英美煙草 (BTI) 2018 Q2 法說會逐字稿

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and welcome to British American Tobacco's 2018 Interim Results Presentation.

I am Nicandro Durante, Chief Executive of British American Tobacco.

And with me this morning is Ben Stevens, Finance Director.

As always, a warm welcome to those of you who are listening on the conference call or listening via our website, bat.com.

As usual, after taking you through the results presentation, there will be an opportunity for you to ask questions.

Before I start the presentation, I'll take it that you have all seen and read (inaudible) on Page 2 and 3. And it's clear that these interim results have benefit significantly from the inclusion of Reynolds as a fully owned subsidiary.

Given this, volume and revenue and profit from operations will be presented as though the group has owned acquisitions made in 2017 for the whole of that year.

We will refer to comparisons of results on this basis as performance on a representative basis.

This comparison will provide shareholders a better understanding of performance.

Moving now to the interim results.

Overall, we have another good year in 2018, with the group performing well.

Once again, we have delivered on our commitment to high single figure earnings growth, with adjusted diluted EPS up over 10% at constant and 2% at current rates.

Our strategic portfolio, which covers our key combustible, oral tobacco and NGP brands has grown strongly in the first half with revenue up over 8% on a representative constant currency basis.

You'll see over the next few slides that our combustible business, which remains 94% of our business, continue to perform strongly and industry fundamentals are robust.

The U.S. remains a great opportunity and Reynolds is performing well.

And finally, that we have a great opportunity in Next Generation Products, and it has been demonstrated that our multi-category strategy, driven by consumer needs, is the right strategy.

And we have the capabilities and products to win.

Turning now to the results highlights.

Reported volume, revenue and profit from operations obviously benefited from the inclusion of Reynolds as a wholly owned subsidiary and were up 11%, 57% and 72%, respectively.

On a representative basis, volume was down 2.2%, again, outperforming the industry.

We expect the industry volume to be down around the 3% to 4% this year.

Constant currency adjusted revenue was up 1.9% on a representative basis.

However, 2017 revenue in the U.S. benefited from a number of one-off items recognized by Reynolds prior to acquisition, principally, the sales of Natural American Spirit inventory to JT as part of the disposal of the international brand rights.

Excluding these, adjusted revenue would have grown by 2.6% on a representative, constant currency basis.

Tobacco price mix was a robust 4%, which reflects improved pricing, held back by the negative mix effects of strong volume growth in Pakistan following the excise change in mid-2017 and down-trading in the GCC.

Excluding the one-off effect of NAS inventory sale, price mix would have been close to 5%.

We continue to expect a stronger second half with full year price mix ahead of last year.

Despite the recent slowdown in the THP category in some markets, excluding Japan and South Korea, we remain confident of exceeding NGP revenue of GBP 1 billion in 2018 as we expect a range of new launches to reenergize NGP category growth in the second half.

As we said in the full year, we expect profit growth to be weighted to the second half, driven by improved price mix, continued share growth and strong growth in NGPs.

Foreign exchange was a headwind of 8% in EPS for the 6 months of the year and is estimated to be a headwind of 6% for the full year, assuming rates stayed where they are today.

I am very confident of another good year of adjusted earnings growth at constant currency, driven by strong underlying profit growth with the benefit of the U.S. tax reform, enabling us to accelerate investment behind our NGP business.

Group market share grew 40 basis points, driven by another strong performance from our strategic brands.

Kent, Lucky Strike, Pall Mall and Rothmans all grew share globally.

Dunhill held up very well in the premium segment, and share was down only 10 basis points.

Record share in South Africa and growth in Brazil were offset by decline in Malaysia, South Korea and the GCC due to excise-driven market contraction and down-trading.

Kent grew 50 basis points.

The brand had a strong performance in Japan, driven by THP and grew share in Russia, Brazil, and Turkey where Kent is the fastest-growing brand in the market.

Lucky Strike was up 10 basis points, driven by Indonesia, Colombia and Japan.

Pall Mall grew 30 basis points, with strong results in Pakistan and the GCC, where the brand was launched ahead of the significant excise increase last year to address the needs of down-trading consumers.

Rothmans continues its strong performance and was up 80 basis points, driven by good results in Russia together with an excellent performance in Malaysia, where the brand grew 260 basis points.

The brand also benefited from migrations in Poland, Brazil and Colombia.

In the U.S., the strategic brands continued to perform well.

Natural American Spirit and Newport share were both up 10 basis points, while Camel declined by 10 basis points.

Following the gains made last year, Pall Mall was down 10 basis points, reflecting some increasing competitive discounting.

Overall, these strategic brands had an outstanding performance, growing share by over 160 basis points.

In the U.S., industry volume decline remains within their historical range, and Reynolds is performing well.

Looking at sales to retail, which are a good measure of consumer trends.

