菲利普莫里斯國際 (PM) 2020 Q3 法說會逐字稿

Good day, and welcome to the Philip Morris International Third Quarter 2020 Earnings Conference Call. Today's call is scheduled to last about 1 hour, including remarks by Philip Morris International management and the question-and-answer session.

(Operator Instructions) I will now turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.

Welcome, and thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2020 third quarter results. You may access the release on www.pmi.com or the PMI Investor Relations app.

A glossary of terms, including the definition for reduced-risk products or RRPs as well as adjustments, other calculations and reconciliations to the most directly comparable U.S. GAAP measures and additional heated tobacco unit market data are at the end of today's webcast slides, which are also posted on the website. Unless otherwise stated, all references to IQOS are to our IQOS heat-not-burn products. Comparisons presented on a like-for-like basis reflect pro forma 2019 results, which have been adjusted for the deconsolidation of our Canadian subsidiary, Rothmans, Benson & Hedges Inc., effective March 22, 2019.

Please also note that growth rates presented on an organic basis for consolidated financial results reflect currency-neutral underlying results and like-for-like comparisons where applicable. Today's remarks contain forward-looking statements and projections of future results. I direct your attention to the forward-looking and cautionary statements disclosure in today's presentation and press release for a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements. Please also note the additional forward-looking and cautionary statements related to COVID-19.

It's now my pleasure to introduce Emmanuel. Babeau, our Chief Financial Officer. Emmanuel?

Thank you, Nick, and welcome, ladies and gentlemen. I hope everyone listening to the call and those close to you are safe and well.

Our business delivered an even better-than-expected performance in the third quarter despite the ongoing circumstances of the pandemic. Most importantly, the excellent momentum of IQOS continues. HTU volumes have grown 28% year-to-date with a positive mix effect on our net revenues, where RRPs again made up almost 1/4 of our business in Q3. IQOS user acquisition outpaced the prior year quarter to reach an estimated total of 16.4 million users at the end of September.

While still below pre-pandemic levels in most places, our combustible business recorded an improved sequential performance. Underlying industry volumes were better across both developed and emerging markets, reflecting increased consumption occasions. This was notably the case in market with a significant proportion of daily wage workers like Indonesia, Mexico and the Philippines.

Despite these better industry volumes, Indonesia remains challenging together with Duty Free. We must also retain a degree of caution around a second wave of the pandemic and its overall economic consequences across all of our markets.

Our operating margins were again significantly ahead in the quarter and on a year-to-date basis despite the challenges in our Duty Free business. These reflect the increasing weight and profitability of RRPs and cost efficiencies. Our cash generation was also strong with $3.6 billion of operating cash flow in the quarter, putting us on track to reach our target of at least $9 billion this year.

Turning to the headline numbers. Our Q3 net revenue declined by 1.5% on an organic basis, making -- marking a significant improvement from the decline of almost 10% in Q2. While this was somewhat aided by certain timing factors, including the revaluation of distributor inventory in Japan, ahead of the October price increase, it nonetheless reflect the continued strength of IQOS, combined with the sequential improvement in our combustible business. Indeed, the positive effect of the shift in our sales mix towards RRPs can be seen in the 6.5% organic increase in net revenue per unit.

Combustible tobacco pricing was 2.1% up, reflecting solid pricing in a number of markets, partially offset by timing differences with the prior year, a strong prior year comparison in Turkey and headwinds in Indonesia. These timing differences include the effect of delayed pricing in some instances, such as the Philippines, where we took a price increase this month rather than August in 2019.

Given this net revenue decline, we were pleased to deliver such a strong adjusted operating income margin expansion of over 300 basis points on an organic basis. I will cover this in more detail shortly, noting that we saw a further benefit versus our prior expectation from additional cost efficiencies and some delayed spending in the last month of the quarter.

Adjusted diluted EPS of $1.42 increased by 5.6% excluding currency, better than our prior expectation of a flat organic development. The primary driver was the above cost benefit as well as better industry volumes in Indonesia and the EU region, where increased mobility coincided with the reopening of hospitality settings and warm weather.

I also want to reflect on our strong performance over the first 9 months of the year. This was clearly a challenging period with disruption to many aspect of our operations, including our supply chain and route to market. Our net revenue declined by only 0.9% on an organic basis, an exceptionally resilient performance given these unprecedented headwinds. We estimate that Duty Free and Indonesia alone were a mid-single-digit drag on our top line growth.

Despite these factors, we saw very good organic progression in our net revenue per unit from the increasing weight of RRPs and solid pricing in combustible. Our adjusted operating income margin increased by 260 basis points to deliver 7.4% adjusted diluted EPS growth, all on an organic basis.

Let me now go into the driver of our Q3 margin expansion in more detail, starting with gross margin, which expanded by 180 basis points on an organic basis. This is driven by multiple levers. First, our ongoing transformation is delivering an increasing mix of RRPs in our business. Second is pricing on combustible. Third is our focus on overall manufacturing productivity, where our focus on efficiency, quality and footprint more than offset the impact of lower combustible volumes.

