菲利普莫里斯國際 (PM) 2011 Q2 法說會逐字稿

Good day, and welcome to the Philip Morris International Second Quarter 2011 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, and thank you for joining us.

Earlier today we issued a news release containing detailed information on our 2011 second quarter results.

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

During our call today, we will be talking about results for the second quarter 2011 and comparing them with the same period in 2010 unless otherwise stated.

References to PMI volumes are for PMI shipments.

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

Organic volume refers to volume excluding acquisitions.

Net revenues exclude excise taxes.

Operating Company's Income or OCI, is defined as operating income before general corporate expenses and the amortization of intangibles.

You'll find data tables showing how we made adjustments to net revenues and 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 slides 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 wtatement 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?

Welcome, ladies and gentlemen.

We reported another very strong performance during the second quarter.

We achieved stable organic cigarette volumes.

Net revenues, excluding currency and acquisitions, grew by a strong 10.1%.

Adjusted OCI, excluding currency and acquisition, surged 16.5%.

And, adjusted diluted EPS were 21% above the prior year's level, excluding currency.

These excellent results can be attributed in particular to the Asia region.

With Indonesia, Japan, Korea, and the Philippines all performing very strongly.

And higher prices in a wide range of markets.

During the second quarter, our pricing variance reached $617 million for a total of $1.1 billion during the first half of the year.

In the last three months, we implemented, or announced, price increases in markets such as Algeria, Argentina, Australia, Canada, Egypt, Germany, Italy, The Netherlands, Russia, and Saudi Arabia, thus reinforcing our strong pricing momentum.

Furthermore, the pricing situation in Spain improved in July.

We also have strong overall business momentum.

Our share in the second quarter for our top OCI markets was up 2.3 points to 38.5%.

Marlboro had stable volume in the quarter on the global PMI basis, as higher volume in the Asia and [EMA] regions offset the impact of lower industry volume in the EU and Latin America and Canada regions.

The brand share was upper stable in all four regions and its global share, excluding China and the USA, grew by 0.4 points to 9.3%.

During the second quarter, L&M, our second largest brand, increased its volume by 3.1%.

Accelerating its growth in the EU region and part of the EMA region.

These results were achieved by strong share growth in a wide range of markets, including Egypt, Germany, The Netherlands, Holland, Slovakia, and Turkey.

In light of our excellent results, strong pricing, and good share in business momentum going into the second half of the year, as well as a more favorable currency outlook at prevailing exchange rates, we announced today a further $0.15 increase in our reported diluted EPS guidance for 2011.

$0.10 of the increased guidance relate to the business.

The improvement being largely attributable to Japan.

$0.05 relate to currency, which should be noted that exchange rates may still experience some volatility over the balance of the year.

The new guidance range is $4.70 to $4.80 compared to our adjusted diluted EPS of $3.87 in 2010.

This corresponds to an increase of approximately 21.5% to 24% at prevailing exchange rates and approximately 15% to 17.5% excluding currency.

Our excellent results in the first half, and our favorable outlook for the second half of 2011, demonstrate the benefits of our global footprint and highlights our success with attractive acquisitions and organic volume growth over the last 10 years in Asia, where half of the world population lives.

Our strong results in the second quarter reflect the strength of our management teams in these markets, and especially in Japan, where we took the calculated risk to commit around $100 million in air freight when the extent of the additional demand for our brands was still difficult to judge.

Our efficient, yet flexible, global manufacturing footprint and effective market response, enabled us to fill the void caused by the shortage of JT and, more recently, BAT products.

In the second quarter, net revenues in the Asia region grew by 27.7%, excluding currency and acquisitions.

And, adjusted OCI was 48.2% higher on the same basis.

As a result, the region is now our largest contributor to these measures, accounting for 35% and 36%, respectively, of PMI's net revenues and adjusted OCI during the first half of this year.

And, this contribution is expected to increase further as our business in the region continues to expand.

During the second quarter, PMI shipments to Japan reached 19.5 billion units, up 1.9 billion, or 11%, compared to the same period last year.

This increase was achieved despite the unfavorable impact of the large October 2010 tax driven price increases, and the boost to our shipments that occurred in the second quarter of last year ahead of that increase.

Our market share has reached 42%.

17.7 points above the prior year level and 16.4 points above our share in the first quarter of 2011.

As we ensured full product availability throughout the period, all our brands gain share, and, in particular, Lark and Marlboro.