First half industry volume was down 5%, mainly due to the impact of state excise increase in California in April 2017 and high U.S. gasoline prices.

We expect U.S. industry volume to be down around 4.5% to 5% for the full year.

Vapor category growth appears to be driven largely by new consumers and new behaviors.

And we continue to see limited impact on U.S. cigarette industry volume.

Reynolds shipment volume to wholesale was down 5.5%, broadly in line with the industry.

Revenue was GBP 4.5 million to GBP 5 million, which was flat on a constant currency representative basis.

However, this was against a comparator which benefited from a number of one-off items principally related to the sale of NAS inventory of -- to JT of approximately $100 million.

Excluding these, revenue would have grown 1.8%.

Price in the U.S. is robust, and despite some increasing competitive discounting, the price environment remains good.

Delivery of the cost synergies is ahead of plan, with annualized cost savings now running at almost $140 million at the half year point, we're well on track to deliver at least $400 million in cost synergies by the end of 2020.

We have submitted our comments to the FDA on its ANPRM on nicotine and flavors.

There's a large and diverse quantity of material, and this is likely to take some time for the FDA to digest, given the complexity of the issues.

As we have said, these are the first steps in a lengthy process as to whether the FDA issues a product standard on these issues.

Our new product applications for the FDA are also progressing well, and we are very pleased that clearance for the SE application for the improved Eclipse, our carbon-tip Tobacco Heating Product has now been received.

The scale of the opportunity for THP in the U.S. remains uncertain and heated tobacco products will attract full cigarette excise.

However, we will be testing the potential of the improved Eclipse in the U.S. during the next 12 months.

We filed SE application for glo in February.

The application is currently under scientific review with the FDA, potentially completing its review by the end of '19.

We will also continue work on our plan to submit an MRTP application for glo.

The Camel snus' MRTP application is also proceeding well, and the TPSAC, as it is meeting in September, will review the application.

In oral tobacco, the business continue to grow strongly.

Total first half revenue grew over 11% on a constant currency representative basis, driven by strong performance in the U.S., Sweden and Norway.

In the U.S., oral tobacco industry volumes were broadly flat in the first half, with American Snuff Company volume in line on a representative basis.

Grizzly saw a strong first half revenue and profit growth, driven by good pricing.

Market share was down 30 basis points against a comparator, which benefited from gains made during the USST product recall in Q1 2017.

Outside the U.S., the white pouch market is the fastest-growing oral tobacco segment.

In the first half, the category grew by more than 120 basis against last year and now accounts for 3.5% of European oral tobacco category, with margins up to 2x that of premium cigarettes.

Across the Nordics, where Epok is the fastest-growing premium oral brand, BAT continues to grow share, with 12% share of the market in Sweden and 8% share in Norway.

In Switzerland, Epok has grown to 14% share of the total oral tobacco category just 10 weeks after its launch.

This is a profitable, growing business with very attractive margins.

In tobacco heating, glo continues to perform well.

In Japan, glo national share is 4.3%, up from 3.3% at the end of December, having added a full share point over the year to date.

Our share of the total tobacco market in Japan is now 16.2%, up 80 basis points since December, benefiting from share growth in both THP and cigarettes.

We are the fastest-growing company in Japan across both categories.

However, it is clear that the THP category has plateaued over the last 4 months.

As the category expands into more conservative consumers, barriers to adoption are higher and growth naturally slows.

We know that one of the greatest barriers to consumer adoption is the price of the device.

We have been focusing on driving down the production cost of the current glo device and have been passing these on to the consumers through increased service -- device discounting.

In the coming months, we'll be launching different device and consumables at different price points.

For example, we had recently launched a new premium price range of consumables, with higher nicotine and different flavors.

The second half will benefit from these initiatives and from our new consumer activation plans, including our consumer Hypercare conversion program.

In South Korea, the THP category has grown to 12% of the tobacco market in June, although this has plateaued as well over the last 4 months.

Glo continues to grow national share and now has a share of 0.7% and a category share of 6%.

Following the successful launch of 2 capsule variants in mid-April, we are now relaunching the brand with a revised marketing mix and upgraded device.

Outside of Japan and Korea -- South Korea, category growth has been mixed.

However, glo's presence has continued to grow, with Italy joined existing markets of Canada, Russia, Switzerland and Romania.

We are now unconstrained on device supply and have a strong pipeline of activity.

We have a number of new market launch planned for glo in Q3, together with a significant uplift in activity in Japan.

We maintain our view that the category could represent 30% of the Japanese market by 2020.

We remain confident in glo's potential, and as new offers enter the category and product is improved, growth should return.

On this basis, we remain confident of exceeding GBP 1 billion in NGP revenue in 2018.

In Vapor, on a representative basis, volumes were up over 16%.

