菲利普莫里斯國際 (PM) 2010 Q3 法說會逐字稿

Good day and welcome to the Philip Morris International third quarter 2010 earnings conference call.

Today's call is scheduled to last about one hour including remarks by Philip Morris International management and the question-and-answer session.

(Operator Instructions).

Media representatives on the call will also be invited to ask questions at the conclusion of questions from the investment community.

I will now turn the call over to Mr.

Nick Rolli, Vice President of Investor Relations and Financial Communications.

Please go ahead, sir.

Welcome.

Thank you for joining us.

Earlier today, we issued a news release containing detailed information on our 2010 third-quarter results.

You may access the release on our website at www.pmi.com.

During our call today, we'll be talking about results in the third quarter of 2010 and comparing them with the same period in 2009, unless otherwise stated.

References to volumes are for PMI shipments.

Industry volume and market shares are the latest data available from a number of internal and external sources.

Net revenue data excludes excise taxes.

Acquisitions, for the purposes of this presentation, also include our business combination with Fortune Tobacco Corporation in the Philippines.

Organic volume refers to volume excluding acquisitions.

You'll find data tables showing how we made adjustments to net revenues and operating Company's income, or OCI, for currency, acquisitions, asset impairment, exit and other costs, free cash flow calculations, and adjustments to earnings per share or EPS as well as reconciliations to US GAAP measures at the end of today's webcast slide which are posted on our website.

Today's remarks contain forward-looking statements and projections of future results and I direct your attention to the forward-looking and cautionary statement disclosure in today's presentation and news release for a review of the various factors that could cause actual results to differ materially from projections.

It's now my pleasure to introduce Hermann Waldemer, Chief Financial Officer.

Hermann?

Thank you Nick and welcome, ladies and gentlemen.

As anticipated, our third quarter results were adversely impacted by various timing issues in particular relating to Japan.

More than half our organic volume decline in the quarter was attributable to the payback for the previously disclosed 3.4 billion unit build-up of stocks at our distributor in Japan during the second quarter this year.

The lower sales to Japan also drove an unfavorable geographic mix in the quarter.

We do, however, remain very competitive in this important market.

The Marlboro is growing share behind innovative line extensions such as Marlboro Black Menthol and Marlboro Ice Blast, which reached a combined market share of 2% in the quarter.

We continue to face a difficult environment in both Greece and Turkey, resulting from the significant tax increases that occurred earlier this year.

Industry volume in these markets was down by 8% and 6% respectively in the third quarter.

And the widening of price gaps has led to consumer down-trading and an unfavorable product mix.

These three issues masked an otherwise strong underlying business performance.

I would like to mention in particular the good results of Marlboro driven by the new architecture and innovative line extensions.

The market share of Marlboro was higher or stable in the third quarter across all four of our regions.

A notable highlight of the quarter was our continued strong cash flow performance with operating cash flow increasing by more than 30% in the quarter.

This allowed us to accelerate the implementation of our share repurchase program and to increase our dividend by 10.3% in September.

Indeed, the strength of our underlying business along with more favorable exchange rates and the lower tax rate has led us to raise and narrow our reported diluted EPS guidance for 2010 to a range of $3.90 to $3.95.

This represents a reported diluted EPS growth rate of approximately 20% to 22% compared to the $3.24 achieved last year.

Excluding currency the growth rate in our guidance is now approximately 16% to 18% compared to 14% to 17% projected previously.

Our cigarette volume in the quarter increased by 4.5% to 229.2 billion units driven by our successful business combination with Fortune Tobacco in the Philippines.

Excluding acquisitions, our volume declined by 2.9% or 6.3 billion units.

In addition to Japan, Ukraine contributed 2.6 billion units to this decline reflecting both the timing of shipments and market contraction following a series of tax-driven price increases.

Our volume was also unfavorably influenced by lower industry volumes in such markets as Greece, Poland, Spain, and Turkey.

On a year-to-date basis our organic volume was down by 1.6% or 10.5 billion units.

The decline was driven in particular by Turkey and Ukraine whose combined volume was down 10.1 billion units, as well as by Greece and Spain.

Our volume in a number of important emerging markets including Algeria, Argentina, Egypt, Indonesia, Korea, Mexico and Russia has however increased this year.

Our net revenues excluding currency and acquisitions were down slightly in the quarter, impacted in particular by the timing of shipments to Japan, the needs to partially absorb taxes and lower volumes in Greece, lower volumes and an unfavorable mix in Turkey, and the lapping of last year's price increase in Germany.

On a year-to-date basis, our net revenues, excluding currency and acquisitions, are up 3.6%.