The positive gross margin development was augmented by our focus on SG&A efficiency with our total marketing, administration and research costs, 140 basis point lower as a percentage of net revenues on an organic basis. This reflect the ongoing digitalization and simplification of our business processes, including our RRP commercial engine and more efficient ways of working. There was also a benefit from the timing of certain costs, as I already mentioned.

Despite the challenges of 2020, we are today raising our expected full year adjusted diluted EPS range to between $5.05 and $5.10, reflecting around 5% to 6% organic growth. This exclude an assumed unfavorable currency impact at prevailing exchange rate of $0.32.

As stated in our earnings release, we have also updated certain guidance assumption. We now expect a total industry decline of 7% to 8% and a like-for-like decline in total PMI shipment volume of 8% to 9%, both of which factor in the better Q3 development in the EU and a smaller expected market decline in Indonesia.

We assume an organic expansion in our adjusted OI margin of around 200 basis points, also reflecting the above factors and ongoing cost efficiencies. We expect capital expenditure of approximately $0.6 billion and an effective tax rate, excluding discrete item, of 22% to 23%. We also assume no recurrence of national lockdowns in our key international market in the fourth quarter and remain vigilant with regard to the pandemic as economic uncertainty remains and localized social restriction are being tightened in some geographies.

Focusing now on the fourth quarter. We assume underlying consumption trends should be broadly stable versus a robust Q3. In many markets, including the EU region and Russia, increased consumer mobility, the opening of hospitality settings and summer conditions provided a helpful backdrop to our performance. However, there remains continued pandemic-related uncertainty as we now see localized restriction tightening in certain countries, with potential impact on both mobility and economic vitality.

The delay of certain SG&A costs from Q3 will also have an impact on our fourth quarter results. In addition, it's worth noting that while the price increase in Japan took effect on the 1st of October, the majority of the impact this year was realized in the third quarter through the revaluation of distributor inventories.

I should remind you that Q4 2019 present a strong base of comparison. This is notably due to pricing in Indonesia, ahead of the January 2020 excise tax increase, and an exceptional share gain in Saudi Arabia due to market disruption ahead of new plant packaging requirement. As such, while we expect around 5% to 6% organic EPS growth for the year, we expect the organic progression to be flat to modestly negative in the fourth quarter, excluding $0.04 of estimated unfavorable currency.

I will now cover our third quarter performance in more detail. As with the net revenues, our combustible shipment volume sequentially improved, albeit the year-over-year decline remains greater than historic average. This was supported by better industry trends in all regions.

Conversely, our HTU shipment volume continued to grow strongly to reach a record 19 billion units driven by the EU region, Japan and Russia. I also want to touch on the year-on-year inventory movement in the quarter, which negatively impacted our shipment on both cigarettes and HTUs vis-à-vis consumer offtake.

The reversal of trade buildup in H1 in markets like Germany and Russia was one contributing factor. Specifically for Japan, there were reduction in distributor inventory in Q3, following increases in both Q1 and Q2 of this year, in anticipation of retail and consumer loading before the October tax-driven price increase. As such, our shipments in the quarter were less than our in-market sales volume.

Importantly, inventory for cigarettes and HTUs in Japan are now aligned to the expected market size following the price increase. The main positive impact of the price increase on our Q3 results was the revaluation of distributor inventory.

This strong performance from IQOS means that heated tobacco unit made up over 10% of our total shipment volume in the first 9 months of the year as compared to approximately 8% in 2019 and 5% in 2018. We continue to expect this proportion to grow over time as the positive momentum on RRPs continues and remain well on track to achieve our target of 90 billion to 100 billion units in 2021.

Our mission is to grow the RRP category globally and transform the mix of our business. With $4.9 billion in sales year-to-date, RRPs are now approaching 1/4 of our total net revenues. Indeed, while this percentage was just over 23% in the quarter, if we were to adjust for inventory movements, Q3 would have almost reached 25%. IQOS devices accounted for approximately 8% of RRP net revenue year-to-date, mainly due to a naturally lower ratio of new user to existing users, longer replacement cycle and geographic mix, particularly in the third quarter. In some geographies, we still sell a substantial amount of the lower-priced original IQOS 2.4 Plus device. And we have now introduced a lil SOLID in Eastern Europe.

The East Asia and Australia region provide an illustration of RRPs operating at scale and is on track to deliver over half its revenue from RRP this year. While the investment phase of building commercial infrastructure can weigh on margin as scale is built, the strong margin expansion over recent years show our powerful scale and experience in RRP can be as investments start to pay back and the commercial approach is optimized.

Focusing now on our total international market share. The development were very positive for the bulk of our business. Before the impact of Duty Free cigarettes and Indonesia, our share increased by 0.4 points. This was driven by higher share for heated tobacco unit, which increased by 0.8 points to reach 3.1%, only partly offset by lower share for cigarette.