Determining exactly how the rest of the year will pan out remains very difficult due to the complex interaction of multiple factors.

These include the impact of the tax-driven price increase in October last year.

The consumer and trades prior year loading and subsequent de-loading patterns.

The underlying market decline print.

The price elasticity and whether it will diminish over time.

The disruption of changing supplies and shortages of certain BAT products.

The precise impact of our efficient response, and our level of smoker share retention once a full range of competitive products are available.

The new trend for industry volume, and the new base for PMI's future market share growth, will not be clear until the fourth quarter of this year at the earliest.

Our business is also doing very well in Indonesia, thanks to a strong economy and the favorable comparison, with a relatively soft second quarter 2010, industry volume grew an exceptional 13.9% in the second quarter of this year.

For the full year we expect the annual growth rate to be in the range of 4% to 6%.

Our volume in the quarter was up by 20.7% to 22.6 billion units, and our market share grew by 1.6 points to 30.2%, with all our kretek brands gaining or maintaining market share, and Marlboro increasing its volume and its share within the wide cigarette segment despite a reduction in its overall market share.

The growing volume along with continual moderate price increases, is driving strong profitability growth in Asia's second largest cigarette market of China.

In Korea, we continue to achieve strong volume and share growth behind Marlboro and Parliament.

Our market share grew by 3.3 points to 19.9% in the quarter.

With a 1-share point contribution from innovative Marlboro menthol line extensions.

Korea is one of the few key markets worldwide that we have not increased retail prices in the past year, in light of the more important need to secure excise tax reform for the long-term.

PMIs organic volume in the EMA region declined by 3.4% in the second quarter due primarily to Ukraine.

For the full year, we expect our volume to be stable in the region.

Net revenues were up 3.6% during Q2, excluding currency and acquisitions.

Adjusted OCI was 4.8% higher, excluding currency and acquisitions.

Driven primarily by increased volumes in Turkey and North Africa, and higher prices across many markets, in particular Russia.

This was partly offset by lower volumes in eastern Europe and additional investments in business building initiatives in Russia.

These investments will further boost the momentum of Parliament, Chesterfield, and Bond Street in Russia, while addressing the issues surrounding Marlboro.

These efforts will, however, take some time to have a measurable impact on our market share, which declined 0.1 point to 25.4% in the second quarter through the end of May, due mainly to a temporary price disadvantage to competitive products.

At the beginning of this month, we announced to the trade a further price increase of RUB3 on Marlboro and RUB2 on average across the rest of our portfolio.

Our lowest price in the market will now be RUB21 a pack for Optima, up 27% from a year ago.

These price increases, along with lower disposable incomes as wage increases have failed to keep pace of inflation, are limiting the extent of consumer up-trading.

Industry volume, meanwhile, is expected to decline at an annualized rate of some 2% to 3% this year, in line with 2010.

Earlier this month, the Russian Government approved its tax policy guidelines, or TPG, for the period 2012 through 2014, including a detailed three-year excise tax development plan for tobacco products.

The TPG foresees that excise taxes will be indexed periodically in line with inflation and economy conditions in Russia.

In addition to the excise tax increases already foreseen for January of 2012 in the current law, the TPG calls for an additional increase in July 2012 of 8.3% in the specific element to RUB390 per thousand, and 10.9% in the minimum excise tax to RUB510 per thousand.

While the proposed increases are significant, we believe they should be manageable.

It should, however, be highlighted that this is the first step in the process and that the plan needs to be submitted to the DUMA and the Federation Council for approval.

The final adoption of the law is not expected to take place until November this year.

In Ukraine, the estimated 15% decline in industry volume in the second quarter masks an improving underlying trend.

As to date, it's distorted by the heavy trade loading that took place in the same period last year, ahead of tax driven price increases.

We expect the market to stabilize during the second half of the year.

The Ukrainian market is tending to polarize, with the premium and the super low price segments of expanding, while several small manufacturers and illicit trade continue to grow volume.

PMI's market share was down 3.5 points in the quarter to 32.1%.

As we are under represented in the super low price segment.

We have reduced the price gap between Bond Street and the bottom of the market to address this issue.

Meanwhile, both Parliament and Marlboro are performing well and increased their market share during the quarter.

Overall, the Turkish market has now stabilized.

Our volume grew by 12.1% in the second quarter, though it remains below the levels prior to the tax increase of January 2010.

Our market share reached 44.6% in the quarter through the end of May, up 3.8 points.