And after excluding the impact of U.S. Vibe product recall, revenue grew by 8%.

In the U.K., the market grew by almost 26%.

And BAT's Vapor retail share grew by 20 basis points in value to 41.1%.

We remain market leader in traditional retail in closed systems.

Earlier this month, ePen 3 was launched in the U.K. after an extensive pilot program with excellent results.

EPen 3 represents the cutting edge of current vaping technology, providing a more intense and satisfying vape experience.

While it's still very early days, initial indications are very positive.

In our VIP Vapor stores, ePen 3 has achieved the highest rate of sale for any Vype device to date.

With higher margins than ePen 2, and refill purchase rates the highest achieved for any Vype product to date, the early signs are encouraging.

In the U.S., the category has continued to grow up rapidly and is up over 20% in the first half, driven by a significant increase in the size of the consumer base.

Vapor revenue was down 4%, but up 12% after adjusted for the impact of VUSE Vibe recall.

The overall VUSE family, which has featured nicotine salts technology since 2012, continued to grow volume and value.

However, share was down 10 percentage points to 21% due to the growth in the Vapor category.

In Q2, VUSE Vibe recall volumes were absorbed as negative sales.

However, both VUSE Ciro and VUSE Solo have captured a significant proportion of their volume loss by the recall.

Recall costs have not been material.

In August, we will be launching the VUSE Alto in the U.S., our first Pod Mod product.

This will be available in 4 variants, and will new feature, an innovative ceramic wick.

Like other VUSE products, Alto has a 5% nicotine concentration liquid and is a nicotine salt product.

Our research shows that Alto rates significantly higher than any other nicotine salt Pod Mod products on a number of key consumer attributes and purchase intent.

We continue to perform well in our other markets and remain the market leader in Poland and in Germany in closed systems.

We also recently launched ePen 3 in Canada and Vype in Greece.

The opportunity in the category remains significant.

When you look at total nicotine consumption, we continue to see a growing market for nicotine with new consumers and behaviors, driven by the growth in the Vapor category.

With a strong product pipeline, we are well positioned with our multicategory approach to be a winner.

So in summary, we are continuing to deliver on our commitment to high-single figure earnings growth.

Our combustible business is outperforming the industry, and we are generating strong revenue growth from the strategic portfolio.

In the U.S., the business performing well and synergy delivery is ahead of plan.

Our potentially reduced risk products continue to grow strongly.

We have significant additional investments in NGPs planned as well for the second half and expect to see THP category grow again in Japan.

Given these, I continue to believe we can deliver in excess of GBP 1 billion in NGP revenue this year, more than doubling the size of our business over the course of 2018.

We are on track for another good year of earnings growth at constant currency, driven by strong underlying profit growth and with the benefit of the U.S. tax reform allowing us to accelerate our NGP investments.

Overall, the business is performing well.

I will now hand over to Ben, who will take you through the details of the results.

Thank you, Nicandro, and good morning, everyone.

As Nicandro said in his opening, reported volume, revenue and profit from operations were up 11%, 57% and 72%, respectively, benefiting significantly from the inclusion of Reynolds as a wholly owned subsidiary.

As we said earlier, for clarity, I will now focus on the adjusted representative results, which were all against a comparative base that assumes full ownership of Reynolds and other acquisitions throughout 2017.

This doesn't affect comparisons made on an EPS basis.

Representative volume was down 2.2%.

This was mainly driven by trade inventory movements in the GCC and industry volume decline, in particular in Ukraine, Brazil and Russia; partially offset by growth in Pakistan and THP volume, which reached 3.3 billion sticks in the first half.

Adjusted revenue was down 6.4% at current rates but was up 1.9% on a constant basis as higher pricing across the majority of our markets was partly offset by negative geographic and portfolio mix of around 3%.

Adjusted profit from operations was up 2.4%, excluding the impact of currency translation.

On a current basis, it was down 5.4%.

Adjusted diluted EPS was up more than 2% at current rates and over 10% on a constant basis, exceeding our high single figure EPS growth objective.

Turning now to the regions.

Revenue in the U.S. was in line with the prior year on a constant currency representative basis.

Good pricing in both the cigarette and oral tobacco categories and higher VUSE consumable volume was offset by the reduction in cigarette volume and the impact of the Vibe recall.

Excluding the one-off items in the revenue comparator, which principally related to the NAS inventory sale in 2017, revenue grew 1.8%.

Operating margin of 41.4% or 46.2% on an adjusted basis, benefiting from [comps] synergies achieved since acquisition and the timing of expenditure.

As a result, adjusted profit from operations was up 5.6% on a constant currency representative basis.

In APME, adjusted revenue on a constant rate representative basis grew strongly and was up 5.6%.

This was driven by pricing, volume growth and the benefits of higher-revenue THP volume, which more than offset the negative mix effect of down-trading in GCC and the growth of illicit in Malaysia.

