英美煙草 (BTI) 2017 Q2 法說會逐字稿

Good morning, everyone, and welcome to the British American Tobacco 2017 Interim Results Presentation.

I am Nicandro Durante, Chief Executive of British American Tobacco; and with me this morning is Ben Stevens, Finance Director.

And as always, a warm welcome to those of you who are listening on the conference call or watching via our website, BAT.com.

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

Before I start the presentation, I will take you that you have all seen and read the disclaimer.

As you are no doubt aware, it has been a busy start of the year.

I am pleased to say that we have delivered another good performance over the first half of this year, despite lapping a strong volume comparator.

During the first half of 2017, we continue to grow share, again, driven by the outperformance of the Global Drive brands.

Although volume was down 5.6%, with strong price mix, adjusted revenue at constant rates was up 2.5% and adjusted profit grew 3.2%.

Adjusted EPS was up over 6% at constant rates and up 21% at current rates.

In AGPs growth continued to go from strength to strength and has reached an estimate share of 8% in Sendai, with rollout in Japan progressing well.

In Vapor, our business in the U.K. also reached the record share in retail of 41.5% with Vype reaching all-time highs.

I will cover this in more detail later.

Perhaps more importantly, I am delighted that 2 days ago, we complete acquisition of Reynolds America with overwhelming support from both sets of shareholders.

This makes BAT one of the world's leading consumer products business.

I am very excited about the prospects for the larger group.

We will now focus on integrating the 2 companies and delivering expected synergies.

I am pleased to welcome Debra, who has joined the management board and now the Reynolds group employees to BAT.

I will now hand over to Ben, who will as usual take you through the detail of the first half results.

Thank you, Nicandro, and good morning, everyone.

As Nicandro mentioned, the group performed well against the strong first half comparator last year, when organic volume was up over 2%.

Reported volume was down 5.6% and organic volumes down 5.8%.

This is mainly due to industry volume decline, in particular in Pakistan, following significant excise-driven price increases last year as well as the phasing of volume shipments, which we expect to unwind in the second half.

Excluding Pakistan, volume would have been down only 2.6%.

This reflects our continuing corporate share growth of 30 basis points and another strong performance from the Global Drive Brand, which grew share 50 basis points.

Although reported Global Drive Brand volume was down 1.3%, excluding Pakistan, it would have been up 2.6%.

Adjusted revenue was up 2.5% at constant rates, benefiting from strong price mix, growing NGP revenue and M&A.

Adjusted revenue excludes the excise included in goods acquired under short-term contract manufacturing arrangements, mainly from (inaudible).

Adjusted profit grew 3.2% on a constant basis and the operating margin was up 30 basis points, despite the absorption of a 3% transactional currency headwind.

Constant-currency adjusted EPS grew 6%, and was up 21% at current rates.

Throughout the presentation this morning, we'll be referring to adjusted revenue, adjusted profit and adjusted EPS as revenue profit and EPS.

Turning now to operating margin.

I'm pleased to say that after 2 years of reported decline, we have returned to operating margin growth.

On an organic basis, improvement was 50 basis points, driven by good pricing and TaO efficiencies together with significant product cost savings and the benefits of factory footprint optimization.

This was despite absorbing a 3% transactional FX headwind.

Operating margin was up 30 basis points after the impact of acquisitions.

If foreign exchange rates were to stay where they are today, the transactional currency impact would reduce in the second half, but we would still expect a full-year impact of around 2% on operating profit.

Whilst we don't give guidance for any particular year, I remain confident in our long-term ability to grow operating margin between 50 and 100 basis points per year on average.

Moving on to the regions.

Asia Pacific delivered another good performance in the challenging environment.

Significant industry contraction and the timing of shipments, mainly in Pakistan, saw regional volume down 9.8%.

But excluding Pakistan, regional volume would be up 0.5%.

Despite the volume decline, revenue at constant rates was down only 2.9% as a result of good pricing and glo revenues.

Constant currency operating profit grew 2.3%, driven by Australia, Bangladesh, Vietnam and New Zealand.

With a strong currency tailwind, profit grew 14.4% at current rates.

Share in the region was up 30 basis points, underpinned by a good performance from the Global Drive Brands, which grew share 40 basis points.

In Australia, both revenue and profit were up, share grew strongly, driven by Rothmans, which remains the fastest growing brand in the market, and Winfield, the #1 capsule brand.

In Malaysia, volume and profit declined, as the significant excise-driven price increase in 2015 continued to drive market contraction, down-trading and growth in illicit.

As a result, overall share was down; however, shares improved sequentially since the beginning of the year and is now up 100 basis points, driven by Dunhill, which is up 80 basis points since December.

Kent drove another strong share gain in Japan.

In THP, glo continues to exceed expectations and Nicandro will cover this in more detail later.

Volume and profit in Pakistan was significantly lower.

This was driven by industry volume decline and growth in illicit, following the excise-led price increases as well as the phasing of shipments, where trade loading in H1 2016 ahead of an excise increase was not repeated.

In Indonesia, volume was down as excise-driven price increases resulted in industry decline and down-trading.