Our OCI in the third quarter was unfavorably impacted by two timing effects and difficult comparisons, namely, the aforementioned timing of Japanese shipments and pricing as well as the tax-driven industry volume declines and unfavorable mix in Greece and Turkey and lower industry volumes in Spain and Ukraine.

During the third quarter last year, we achieved a record pricing variance of $590 million.

Our pricing variance in the third quarter this year was $292 million as we notably lapped price increases in Germany and Turkey and were obliged to partially absorb higher taxes in Greece.

Consequently, we were not able to fully offset the lower volume and unfavorable geographic mix in this quarter and adjusted OCI declined by 1.7% excluding currency and acquisition.

While adjusted diluted EPS grew at the slower rate of 5.4% excluding currency.

On a year-to-date basis adjusted OCI increased by 4.5%, excluding currency and acquisitions.

These results were impacted by lower volumes, the skew of our pricing variance this year towards the fourth quarter and higher costs which we were able to partially offset through our productivity [gains].

As previously disclosed, tobacco leaf price increases are expected to have an impact of around $215 million for the full year 2010.

In addition, we have increased our investments in marketing, sales, R&D, and infrastructure.

Going forward we expect tobacco leaf prices increases to be broadly in line with inflation and we will continue our rigorous focus on cost controls and productivity gains.

Our adjusted diluted EPS growth so far this year was 12.5% excluding currency.

The underlying strength of our business and favorable pricing prospects are the basis for our confidence in our full year guidance.

We expect to reap the benefit in the fourth quarter of recently implemented price increases in Argentina, Indonesia, Italy, Japan, Russia and the UK.

In addition we have announced a price increase of EUR0.30 across our portfolio in France, higher prices as of next month in Poland and have filed for a price increase with the customs authorities in Portugal.

Furthermore, we will benefit substantially in the fourth quarter from the revaluation of the inventories at our distributor in Japan.

This represents the increased margin on our future sales to the trade but from an accounting perspective was taken in October in one go due to our import structure in this market.

We therefore expect our pricing variance in the fourth quarter this year to be significantly higher than in the third quarter.

Our underlying business performed strongly in the third quarter with a share gain for the Company and for Marlboro in the EU region and good share momentum across all regions.

PMI achieved year-on-year or sequential share growth, notably in Algeria, Argentina, Egypt, Greece, Indonesia, Korea, Mexico, the Netherlands, Poland, Russia, Serbia, Spain and Turkey.

A key driver of our improved business momentum has been the successful rollout of the new Marlboro architecture.

In the third quarter, the share of Marlboro increased or was stable in all four of our regions.

The market share of Marlboro in the EU region grew by 0.2 points in the third quarter to 18.4%, with solid performances notably in Belgium, Italy, the Netherlands, Poland and Spain.

In the highly price sensitive German market, Marlboro's recovery is being hampered by a widening of price gaps.

In Greece, consumers have been down-trading due to steep price increases and the large price gaps in a difficult economic environment.

L&M is the second best-selling cigarette brand in the EU region after Marlboro.

Its strong momentum continued in the third quarter.

This market share growth notably in Belgium, the Czech Republic, Germany, Greece, the Netherlands, Poland, Portugal and Slovakia.

For the region as a whole, L&M grew by 0.6 share points to 6.3%.

Outside the EU region, Marlboro is performing very strongly with market share gains across a wide range of different geographies.

Marlboro volume increased by 9.8% in Asia excluding Japan, was up 0.8% in the Latin America and Canada region, and was down only marginally in the EEMA region.

Let me now turn to our momentum in key markets starting with the EU region.

In the third quarter, total industry volume was down 5.5% driven primarily by the recession-related double-digit decline of the Spanish market.

The combination of price elasticity this year and trade purchase patterns last year in the Polish market and the impact of higher prices and the economic crisis in Greece.

Our total market share in the EU region increased by 0.2 points in the third quarter to 39.1%, behind an overall solid performance across our main markets.

In Greece our market share is increasing sequentially as the growth of L&M has more than offset the decline in Marlboro.

To maintain the competitiveness of Marlboro, we were obliged to partially absorb tax increases that occurred earlier this year.

We expect that the Greek market will continue to act as a drag on our regional profitability growth into the beginning of next year while discussions on structural changes to the excise tax system continue.

We increased our shipment volume in the very important Russian market by 1.4% in the third quarter to a record level of 25.4 billion units.

This strong performance was driven by above premium Parliament, mid-price Chesterfield and low-price Bond Street and mixed.

PMI implemented price increases of RUB2 to RUB3 per pack in July.

The market is stabilizing overall and consumer down-trading continues to slow.