In markets where IQOS has a meaningful presence, our share increased with few exception. It follow that our combined market share increased in the EU region, Japan and Russia. However, our total international market share was negatively impacted by Duty Free where our share is higher than the PMI average, resulting in an impartial recapture of volume in other markets; and by Indonesia, which I will come back to separately.

It is also true that in many markets, Marlboro over-indexes to social consumption occasion, which are naturally lower during COVID-related restriction. While the easing of measures is uneven across market, we saw aggregate Marlboro share start to recover sequentially in the quarter.

I turn now to Indonesia. While the challenges related to the excise tax structure remain, underlying consumer trends improved in the quarter. Industry volumes declined by 6% excluding trade inventory movements, a notable improvement from the 22% decline in Q2. This primarily reflects a recovery in daily consumption from depressed level as confinement eased.

Given the continued rise in COVID cases and the possibility of more localized restriction, such as those temporarily introduced in Jakarta last month, we do not assume significant further improvement in the fourth quarter. However, reflecting the better third quarter industry volume and exit rate, we now expect the total industry decline on a shipment basis to be around 11% for the full year versus 15% previously.

While the smaller industry decline has a commensurate effect on our volumes, our market share remains under pressure despite improved performance from the higher-margin A Mild, Dji Sam Soe Magnum and SKT brands. This is due to the same dynamic mentioned last quarter.

Most notably, the growth of tax advantage below Tier 1 brands continues as tax-driven pricing and the pandemic have increased down-trading. To illustrate this issue, the tax per stick on our Tier 1 A Mild brand is more than 60% higher than on a comparable Tier 2 kretek brand, with a similar resulting difference in the retail selling price. With the segment now at 26% of the market, this represents a serious and growing threat to state excise revenue and a diminished return on this year's tax increase.

The correction of volume-based tax tiers remains urgent. We are hopeful that the government will take steps over time to ensure more predictability in tax revenue and a level playing field by reforming the multi-tier excise structure. The process of minimum selling price implementation also continues to progress slowly, hampered by the pandemic. Full enforcement may not be complete until the end of the year at the earliest.

I move now to our RRP performance. We estimate that there were 16.4 million total IQOS user as of September 30. This represent the addition of around 1.1 million adult users since the end of the second quarter and over 4 million since the same time last year, with more users added in both Q3 and year-to-date than the corresponding period in 2019. This is an exceptional achievement given the circumstances, where our accelerated pivot to digital and remote engagement is paying dividends.

We further estimate that 72% of this total or 11.7 million adult smokers have stopped smoking and switched to IQOS, with the balance in various stages of conversion. This again reflects widespread user growth momentum across all key IQOS geographies, including Japan, the EU region and Russia. As our user base expands in markets like Japan and Russia, we are increasingly enriching our offer and segmenting the market with new product and more price points. We plan to bring more exciting innovation from IQOS in the coming quarters.

We are also optimistic that the FDA is granting of modified-risk tobacco product. Reduced exposure orders for a version of IQOS will contribute over time to better understanding of the heated tobacco category and the benefit of switching to IQOS compared to continued smoking.

The success of IQOS in global key city, where our commercial strategy typically has a strong initial focus, serve as a useful indicator for national share growth potential. In many such cities across a wide range of market, our share is now well into double digit and still growing. This provides an excellent base from which to further grow our RRP business as we innovate and broaden the IQOS offer.

In the EU region, we added a further 0.4 million IQOS user in the third quarter to reach 4.7 million, a continuation of a recent strong performance, while most adult menthol smokers have switched to non-menthol cigarettes since the ban in May. We have seen some incremental switching to RRP over the May-September period and continue to see further opportunity to convert these consumers.

Third quarter share for HEETS reached 3.9% of total cigarette and HTU industry volume. This was in line with Q2 2020 but sequentially increased by 0.1 point, when adjusted for estimated retailer inventory movements and consumer pantry loading effect. Sequential IMS growth also on an adjusted basis was plus 16%. This reflects strong absolute growth in Italy and Poland. It also include further progress in Spain and in the U.K., where both national and London off-take share continued to grow, with the latter exceeding 3% in September. I also refer you to the appendix where we show shares for key EU markets.

IQOS continued its strong performance in Russia, with our HTU share up by 1.8 point to reach 5.8%. On a sequential basis versus the second quarter of 2020, share decreased by 0.2 points, reflecting a cigarette market, which grew 6% on the same basis, aided by seasonality of consumption and lower illicit prevalence.

Sequential HTU in-market sales adjusted for trade inventory movement increased by more than 9%. With the introduction of HEETS creation in Q1 2020 and fit consumable for lil SOLID this quarter, we now have a price tier portfolio to cater to a broader range of adult smokers across the social economic spectrum.

In Japan, our total reported share for heated tobacco unit reached 20.5% in the third quarter, supported by line extension for both Marlboro HeatSticks and HEETS, such as the recent launch of Marlboro Black Menthol. IQOS user grew to an estimated total of 6 million, of which an estimated 4.4 million have stopped smoking and switched to IQOS.