This impressive share improvement covers all three price segments and is led by premium Parliament, mid priced Muratti, and low price L&M.

Despite the issues that continue to impact Spain, and to a lesser extent Greece, the results in the EU region in the second quarter were more positive from a number of standpoints.

Industry volume declined by a modest 1.7% and both actually up in markets such as the Czech Republic, France, and Germany.

PMI volume was 3.1% lower due to an 8.4% decline in Greece.

A 17.6% reduction in Spain and a decrease of 9.7% in Poland where we should share at the lowest and least profitable end of the market.

Our key brands, Marlboro and L&M, performed well.

Marlboro's regional share was stable at 18.1%, and L&M's share grew at the further 0.3 points to 6.6%.

Net revenues and adjusted OCI were up 0.7% and 2.3% respectively, excluding currency and acquisitions.

While we are not entirely satisfied with the situation, there are some clear signs for renewed optimism concerning the future contribution of the EU region to PMI's profitability growth going forward.

Germany has, again, become one of the strongest tobacco markets in the EU.

During the first half of the year, industry volume was up 1.9% for cigarettes and 4.8% for fine cuts.

PMI increased its market share by 0.3 and 0.4 points to 35.9% and 14.8%, respectively, during this period.

L&M continues to perform very strongly, gaining a third of 1 share point in the second quarter to reach a cigarette share of 10.4%.

Unit margin enhancing price increases have been implemented.

A remaining concern is the growth of discounted larger pack sizes.

While the market share of the big packs, defined as 22 to 25 cigarettes per pack, appears to have stabilized, the share of maxi packs, that is packs with over 26 cigarettes, continues to increase and may receive a boost from the recent introduction of packs of 40 cigarettes.

The Spanish economy continues to suffer from high unemployment levels with few signs of improvement.

Consequently, cigarette industry volumes have been contracting at double digit rates, and consumers have been downgrading to cheaper brands and illicit trade products.

This is a special context in which price competition was exacerbated in May and June this year.

However, recent developments indicate the situation has improved.

Industry volume increased 1.8% in France, and was stable in Italy during the second quarter.

Our cigarette market share was up slightly in France to 40.9% as the continuous growth of the Philip Morris brand, also positioned in the premium segment, more than offset the slight decline of Marlboro share.

At the same time following the entry of Marlboro into the category, we also became the market leader in fine cut with a quarterly share of 25%, up 5.6 points.

Our market share in Italy was down 0.7 points to 53.4%, with Marlboro down 0.3 points.

This was attributable to the relative decline of the premium segment, where PMI has a 95% share.

Our profitability, however, continues to improve in both markets with high single digit increases in the quarter.

Furthermore, we recently announced a EUR0.10 price increase across our portfolio in Italy.

After increasing the specific total component and its excise tax last December, earlier this month the Greek government increased the minimum excise tax from 75% to 100% of the excise tax levied on the weighted average price.

This implies a pass on of nearly EUR0.50 per 20 cigarettes at the very bottom end of the market, where cigarettes retail at EUR2.40.

PMI has announced an increase in the price of its main low price brand L&M 25s, from EUR3.20 to EUR3.70 per pack.

The reduction in price gaps should help to continue the recovery of Marlboro's market share in Greece.

Our volume in the Latin America and Canada region was 4.8% lower in the quarter driven by a double digit market contraction in Mexico following the large tax driven price increases at the end of last year, and by the timing of shipments in Brazil.

Despite the challenging pricing environment, our market share in Mexico reached 72.2%, with Marlboro surging 3.8 points to reach a 52% share.

Our business in Argentina performed very well.

With volume growth of over 8% in gains for Marlboro which added 0.6 points to reach a 24% market share.

Net revenues for the region increased by 5.8% in the quarter, excluding currency and acquisitions, and adjusted OCI was 8.8% higher on the same basis.

On the regulatory front, the main focus remains on plain packaging.

Although certain other governments have expressed their opposition to such a measure, the Australian Government continues to appear intent on mandating the implementation of plain packaging in 2012, and has submitted a proposed bill to Parliament.

Plain packaging will result in the illegal confiscation of our very valuable trademarks and branded assets, in violation of International Trade Laws and treaties.

We have, therefore, served notice of our intention to file an arbitration claim against the Australian government under the Hong Kong, Australia Bilateral Investment Treaty.

We are now in a mandatory three-month period set aside for negotiation under this procedure.