Industry volume during the third quarter in Ukraine is estimated to have been down about 15%, reflecting the size of trade purchases in June ahead of the latest tax increases and a market contraction resulting from continuous price increases over the last two years.

Our volume declined by 2.6 billion units or about 25%.

Premium Marlboro and mid-price Chesterfield gained share but they shed share at the low end of the market.

The improved mix and higher prices enabled us to strongly increase our profitability in Ukraine during the third quarter.

While the decline slowed in the third quarter, industry volume in Turkey was still down by about 6% year-on-year as consumers have switched to contraband cigarettes and loose tobacco, following the very large tax-driven price increases earlier this year.

Though our volume and product mix remains unfavorable compared to last year, our market share in Turkey is starting to improve sequentially which makes us optimistic that the outlook will be better next year after a difficult 2010.

While our shipments to Japan in the third quarter were 3.5 billion units below the prior year, sales by our distributor to the trade rose by 4 billion units or 27.3%.

We estimate that the retail trade built up about ten days of additional stock and consumers purchased some three weeks of stock ahead of the October 2010 retail price increases.

Consequently retail sales this month have been very limited and we will only be able to see the consumers' reaction to the higher prices towards the end of the quarter and during the first part of next year.

Let me remind you, that the retail selling price for cigarettes grew very significantly this month, with a 37.5% increase for Marlboro.

While the price increases are unprecedented in their magnitude and take place in a deflationary environment, cigarettes remain relatively affordable and therefore, we are optimistic that our profitability will be enhanced going forward.

Industry volume in Indonesia grew by a further 3.9% in the quarter, broadly in line with the annual trends.

Our shipments were up 3.1% in the third quarter despite the temporarily unfavorably impact on A Mild, the leading brand in Indonesia of passing through the IDR10,000 per pack price points.

Our overall market share was down 0.2 points while our profitability in Indonesia grew at a double-digit rate in the quarter thanks to higher prices and the growing volumes.

In Korea, PMI volume increased by 9.7% in the third quarter and our market share grew by 2.4 points to 17% thanks in particular to Marlboro and Parliament whose growth in recent quarters in Korea has been nothing less than spectacular.

Meanwhile, as elsewhere in the world, PMI continues to advocate for the adoption of a system of regular and moderate excise tax increases.

In the Latin America and Canada region, overall industry volume in key markets was essentially stable in the quarter.

The Canadian market grew by 4.2%, a slower pace that reflects the fact that we have lapped the period last year when the provincial authorities in Quebec and Ontario started to increase their enforcement against contraband sales.

The markets in Argentina and Mexico were down slightly.

Our strong share growth continued in the quarter in the key markets of Argentina and Mexico.

In the latter, Marlboro continued to grow share and has now captured nearly half the market helped by the roll-out of the new architecture.

Excluding currency and acquisitions, OCI in the quarter was up 2.2% driven by higher pricing that was partially offset by lower volumes and an unfavorable mix in Canada where low-price brands have become more prominent following the decline in the illicit trade.

In the fourth quarter, profitability will be enhanced by the recently announced retail price increase of ARS0.5 in Argentina.

Our working capital reduction program is reinforcing our tremendous cash flow generation.

In the third quarter this year, our operating cash flow was 30.9% higher at $2.4 billion.

Excluding currency, operating cash flow was up by 43.6%.

Free cash flow increased at the slightly faster rate of 33.6% and 47.4% excluding currency.

On a year-to-date basis, our operating cash flow has reached $7.9 billion for a cumulative total of $23.7 billion since the beginning of 2008.

With one quarter to go, we have already surpassed the $21.7 billion cumulative three-year operating cash flow target that we established at the [spin] by nearly 10%.

Our financial strength enables us to generously reward our shareholders.

Thanks to the continued strong growth of our cash flow, we have increased our allocation for share repurchases for the full year to $5 billion, accelerating the rate of purchases this year under our previously approved program by $1 billion more than originally foreseen.

In the third quarter, we spent $1.1 billion to purchase an additional 20.7 million shares and have spent $3.9 billion in all so far this year to buy 78.5 million shares.

In September, we increased our quarterly dividend by 10.3% to $0.64 a share, an annualized rate of $2.56.

In fact, since the March 2008 spin, we have raised our dividends by 39% and our dividend yield stands at 4.5%.

So let me now summarize why we believe we continue to be an attractive investment opportunity.

We have strong business momentum going into the fourth quarter and we'll benefit from higher margins in Japan as well as price increases in Argentina, France, Indonesia, Italy, Poland, Portugal, Russia and the UK.

We also have a more favorable currency tailwind than previously factored into our forecast and a lower tax rate.

Consequently, we are raising and narrowing our reported diluted EPS guidance for 2010 to a range of $3.90 to $3.95.