Volume was up 3.5%, with strong growth in Pakistan, Bangladesh and THP outperforming the industry, which was down around 3%.

Market share in the region grew strongly and was up 110 basis points.

On a representative constant currency basis, adjusted profit from operations was down 5%, driven mainly by the impact of inventory movements and down-trading in the GCC and increased investment behind THP.

Australia continued its good performance.

Profit was up and share grew, driven by Rothmans.

In Japan, revenue grew but profit was down due to decline in industry cigarette volume and investments in NGPs.

In Malaysia, the duty-paid industry declined by 5.5%, and illicit trade increased to reach 67% of total consumption.

This impacted both profit and revenue.

The strategic brands had an excellent performance, with volume up over 15%.

Share was up 90 basis points, mainly driven by Pall Mall in Pakistan and Saudi Arabia as well as good performance from Lucky Strike in Indonesia.

Revenue in AMSSA was down 9% to GBP 1,951 million due to a significant translational foreign exchange headwind of 12%.

However, on a constant currency representative basis, adjusted revenue grew by 2.9% to GBP 2,206 million.

Good pricing across the region, notably in Canada, Chile and Nigeria, more than offset lower volume.

Volume in the region was down 5.9%, mainly driven by industry decline in Brazil, South Africa and Mexico.

Adjusted profit from operations on a representative constant currency basis grew by 4.1%, driven by Canada, Nigeria and Chile, partly offset by the continued difficult trading conditions in South Africa.

In Brazil, although there are signs of improvement and no new excise increases are currently planned, the weak economy continues to affect industry performance and drive further growth in illicit trade.

While pricing was good and premium share was up, aided by good performance from Dunhill, revenue and profit declined, impacted by lower volume.

In South Africa, revenue and profit were also lower as volume was down due to the continued growth of illicit trade and VAT and petrol price increases.

Strategic brands performed well, driven by share gains for Rothmans and Dunhill, which reached a record share of 15.7%.

Canada posted another strong performance, with revenue and profit growth driven by continued good pricing.

Strategic brand volume was up nearly 30%, driven by growth in Mexico as well as migrations in Brazil, Colombia and Nicaragua.

In ENA, adjusted revenue on a constant representative basis was up 1.3%, driven by improved pricing and mix in Germany, Romania and Russia, partly offset by the impact of lower volume and continued excise absorption in France.

Volume was down 3.9%, driven by Russia, Ukraine, France and Italy, which offset good performances in Turkey and North Africa.

Adjusted profit from operations at constant rates on a representative basis was up 2.2%, with good performances from Germany, Ukraine and Romania.

In Russia, volume declines was offset by good pricing and cost savings.

Rothmans and Kent both grew share, and Kent remains the #1 premium brand in the market.

In Germany, BAT is the fastest-growing total tobacco company.

Volume was down, but constant-currency revenue and profit grew, driven by pricing and improved mix.

A good performance in the Ukraine saw revenue and profit increase, driven by improved pricing and share growth.

Rothmans is the #1 brand in the market with a 17.3% share.

In France, share was stable despite aggressive competitor pricing activity.

Strategic brand volume was up 11%, with strong performances from Rothmans in Russia, Ukraine and Poland; Pall Mall in Egypt; and Kent in Turkey and Russia.

The first half also saw a great performance from our oral tobacco business in the region.

Volume grew 29.6%, driven by Epok, outperforming the industry, which was up 6%.

Turning now to operating margin.

On a reported basis, margins were up 340 basis points, benefiting from the inclusion of Reynolds as a fully owned subsidiary.

Underlying margin improved by 180 basis points.

This was driven by pricing, cost savings and synergies with Reynolds.

This is offset by higher NGP investments, which represented a headwind of 130 basis points.

Adjusted operating margin on a representative basis increased by 50 basis points.

We will continue to make good progress on an underlying basis and remain confident in our ability to deliver 50 to 100 basis points of margin improvement on average over the years.

Adjusted diluted EPS of 137.2p was up 2.1%, despite a currency headwind of a 8.3 percentage points.

On a constant basis, EPS grew 10.4%, driven by growth in operating profit, the contribution from Reynolds, the benefit of U.S. tax reform and an improved result from ITC.

Net finance costs were up, mainly as a result of the Reynolds acquisition and the financing of the transaction.

We continue to expect the full year net finance charge to be around GBP 1.5 billion.

Despite profit growth from ITC, the contribution from associates was down due to the removal of Reynolds as an associate company.

Our effective tax rate was lower at 26.9%, mainly driven by the impact of the U.S. tax reform.

I would continue to expect a tax rate of around 20% -- 27% for the full year.

Noncontrolling interests were marginally higher as profit growth in Bangladesh, Sri Lanka and Pakistan was partly offset by a decline in Malaysia.