On a total tobacco basis, including cigarillos and adjusted for trade inventory movement, the share for our HTU brands increased by 2.6 points versus the prior year quarter and by 0.2 points sequentially to 18.9%.

Q3 2020 adjusted in-market sales volume for our HTU brands grew 7.3% sequentially. The overall heated tobacco category continues to grow with a large majority of this growth driven by IQOS and now makes up almost 26% of the total tobacco market.

In addition to a strong growth in existing market, the geographic expansion of IQOS continues. We leverage our digital capabilities to launch in 4 new emerging market, Costa Rica, Georgia, Jordan and the Philippines. This takes the total number of markets where IQOS is available for sale to 61, of which over half are outside the OECD.

The launch in the Philippines was initiated digitally before adding retail touch points and is focused on Metro Manila, where consumer purchasing power is higher. While the geographic group is limited, we are encouraged by progress so far.

We have also now started the commercialization of IQOS VEEV, our new e-vapor product, which was launched in New Zealand during the quarter. Initial adult consumer feedback is positive, and we plan to roll out to further market in Q4 and 2021. The commercial infrastructure of IQOS will allow us to deploy efficiently and at scale.

We place great importance on guarding against youth access for all our product. In this category, in particular, we will be testing age verification technology in select markets.

As part of our mission to build and accelerate the global RRP category, we aim to offer a choice of experiences, formats and price points to adult smoker and consumer of other nicotine product. Our collaboration with KT&G is consistent with this goal, as demonstrated by the first launches of lil product through our IQOS infrastructure. We introduced the lil SOLID heat-not-burn device and Fit HTUs in both Russia and Ukraine during the quarter.

As we reach shares approaching 15% to 20% with IQOS in key cities such as Moscow and Kiev and we expand to area with lower purchasing power, a simple affordable proposition can play an important complementary role in reaching more adult consumers and maintaining a strong rate of user acquisition. Early result are encouraging with positive feedback from adult user. This means that in both these markets, we now have HTU brands at 3 price points within the heat-not-burn category, super premium HEETS creation dimension, premium HEETS and mid-price Fit, all of which present attractive margin.

We will also shortly be launching the lil HYBRID device, mix consumable and nicotine-free liquid cartridge in 2 Japanese prefectures, offering adult consumer a differentiated premium experience, which combine the satisfaction and rich flavor of heated tobacco with added sensorial element. There is a consumer segment in Japan looking for such an experience, and we believe this will be the best hybrid product available in the market.

I want now to emphasize the deep alignment of our business with sustainability and ESG objective, which sit at the core of our mission and strategy. Our most important ESG issue is the health impact of our product. By innovating with significantly better alternatives such as IQOS, we have a historic opportunity to substantially reduce this impact by switching adult smoker who would otherwise continue to smoke to reduced-risk product.

Through deploying RRPs at scale, we can improve public health and contribute to the sustainable development goals, especially goal 3, good health and well-being. We also have best-in-class practices across a range of central ESG issues, where the other 3 of our 4 system pillars are focused. We believe this provides a unique combination, whereby sustainability is a true driver of innovation and growth. By embedding sustainability into the core of our business, we can create value for our shareholders and society at large.

To conclude, our Q3 result were stronger than expected, and we have raised our full year guidance to reflect around plus 5% to plus 6% organic EPS growth. We are building a business through RRPs to deliver superior and sustainable growth over the coming years. The continued momentum of IQOS through the challenges of the pandemic demonstrate the structural growth characteristic. We are also committed to maintaining the competitiveness of our combustible business.

We have a number of levers for growth in our top and bottom line: first, the powerful mix effect of RRPs; second, pricing, which will remain important for combustible and where appropriate for RRPs; additionally, efficiency in our manufacturing and SG&A cost are further levers as we continue to hone our business model.

Moreover, with the launches of the IQOS VEEV and lil product, we are broadening and stepping up our product offer and innovation in 2021. You can also expect us to bring further exciting innovation to our IQOS heat-not-burn platform.

As I just mentioned, sustainability and ESG are at the heart of our smoke-free strategy, and we continue to work tirelessly to further our mission. As we all know, there remain continued uncertainty regarding the pandemic, the impact of social restriction and their economic aftermath. However, when COVID-related headwinds abate, we expect to resume growth, consistent with the currency-neutral compound annual growth rate in our 2019-2021 algorithm of at least 5% net revenue growth and at least 8% adjusted diluted EPS growth on an organic basis.

In short, we look forward with confidence, and we will expand on these topics further at our next Investor Day, which we plan to hold in early 2021.

Thank you. I'm now more than happy to answer your questions.

(Operator Instructions) Our first question comes from Adam Spielman of Citi.