Compared to 2009, this represents a strong growth rate of approximately 20% to 22%.

We have market leadership and are growing volume and overall share in emerging markets.

Marlboro is performing well behind its new brand architecture, and innovative line extensions with overall share up in EU region in the third quarter and either increasing or stable in our three other regions.

Our pricing power remains strong due to our brand leadership and growth portfolio.

The outlook for costs going forward is improving.

Our growing cash flow has enabled us to accelerate our share repurchase program this year to a total spending target of $5 billion and we raised our dividend by 10.3% in September, thus providing attractive returns to our shareholders.

Thank you.

I will now be pleased to answer any questions you may have.

(Operator Instructions).

Our first question is coming from David Adelman with Morgan Stanley.

Hi.

Good morning, Hermann.

Good morning, David.

I want to ask you three things, Hermann.

First with respect to pricing in the quarter you highlighted a number of comparative issues, timing issues, you talked about the fourth quarter.

But if you step back, do you feel as if there's been any moderation in your broad global capacity to raise pricing either because of consumer resistance or competitive dynamics?

Okay.

No, I don't see a moderation there.

We continue to do what we did last year and the year before.

We look at every market.

We take our decisions on a market-by-market basis.

I see no fundamentals -- underlying fundamentals that would have changed.

Okay.

Secondly, Hermann, I know you are not going to discreetly comment about the outlook for next year, but would you agree there are a number of dynamics that should flatter results next year?

You are going to have significant pricing in Japan where presumably profits, prior to this increase, have been on a downward trend.

You have FX in your favor.

You are seeing some improvements in the EM, in emerging markets.

You're going to get some cost savings in the Philippines and the buyback will continue.

Do you agree with those -- not that there won't be negative dynamics next year but you certainly will go into next year with those things in your favor.

Yes.

Absolutely.

I don't know about ForEx because nobody knows about foreign exchange the way it looks now today.

Yes, Japan of course, we have tremendous margin increases in there.

We all know that we have to see what the consumer reaction is.

Yes, we do have a very strong position in emerging markets, further reinforced, of course, by the business combination in the Philippines and beyond that, of course, fantastic position there.

Yes, there are certainly cost synergies as well that we can find there.

Overall, I would also say that we will certainly keep our cost focus and productivity focus also in the next year.

Okay.

And then lastly, Hermann, in Japan, am I right thinking that this one-off windfall from the revaluation of inventory, maybe that's a $100 million or $120 million?

Might be even slightly better than that.

Although that is truly one-off, correct?

I mean, that is a windfall.

You will be less that next year when you look at the fourth quarter.

No, that is not a windfall.

Really what it is there, this reflects the increased margins on our products.

In a different situation, a different structure in a market, you would realize those additional margins simply as you sell your products now to the consumer.

We have an import structure in the Japanese market which only means that on the inventories at the distributor you take this margin increase in one go already in the month of October which otherwise would have come in every day.

So it's not at all a windfall.

It is simply reflecting the increased margins in that market going forward.

Okay.

Thanks a lot.

You're welcome.

Our next question comes from Judy Hong of Goldman Sachs.

Thanks.

Hey Hermann.

Hey Judy.

Just on Japan, so all of the inventory that got built up in the second quarter, would you say that that has been now flushed out at the shipment level.

So in the fourth quarter, it would really be a reflection of what the consumer dynamic would look like?

Yes.

We have inventories in the market that is on the basis of the middle of the road assumption we consider to be reasonable.

Now, of course, we will see what the real consumer reaction is and you always have to adapt then inventories to your prospective sales.

But I believe that we are on a very reasonable basis there which is baked into our full-year guidance.

Okay.

And then just staying on Japan, in terms of -- going back to David's question, so you have the margin improvements from the higher pricing that you've taken, but you also have the favorable revaluation of I think about $32 million that should benefit you in the fourth quarter?

No.

The sequence in Japan has simply been, that if I go quarter-by-quarter, you have the inventory build-up in the second, you have to pay back for that in the third.

There is no tax windfall in the market in Japan.

That is taken by the government.

Every product sold as of October 1, the new tax has to be paid and gets to the government.

So now what is coming in now is really the additional margin on the stock at the distributor which we have.

That additional margin that is made on the inventories at the retail stays with the retailer.

That is the only thing there.

Okay, okay.

All right.

And then just taking a step back and looking at your operating profit in the third quarter, obviously a lot of negative impact from Japan and so forth.

But if you adjust for Japan and the tax absorption in Greece, is there -- are you able to quantify how much adjusted operating income ex-currency and ex-acquisition would have been in the third quarter?

Okay.

There's two ways of looking at that.