Consequently, we have written to the government seeking a meeting.

Strong pricing and very moderate increases in tobacco and non-tobacco material costs, as well as our continued focus on productivity improvements, resulted in a 2.5 point increase in PMI's adjusted OCI margins, excluding currency and acquisitions during the second quarter.

Our free cash flow increased by $638 million, or 19.4% in the quarter, to $3.9 billion, excluding currency the increase was $402 million, or 12.2%.

The increase was driven mainly by our excellent business results.

During the first half of the year, our free cash flow was up more than $1 billion to nearly $6.2 billion.

During the second quarter we spent $1.5 billion to repurchase 22.7 million shares at an average price of $68.32.

Since the March 2008 spin, we have now repurchased 17.9% of the shares outstanding at that time.

In conclusion, PMI had an excellent quarter.

Our adjusted diluted EPS growth reached 21% excluding currency.

Our outlook is promising with strong market share and business momentum.

Pricing remains a very strong driver of profitability, with Spain being a special case.

We are not under any significant input cost pressures, and expect to exceed our annual productivity savings target of $250 million this year.

We have increased our 2011 EPS guidance by a further $0.15, bringing it to a range of $4.70 to $4.80.

Compared to the adjusted diluted EPS of $3.87 in 2010, this corresponds to an increase of approximately 21.5% to 24% at prevailing exchange rates and approximately 15% to 17.5%, excluding currency.

And, finally, and most importantly, our cash flow continues to grow.

And we are focused on generously rewarding our shareholders through dividends and share repurchases.

Thank you.

I will now be happy to answer your questions.

Thank you.

We will now conduct a question and answer portion of the conference.

(Operator Instructions)

Our first question comes from Chris Growe of Stifel Nicolaus.

Hi, good morning, Hermann.

Good morning, Chris.

A very good performance here this quarter.

Thank you.

I wanted to ask you two questions.

One would be as we're looking at and doing some modeling around the price realization for the year, you talked about being able to sort of beat the level of pricing last year.

And, just hearing some of your comments on some of the recent price increases from Russia to Italy, as well as the pricing that came through this quarter, my estimates suggests you're going to pretty meaningfully outpace that unless I'm not factoring in some second half factors.

Is there anything we should keep in mind there in relation to the dollar amount of pricing coming through this year?

I would say if you look at the numbers year-to-date June, $1.1 billion for the half year versus actually $1.7 billion for the full year of 2010 last year, I think these numbers speak for themselves.

You were quoting a number of markets that we have recently implemented or announced price increases, that's correct.

At this point of the year, I think it would be inappropriate to go into further details because any comment I would make could be interpreted or linked to a specific market.

So, bear with me.

I think it's better if I stop it there.

Sure.

Understood.

And, then, my follow up question is to be in relation to Japan.

And, I'm just trying to get a sense, especially in this quarter, there is a lot of moving pieces, I realize, particularly a year ago increase in inventory.

I'm just trying to understand, to get a sense of where you think you stand today in your inventory position in Japan.

Is there any rebuilding that needs to occur giving the lag you had in volumes given your in market consumption this quarter?

I think our inventory levels are okay in the Japanese market.

That was really a tremendous effort we have made now during this period.

I mean, congratulations really to our team in Japan there.

They have done a terrific job in difficult times for the country and for our employees there.

Also, congratulations to our factories.

I mean, 10 factories actually have been involved in the production ramp up.

Our factory workers, production workers actually have put in 200,000 of hours of overtime during the period.

And, we actually chartered the equivalent of 150 Boeing 747 cargo planes to bring 10 billion cigarettes into the market.

So, I think we are good from that side.

I mean, if you go back to really what happened in the first half of the year, as you said yourself, the full year with all the moving targets that remains to be seen.

But, if you look at the first half of the year, then, well, you look at the total market of 90 billion cigarettes.

We had a share of about 25% January and February before the events.

We have a year-to-date share of 34%.

That's 9% points difference on 90 billion, so I talk about 8 billion cigarettes here.

You make your own estimate of the solid margins that we have in Japan.

There was the air freight.

There were other costs, you deduct our corporation income tax rate, and you probably come into the range of a net income impact of $200 billion, or something like anything in the neighborhood of $0.10 to $0.12 EPS.

Okay.

That was very helpful.

Thanks for the color on that.

You're welcome.

Our next question comes from David Adelman of Morgan Stanley.

Good morning, Hermann.

Good morning, David.