So my first question, you reiterated that you're very, very comfortable with the 90 billion to 100 billion target for 2021 for RRPs. Are you still comfortable that you are -- will exceed 250 billion in 2025, which is your other longer-term target? That's my first question.

Thanks, Adam. We definitely are repeating our ambition to reach next year 20 -- 200 billion stick in the heat-not-burn category, and I think that the growth that we deliver quarter-after-quarter is clearly pointing to that direction.

Then you are alluding to the 2025 objective of a 250 billion Plus, which is, I think here, aligned with what I've started to detail on the presentation, which is really the fact that we are broadening the portfolio when it comes to RRPs product. And we are going to, of course, come with more enrichment, more segmentation, more offering when it comes to heat-not-burn. We are entering the e-vaping category. And all that is going to put us on the track to deliver that ambition.

And I think everything I've been saying in term of segmentation of the devices now that we are coming with the lil offering. What we have started to do now in Japan, in Russia, when it comes to the consumable, it show that we are clearly now that -- the market is getting a bit more mature. Of course, it's still at an early stage in most places. But in a few places, we have some first element of a bigger market. It is time now to enrich the offering and broaden the spectrum of what we can offer to, I would say, conquer and convince more smoker to switch to our product. And therefore, that is what is going to put us on the right track for this ambition for 2025.

And then (inaudible). I don't want to put words in your mouth. But your market shares in Russia, in Japan, they grew in Q3 but sequentially less than in Q2. And I'm wondering why that was, do you think, and whether really it's significant or it's just sort of random quarterly fluctuations and we should just ignore that one?

Yes. I don't think that there is anything to be read there. I think that we are very happy with the performance on the key market. Of course, what has been -- and depending on the season and the consumption pattern and what has been happening on the borders, we know that some border were closed. We talked about illicit trade being stopped. I mean that can be disruptors to the evolution, if you take a kind of flash or spot quarter view. But I would say the trend that we have seen in Q3, we are very much aligned with the nice strong trend that we've been observing over the first part of the year, over H1. So I don't think that there is anything in Q3 that would be signaling a slowdown in the way we are gaining share in an underlying manner.

Our next question comes from the line of Pamela Kaufman of Morgan Stanley.

So there's obviously a lot of ongoing uncertainty, but as you just reiterated, you are on track for your heated tobacco target for 2021. I guess broadly, how are you thinking about how you're positioned for growth next year? And do you anticipate accelerating growth as you lap the performance this year and see benefits from the enforcement of minimum price increases in Indonesia?

Well, thanks for the question. Obviously, it's very early stage to start talking about next year. I think you very rightly said it, 2021 is full of uncertainty. And we even recognized that the last months of 2020 have their fair share of uncertainty as well. So difficult to, of course, start to elaborate on 2021.

The only thing I can say at that stage is that we are going to enter 2021 with the strength of our RRP business. That is clear from this first 9 months performance. There will be certainly a number of low comps in the basis of 2020, but as we don't know how the markets are going to be in 2021. And if I take the example of Duty Free, which, of course, you could say, we're going to have 9 months with very, very low business in Duty Free in 2020. So one could argue whether that's an easy basis of comparison. But nobody is able to say today what's going to be the rebound next year of Duty Free.

So it's just difficult to say which kind of growth trajectory at that stage it design, if you want. I hope we'll know more at the beginning of 2021 when we will comment on our full year 2020. And at that stage, we can share a more detailed view. But I think that for us, the main element today that I would say is a kind of for sure, whatever is the environment, is a very, very strong performance of our heat-not-burn business.

And also, obviously, very strong margin performance in the quarter. Can you elaborate on the factors that contributed to that in terms of lower marketing and administrative costs? You pointed out manufacturing efficiencies. How are your IQOS customer acquisition costs trending? And how much of the lower cost is temporary versus sustainable going forward?

Sure. Happy to do that. Well, the margin improvement is -- and that's probably the strength of the performance, is not coming from one element. I think it's a collection of driver that we have to add to the top line evolution, nice margin evolution. And that is coming, first, of course, from the growth of RRPs. And I think we are showing this quarter's impact on the gross margin of the positive impact on the mix of the consumable in heat-not-burn. And as we keep growing the business, that is, of course, a nice mix positive impact, clearly helping the margin.

There is also everything we are doing on price. And we keep clearly working in the direction of improving nicely price on combustible. There is -- and I would be happy to elaborate further if you want.

Then there is, of course, everything we do on manufacturing productivity, which is also a nice driver. And then below the gross profit, you're right. We have this very positive evolution of our SG&A, where we managed to decrease, on an organic basis, SG&A by about 7% when the decrease of the top line is only 1.5%. So we have a nice leverage, if you want, between the 2.

And here, you have a mix of things. First of all, yes, of course, we are working on the efficiency of our costs. So all functions, all team are working on -- working in a simpler, more efficient, more digitized manner. We are platforming our work. We are standardizing. We are automating. We are using digital in all capacity in order to work in a more efficient manner. So that is contributing to certainly some saving.