The first one is adjusted growth rates, well, let's put it this way.

Japan alone is about a 4 percentage points drag on PMI results in the quarter.

And Greece and Turkey together would add another 2 percentage points, but actually maybe an even better way to answer your question is really to look at OCI margins because in the third quarter there is, the overall PMI ex-currency and acquisition is negative.

There are so many distortions in there that I would rather say why don't we look at September year-to-date where only actually Asia, then, would still show a negative OCI ex-currency development of minus 2.9%.

In Asia, then you have two things in there which is of course, first, the Philippines, which is what I call a welcome dilution effect of the margin because the Philippines is, of course, a new basis for future growth.

So if you then take that one out, then Asia ex-currency and ex-acquisition would be down minus 1.3% and would be the only region where you have negative OCI margin developments.

Well, now as we were just talking, with our new margins and with the revaluation effect in the fourth quarter, also Asia is going to turn positive by year end and all four regions, in my opinion, will show positive OCI margin increases even excluding currency and acquisitions.

And that is another way of looking at it and is another way of demonstrating that the fundamentals are in very good shape.

Okay.

And then finally in terms of your share buyback comments, so as you continue to deliver on the cash flow figures that actually are pretty robust, would you commit to -- you've got this $12 billion of share buyback over a three-year period.

But if the cash flow does comes in better than expected, would you be open to accelerating the buyback beyond what you are doing in 2010?

Well, we have made a decision for 2010 to accelerate by $1 billion and to bring it to a $5 billion total for this year.

We will take the decision for next year then at the beginning of next year I would say.

So, I'll ask your patience.

Let's talk about next year when we are in next year.

Okay.

Thanks, Hermann.

Thank you.

Our next question comes from Adam Spielman of Citigroup.

Hi, Hermann.

Can I ask you a couple of questions?

The first simple one is you talked about the tax rate going down.

Can you give some guidance about what the ongoing tax rate is likely to be?

The ongoing tax rate is in the range of 29% as it was before.

Actually, for this year and if you take the mid-point actually of our guidance increase, then this is $0.125, $0.02 were actually for the tax reasons -- tax rate reasons, $0.08 were for currency and anything between $0.02 and $0.03 were for improved business outlook.

I'm sorry.

I missed that.

It's 29% is the ongoing tax rate?

Correct.

Yes.

Of that about $0.02 or $0.03 increase you just mentioned just a second ago, geographically, can you say where you've gotten more optimistic?

It is not more optimistic.

It is a better business.

It is good pricing in many places around the world.

I've been quoting many of them for the fourth quarter.

By the way, we will benefit from those also going into the new year and also a pretty good competitive position in many places around the world.

So those two together are the basis for the increase on the business.

If I summarize that, that sounds like it's the price increases you've recently announced.

Is that fair enough to boil it down to --?

No.

It's -- I was just quoting two reasons.

It's the price increases on one hand but it's also the improved competitive position.

You heard me in the prepared remarks that our share performances, including Marlboro, over many places in world; it's the combination of the two.

Thank you very much.

One final question.

If I look at your pricing variance over time, it's obviously you've got some very tough comps but at the beginning of this year -- well, last year and the closest toward the end of last year, it was over $500 million and then the fourth quarter it was almost $500 million.

This year it's been consistently below that, $340 million in the first couple of quarters and now $292 million.

Now, if you exclude Japan which is a bit of a one-off, do you think -- I suppose the question is, do you think the pricing variance we've had so far this year, is a reasonable number to be thinking about going forward?

Or do you think 2009 is a better base?

Well, if you go back one more year, then 2008 was roughly a pricing variance of $1.2 billion.

2009 was actually $2 billion.

2010, you are somewhere in the middle of the two.

I would not call at all, Japan a one-off, okay?

There's probably not going to be a price increase in Japan next year.

However, it is always a mixture of around the world.

There is a mixture of markets.

There is also a mixture of timing and that's what I was alluding to.

Okay, the third quarter was a relatively moderate quarter in that sense but it doesn't mean anything on the fundamentals.

As you see that this year the fourth quarter happens to be a strong quarter.

Okay.

Thank you very much.

You're welcome.

Our next question comes from Christine Farkas of Bank of America Merrill Lynch.

Thank you very much.

Hello, Hermann.

A couple of pricing questions, if I could.

Could you tell us maybe, or quantify a little bit, how much of the tax absorption in Greece and Turkey impacted or affected your pricing variance in the quarter?

Well, the tax absorption is principally in Greece, only minimal in Turkey.

It's principally in Greece.

It continues to be about a 3% drag on the EU region's results.

On top line?

3% profit drag, on the profit growth rate of the EU region.