Market share was slightly lower as Dunhill was impacted by the down-trading.

However, Lucky Strike continues to perform well.

Bangladesh posted an outstanding result, with double-digit growth in volume, revenue and profit.

Share also grew strongly and was up over 400 basis points.

In the Americas, volume was down 6.5%, mainly due to industry decline in Brazil and Venezuela.

However, good pricing led to strong constant currency revenue growth of 6.5%.

Profit growth in Canada, Chile, Colombia and Mexico offset decline in Brazil and the Caribbean, leading to regional profit growth of 2.3% at constant rates; at current rates, profit was up 14.8%.

In Brazil, the excise and VAT-driven price increases together with a weak macroeconomic environment continue to drive down-trading and growth in illicit trade.

Volume and profit declined as a result.

Although market share was down Minister grew share strongly.

In Canada, good pricing drove revenue and profit growth despite lower volume.

Share was maintained and Pall Mall is the fastest growing brand in the market.

Mexico posted another strong performance with an increase in volume driven by Pall Mall.

This together with good pricing and cost savings led to higher profit.

Regional share was down 10 basis points, although the GDBs performed very well.

Their volume was flat and share was up 60 basis points, mainly due to a strong performance from Lucky Strike in Chile and Colombia, and Kent in Chile.

Western Europe continued its good momentum from 2016.

Profit at constant rates was up 4.8% with good performances in Germany, Romania and Denmark, partly offset by France and the U.K. At current rates, profit was up 16.8%.

Reported volume was up 0.7% and down only 0.4% on an organic basis, with regional share growth of 20 basis points.

Profit in Germany increased due to good pricing and lower costs.

Share grew driven by Pall Mall and Lucky Strike, both reaching record shares.

Excellent performances from Pall Mall and Dunhill in Romania led to higher volume.

This together with good pricing and improved mix and cost savings resulted in strong revenue and profit growth.

In France, profit was down due to the partial absorption of excise.

Immediately following the capsule ban at the beginning of the year, market share and volume declined; however, recent trends are more positive.

In the U.K., Rothmans and Pall Mall performed well, driving a small increase in market share.

However, volume declined as the overall market contracted.

In Spain, volume and profit grew and share was up strongly, driven by the continued success of Rothmans and Lucky Strike.

The Global Drive Brands posted an excellent performance with volume up 8.2% and share up 50 basis points, mainly driven by Pall Mall and Rothmans.

In EMEA, despite a significant transactional FX headwind and challenging trading conditions in Russia and South Africa, the region delivered a good performance.

Strong price mix more than offset volume decline of 4.6%, leading to revenue growth of 5.9% and profit up 3.5% with good results in Turkey, Iran, Ukraine and North Africa.

Excluding the impact of transactional FX mainly in Nigeria, Russia and South Africa, profit would have been up around 12%.

At current rates, profit was up 17.7%.

In Russia, volume is due to the growth in illicit trade and market contraction.

Profit was lower, driven by competitor-led price discounting and consumer down-trading.

However, market share increased with Rothmans and Royals driving growth.

In South Africa, a continued weak macroeconomic environment and illicit trade growth resulted in a reduction in volume and profit.

Benson & Hedges and Dunhill both grew share.

Although overall market share remained lower, it has now been stable for the last 9 months.

Turkey had another excellent performance.

Share increased, driven by Rothmans and Kent, the fastest growing brand in the market.

Good pricing led to an increase in revenue and profit, despite a decline in volume.

In Ukraine, prices have started to recover following the price war.

This led to a markedly improved financial performance.

Volume is significantly lower, mainly due to market contraction and short-term disruption to industry distribution.

GDB volume is up 1.2% and their share was up 60 basis points, mainly due to Rothmans and Kent.

Regional share grew 40 basis points.

Adjusted earnings per share of 134.4p at current rates was up 21%, driven by growth in operating profit, good results from associates both Reynolds American and ITC and a 15% translational currency tailwind.

Net finance costs were flat; however, the average cost of debt was marginally lower.

Our effective tax rate was 28.4%, 150 basis points below last year.

Noncontrolling interests were marginally higher as profit growth in Algeria and Vietnam was offset by decline in Malaysia.

I usually give some guidance around the expected full-year tax rate; following the inclusion of 5 months of Reynolds, we expect to maintain an effective tax rate of around 30% for 2017.

A pro forma full-year tax rate would be around 32%.

On currencies, if rates were to stay where they are today, the translational tailwind, including 5 months of Reynolds as a subsidiary, would moderate to a full year benefit of around 9% on operating profit and 8% on earnings per share.

Now on to cash flow.

Overall free cash flow was GBP1,083 million, which is GBP524 million higher than last year.

This is mainly due to higher operating cash flow conversion, lower tax outflows and higher dividends received from associates.

Depreciation is the main component of noncash items.

Working capital outflows of GBP899 million were lower than this time last year.

This is primarily due to nonrecurring stock builds in the prior year relating to the implementation of the Tobacco Products Directive.

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 of GBP187 million is higher than 2016, driven by investments in Next Generation Products.