Because of its importance, let me ask you a few other things about Japan, Hermann.

Can you walk through with us how your in market share evolved during the second quarter, presumably it came down in general, correct?

That's correct.

I mean, we would have started really April with the share of about 55%, May 40%, June 35%.

And, the latest I've seen, in daily off take shares now, which is not the same basis, but just if you go to a couple of the important sea store chains, then I still see shares slightly above 30% as we speak now.

These are not yet what I would call retention shares, then we have to wait a little later into the year.

Okay.

And, then, beyond having your product available in market, are there any other tactics that you've been employing to try to enhance your prospect of ultimately retaining consumers that are using and trying your products during this period?

Well, our teams there really have given full support on the distribution side.

I mean, I'll say first they have been in the market day and night so both the sales, the promotion, the logistic departments have been working very, very hard.

This, I don't think is the moment where you need to bother the consumer with new variance.

This is the moment that you have to support your broad array of very complex variants.

And, we have seen really, as I've said in the remarks, real strong growth in all brands, but in particular strong growth in Lark, a more traditional brand, if you like.

But also in Marlboro, which is a very inspirational brand in the Japanese market.

And, on that particular dynamic, are you surprised, or the people in the market surprised, that the gain seems to be skewing to Lark, and do you think longer term, Hermann, does that have any implications on the limitations of Marlboro's longer term share prospects for growth?

Quite frankly, if I look at what happened, what we have seen during the process, it gives me confidence in the growth prospects of Marlboro in that market.

Okay.

And, then on Korea, am I correct, Hermann, that some of your competitors in that market have raised prices 4, 5 or 6 weeks ago, and to this point you have not?

That's correct.

I mean, when it comes to pricing, as you know, of course I will not make comments on the future.

But, I mean, I'll give you some facts here.

In that market you're correct that there were price increases of BAT and JT in April and May.

We have also seen the biggest competitor KTG putting posters into the point of sales informing their consumers that they will not raise prices.

A third point would be that the Government, the Korean Government, is very concerned about inflation trends.

And, as I was saying before, PMI seeks excise tax reform, a multi-year plan would be much more important.

So, things are a bit more complicated as they look at first glance.

I would say sometimes in life it's not enough to do the right thing.

You also have to do it at the right time.

Okay.

And then, Hermann, one last thing.

The arbitration process that you alluded to in Australia with respect to plain packaging, I just want to confirm the fact that that action on your behalf does not preclude any other subsequent different type of legal action that you would otherwise have the opportunity to take.

Is that correct?

It's not an either or situation.

You can ultimately, if necessary, pursue multiple different avenues of redress?

That is correct.

Okay.

Thank you.

Your next question comes from Judy Hong of Goldman Sachs.

Hi, Hermann.

Hi, Judy.

Just two quick follow-ups on Japan and then a question on Russia.

So, when you think about your guidance increase for the year about $0.10 coming from Japan, that's basically all of the realization of what you've gotten so far and doesn't assume any of the market share retention going forward.

So, to the extent that you do get the market share retention, is that an up side of your guidance?

The $0.10 to $0.12 that I have just explained, that is the first half of the year, that is the actuals.

Okay.

And, then the way it played out in the quarter, so it looks like you actually captured more than sort of your fair share of the non-Japan tobacco volume, which I guess you've talked about the BAT product shortage as well.

But, just in terms of how much you've captured in the second quarter, do you think that with the function of BAT not having as many products in the marketplace, or just more brand equity on your brands that allowed you to take more share?

Well, I would call it the optimal way of seizing a business opportunity, which our folks have done and have implemented.

I think that's really what it is.

But, to come back to the beginning of your question, when you look at the overall EPS guidance, then you have to remember that, of course, at the very beginning of the year, in February, we had a certain assumption in there for our business already in Japan.

You remember there was a price increase and everything.

And, then when it came to the First Quarter, we said about half -- about $0.05 of the increase business guidance, the increase now was due to Japan and now in this quarter's call the majority of the new $0.10 business driven increase is due to Japan, but not only due to Japan.

I would also want to highlight really the terrific performance we have had in Indonesia and also, by the way, to the fact that if you exclude Spain for a moment, which is a special case by itself, that the total market size in the EU region is stable.

Okay.

And, then, just in terms of your guidance, what are you factoring in, in terms of Spain's situation with respect to your guidance at this point?

Well, the Spain situation is, of course, in.

It is, again, a moving target.