Okay.

Great.

Did I hear you correctly that you have applied for or plan to implement price increases in Poland and Ukraine in the fourth quarter?

No, not in the Ukraine.

In the Ukraine, prices have just gone up.

There was a price increase -- tax increase July 1.

There was about all products for a one-and-a-half months in the market.

Now, since mid-August, I would say the consumer has seen the new price.

Yes, we are in the process of implementing a price increase in Poland.

That's right.

There is -- the government there has decided for a tax increase of about 4% as of January.

The price increases, however, will come before and we have applied with customs authorities in Portugal.

In Portugal, okay.

Now Poland has been tough with a tough third quarter with further price hikes.

Do you see these levels as reasonable or do you expect more shock to the volumes there?

No, the volume comparisons are just a bit distorted in the Polish market.

You had the situation there remember where the roll your own pipe tobacco taxation changed where you had a lot flowing back into the cigarette markets.

So comps are a bit difficult there.

We are pretty happy about the Polish market.

We are growing share.

We are performing well.

Marlboro is growing in the market.

I don't see an underlying problem there.

Okay.

And just rounding out the EU, if I look at historical numbers correctly, it looks like you won share in the EU for the first time in about seven quarters or longer.

I just want to understand because still the Marlboro or your volumes are still a bit tough in a couple of countries but we did see Marlboro win share in some regions as well.

I'm wondering if you think this is now a turn or if there's something structural in the quarter that allowed you to win share optically but likely could still be challenged there on the trade-down basis?

I really think that we see are initiatives on the new Marlboro architecture, on innovation about Marlboro that this is really bearing fruit around the world.

I would not limit that to Europe.

Then there are of course, in addition to that, there are always some more difficult countries in Europe.

That would be Germany where Marlboro is still -- is held back, but that is more or less, the reason for that is increased price gaps because of rebates given on what big and what they call maxipacks.

That's packs of 30 cigarettes, 28, 29, 30 cigarettes, but that's more of a price gap issue.

But if you take it all together, really many of the markets in Europe where we are doing well, that's for Marlboro for the overall share.

We should never forget that we always have with L&M, also the number two brand in the EU region.

So we are very, very strongly positioned with the number one and the number two, i.e., at the top end and at the low end of the markets.

Okay.

Thanks for that.

A couple of final little questions on Pakistan.

Your press release indicated growth.

I just wanted to understand if there was organic growth there, given the floods and the impact on distribution in the quarter?

Well, in terms of consumer off-take, that's very hard to say what the situation there in Pakistan is.

These floods, as we all know, covered an area as big as Italy.

When it comes to shipments in our case, those shipments are actually up, but it is a load and deload thing.

We had some trade load in this quarter, Q3 2010 ahead of rumors about price increases, whereas in Q3 2009 there was actually a deload in the market because there had occurred a price increase in June 2009.

So it's easy comps in a sense, therefore our shipments are up in Pakistan.

The one thing that concerns me a bit more in Pakistan is that we see the non-tax paid segment, let me call it, which is now approaching 20% of consumption in the market.

Okay.

And, finally, Hermann, on your guidance you gave us a breakdown of the $0.125.

Thank you very much.

You also boosted the buyback plans in the fourth quarter.

Do you not see that as having an impact on your earnings in the fourth quarter or is that built into the $0.02 to $0.03 business outlook?

No, no.

The additional share buybacks in the fourth quarter only have minimal effect on the EPS growth of this year.

So the divisor, if you like, when you go for EPS per share is essentially a daily rated average, i.e., the share repurchases at the end of the year have very little impact on your EPS rates of the year.

However, then you have to imagine that the counters are put back to zero on January 1 of the subsequent year so you do get the full benefit, then actually the year thereafter, i.e., in our case, in 2011.

But no meaningful impact actually on the EPS growth rate of this year, the $0.025 -- the $0.02 to $0.03 that I was quoting is real underlying business.

Okay.

Great.

Thanks for that, Hermann.

You're welcome.

Our next question comes from Jon Fell of Deutsche Bank.

Hi, everybody.

My questions have all been answered.

Thank you very much.

Thank you.

Let's go to the next.

Our next question comes from Ann Gurkin of Davenport.

Hello everybody.

A couple of questions.

Can I just get an update on the fine cut tobacco market and your strategy for that market?

Okay.

Fine cut tobacco market essentially in the international arena, the most important part is in Europe.

We are doing well in there.

You know that we have a couple of take-on acquisitions of some brands there.

We are doing all right.

We keep on going.

On the other hand, the focus certainly always should be cigarettes because the margins are higher in cigarettes and very often this is a question of taxation of roll-your-own, make-your-own.