Net interest paid was higher at GBP326 million, due to upfront costs relating to financing arrangements for the acquisition of Reynolds.

Tax outflows of GBP547 million were lower than the same period last year, as a result of timing differences in payments.

Higher dividend payments to minorities were driven by Malaysia.

Restructuring and settlement outflows were higher, mainly as a result of translational FX movements on escrow payments relating to the Quebec class action lawsuit.

Dividends from associates increased, driven by strong results from Reynolds.

This delivers free cash flow of GBP1,083 million.

Turning now to financing and shareholder returns.

Net debt increased GBP 1.7 billion to GBP 18.5 billion.

Following the announcement of our recommended offer for the remaining 58% of Reynolds American, S&P and Moody's confirmed the group's credit rating at BBB+ Baa2 stable.

We're targeting net debt-to-EBITDA of around 3 times by the end of 2019, with further deleveraging thereafter, returning us to the higher end of our historic net debt-to-EBITDA target of 1.5 times to 2.5 times.

The cash component of the Reynolds acquisition has been financed through the drawdown of the $25 billion acquisition facility.

The $20 billion bridge component will be refinanced in due course through capital market issuances.

We remain committed to rewarding shareholders with an increasing dividend and continue to see 65% as a sustainable long-term payout ratio.

From 2018, BAT will pay 4 equal quarterly dividends.

And as part of transition, an additional interim dividend will be paid in February 2018.

This will be 25% of the total cash dividends paid in 2017 amounting to 43.6p.

Before I hand back to Nicandro, I'd like to make a few comments on the addition of Reynolds to our numbers.

We will report the U.S. as a separate division alongside the other regions.

We understand from Reynolds' management that they had a good first half with good growth in revenue and adjusted profit.

Cigarette market share was flat; however, the premium brands Newport and Natural American Spirit saw growth.

[Molly's] snuff performed strongly with share gains.

And in Vapor, VUSE had an excellent first half with double-digit revenue growth.

As you know, we're confident of delivering at least $400 million of annualized cost synergies by the end of the third full year following completion, and savings are expected to flow through from early next year.

The one-off costs of delivering these synergies are expected to be around GBP 350 million -- $350 million.

We will be treating the purchase price allocation charge for inventory valuation uplift, the charge for amortization of acquired trademarks and transaction fees as adjusted items.

Note that the pro forma P&L published in the offer documentation is based on unadjusted figures and 2016 FX rates.

Finally, whilst the field was accretive to EPS in its first full-year, accretion in calendar 2017 will be limited, given the short period post completion and the phasing of the synergy benefits.

Thank you, and I will now hand you back to Nicandro.

Thank you, Ben.

Looking at share, the business continues to perform well, and we are now in our seventh consecutive year of share growth with an increased 200 basis points since 2010.

The GDP grew share another 50 basis points in the first half.

Their consistent, strong growth remains the key driver of our corporate share performance.

Looking at the brands in a little bit of detail, Dunhill performed well in a number of its key markets, including Romania and South Africa.

Volume was down 4.5%, mainly due to industry decline and down-trading in Malaysia and Indonesia.

Market share was down 10 basis points, although it has recovered in the last quarter with an improved share in Malaysia, Brazil and South Africa.

In Indonesia, Dunhill remains the largest international kretek brand in the market with a 4.7% share, despite consumer down-trading.

Dunhill continues to perform well in Romania with a strong volume growth.

In South Africa, Dunhill also reached a record share of 15.1% in May 2017.

Kent share was up 15 basis points and volume was down only 1.6%.

Volume and share grew strongly in Turkey, while Kent reached a record share of 6.3%, driven by the continued success of the Switch and (inaudible) range.

In Brazil, the migration of free to Kent is on track, with 100% retention to date.

Around 60% of the consumer volume has now been migrated.

Kent's volume in the Middle East and Russia was down through much decline and down-trading.

In Chile, Kent grew share for the second consecutive year, reaching 23.7% post implementation of the Kent Spark new brand Imagery.

The brand saw strong volume growth in its little range with Kent's demis performing well and Kent's Super Slims volume in Japan reaching a share of 3.5%.

Lucky Strike had a very strong first half, with share up 20 basis points and volume up 12.4%, reaching new record shares in Germany, Spain and Chile.

In Indonesia, Lucky Strike Mild, our second international kretek brand, continues to grow both volume and share.

Following its launch in May 2016, the success of migration of Club Mild.

In Spain and Chile, share increased strongly up 70 to 90 basis points, respectively, driven by the continued success of the Black Series.

In Croatia, Lucky Strike is the fastest-growing brand in the market with a record 81% share year-to-date, a really great performance.

Pall Mall grew share 10 basis points, driven by the good results in Pakistan, Poland, Canada, Chile and Germany.

Volume was down 9.6%, mainly driven by the marked decline in Pakistan.

This masked its growth in Germany, Poland, Romania and Mexico.

Excluding Pakistan, Pall Mall volume would have been up 4%.

The implementation of the new brand Imagery and Package in Germany showing encouraging early results.

And in Poland, Pall Mall share grew 170 basis points.