On currencies, if rates were to stay where they are today, the translational FX impact on full year results would be a headwind of around 5% on operating profit on a representative basis and a headwind of around 6% on EPS.

Now on to cash flow.

Overall adjusted cash generated from operations was GBP 2,953 million, which is GBP 1,983 million higher than last year.

This is mainly due to the benefit of higher adjusted operating profit, driven by the 6 months contribution from Reynolds and the early MSA payment of $1.8 billion or GBP 1.4 billion made by the group in December 2017.

As a result, operating cash flow conversion was up 27 percentage points to 97%.

Excluding this early MSA payment, operating cash conversion would have been approximately 68%, which is in line with the prior period.

Depreciation is the main component of noncash items.

Excluding the MSA payment, working capital outflows of GBP 1,611 million were significantly higher than 2017, which was an outflow of GBP 899 million.

This is primarily due to nonrecurring stock builds.

As always, I'd like to caution that the timing of working capital movements tends to absorb cash in the first half, largely due to the timing of leaf purchases.

Net capital expenditure was GBP 44 million higher than 2017, largely due to investments in NGPs.

We continue to expect gross CapEx in 2018 to be around GBP 1.1 billion.

Net interest paid was higher at GBP 723 million due to the financing arrangements for the acquisition of Reynolds.

Tax outflows were higher at GBP 813 million, and now include tax outflows related to the Reynolds business.

Dividend payments to minorities was slightly lower compared to 2017.

This delivers adjusted cash generated from operations of GBP 2,953 million.

Turning now to financing, we are targeting net debt to EBITDA of around 3x by the end of 2019 with further deleveraging thereafter returning to the higher end of our historic net debt to EBITDA target of 1.5x to 2.5x.

Closing net debt was GBP 46 billion at 30th of June 2018.

Our target credit rating remains BBB+, Baa1 with S&P and Moody's, with the rating currently standing at BBB+, Baa2.

This rating is driven by our net debt to EBITDA ratio, and we are focused on managing this down with no share buyback programs or significant debt-financed M&A until leverage returns to appropriate levels.

So in summary, the business performed well in the first half.

On a constant representative basis, adjusted revenue grew 1.9%; profit, 2.4%; and adjusted diluted EPS, 10.4%, exceeding our high-single-figure earnings growth target.

We continued to outperform the market and have once again grown share, powered by the continued strength of our strategic brand portfolio.

With a 48.8p quarterly dividend based on our previously announced annual dividend growth rate of 15% in 2017 backed by EPS growth, we have demonstrated our continued commitment to growing shareholder returns over the long term.

Thank you, and I'll now hand you back to Nicandro.

Thank you, Ben.

So in summary, our combustible business, the fundamentals are strong, and we are outperforming the industry.

Reynolds is performing well in the United States, and our multicategory NGP strategy with the consumers at its heart is the right strategy.

Looking to the second half, we expect stronger profit growth driven by improved price mix, continued share growth and a strong growth in NGPs, offset by increased investment in NGPs rollouts.

I am confident we are on track for another good year of constant currency earnings growth, and we'll now open up to questions.

So who would like to start?

(Operator Instructions) And our first question comes from the line of Jonathan Leinster of Berenberg.

A couple of questions, if I may.

First of all, the U.S. served markets, and obviously, your market share experienced a slight decline, which is quite a marked shift from where we've seen it in the past.

Is that because you're concentrating more just on 2 or 3 brands and letting some of the tail brands decline at perhaps a faster rate?

Or has there been perhaps a more noticeable shift or deceleration in the market share growth of Newport and NAS?

Well, John, the answer for this question is that we are coming from a very strong growth in 2017, our market share.

The market share in U.S. is slightly down, around 10 basis points, but the strategic brands, the 2 truly premium brands in U.S. markets, that they are Newport and Natural American Spirit, the share is up.

We expect to have a very strong second half, and we expect that to have a much better performance.

But we are against a very strong comparator against the first half of next year -- last year.

But full year, we expect to have a different performance.

But the share is 10% down.

You'll see the low-price brands, the tail brands declining but the strategic brands growing.

So the performances, I think that's quite good in the current environment.

By the full year, as I said, we expect some improvement because we expect the second half much stronger.

Okay.

Secondly, I wasn't quite sure, on the carbon tip cigarettes within the U.S. market, are you saying that the SE application has now been cleared with the FDA?

Or does that mean that, actually, the whole thing has been clear and, therefore, you can launch onto the market as and when you want?

We are delighted to be the first tobacco company to be able to launch a THP proposition in United States who have clearance to launch the product.

But as I said before, a word of caution, we don't know the size of this category in United States.

We will pay full excise.

The financials are not going to be as good as in some other markets.