Remember that's why you had a steep increase a year ago in Spain until the taxation gap was corrected.

Since then, things are back to normal.

We are an active player in the market and things are going okay, I would say.

Okay.

Great.

And then secondly, Hermann, I don't know if you'll comment with respect to the potential adoption of the use of LIP paper.

Have you made any decisions as to when you would adopt the use of LIP?

When you think that requirement will be put through in the EU market, and who you might use as your supplier?

So, I think the best estimate for now is that the EU region -- sorry, the EU commission will come out with defined standards towards the end of 2011, towards the end of next year.

Implementation probably in the year 2012.

We are, of course, in discussion with several suppliers of what the cost of such different paper would be on an industrial scale.

As you know, there are several techniques that can be used to achieve the desired result.

As these discussions are going on, with various suppliers, you will understand that I would rather refrain from giving a cost estimate and let's wait for the outcome of those discussions and negotiations.

Is it fair to say you will probably wait to adopt the use of LIP until middle of next year 2011 or can you comment on that?

We will adopt it when the legal requirement is there.

I see no reason to do it earlier.

Okay.

That's great.

Thanks very much.

Thank you.

Our next question comes from Jon Leinster of UBS.

Good morning, gentlemen.

A couple of things.

First of all, just to follow up on Japan.

What is the average stock in terms of weeks or months that's held by the distributor in Japan?

Well, we always take -- that is a little bit too much of a detail that I probably don't want to go to.

We think -- you have to take into account that we have a long pipeline because the product is coming from our European factories.

We always adapt it to our prospective sales but to go into the detailed inventory number, I'm afraid I wouldn't want to do that.

Okay, sure.

Secondly, in Germany, the market share loss, is that going to other branded players or does that represent the growth of the retail brands?

No, trade brands are actually not growing much.

They are stable at around 12% to 13% in the market.

Our market share situation, and in particular, the market share situation of Marlboro is driven by increased price gaps in that market.

Remember a year ago or so we had those price skirmishes around soft packs.

That has disappeared.

Now we have price skirmishes in rebates for big and bigger packs, i.e., 25s up to 30s packs.

There are rebates now in the market for packs if you would reconvert that to 19s packs that go up to $0.23 per pack.

So that's the situation, the competitive situation there.

We, of course, had to follow and we have just launched by the way a Marlboro maxipack, EUR6.90 for 29s there.

So that's a bit the situation in Germany.

It's not about the trade brands.

It's about industry competitors bringing packs with rebates as the justification of their size.

Right.

Also in Spain, it seems slightly counterintuitive given the problems with the Spanish market and the Spanish economy in general that Marlboro should be growing.

Is that just a reversal of what is going on in Germany, just the price gaps have closed or is there something else going on within the Spanish market?

No, in all fairness, I have to say that the Marlboro share during the summer period when the tourists are coming into Spain is always higher.

So there is a benefit on Marlboro on that clearly.

However, we have some research and some preliminary evidence that it was not only the foreign tourists that were smoking more Marlboros than before.

It was also local, i.e., Spanish tourists during the holiday period.

I think if all goes well for the future once the economy in Spain will recover and it is just another proof of really of the vibrancy of the Marlboro brand in that market and good prospects going forward.

Okay.

Thanks very much.

You're welcome.

Our next question comes from Roger Fujimori of Credit Suisse.

Hello everyone.

Just one quick question on Mexico.

If you could you give us an update on the outlook for cigarette taxation given the current discussions in Congress?

Thank you.

So, it's correct that the Lower House yesterday voted for an increase of specific tax, not ad valorem, that was unchanged from a previously foreseen amount of MXN1.20 per pack to MXN7.

The legislative process is still ongoing.

The Senate vote in that process is outstanding.

The key question I believe is can and will those MXN7 per pack be split over a period, i.e., over several years which I think would make eminent sense.

Thank you.

You're welcome.

Our next question comes from David Hayes of Nomura.

Hi Hermann.

Two areas if I can.

Firstly, on Turkey.

Looks like sequentially, Turkey is getting a little bit easier in terms of volumes.

Is that just the consumer getting used to the new price points from January or is there anything else going on there that means that those volumes seems to be stabilizing a little bit?

And then, just in terms of Russia, clearly better trends again.

I just wonder whether -- just through the quarter whether you can talk about whether those trends were getting better through the period or whether there was any negative impacts?

Obviously, there were fires and heat waves, it was a bit disrupted during the period in Russia.

And then just also whether there's an update on what is going on with tax increases moving forward.

I know there's meant to be good visibility on that but there seems to be news flow coming out that that may change slightly.

So I just wonder what your position is on that tax risk in Russia moving forward.