And in Chile, demand was up 70 basis points.

In Germany, the brand reached a record share of nearly 11% in May.

Finally, Rothmans continued its excellent performance despite lapping a strong comparator, share grew 15 basis points and volume was up 6.2%.

In Russia and Turkey, the success of Rothmans' Demi Click capsule vials continues to drive good share growth.

Rothmans' tubes continue to perform very well in Italy, where the brand grew share 50 basis points.

Volume grew strongly in Russia, Nigeria, Czech Republic and in Spain.

Turning now to Next Generation Products.

We have made significant progress building our Next Generation Products business, investing over GBP1.5 billion over the last 60 years.

Consumers are not homogeneous.

They want different products at different times and for different reasons.

Our strategy of development and marketing a range of THP and Vapor products put us in the best position to capture significant share of these exciting and profitable markets.

It also has the potential to generate the greatest benefit to public health.

We continue to believe that as products improve, Vapor will achieve substantial consumer penetration.

We are seeing an increasing use of flavors not related to tobacco, with 10% of consumers not even using nicotine-containing liquids.

This is clear different consumer behavior to both consumed combustibles and THP.

In the U.K., BAT now has a leading 41.5% retailer share of Vapor based on user and Vype continues to perform very well, reaching a new record retail share of nearly 11%.

Vype is also the #1 brand in U.K. pharmacies.

Good progress has also been made in France and Italy.

And our Vapor revenue grew strongly in the first half.

Last year, the Vapor category, outside the U.S., grew over 40% to an estimated consumer value of nearly GBP 4 billion.

We also estimated that U.S. market was over more than $5 billion in 2006.

With VUSE, we are now the largest Vapor company in the world.

In tobacco heating, glo share in Sendai is around 8%.

And nearly 1 in 3 smokers have purchased a glo device.

The expansion of Tokyo -- Tokyo, Osaka and the broader Miyagi region in the middle of July has got off to an excellent start.

Glo has already achieved a share of 3.1% in a major continuous chair -- a chain across expanded geographies.

And device penetration is already at over 8%.

After just 3 weeks, shares in the chain is 3% in Tokyo, 2.4% in Osaka and 6.1% in Miyagi, which includes Sendai.

Share in Sendai itself is also holding up very well at around 8%.

And conversional rates have continued to grow, as distribution expanded outside the city.

These are great results.

Glo and Kent Neosticks are now available in more than 13,000 retail outlets in Japan as well as flagship stores in Tokyo and Osaka, with distribution covering 25% of the Japanese tobacco consumers.

Consumer awareness of the brands is already at 35% nationally and [you'll] be rolling out across the rest of the country in the second half, with full coverage expected by end of December.

Our recent launches in Canada and Switzerland are also showing encouraging early results.

In Switzerland repurchase rates for glo have been steadily rising.

In our City test in Vancouver we have opened a flagship store with distribution of further 300 outlets.

Next month, we'll be launching glo in South Korea.

So in summary, the business performing in line with our expectations in the first half of 2017, with good results against the backdrop of a strong prior-year volume comparator.

We continue to grow share powered by the GDBs.

Although volume was impacted by industry decline in the phasing of shipments, we anticipate a strong volume performance in the first half.

As a result, we continue to expect profits to be weighted in the second half of the year, although this is moderated by NGP rollout cost and lacking a strong comparator in Ukraine.

Reigns now a key part of BAT group.

And we are now focused on progressing integration delivering the synergy benefits.

These are good first half results, and I'm confident of another good year of constant-currency earnings growth.

So now we are going to open it up for the Q&A.

Who would like to come with their first question?

(Operator Instructions) Our first question comes from the line of Owen Bennett from Jefferies.

Three questions, if I may, please.

And the first one.

You mentioned how we spend on NGPs will be ramped up in the second half.

I was just wondering if you could be a bit more specific in terms of how much it will increase versus the first half to get an idea of how margins may progress.

Secondly, is it possible at this stage to give a rough idea of how much NGPs are contributing to revenue number?

And then thirdly, obviously, a very strong share performance of glo in Sendai; I was just wondering, is this taking share off competition?

Or is it all incremental to the overall tactically?

And also you said conversion levels continue to grow.

I was just wondering what they're actually at the moment?

Okay, it's Ben here.

Just struggling against the feedback.

We're not going to give you a separate figure on spend for NGP, but I can guide you towards CapEx for the full year for BATs, excluding Reynolds.

So it will come in around GBP700 million to GBP750 million in CapEx for the year and that'll include the extra spending on NGP.

In terms of contribution to revenue, again, I'll give you a bit of a clue on that.

In terms of our price mix figure, you'll remember the price mix figure was pretty high at over 8% in the first half.

About 0.6% of that came from NGP, which is obviously a considerable amount of turnover at the moment as we grow.

So hopefully that's helpful.

And I'll hand you back to Nicandro to talk about share.

Answering your question about glo.

As I mentioned during the presentation, we are growing extremely well ahead of expectations in Japan.

The share that we are experiencing in places like Tokyo with 3% in this retail chain, in Osaka 2.4% and Miyagi region 6.1.