But yes, we are looking at -- we have plans to test market these in the next 12 months to understand a little bit better the potential.

But yes, we have the clearance to launch, so we are delighted with that.

Right.

And lastly, with the Alto product, just to be clear, therefore again with that one it's clearly been launched.

So this is not a new product.

This is something which has already got the clearance with the F -- so when you say can launch this product, this is not something that requires a premarket approval from the FDA?

This is something you can launch straight onto the market, including nicotine salts variants?

So this -- you're suggesting therefore that this is a sort of variation on an existing product -- in the market prior to August 16?

Is that the correct interpretation?

Jon, this program has been grandfathered in August 16, but they were not widely available in United States.

There a lot of products that were grandfathered at that time, and I can say that they were not widely available because to be grandfathered, you could be in market, in 1 store, 2 stores only the whole country.

So it was grandfathered.

Now is the time to launch the product in scale, and I think that it's going to be a -- we are going to launch 2 Pod Mods in the next 12 months even before the end of the year.

The first one is going to be the Alto that you're going to launch now in August.

Consumer testing, the results are really good in several consumer attributes.

The Perl has rated superior to other Pod Mods in the markets, 5% nicotine, with nicotine salts.

So we are very optimistic about the launch.

But with any launch, we have to wait and see.

You take some time, but you're going to launch these in August and the second one towards the end of the year, probably towards the end of the year, in different price points, by the way.

This is going to be one of our premium proposition.

We are discussing the second one where this is going to be positioned.

Our next question comes from the line of Fulvio Cazzol of Goldman Sachs.

I've got 2 on price mix.

I know you highlighted that geographic and product mix had a negative 3% impact in 1H '18.

I was just wondering if you can give any comments on how you expect that to moderate in the second half given that you will be lapping the key anniversary dates for events in Saudi Arabia, Pakistan, and also, the U.S. volume trends have also improved.

So that's my first question.

And then my second question is on pricing.

You highlighted that 70% of the price increases that you had budgeted so far in 2018 has been -- have been implemented.

Can you remind us what the comparable figure was in 2017, please?

Fulvio, it's Ben here.

Yes, look, we expect price mix to improve in the second half.

As you say, we'll be lapping some of the more difficult markets from the first half of the year.

So we believe that pricing is improving in the industry, and we expect a higher price mix in the second half.

I'd remind you also that the 4% price mix that we've reported is actually 5% if you exclude the NAS net turnover because that was at 0 margin.

So decent price mix in the first half improving in the second half.

And in terms of pricing, we're broadly the same as we were last year in terms of the percentage of pricing that's gone through.

Our next question comes from the line of Michael Lavery of Piper Jaffray.

I was wondering if you could just touch a little more on Natural American Spirit back in the U.S. What's driving the declines there?

That's obviously -- historically had very strong positive growth, even typically double digits.

Can you just touch on what's different that's driving that negative now?

Well, there is nothing negative in Natural American Spirit.

We are growing market share 10 basis points.

The volume is probably consequence of the industry decline.

So in the first half of the year, volume is 4% up in an industry that was declining 5%.

So the growth is, against the industry, is 9%.

So it's a fantastic performance.

And if you look at historical numbers for Natural American Spirit, the size of share growth that you have experienced is similar to [on the] past, so the brand is growing very strong.

We have extremely strong first half of last year.

We are still growing 10 basis points.

It's the most premium brand in United States.

And if you consider all of these, I think that has been a great performance for the brand.

So nothing wrong with that.

So can I just clarify on -- I'm looking at the release, and it says that the share momentum continues that is up but then it says with volume lower by 4% on a representative basis.

Is the volume actually down?

Well, I can come back to you on that Michael, but the numbers that I have it here is that the number is up and the market share is 10% basis up.

But can I get back to you?

Yes, sure, no problem.

And could you just touch on Korea with the Korean FDA, I think, creating a little bit of confusion for consumers around the risk reduction for Tobacco Heated Products?

How significant of a challenge have you seen that in the market for consumers, and what, if anything, do you feel like you can do to counter that?

Well, honestly, there are a lot of reasons that why Korea has stabilized of around a 12.5%.

To be honest, I think that the main reason for stabilization in Korea is because the dynamics of Korea and Japan, that they are the 2 biggest THP markets, are completely different.

For example, in Korea, you have different touch points with the consumers.

We cannot do sampling.

You have different Hypercare needs, the way there to engage with consumers, requirements and restrictions on one-to-one engagement with consumers.

We have -- the number of sole users in Korea is much higher than -- sorry, the growth of sole users, we don't see this happen in Korea the same proportion that you're seeing in Japan.

And when you have a higher percentage of dual users, and we always have the high percentage of dual users, in Korea, there is a tendency that they, because of product satisfaction, there is a higher percentage of people going back to the combustible category.