Thank you.

First, Turkey then.

Well, it is simply, Turkey, take it as a country first.

The macros are really excellent.

GDP is up 10%, purchasing power is up, unemployment is down.

Inflation is at fairly low levels for Turkish standards, 6.5%.

So consumer confidence is up.

All that together I think we see that consumers have adjusted a little bit to the price.

That being said, prices are extremely high and we see negative mix in that market because price gaps are also high.

I believe that's about the story about Turkey.

Moving over to Russia, there are two things here.

Really, the down-trading which we see phasing out.

I mean there are clear and hard numbers here.

If I look at our ex-distributor sales, then premium -- our sales in Q3, premium is down minus 3.5%.

In Q1, this was down 12.2%.

You can see a huge improvement.

Mid down 3.6% in Q3 versus 11% in Q1, and low increasing 8% versus 11% in Q1.

Our brand, same thing.

Q3 Parliament up 2.7%.

Chesterfield 6.7% up.

Bond Street 20% up and Optima 1% up.

So you clearly can see down-trading is phasing out in that market.

When it comes to excise tax, well, the present proposal has gone through the first reading at the Duma.

That proposal means roughly a rollover need of RUB3 per pack.

So that's an increase above inflation but I wouldn't call it disruptive.

The legislative process however is not yet over.

But for now, things look reasonable.

Okay.

That's great.

Thank you very much, Hermann.

Thank you very much.

Our next question comes from Priya Ohri-Gupta with Barclays Capital.

Good morning.

I was just wondering if you could talk about your priorities for cash usage given your strong cash flow generation in the quarter.

And secondly, if you could just discuss your plans around leverage.

Your leverage ticked up slightly in the quarter and I just wanted to see if you could talk about where you ultimately want to see your leverage.

Thank you.

Okay.

I think I can actually answer both questions at the same time because they, of course, go together.

At the end of the day, the way we look at that is, we look at our projections of our operating cash flow.

From there, we would look at our capital expenditure requirements we have, our mid and long term over multi-year average would here be that, it should about equal at max, depreciation and amortization.

Then you would look at your multi-year average of what you might need for tack-on acquisitions.

Take a multi-year average of $1 billion or so for the tack-ons.

Then you would put the framework around that our credit rating, our single-A credit rating gives us.

We like our credit rating.

We want to keep that credit rating because it gives us all the flexibility in the world.

So within those ratings, then you get to your dividends.

Our dividend payout ratio is 65%.

You know that.

You also have seen our last dividend increase in there.

And from there you get to the share repurchases which is the remainder of that whole calculation.

Thank you.

That's very helpful.

You're welcome.

Our final question comes from Adam Spielman of Citigroup.

First of all, thank you very much for taking a follow-up question.

If I can, two very brief ones.

One is, in Australia you had a big tax rise.

Are you able to say very briefly what happened to volumes and what happened to profit in that market?

Secondly, on pricing, if you look at your emerging markets, would you say that typically, your pricing is above inflation in those markets?

And if so, sort of roughly how much?

In very broad terms, how should I think about it?

Thank you.

Okay.

So let's go first to Australia then.

Well, the total market decline is moderating in Australia.

It is down about 14% since the April tax increase but more recently, we've seen about 6% decline so it is moderating.

When it comes to profitability, we have solid single digit OCI growth in that market.

So there is real increase in profitability still in Australia.

So from that sense it's good.

By the way, there is no really new news on plain packaging in that market.

The government is now studying the situation and we remain confident that they will recognize their eventual legal exposure and finally listen to the commonsense arguments there that a combination of high prices, product display ban and plain packaging will do nothing else but facilitate illicit business of criminals.

So much on Australia.

Then on your more general pricing question, well, it always is a situation that we really take on a market-by-market basis.

Our price increases in Russia would have been clearly above inflation.

In Indonesia, would have been slightly above inflation.

So it is, like always, it is really there's no general answer, I'm sorry, can't give a generalized answer.

It is on a market-by-market basis, depending what is the competitive situation, what is the purchasing power, what are the unemployment trends in the market, what else is happening, what is the consumer confidence level in the market?

So these are all elements that go into it.

So I only can give you examples for the past four key markets like Indonesia and Russia.

Thank you very much.

You're welcome.

Thank you.

That was our final question.

I'll now turn the floor back over to Nick Rolli for any closing remarks.

Thank you very much for joining us.

That concludes our call for the day.

If you do have any follow-up questions, you can contact the Investor Relations team in Lausanne, Switzerland.

The telephone number is posted on our press release.

I'm sure most of you have it.

Again, thank you very much and have a great day.

Thank you.

This concludes today's conference call.

You may now disconnect.