They are above our expectations, and if you compare this with the numbers that you have reached in Sendai at the same period 3 -- 2 weeks, they are much stronger, much stronger.

So we are very happy with the results so far.

Regarding your question, if you -- is the capital that is growing and you are taking share off on the competition, it's very difficult for me to say.

I think it is better for you to ask the competition how they are doing.

But we are growing very fast and we are very happy with that.

Our next question comes from the line of Adam Spielman from Citi.

Some more questions on tobacco-using products, if I may.

First of all, you say that Switzerland is going very well.

In the past, you've said that you thought that Japan was really the most -- the best market.

And I was wondering if you could just give your sort of personal guess as to relative to market size between Japan, Korea and Europe?

So in order words, if share in Japan reaches, I don't know x, in Europe, do you think it will be 1/2 x or 1/4 x?

The second question, do you see any reason why, in Korea, you shouldn't have the main -- same market share as iQOS.

The third question is, do you think capacity will constrain your volumes at all this year and in 2018?

In other words, can you give some color on your capacity for glo 6.

Thank you, Adam.

Very good questions.

Let me start with the first one about Switzerland.

I reconfirm what I have been saying for a long time.

I think that Japan is rather unique.

The specific critical conditions come together in Japan really drives this exceptional performance of the category.

For example, there is no vaping there.

Consumers are exceptionally high on social consideration.

It's a very conformist consumer [over-indexing] 1 million on menthol and allow for technology of innovation.

You're not going to repeat this in Europe.

When I say this is ahead of expectations, it doesn't mean that in Switzerland we are repeating the success in Japan.

Just to give you some data, after 3 weeks in Sendai -- after 6 months in Sendai, sorry, after the same period of the launch in Sendai that we are in Switzerland, which is around 15 weeks, in Sendai, the device penetration was 12.3% (inaudible) Hunters was 5.6%.

In Switzerland, device presentation is 0.2%, (inaudible) Hunters, 0.2.

So they are -- when I say that the results are good according to our expectations, we are not expecting to have in Europe and Switzerland or in Vancouver, which the results are similar, the same success in Japan for the unique characteristics of the consumers.

So I hope that I answer your questions.

So do not expect to have Switzerland having half of the success in Japan in the same period of time.

This is not going to happen.

The consumers are completely different.

So the potential is not the same.

It doesn't mean that the category is not going to grow over time, but this is going to take much, much more time and it's going to be much, much slower.

That's your first question.

Regarding Korea, you said, do I expect to have in Korea the same results as the competition is having?

Well, our objective is to lead the NGP category, to lead in vaping and to lead in tobacco-heating products.

So over time, I expect to have more than 50% of the category; that's our objective.

That's why we are working.

If it's going to happen in the first 6 months, in 1 year or 2 years, I don't know.

But this is our objective.

So I see no reason for not being successful in Korea as we're being successful in Japan.

The third question that you raise about capacity.

Our consumables capacity is going to increase 4 times between end of '17 to '18.

And you have the ability today to supply more than double our current demands for '17 and '18.

And by end of '18, we want to be present in 20 markets.

But the supply chain is complicating this category.

We utilize multiple partners and particularly on the device; however, the compatibility of glo -- a very stunning process and technology -- helps in flexibility and responsiveness.

At the end of the day, the lead time for us to increase capacity as a category is around 9 months.

So it's all about the successes that you're going to have going forward.

If it's going to be more than double that you're estimating, yes, we may run into capacity issues, but that's a good problem to have.

Can I -- I just want to come back on the capacity, because you gave a lot of data, which I didn't quite understand.

You said it's going to be 4x at the end of '18 where it is at the end of '17.

And then you said in '17, you can fully supply the current demand.

Is it -- can you just expand on that last bit?

I'm saying that we have launch plans for '17 and '18.

And as I said, by the end of this year, we expect to be in 5 markets.

By the end of next year, we expect to be in 20 markets.

What I'm saying is that, according to our projections, in terms of demand, we'll be fully equipped to supply double the demand that we're estimating for these 5 markets this year and the 20 markets next year.

And as I said...

You are estimating?

Demand that's more than double than we estimate.

We may run into problems of capacity, but it's a good problem to have if you have more than double than the demand.

And I said that the lead time to create a new capacity is around 9 months.

So you have early signs if the success is significant, then you can increase our capacity.

Excellent.

That's good news.

Are you able to say what you're expecting, what you're forecasting for demand?

No, we are not.

Because we think that the markets that we are launching and the volumes that we intend to sell, no, we are not -- whatever it's close (inaudible)

Our next question comes from the line of Jon Leinster from Berenberg.

Afraid a couple of questions still on the same subject, just following up from Adam's.

If you're going to be launching in the further 15 markets for glo during 2018, does that imply a significant shift in the internal resources in terms of marketing and also sort of big pickup in the sort of number of flagship stores around the world?

So is it going to be a big increase in marketing?

And does that reflect in a sort of reallocation away from the conventional business into Next Generation Products?

Jon, the reality, there will be some resource allocation, of course.