Then on top of all this effort, you're absolutely right, we have increased efficiency as we turn toward a more digital commercial engine on RRPs. And that is, of course, something that is going to accompany us on the long term. We build at the origin the IQOS business with a business model we know, with a lot of physical cultures and based on having some retail places that we were owning. And that was great to start. We needed to do that.

But of course, as we are growing the market, as we are learning about it and as we are developing our digital skills, we are indeed developing a tool, which is really efficient, both in term of digital customer experience and in term of digital trade experience. And that is allowing us to be much more efficient in contacting smoker that we can convince to switch to IQOS, in explaining and accompanying them on answering all their question, in coaching them in a digital manner for them to understand how it works, how it's a global experience.

To answer the question, we have been creating communities where people switching to IQOS can exchange their impressions and their tips. And then once it is done, of course, the job is not done, and we are moving to retention and really build this intimacies through having a lot of data about our customer of IQOS and really being able to bring them the best overall experience and keep them as a customer of our heat-not-burn business.

So that's what we are doing today. And absolutely, that is translating into a reduced cost of acquisition and a reduced cost of retention. We are certainly not at the end of this improvement, but that is nicely helping the performance in 2020, for sure.

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

You've launched in some markets this year, and certainly it doesn't seem like the easiest of circumstances to really get those going with pandemic closures and restrictions. But you've got some like Saudi Arabia already at 40 basis points of share. Obviously small, but France took several years to get to that; Mexico also, 20 basis points. It's early, but these look like they're a pretty good start. Can you touch on some of what's driving that? I know you just mentioned some of the digital things. Is that really the key? Are there other factors? What's just getting some of these markets going a little bit more quickly than we've seen in the past?

Well, I think it's -- and each market, Michael, is different. So the answer probably could require a long explanation in answering the various type of dynamic.

And starting with the regulation, of course, the capacity that we have to speak about IQOS and explain how it works. In some market, we have this capacity to explain to smoker that a better alternative does exist. In other country, we are much more limited. So that is clearly having an impact.

Then certainly, there is an impact. As you grow the visibility of IQOS, as you are -- people starting to see friends, family around them using IQOS, you may have a kind of snowball effect. Maybe it's a little bit of a caricature, but I think, to some extent, it can play like that. And that can accelerate the evolution of the market.

You have also the cultural dimension, which is quite important. In some country, people will be proud of having discovered IQOS, and they will want to share that with their friends. And they will become our best salespeople, I would say, about IQOS and taking themselves the time to explain and convince friends and relatives.

In other culture, it will be very different, and that won't happen because they will believe that it's a personal choice, and they don't want to interfere on that. So all that to explain the very different pattern that we are seeing in term of development of the business.

Having said that, you're absolutely right. The more we're going to be able to go digital and have great digital tool to contact smokers, talk about IQOS, be able to engage them in what is the IQOS experience, the more we're going to be able to grow the market. And clearly, developing the digital customer experience is going to be key, hopefully, in accelerating the growth in several markets.

But let's not underestimate the fact that regulation can be a pretty significant restriction, nevertheless, even when it's come to using digital tools. So again, that explains why -- I think there is certainly no market where we are not saying that we have the ambition to make them RRP market. But certainly, in some market, it's going to take a bit more time.

Okay. That's helpful. And then we're about 5 months into the menthol ban in the EU for cigarettes. You mentioned a little bit of incremental momentum on IQOS menthol, especially in a market like Poland. There's been a big share jump there. How much is that related to menthol success, getting cigarette smokers to switch? And how much more runway is there for that to go?

Sure, Michael. What I can share with you is that -- so you remember that menthol was roughly speaking, 10% of the EU market altogether. I think the vast majority of the menthol smokers have been switching to other type of combustible cigarette. So I don't think that there has been -- certainly not the -- maybe what was up in term of people stopping to smoke. It's probably a few percent, but no more than that.

And when it comes to switching to other alternatives like heat-not-burns and IQOS in particular, maybe around 5% of the people have done that so far, which doesn't mean that we are giving up. We think that we can certainly convince more people. But I think the impact has been relatively limited. You're right, probably helping a little bit in Poland, maybe in the U.K. as well, which are 2 big market for menthol. But I will not say that it has been having a big, big positive impact so far on our IQOS business.

Our next question comes from the line of Vivien Azer of Cowen.

Appreciate all the detail around digitization and IQOS user engagement. Seemingly, a lot of the hard investments, you guys made early, and then the incremental investments are paying off. I was wondering if we could kind of pull that all together and perhaps quantify the evolution of your IQOS user acquisition costs, in particular, over the course of 2020 given COVID.

Well, I understand the question. But at that stage, I think we're not going to enter into more granularity. I think we are giving through this set of numbers and presentation more detail on the driver for profitability. So I'm sure that you're able to capture through the gross margin evolution and other element that we are giving some elements.