So I think that these are the main reasons for not -- for stabilizing in the range that it has.

It has grown very fast to 12%.

But honestly, I think the category will go back to growth because one of the main reasons for the category not growing is product satisfaction.

There will be a lot of launches in the second half from BAT and a lot of competitor activity, to be honest.

We are launching new device.

We are launching glo 2.0.

We are launching mini at the end of the year.

In terms of device, we have capsules in the market.

You have, for example -- in Japan now, we are just launching Neo, a premium consumable with a higher nicotine with different flavors.

Because of the new launches in the market, I expect the category to go back to growth.

That's very helpful.

Just one last follow-up on Jon's question.

Any sense of how soon, I think you said that the carbon tip launch -- test launch in the U.S. would be in the next 12 months.

Is it the sooner end of that, or when might we expect to see that?

There, as I said, we are going to test market the product in the next 12 months because the size of the category in U.S. is unknown.

And as I said, there will be full excise in the category.

So you have to understand the category a little bit better before a full launch.

So we'll test market in the next 12 months, and dependent on the test market, we're going to expand this.

But I cannot be precise to you in terms of time.

[Six are the states] that we're going to do that because we are just working on these now.

We have plans, and we are discussing the finalization of those plans.

Our next question comes from the line of Owen Bennett of Jefferies.

A couple of questions, please.

First of all, just one for Ben, I was hoping to get a bit more detail on margin expectations for the year and, specifically, the impact of the NGP investments.

So you said there was an impact of 130 basis points in the first half.

I'm guessing this will be much greater in the second half.

And then secondly, just coming back to the U.S., with the recent recovery in industry volumes, I was a bit surprised that you're guiding down to 5% for the year.

I was just wondering what is actually driving this assumption for the 5%.

Yes.

Ben here.

Look, I'm not going to give a prediction on margin for the full year, but we are confident we can grow operating margin, as I say, 50 to 100 basis points over time.

Whilst the investment goes up in the second half of the year, remember we've also said that results will be biased towards the second half of the year as well.

So I'm expecting a good performance on margin for the full year.

In terms of U.S., we are talking about 5% for the first half of the year, and I said 4.5% to 5% in the -- for the full year.

So I do expect that the second half is going to be better than the first half.

I'm talking about the industry because from the Reynolds perspective, I think that we're going to outperform the industry in the second half because I expect share growth, and there are reasons for that.

As I said, the main reasons for this decline of the industry in the first half was disposable income in U.S. because gasoline prices went up big time.

There is a huge influence in terms of consumption.

You have the [SCT] excise increase in California.

Those are the 2 main reasons for the decline in the first half.

And the gasoline, for example, will be -- is the same reason for the full year.

But I think that the second half of the year, Owen, I think it's going to be better than first half.

And I think that Reynolds, as BAT, in the second half, you have a very strong second half, you outperform the industry.

(Operator Instructions) And our next question comes from the line of Adam Spielman of Citi.

So my question comes back to this thing about price mix.

If I understand it correctly, pricing must've been about 8% because I think you said that price mix was 5%, but you have negative 3% mix, leaving 8 percentage points to price.

Is that correct?

Yes.

That's correct, Adam.

And as we look -- can you sort of say geographically where -- I mean, because that's a huge number, more than you've done before.

And I'm just wondering, sort of geographically, particularly as you didn't take pricing, in my understanding, in Russia where the biggest movements from that is.

Alan (sic) [Adam], this is not a number that is much higher than previous years because the price mix last year, while it's 3% this year, was even higher last year.

I think that if we look at the price mix excluding geographic portfolio mix, I feel that the second half -- the first half of this, it was lower than last year.

So I don't feel that 8% is much higher than it was first half of last year.

It's lower.

If you look at the first half last year price mix including geographic portfolio that was higher than this year, you see that is a little lower.

Okay.

And -- sorry.

Okay, fine.

Can you just talk about, in terms of volumes, you had a positive surprise -- I don't know if surprise is right word -- but you had a positive one-off in Pakistan and a negative one-off in GCC.

Can you say which one is bigger and how much?

Can you give any sense of the scale of those 2 movements?

Alan (sic) [Adam], to be honest, to do the math is now about the impact of each market in terms of volume is not going to be as -- I would be more than happy to come back to you later with the answer for this question.

But in the case of Saudi Arabia, we had the industry declining almost 40%.

And if we look at Pakistan, first half against first half of last year, we have the industry declining probably less than that.

So I think that there is a huge impact in the case of Saudi Arabia in the numbers.

But if you do the math about the impact of each specific market and the total volume numbers, we can discuss this later if you don't mind.

I'll get back to you about the specific...

Okay.

Of course.

And the final thing is, in terms of pricing in the U.S., you obviously had a very strong pricing in the first half.

Do you expect it to be equally strong in the second half?

