Philip Morris International (PM) Q2 2014 Results - Earnings Call Transcript

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 |  About: Philip Morris International Inc. (PM)
by: SA Transcripts

Start Time: 09:07

End Time: 10:08

Philip Morris International Inc. (NYSE:PM)

Q2 2014 Earnings Conference Call

July 17, 2014 09:00 AM ET

Executives

Jacek Olczak - CFO

Nick Rolli - VP of IR and Financial Communications

Analysts

David Adelman - Morgan Stanley

Judy Hong - Goldman Sachs Group, Inc.

Chris Growe - Stifel Nicolaus

Bonnie Herzog - Wells Fargo Securities

Erik Bloomquist - Berenberg Bank

James Bushnell - Exane BNP Paribas

Michael Lavery - CLSA

Owen Bennett - Nomura Asset Management

Vivien Azer - Cowen and Company

Adam Spielman - Citigroup

Operator

Good day and welcome to the Philip Morris International Second Quarter 2014 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’ll now turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communications. Please go ahead, Sir.

Nick Rolli

Welcome and thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2014 second quarter results. You may access the release on our Web site at www.pmi.com.

During our call today, we'll be talking about results for the second quarter 2014, and comparing them to the same period in 2013, unless otherwise stated.

A glossary of terms, data tables showing adjustments to net revenues and OCI, for currency, asset impairment, exit and other costs, free cash flow calculations, and adjustments to earnings per share, or EPS, as well as reconciliations to U.S. GAAP measures are at the end of today’s Webcast slides, which are posted on our Web site. Please note that reduced-risk products, or RRPs, is the term we use for products that have the potential to reduce individual risk and population harm.

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.

It’s now my pleasure to introduce Jacek Olczak, our Chief Financial Officer. Jacek?

Jacek Olczak

Thank you Nick, and welcome ladies and gentlemen. As we expected, we achieved strong results in the second quarter, driven by a lower cigarette volume decline of 2.7% and a solid pricing variance of $494 million. As a result, net revenues, excluding currency, increased by 4.5%, and adjusted OCI was up by 9.5% on the same basis.

Both the EEMA and Latin America & Canada regions had a very strong quarter, with adjusted OCI growing by 28.8% and 27.1%, respectively, excluding currency. Furthermore, the EU Region achieved a 3.3% increase in adjusted OCI, excluding currency, despite the adverse pricing impact in Italy. The results in the Asia Region, meanwhile, continued to be impacted by challenges in specific markets, although we are making progress in dealing with them.

Our adjusted diluted EPS, excluding currency, grew by 20% to $1.56 per share. This was driven by our strong business results and a relatively easy comparison with the same quarter last year.

For the first half of the year, our adjusted diluted EPS, excluding currency, increased by 12.4% to $2.91. However, we will face much more challenging comparisons during the second half of the year and in particular during the fourth quarter. In the second half, we will make investments behind the commercialization of reduced-risk products, roll out Marlboro Red 2.0 and incur some underlying costs related to the optimization of our manufacturing footprint. Overall, our spending this year is skewed towards the second half. As a result, we’re anticipating a lower EPS growth, excluding currency, for the second half of this year.

As we announced at our Investor Day in June and reaffirmed today, our reported diluted EPS guidance for 2014, at prevailing exchange rates, is in a range of $4.87 to $4.97, versus $5.26 in 2013. Our guidance continues to include approximately $0.61 per share of unfavorable currency, at prevailing exchange rates; an after-tax charge of $0.24 per share recorded as asset impairment and exit costs in the second quarter related to the discontinuation of cigarette production in the Netherlands in 2014; and the $0.01 per share charge recorded in the first quarter relating to the decision to end production in Australia.

Our 2014 guidance represents a growth rate, excluding currency and these restructuring charges, of approximately 6% to 8%, compared to our adjusted diluted EPS of $5.40 in 2013. As stated in June, given the down-trading and heavy price discounting in Australia, in combination with plain packaging, we anticipate that this could result in our currency-neutral adjusted diluted EPS being at the lower end of this range.

Let me now provide you with an update on key markets, starting with the challenges we face this year in a number of Asian markets and the progress we’re making in addressing them.