But it's obviously as you can imagine, a relatively strategic information, sensitive. And therefore, it's not something that we can share. But I'm certainly happy to confirm that we are seeing a significant decrease and that we have ambition for more significant decrease in the future.

So I'm just reiterating my comment that you should expect more improvement on the ramping up of the profitability of our RRP business in the future, which is really great because we are combining a big, big driver for the top line growth, quite obviously. And in addition, a nice driver for profitability improvement.

Okay. That's fair. And my second question is just on price gaps in the heat-not-burn category. Makes a lot of sense to me that you would want to introduce a tiered portfolio as your penetration continues to mature, if you will. How are you thinking about those price gaps relative to combustibles, though? I mean you've used the same kind of descriptive language in terms of the price segmentation in Russia. Are we meant to take that to understand that you're going to match price gaps against combustibles with a tiered heat-not-burn consumable portfolio? Or is there a reason to think it might vary?

Well, as you know, globally, we have a position because it deserves it, our RRP business as a premium business. It's a unique consumer experience, and that fully justify a premium price positioning.

Now of course, as you know, in some country as well, the excise duty level is lower; sometimes, materially lower on RRPs and on heat-not-burn than on combustible cigarettes. And therefore, that is also justifying a lower price point. So I would say, as a rule, we have our combustible that are priced at the price on Marlboro or sometimes even a bit below Marlboro.

And I think it's a good positioning, the sweet spot, to really reflect the overall experience and the value for the consumer, but also the specificity of the heat-not-burn category and our heat-not-burn product.

And in segmentation, we're going to do the same. It's of course related to the customer experience as well. And all 3 consumable are not the same, and they don't deliver the same experience. And exactly like we have been doing for decades on consumable, depending on the level of, I would say, benefit, value for the consumer, the -- we know what is perceiving, the overall pleasure and positive dimension for him, we'll have different price positioning that will be aligned with that. I don't think we should expect anything really materially different there.

Our next question comes from the line of Bonnie Herzog of Goldman Sachs.

Your quarter was stronger than expected, and you're seeing a better demand environment. And then you also took up guidance again. So I guess I'd like to get your thoughts on resuming your share buyback program and if this might be realistic next year. It seems like you have flexibility. And I guess I think of it as an important positive signal for the market that probably would be viewed favorably. So I just think it would probably help to support your stock price. So I'd love to hear what your current thinking is on this.

Thanks for the question, Bonnie. We haven't changed our mind at that stage on the buyback. We've announced, as you know, a 2.6% increase of the dividend to $4.80 a year. So we continue to reward the shareholders. And I think we stated in the past, and we are very much on that line, that we will not start a share buyback that could potentially endanger the rating. And I'm not sure that today, we have a huge flexibility on that rating with the balance sheet that we have today. So we have a very strong balance sheet, and we want to keep that. I don't think that we would love to be losing some notch in the rating because of buyback.

So I'm not closing the door on the long term. Of course, it's a moving situation. And as we keep generating cash and strengthening the balance sheet, we may, together with the Board, decide to change that. But for the time being, this is not on the agenda.

Okay. That's helpful. And then I know it's early, but I was hoping to get maybe your thoughts on what you see as the key tailwinds or maybe headwinds as we look out into '21. I guess as I'm thinking about your business and what you've accomplished during this pandemic, it seems like the setup is quite positive, especially if I think through a few tailwinds, such as, for instance, the one you have in Japan. I'm not asking for guidance for next year, but is there a way that you could just kind of lay out a few of these tailwinds as you see them for your business and/or possibly headwinds?

Thanks, Bonnie, for not asking for the guidance because I would not give it anyway.

Trying to elaborate on tailwind and headwinds. I think the tailwinds are quite obvious. We have this RRP business that is almost 1/4 of the business. So it's very material in term of share of revenue. That is growing very strongly. We talk about a growth of about 28%, 29% year-to-date.

We see a number of market that are actually contributing to the dynamism. We are, as we've said, enriching the offer. So we see that we start to enter into a new phase of this ambition of creating this category that we think one day will be, I would say, putting an end to a smoking world by this segmentation enrichment of the offer. So we have here a very powerful tailwind that is going to help us as we enter into 2021.

And as you have seen, it's not only, as I said, positive for the top line but it's also nicely positive for the bottom line because we are ramping up the profitability on that business, and that is a business that has a potential to be super nicely profitable.

Then of course, I said it, you have all these very low comps that we're going to have in a few markets. We have this Q2 that have been very difficult. You have the Duty Free business that is extremely depressed. So one could argue that if things were to start gradually in 2021 to be back to normal, but that could provide easy comp for growth.

Now that, unfortunately, is a segue for headwinds because we don't know what's going to be the environment. More and more people are saying that we're not going to be back to normal, maybe until the summer of 2021. Nobody knows what exactly it means, by the way. But people are saying when the vaccine will be available, which could be summer 2021, that's the condition to be back to some more normality. And therefore, we don't know how it's going to play out globally on the business.