Alan (sic) [Adam], we don't talk about prices going forward.

What I can say to you is that we have a very good pricing environment in the United States.

I haven't seen anything changing the last 18 months, 12 months, 6 months, so it's a very solid price environment.

But I cannot talk about price increases going forward as we expect that I couldn't.

So -- but it's a good price environment.

I don't see this changing, but we have to wait and see.

Our last question comes from the line of Rey Wium of SBG Securities.

I just want to sort of start out by saying compliments on the improved disclosures.

It really helps.

I just want to quickly come back to the Next Generation Product investment into the second half.

I mean, if my calculations are correct, it looks like based on that margin charts, it was about GBP 116-odd million that you spent, which was the hit on the margin.

And correct me if I'm wrong, but I think the guidance is about GBP 500 million for the full year.

That's just my first question.

Yes, you wouldn't be a million miles away with those numbers, right?

But remember, the combustibles business will improve in the second half as well, so that would give an offsetting effect on the operating margin.

And then I just wanted -- just touch on Japan and that would be the target of GBP 1 billion for the Next Generation Products.

I mean, in the first half, it was GBP 427 million on a constant currency basis.

Just correct me if I'm -- on this, but as far as I have it, the capacity constraints have now come to an end in terms of your production.

So is it safe to assume that, that market share of yours that have been sort of stable around about the 4.2% in Japan could probably now -- are going to get a benefit from the improvement in your capacity issues?

Well, we have grown market share from 0.9% mid-last year, and since we went national in October, we came from 0.9% to 4.3%.

In December, we were 3.3%.

It has been stable in the last 3 months.

The last reading that I have here with me is May.

That's true.

But we have seen strong growth, we became unconstrained in June as I had said before, so we start shipping July.

To see the impact of these and the impact of the new launches in the market, we have just launched a new device.

The glo 2.0 is a much better premium device.

We are launching new variants.

We are launching a new consumables at higher price point, new flavors, high nic.

Plus, the unconstrained device, we expect to grow market share.

We'll be doing all of these, if you're not expecting significant growth in market share.

And you are right: Japan is extremely important for us to grow in our NGP because I have said before, if we look at the THP category, we have Japan and South Korea, the 2 biggest markets.

So you have to make inroads in Japan to meet our numbers.

We are very optimistic about our portfolio of launch.

We are very optimistic that we're going to grow market share in a growing market because all these competitors' activity should drive volume.

But in order to achieve our NGP numbers, THP is very important, but vaping is also very important.

And I have not talking about vaping enough.

The launch of Alto in United States is something quite important for us.

We -- as I said, the brand, the product has performed extremely well in our research against a comparable Pod Mod products.

And also, the launch of ePen 3, ePen 3 we have test marketed ePen 3 in the first 6 months of this year, and the results have been quite great.

Just to have an idea, in the case of ePen 3, one of the chains that you have not -- never been able to go through being big tobacco is the vape stores.

In the 2,500 vape stores in the U.K., during the first half of the year, we provided product for testing and we had a call to buy in 2,400 out of 2,500 vaping stores, which [we scale up] as soon as production allows during the second half of the year.

So all the indications with ePen 3, Alto and then beginning of next year with iSwitch, that's what we used to call Raptor, we're very optimistic about our vaping portfolio, very optimistic about our THP portfolio.

And that's why we're optimistic that we can reach our targets.

Long answer, but…

Good.

Maybe just a quick little final question, just on Australia.

It's surprising, I mean, I think you indicated -- I don't know if share and revenues or profits are up.

But as far as I have it, the market was sort of down 10% in the first half of the year.

So I'm just curious about your performance in Australia.

The main reason for that are twofold.

First of all, in Australia, we have done quite well in terms of market share.

So we have been growing market share in the last couple of years.

We grew in the first half of this year 30 basis points in Australia, so it's quite important.

We have a very strong position with our portfolio there.

Second, price has been quite solid in Australia in the last 18 months.

We remember that 2 or 3 years ago, we saw a lot of down-trading in the market.

We discussed this several times in the past.

Now, the market has stabilized, we see very good price coming through, and we have a very strong portfolio, and those are the 2 main reasons for our performance in Australia.

We are quite confident about the business.

And the decline in volume, as you know, you have the [zed hawks] excise increase, and when you pass the excise increase -- significant excise increase through pricing, you have a decline in consumption.

And unfortunately, in Australia, illicit trade now is almost 15% of the market.

This is what drives significant excise increase is growth of illicit trades.

So this is the downside of the Australian business.

But on the other side, there are so many upsides.

As that was our last question, I'll return the call to Nicandro Durante.

Please go ahead.

Okay, guys.

Thank you very much for joining this conference call.

Looking forward -- we look forward to seeing you again, to talk to you again in February during the full year's presentation.

Thank you.