So, as I said, the situation has improved.

However, that being said, of course OCI will still be a substantial decline if you compare it to last year, that is factored in.

Okay.

And, then, can you talk about Russia post the tax increase next year.

You talked about it's a significant increase, but you see that as manageable.

Can you just elaborate on how you think that market will play out in 2012?

Well, I mean, let me start answering your question by looking at the economy, because there is one point in there which I think deserves being mentioned particularly.

While real disposable income of the people in Russia, still last year was up net of inflation, about 4% is the estimate.

Now, in the first half of this year, it's actually down.

Inflation is ranging between 9% and 10%.

Disposable income, therefore, probably is down about 2%.

At the same time, there were a number of price increases in the market.

So, why we have not seen really uptrading to mid and premium segment to the extent people have all expected it, say eight, nine months ago, at the end of the day from a consumer perspective they have uptraded.

Because as I was saying in the remarks, our lowest price is now 21rub.

So, prices have gone up quite a bit.

In that context, we have seen last year an estimate, there is no absolute number, but a good estimate that the market was down about 2.5%.

I expect something of the same nature this year and probably also going into next year.

But, we will probably all have a better feel for that once you have seen the second half of this year.

Okay.

Thanks, Hermann.

You're welcome.

Your next question comes from Roger Fujimori with Credit Suisse.

Hello, Hermann.

Hi.

My first question is on Indonesia.

I was just wondering if you could talk about the industry volume outlook for the full year after the exception of 14% or so market growth in the Q2, which is about the historical run rate, was it [up for], is going to persist in the second half?

Yes.

Okay.

I mean, in Indonesia we, of course, see the combination of a thriving economy, also, favorable demographics.

The year-to-date number for the market is actually up 8.5%.

The second quarter was particularly strong because it's kind of easy comps to the second quarter of 2010.

The full year estimate we have right now would be 4% to 6% for the full year of 2011.

Okay.

Thanks.

And, my second question is on the EMA region and your comments.

You indicated a stable volume outlook in the region for the full year after a 3% decline in 2Q, 1% decline in Q1.

Obviously, there was a distortion in Ukraine in the comparison base, but I was just interested if you could give a little more color on the drivers on the improvement in the second half.

Thank you.

Okay.

Yes, I mean, it's really the major impact of the Ukraine market there.

That market was down quite a bit.

You really had difficult comps for the second quarter of last year where the trade ordered way more at the time, because this was before the subsequent price increase, retail price increases in the market.

So, this is why I say that I expect already for the Ukraine a stabilizing, or stable market almost, in the second half that helps overall.

And, the other part would be that we are, despite the suspension of our business in Libya, we are also seeing volume growth in North Africa.

And, thirdly, I think we really have tremendous share performance in the Turkish markets.

That's great.

Thank you very much, Hermann.

You're welcome.

Your next question comes from Vivien Azer of Citigroup.

Hi.

Good morning.

Good morning.

A quick question on pricing, just to follow-up.

Given the strength of your pricing realization, seemingly including and excluding Japan, just relative to your going in estimates for the full year, were there any markets in particular where you were pleasantly surprised by your ability to pass on price or for the price elasticity you were seeing in certain markets?

We had never any doubt that our pricing plans and expectations that we had put into our guidance from the very beginning were realistic expectations.

Then, when you go into the year, it always depends on the market-per-market situation.

This is Government budgetary expectations.

This is the competitive situation as we judge it.

And, so we take our decisions on a market-by-market basis.

And, as the actual results have shown, we have been very successful in there.

To be sure.

In terms of Spain, it seems as if the pricing activity that you're seeing from your competitors has subsided somewhat, but we did see some more price cuts I think from one of your competitors on Monday.

Have you guys announced any response to that?

No, we have not.

Okay.

Fair enough.

Is it your expectation that the pricing movements will continue to subside in that market?

I will not comment on the future pricing.

I'm sorry.

Fair enough.

Thank you.

Your next question comes from Bonnie Herzog of Wells Fargo.

Good morning, Hermann.

Good morning, Bonnie.

I just had a question about Marlboro.

And, if you could provide us an update on any new initiatives on this brand or the franchise that you might have implemented or will be implementing in the market regarding any new line extensions or packaging styles.

Well, there are many, many activities within the new Marlboro architecture.

You will have seen one of the other variants already there in a market, that doesn't mean the potential for rollout of innovational Marlboro is already exhausted to the country.