Because if you're going to go for a big launch, for example, in places like Korea, there will be conflicting priorities in terms of launches.

You have the focus of the company needs to be focused on 1 or 2 big launches during the year.

There will be some reallocation, of course.

But we expect to have an increase in the market investment, not only in reallocation.

We think that this a nascent category that will demand some investments upfront.

And not only in THP but in vaping as well.

We are not talking about -- a lot about vaping here.

But we expect by the end of this year, beginning next year, to launch 2 fantastic products [ZIP and 3] that we have discussed this before, and Raptor.

And also, there will be conflicting investments between the vaping and THP and combustible.

But I think that we can manage it, but net-net, there will be an increase in investment.

Secondly, on Russia, some of the other comments, again, a bit like yours have been that there's been a big price-driven scenario there.

I mean, at what stage are we?

Have there been any price increases since, say, March in the marketplace?

And is -- do you know is there any sort of time frame on that being resolving itself or is this just a competitive situation, we'll just have to see how it rolls out over the next year or so?

Russia is a very competitive market.

We are doing well there, as you know, we are growing share.

Rothmans is doing extremely well.

But there was some absorption of excise in the beginning of this year.

How the price is going to unfold, nobody knows.

So we have to wait and see.

It's a very -- the only thing that I can say, it's a very competitive price environment nowadays.

And the company is doing well in this competitive price environment.

Right.

And lastly, perhaps, in terms of the global market, I think that earlier in the year, you said the global market, in volume terms, you'd expect to be down about 4%.

I mean, given that everybody's volumes seem to be well below that in the first half, is that something which you're still sticking to?

Do you expect volumes in the second half on a global basis to be -- show a significant improvement versus the first half?

I think that the volume decline for this year, we estimate it to be around, I said in the past, 4% to 4.5%, and I still think that's going to be around this.

It's very difficult to be precise on those numbers as you can expect.

So I don't change my view for the year.

We were a little bit higher in the volume decline in the first half, because you have the swing in Pakistan.

Because of excise last year was a different moment.

We have some load -- it usually happens before an excise increase in the first half.

But if you model this, in a yearly base, it should be around 4% something.

I think that it is going to be much better than this, because we are growing share.

We have a very strong share performance, 30 basis points, 50 basis points in Global Drive Brands.

Global Drive Brands now, they are 50% of our portfolio, which is a fantastic progress.

If we go back to 2010, it was around 30%.

So we are doing very well.

And the Global Drive Brands growing much bigger in our portfolio, making our life easier to drive growth.

So I think that the second half is going to be stronger for us for the reason that I highlighted.

So I -- we haven't changed our views about the 4%, and we haven't changed our views that they're going to perform better than this.

(Operator Instructions) Our next question comes from the line of David Hayes from Bank of America Merrill Lynch.

Three from me, if I can.

Just as first, if I can just confirm the answer to an earlier question.

Do you say that the Next Generation Product contribution was 60 basis points to the pricing in the first half?

Sort of making sure I understood that correctly.

And I guess, still on NGPs, just trying to again get you to be a little bit more specific about the medium-term plans.

I mean, can you give us an idea when you think that you'll breakeven based on current plans at least from that rollout of both vaping and heat-not-burn products?

Then secondly, just on the cost-savings and synergies at Reynolds and I know you've only had it for 1 day, so I'm not going to ask you to increase the $400 million expectation just yet.

But you keep talking about being at least $400 million.

I wonder if you can talk about whether you keep making that point because there's specific areas that you think that you can explore that aren't in that number.

Or whether it's just you think potentially you can get deeper into the areas that you've already talked about?

And then finally for me, just on Saudi Arabia, I know it's relatively small, but we've had a big price rise there recently.

Just wondering whether you can give us the quantum of your exposure to that and whether that will affect that number in terms of volume performance in the -- for the full year?

Yes, David, it's Ben here.

So yes, of the 8.1% price mix in the first half, 0.6% came from NGP.

So you can confirm that.

In terms of the breakeven for NGP, NGP is already profitable in a number of markets.

Obviously, as it's being rolled out to new markets, then we invest in those markets.

So it's hard to give a sort of overall figure.

But we expect NGP to be a positive contributor from next year.

In terms of Reynolds, we've said at least $400 million of synergy benefits.

We've only owned the company for 36 hours, so it's going to take us some time to lift the hood on it and have a good look -- I know the U.S. referencing there rather lift the bonnet -- to take a good look at the $400 million and see what really is there and what time it will take to extract that.

So we'll stick to our at least $400 million of synergy benefits for the moment.

And obviously, if we can achieve more, we will do.

Regarding the GCC question, yes, we have a significant excise increase recently.

We expect the market to be down this year because of that, around 11%.

We expect as well some down-trading.

We think that, obviously, premium segments and aspirational premium and even value for money is going to be down to the low price benefiting from that.

We have launched recently Pall Mall as a value-for-money brand and it's doing very well and is taking -- it's doing its role of absorbing the down traders.

So we are doing well, but the industry is going to be down by 11%.

I cannot be precise now how big it is going to perform in the scenario.

