $6.19 to $6.31, including an unfavorable currency impact of $0.36 at prevailing rates. The increased forecast headwind is primarily explained by the devaluation of the Egyptian Pound and recent weakness in the Japanese Yen. As I mentioned, we are taking proactive actions to mitigate the incremental impact. We expect full-year gross and operating income margin expansion, in both organic and dollar terms at prevailing exchange rates, this includes organic expansion in both H1 and H2.
After the excellent Q1 performance, we expect a strong H1 overall with organic net revenue and OI growth around the high-end of our full-year ranges. For Q2 specifically, we assume HTU shipment volumes of $34 billion to $35 billion and continued strong volume growth from ZYN. We forecast currency-neutral adjusted diluted EPS of $1.50 to $1.55, including an unfavorable currency variances of $0.14, at prevailing rates.
With regard to our balance sheet, deleveraging remains a key priority. We continue to target a 0.3 times to 0.5 times improvement in our net debt to adjusted EBITDA ratio in 2024, driven by profit growth and strong cash flow generation. We also continue to target reaching around 2 times by the end of 2026, and will consider buybacks once confirmed we are ontrack. Switching gear. As this quarter coincides with the publication of our 2023 Integrated Report, I would like to welcome Jennifer Motles, PMI Chief Sustainability Officer, to share an update on our sustainability progress. Jennifer, over to you.