There are many more possibilities to continue to a successful rollout of the Marlboro architecture, and positive trends in many, many markets are a testament to this.

Terrific success on several of the main flow variants, in particular in Asia, are probably a highlight in that context.

And, if you compare sort of what's in the market or what you put into the market during the first half of this year versus what you're expecting to put into the marketplace, will you have increased activity here in the second half?

No.

That's permanent activity throughout the year.

We don't time that, except that you probably don't do a new launch when everybody in the market is in the holiday period.

That you will not do.

But otherwise it's better over the year.

Okay.

And, then with regards to the EU, you mentioned you're seeing some signs of stabilization as it relates to downtrade pressure that's occurring throughout the key markets.

Could you talk a little more in depth on your strategy to mitigate this downtrading in some of these key markets?

Is it, for instance, strictly a function of narrowing the price gap, or are there other initiatives you have implemented to help some of this from occurring?

Well, preventing from occurring, that is essentially related to tax structure.

That is then very often the question of how much -- how high the specific element is visible, you have the lower element and the minimum excise tax.

The best news of the quarter there, I believe, came out of Greece.

Where we had a very substantial increase of the minimum excise tax.

So, I said before $0.50 rollover need, essentially at the very bottom of the market.

So, it's always that.

On the other hand, in many other European markets where the price gaps are not that large, there is always exceptions.

But, in general not that large.

So, it's also about being competitive at the lower end that is pretty much the success of the brand L&M in the European region which, by the way, is the number two brand in the region.

And, you know who is the number one brand.

Okay.

Thanks, Hermann.

Thank you.

Your next question comes from Christine Farkas of Banc of America Merrill Lynch.

Thank you, very much.

Hello, Hermann.

Two questions.

First thing, on Libya, and forgive me if you disclosed this, did you tell us how much the -- what was the impact from the disruption there on sticks?

Well, Libya is simply the point that we, of course, suspended our business immediately when the suspensions came and took place.

So, year-to-date compared to last year that is almost a billion cigarettes.

Nevertheless, if you take the total of North Africa together, we are growing volume in the area.

But, of course, we have no volumes in Libya.

Okay.

Thanks.

And, then, just on Japan, you were very clear about the profit impact from the Japan factors in the quarter and I believe you've indicated that there was a bit of a boost in the pricing variance.

Can you tell us how much of your $617 million came from that benefit of the country mix in the quarter?

Would it be in that number?

It will, of course, be part of that number, but I will not single out the number for Japan only.

That I cannot do.

Okay.

Well, that's it for me.

Thanks, Hermann.

Okay.

Thank you.

Your next question comes from Erik Bloomquist from Berenberg Bank.

Hi.

Good morning, Hermann.

Good morning, Erik.

I was wondering if we could come back to the European Union first, where it looks like the volume dynamic is very encouraging.

Can you give us some more color about what is happening in places like France and why we're seeing actually volume growth.

Let's go to three of the really big and important markets in the EU region, being Germany, France and Italy.

I mean, let's use year-to-date numbers.

I mean, Germany is up 2%.

France is up 1%.

And, Italy is stable or a little bit up 0.2%.

That is, of course, a positive sign.

We have decent tax structures in place.

Improvement needs, maybe, in some but overall at least effective minimum excise tax systems are in place.

We have had no disruptive excise tax increases.

We have had price increases in all of those markets and nevertheless with the much improved trend to what we have seen before.

So, those are three examples.

That's why really the total EU number is somewhat distorted really by the Spanish effect.

And, so, in terms of consumer behavior simply that people, if left alone, are happy to continue.

Is that something then that we, I think, can rely on going forward in your view?

I can't predict the future, but it's good trends.

It looks good.

Because in Germany I gave you the number on manufactured cigarettes at the same time roll your own, make your own is also up.

So, overall consumption is up.

It's just not a move between the categories.

It's more than that.

Okay.

Super.

And, can you give us a bit more color on Poland.

I mean, are we seeing something happen there like in Ukraine where the market is polarizing with an increase in the super low?

And, what does that imply for an eventual increase in Polish profitability?

I would not compare it to the polarization situation in Ukraine.

It's different.

On one hand, we see clear uptrading trends in the Polish market where our premium brands, Marlboro and also L&M, really benefit.

But, at the same time you have very intense price promotions at the very bottom of the market.

And, that's probably what is driving the growth there.

Okay.

And, then, in terms of Russia, have you seen competitors follow your price increases?