Because the change in pricing was significantly -- I think that price is almost double.

You have some time for the consumers to get used to that and you'll see how it is going to work.

But we estimate for the year around 11% decline.

But that's a number that we have to wait and see.

It can be 2% or 3% up or down, depends on how it's going to be received by the consumers.

Because that's not an environment that have seen many price increases in the past.

So it's very difficult to understand elasticity there.

So we have to wait another 2 or 3 months to see how the market is going to unfold.

Next question comes from the line of Michael Lavery from Piper Jaffray.

Just wanted to follow up on the capacity.

A couple of questions.

You've talked about some of the limitations.

Is -- am I hearing you right that it's both on the device and the Neostick capacity side?

And then, related to that as you look ahead with the expansion you expect for 2018, you've got CapEx running this year about 100, 150 higher.

What should we expect for 2018 if you'll have 4x the NGP capacity.

Is it some order of magnitude of that incremental increase?

Good question, Michael.

The first one was about capacity of device and consumables.

If it is the question, the numbers that I gave you, in terms of 4 times more capacity next year in order to cope, we've got launch plans for 2017 and '18.

As I said, now we are present in 3 markets.

We are going to be present in another 2 before the end of the year, one of those being South Korea, and we'll have another 15 for next year.

So all the numbers that I gave you for capacity, they refer for both device and consumables.

So there is no difference.

For the second question, then...

I guess, what I'm curious is where is your bottleneck?

Is the restriction that you're not able to make the devices as quickly or the consumables or are both of them constrained?

Or at the moment, is it simply a question of -- are you saying you don't have capacity constraints at the moment and it's just a question of getting the demand to grow?

As I said, Michael, just going back to what I said before, we have capacity for these 20 markets.

We have double the capacity for the demand that we estimate for the both markets.

If the demand is going to be more than double than we estimated, we may run into capacity problems.

The lead time to build the new capacities, either for device or consumables, is around 9 months.

So if you know early enough that we are selling more than double that we estimate, we can build capacity but not less than 9 months.

So the bottleneck is for both, if you sell more than double than our forecast for the category.

Okay, sorry.

That's very helpful.

And then on the CapEx side?

I'm not going to give guidance for 2018 CapEx.

But obviously, to the extent that our THP product is successful, we'll be laying down capacity in line with what Nicandro has talked about.

So I would expect to see a growth in CapEx in 2018, but we're not going to put a figure on that until we got a bit closer to understanding what the amount of capacity we need to or the CapEx we need to spend in '18, because that will depend on our demand forecast for 2019.

That's very reasonable.

One last one.

Just when you look at the Vype flagship store in Milan and then some of the glo stores like in Japan or Vancouver, do you imagine any opportunity to put both of those under one roof?

Or do you feel like the message and the marketing is separate that you would want to keep those -- even if you are present with both products in a market, you would rather keep those separate or could that be a place that operates for both?

There's an opportunity to bring all of our marketing to NGP together.

But you got to remember that individual markets that we're either driving ahead with say glo, which should be a Japan flagship store, or Italy, which would be more on Vype and Pebble and brands like that.

Over time, we see opportunities to bring them together.

But at the moment, we've got different stores in different markets.

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

My first one was on the strong price mix of 8.1%.

You highlighted that 0.6% of that came from NGPs.

Could you break out the rest, i.e., how much was price and how much was mix?

I presume that the decline in Pakistan would have had a significant benefit to the price mix line, please?

And then my second question is, in Australia, you reported improving pricing and marginally lower volumes and market share gains.

Do you think industry pricing power has now been restored in this market?

And then my third question is just on Sendai data, the chart that you provided on -- I can't remember what slide this is, it's not numbered -- but showing that, in the first 10 weeks, you went from basically 0% share for glo to about 6%.

And since then, over the past 20 weeks or so, it's only gained an additional 2%.

Obviously, the overall 8% share improvement is quite interesting, but just wanted to know how you're thinking about future growth prospects in terms of share for that -- for the brand in Sendai.

Maybe I'll take the price mix question.

Two other big influences on price mix, obviously, one was Pakistan, where as Nicandro said, we had trade loading last year ahead of a big excise increase in the second half of the year.

And then this year, of course, we have the impact of that excise increase.

Good news in Pakistan is that the excise structure has actually been changed by the government.

So expect a better performance in the second half.

And then Ukraine, of course, where we were coming out of a price war with prices going up and volumes going down.

So if you put U.K. and Pakistan together, you can probably take another 3% of that price mix.

So that takes us to an underlying price mix of around 4.5% in the first half of the year.

Question about Australia.

Yes, in terms of Australia, as I said before, we had very good share growth of 70 basis points.

The company is doing well, Winfield is doing extremely well, Rothmans as well.

We have a more -- a price environment that was not as complex as last year that was very competitive.

It's still very competitive but we had excise increase and price followed.

I don't know how this is going to unfold for the future, because we don't make predictions about pricing.

But nowadays, we are in a better situation that we were 1 year ago.

That's the fact.

Regarding Sendai and regarding the potential for glo, after 3 months in Sendai, we already had around 5% market share and it continued its growth.