But I think we are taking comfort and confidence from the fact that 2020 will not have been a walk in the park, that's for sure. And despite that, we are delivering what I consider to be a robust performance and targeting now a nice organic growth for the adjusted EPS. So it show that even in a difficult environment, we managed to deliver a nice performance.

Our next question comes from the line of Gaurav Jain of Barclays.

Emmanuel, so a couple of questions. One is on the CapEx. The CapEx was again reduced to $600 million. And now it is meaningfully below depreciation, which runs at about $950 million for your company. So is this the new run rate of CapEx? And can your depreciation step down in the future?

Sure, Gaurav. So no, this is not the new normal for the company. We are obviously going through stormy water, so it's an adjustment. And there is a number of projects, by the way, that given the environment, we prefer to postpone. So that explain why we are now targeting $0.6 billion for the year.

I think you can expect us when we are back to a more normal environment to be back to a more normal CapEx amount that I would say probably to be around $0.8 billion. So that could stay below the level you're right of amortization and depreciation. That is north of $900 million today.

And of course, over time, if it continues like that, that will mean that this amount will decrease as well. You're absolutely right. I'm not able to give you a phasing for that, but that should be over time, a natural evolution. Now of course, with the carryover effect, it will take some time.

Sure. And my second question is on your travel retail business, where you have booked 0 revenues on IQOS in the Middle East and Africa line. And clearly, the market is not down 100%. So you are supplying out of inventory. So is there any risk of inventory write-down in travel retail?

I think at the end of September, we have been taking care of the potential impact of that. So I would not expect anything major for the rest of the year.

Our next question comes from the line of Chris Growe of Stifel.

Emmanuel, I just had a question for me, if I could, on some of the inventory adjustments that occurred in the quarter. And just to understand, so IQOS had an inventory drag that weighed on its volume in the quarter. You reported an even stronger performance for that brand excluding the inventory changes. Are inventories, say, for IQOS -- I guess I'd be curious for your business overall. Are they at the right level? Or are there expected changes to occur in the fourth quarter on inventory, perhaps $1 billion inventory?

No. Chris, I think that you're right, and I think we flagged in H1 that there was a number of country with some anticipation on inventory. We got the reversal of that in Q3.

You're right. If you retreat the shipment by that, we have recalled around 20.5 billion stick of in-market sales, which is -- I mean it's quite a symbolic threshold, but to be above 20 billion is quite nice.

And we believe that we are globally at the right level at the end of September. So we're not expecting today in Q4 any material impact on inventory for heat-not-burn.

Okay. And then just a second question on VEEV. And kind of just understand the degree, which you can undertake a wider-scale launch in more markets in the fourth quarter. Are there production limitations there? Obviously, I'm sure there are at this point. But just to understand how you think about the progression of that launch in more markets in -- starting in the fourth quarter.

So there could be a very limited number of market launch in Q4. I think we're taking the time to have all the lesson learned from what we've seen in New Zealand to make sure that when we launch, we are super ready and very successful.

There are certainly things around age verification on which we are still working and which are very important for us, as you know. So we are still working on these various dimensions. So don't expect too much in Q4. I think the big new launches will be more for 2021.

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

Emmanuel, hope you're well. And first question, please, I just wanted to come back to Adam's, in the 250 billion target by 2025. So you mentioned the role, the expansion of the portfolio into e-vapor here. And obviously very different economics between heated and vapor. So how do you see that 250 billion being split between the 2 categories? I know very early days but kind of a rough idea internally how you see that evolving.

Sure, Owen. So we haven't been splitting the 250 billion. So I won't do it now. I think we believe that quite obviously, each RRP category has a play in getting there. But there is no doubt that we continue to see the heat-not-burn category as being, I would say, the majority of this 250 billion. So we certainly intend to develop e-vaping and IQOS VEEV and other things that we could launch from now until 2025.

But I think you should expect still a big part of this -- a big majority of the 250 billion to come from heat-not-burn. Remember, I mean, this is an aspiration that we've been sharing. I think as we progress, we'll make sure that we put more detail around that. So bear with us. We're going to certainly continue to give more vision, more visibility. But at this stage, I cannot split further the 250 billion.

And quite obviously, we want to developing in a profitable manner. So that is also drive the choices and the final number in the split of the 250 billion.

Okay. And second one, I was hoping you could give me the ex-inventory heated volumes in Eastern Europe for Q1, Q2 and Q3. Just see how that's kind of progressing, stripping the inventory in packs out?

Well, I don't have that with me. But I can see with the team, maybe as toward whether this is something that we can find, Owen, for you. Thank you. Thank you.

And thank you. We have reached the allotted time for questions. I'd now like to turn the call back over to management for any additional or closing remarks.

Well, thank you very much. That concludes our call for today. If you have any follow-up questions, please contact the Investor Relations team. Thank you again, and have a great day.

Thank you all. Talk to you soon. Bye.

And thank you, ladies and gentlemen. This does conclude today's call. You may now disconnect.