We have had recent reports from sales force, which have seen packs of new prices from BAT in retail outlets with increases that seem to be comparable to the ones we have implemented.

But not Japan's Tobacco International?

Yes, also.

Yes, also.

Okay.

And, finally, on Turkey that also appears to be a market that has renewed momentum.

How do you see the market volumes evolving over the next rest of the year and then into 2012?

I mean, the Turkish market has really taken a severe hit at the time of the excise and price increases that the market has seen.

Turkey, typically, is a market that comes out of crisis quicker than others that I actually would say is valid for the entire economy, and not only for the cigarette business.

That's what we see again.

It's improving there.

Now, what is still needed is, of course, some work on the excise tax structure in there.

The element is what I would call over proportional but overall we look into a more positive situation in Turkey definitely than what we have seen the year before.

And, so, the impact of the public place smoking ban appears to be, if it ever had an impact, that's also waning.

Is that fair?

That is included in the total numbers, of course.

So, this is also at max a one time short-term impact, but then you return to the overall underlying trends of the market.

Super.

Thank you, very much.

You're welcome.

Your next question comes from Ann Gurkin of Davenport.

Good morning, Hermann.

Good morning, Ann.

I would be interested in your comments on projected overall volume growth rate for the emerging market over the next 3 to 5 years.

Is there any change there to your thought process?

Really, a percentage number, I don't think I can give that.

But let me -- let me try to answer your question as good as possible at this point in time.

The biggest market in there is clearly Indonesia, and today is already the second biggest market in Asia after China.

The other two markets in the world that would be bigger than Indonesia would be Russia and the US.

Then it will be number four in the world.

It's an important market.

The economy is doing well.

Demographics are favorable.

I think we have a good chance to believe that this market is going to continue to grow.

The same, I think, would apply to the Philippine market.

I would say really same conclusions that those same underlying reasons for growth, that I have just quoted in Indonesia, when it comes to the material market when it comes to Japan where there you need to give me more time to answer that question before the disruptions that we have gone through right now.

Fair enough.

And, then, if I could just ask one more about the distribution you all have with China.

Any updates there in terms of volume or change and arrangements?

No, no change in the underlying arrangements.

There is no need for a change in the underlying arrangements.

We are very happy with it.

It is, as you know, Marlboro production on the license in two of the factories in China are faced with today very limited volumes and it is the international side, our international joint venture.

So, the corporation is going well.

I believe both partners are happy with the development but nothing really new, new that I would have to report.

That's great.

Thank you.

You're welcome.

(Operator Instructions)

Your next question comes from Karen Lamark of Federated Investors.

Good morning, I've got a couple of questions.

Going back to Japan, I want to make sure I understand your expectations around competitive restocking.

Is it in Q3 you would expect both JTI and BAT to be fully restocked in terms of breadth and depth or not until Q4?

No, the restocking and the availability of all products, for example, all of the competetive products as well is kind of as now.

Okay.

Thank you.

And, then, separately in light of competetive payout ratios and your strong cash flow, I just wondered under what conditions you might consider your payout ratio and if you have any time frame under which you might consider that.

Thank you.

I think 65% payout ratio is a very good ratio and, quite frankly, I don't see a reason why that would need to change.

In the international context, that's a very competetive payout ratio.

Terrific.

Thank you.

You're welcome.

Our final question comes from Graham Tanaka of Tanaka Capital Management.

Hi, Hermann, nice quarter.

I just wanted to ask about the price gap in general and your comfort level where you are.

I know there are so many markets and so many different dynamic.

But, in general, how much of a cushion or comfort level do you have in the price gap at the low end especially?

Well, we want to get a price gaps right so we don't want cushions in there.

We just want to get them right.

In many places around the world, I think they are right.

In some cases, they need correction.

The best way to correct is typically via excise tax structure, in particular by the tool of minimum tax.

Because it's not only us who don't like downtrading, it's also the Government that don't like downtrading, be it the Finance Minister, or be it the Health Minister.

What proportion of markets do you think make you less comfortable with the price gap?

The vast majority of the markets we have addressed that problem long before and we are in pretty good shape, otherwise we wouldn't be able to generate the pricing variance that we are generating.

Thank you.

You're welcome.

This concludes the Q&A portion of our call.

I will turn the floor back to Nick Rolli for closing remarks.

Thank you very much for joining us today on this call.

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

Thank you and have a great day.

Thank you for participating in today's conference call.

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