The way that you measure this is not only about the share, but the share has been growing week after week since then.

It's difficult to grow market share in the first -- in the second 3 months as you grow in the first 3 months, of course.

But we look at device penetration, conversion rates, overall share.

And in Sendai, week after week, we are having a great performance.

We are extremely happy with Sendai.

And as I said before several times, when I launched the product in Sendai in December or 6 months ago, someone had told me that I will have 8% share after 6 months -- well, I would have said that, I will be the happiest man in town, which is the case nowadays.

So very happy with that.

What I said in the case of Tokyo is that we are having even a better performance there.

And even more importantly, it's that awareness of the brands in the whole Japan outside Sendai is above 25% without any work done by the company, which helps, of course, the rollout.

And one of the reasons that in Tokyo we are having even a bigger success.

And I think I'll take advantage here just to highlight to the point that I made earlier about Switzerland and Vancouver.

And I said that I don't expect the same results.

And I'd like to highlight that the launch plan for these places, they are exactly the same ones that we implemented in Japan, with exactly the same concept, the flagship store, exactly the same amount of resource.

And the results are not similar, because consumers are different.

Places like in Europe, in which vape is available, social considerations aren't so high, don't expect the same results.

It's not for lack of investment, it's because consumers are different.

The final question comes from the line of Chas Manso from Societe Generale.

I have a question on Vapor and for the pricing outlook, the pricing strategy we have for the Vapor.

Clearly a lower unit price point than heated tobacco, and I was wondering whether you see that price gaps narrowing over time and what your view is to get that up to -- to get the revenue and the profitability up in that area where you are the global leader?

And on combustible, previously you have sort of quantified how big your sort of top 5 tobacco markets were in terms of advantages and profits, and I was wondering whether you could do that again, given that you've called out Brazil, Russia and South Africa as being challenging markets.

I think they are in the top 5. And clearly, that's been offset by good performances elsewhere.

So maybe we should start to focus on how the top 10 are doing maybe?

And the final question from me would be a Western European pricing question.

I think the price mix in Western Europe was less than 1%, and obviously, there's been some absorption in France.

And I was just wondering some -- your view on the price movement in Europe, whether it's still in line with sort of the traditional rates or whether you see the pricing in Europe slowing down?

I'll try to answer your questions.

If I understood well the first one about vaping, you're talking about the market -- the prices.

So let me take advantage and talk a little bit about vaping here and why -- let me start by saying why we believe in this category.

If you look at 2016 against '15, we have 60% more consumers in the category than 1 year ago.

We had -- I'm talking about vaping in the top 40 markets outside United States, we had in 2016, 24 million of users as compared to 15 million roughly users in 2015.

So penetration clearly is not an issue, because the penetration is much, much higher than tobacco-heating products, much, much higher.

The problem is the depth of usage.

And depth of use is going to be solved by quality products.

And we think that's what we have been working so hard and made such a huge investment in the last 6 years to develop an outstanding set of products for consumers.

And that's why I said, we have good products already.

We are leaders in more than 50% market share in Poland, 41% in U.K. So we have leadership in several markets in Europe.

We are leaders already outside of United States in the vaping category, and Vype is probably the biggest brand in the category already.

So -- but we think that with the (inaudible) and Raptor coming end of this year, first half of next year, I think that we have a good chance of crack the product quality.

And if you transform and if you transform consumers with this high penetration to conversion, and I think that the category is going to be a fantastic category and very profitable going forward.

Regarding your questions on the pricing, prices are moving up.

But as I said, you price up as soon as you have outstanding products that differentiate yourself against the consumers.

Our products are already priced above the market with Pebble, (inaudible) and so on and so forth.

These new products that will come to the market, you'll have a good pricing, good margins and the margins have been real, they are in markets between 2, 3, 4x than combustible.

So I don't think that we have a problem with margin.

We don't have a problem with penetration.

We have a problem with conversion, and the quality of the products is going to define how we are going to do that, how we are going to do on that category.

The second question about combustible, you said in the top 5 markets, 10 markets.

Can I ask you after the call have a chat with Mike because I don't know what has been released so far top 5 markets, as you said.

I'm not aware about that.

If you don't mind, Mike, you talk to you about that and check exactly what you need.

And then we will take from there.

And the third question is about Western Europe pricing.

Obviously, we don't give any forward-looking for pricing.

We had some absorption.

As you know, it was a little bit tough in the past in Italy.

We had some absorption this year in France.

On the other hand, in some other markets, price is moving quite well, in places like Romania and so on and so forth.

So it's a mix situation.

So prices is a little bit -- if you talk Western Europe as a whole, prices are not as strong as they were last year.

That's what I can say.

How this is going to unfold?

As I said, we don't make predictions on pricing.

There are so many elements that you have to take into account.

Europe is an extremely competitive market, as you can expect.

So you'll have to see how the things will go.

I will now be handing over to Nicandro Durante for any closing comments.

Okay, guys, thank you very much for joining us in this conference call.

If you have any further questions, please give Mike a call.

Thank you very much.