In Japan, cigarette industry volume declined by 14.4% in the quarter as the trade de-stocked following the April 1st tax-driven price increases. Our shipment volume decreased by 16.4%, reflecting the overall market decline and our lower market share. On a June year-to-date basis, industry volume declined by 2.8%.

As expected, our market share in Japan rebounded during the second quarter, reaching 26.4%, following our 25.5% share in the first quarter when the trade built up higher inventory levels of competitive products. Adjusting for trade inventory movements, we estimate our share in the quarter was 25.8%, indicating that the process of stabilizing our market share is under way, and we believe that our share should level out during the second half, a period during which we plan a number of new product launches, including Marlboro Clear Hybrid, a smooth-tasting, regular-to-menthol capsule product.

In Indonesia, we witnessed a rebound in cigarette industry volume, with a second-quarter increase of 4.9%, which brought the first half of the year to a 2% growth rate. We are currently maintaining our forecast for the full-year of market growth of up to 1%.

Our market share increased sequentially from 34.6% in the first quarter to 34.9% in the second quarter, though it was below the last year’s level of 36.1%. While the unfavorable trends in the hand-rolled kretek segment continued to impact our overall share performance, the decline moderated, and we achieved strong share progression in the machine-made kretek segment. This was helped by the April launch of Dji Sam Soe Magnum Blue, which reached a quarterly share of 0.6%. We expect this sequential improvement to continue during the second half of this year.

Total estimated tax-paid cigarette industry volume in the Philippines declined by 13.4% during the second quarter, while consumption levels remained resilient, as measured by adult smoking incidence and daily consumption. The drop in tax-paid industry volume reflects the fact that Mighty Corporation’s tax-paid volume was down by around 40%. In contrast, we estimate that its total sales volume, both tax-paid and non-tax-paid, increased by about 20%.

PMI’s share of the tax-paid market increased to 85.9% during the second quarter, representing an increase of 3.4 share points, driven mainly by Marlboro and Fortune. The pressure on Mighty Corporation continues and we hope that the introduction of tax stickers, now expected in August, will reduce its ability to avoid paying excise taxes and VAT.

Let me now move to Australia, where the combination of a certain commoditization of the market, induced by plain packaging, large excise tax increases, and heavy price discounting, particularly at the bottom of the market, has accelerated down-trading to lower price, lower margin brands, or even illicit products. The super-low price segment has grown from 6.3% in 2011 to 28.3% in the first half of this year, when the effective price gap between a premium brand, such as Marlboro, and a super-low price brand, such as Bond Street, widened to about AUD$1 per pack of 25 cigarettes, or about 36%. This compares to a gap of about 26% in 2011.

Our market share averaged 37.7% in the period 2011 through 2013, but came under significant pressure from competitive discounting in the first quarter of 2014, when it dropped to 32.9%. We responded with increased investments in tactical price discounts for choice and Bond Street in order to regain our market position. As a result, in the second quarter, we increased our segment shares in the low and super-low price segments from 31.4% and 11.2% last year to 36.8% and 14.5%, respectively. However, the combination of increased price discounts and volume/mix deterioration due to the down-trading is impacting our profitability in Australia this year

Let me now turn to the EEMA Region, starting with Russia where our strong and diverse brand portfolio is driving market share gains and enabling us to increase prices. On a May quarter-to-date basis, our market share increased by 0.9 share points to 26.8%, thanks to premium Parliament, mid-price L&M and low-price Bond Street.

We estimate that cigarette industry volume declined by around 10% during the second quarter. This was driven by price increases averaging some 25% year-on-year, an increase in the prevalence of illicit trade and the weakening economy.

As you know, we announced in May a further price increase of RUB$4 per pack across most of our portfolio. This should impact adult smokers later this month and, along with the implementation of the restrictions on public smoking that were introduced in June this year, is expected to result in a full-year decline of between 9% and 11% in cigarette industry volume.

In Turkey, cigarette industry volume increased by an estimated 2.5% in the second quarter and was slightly up June year-to-date. A stable underlying trend is expected during the second half of the year, despite a mid-year upward adjustment in the specific and minimum excise tax of 5.1%. We increased the prices of our low and super-low price portfolio, Bond Street, Chesterfield, Lark and L&M, by TRY$0.50 per pack.

Our May quarter-to-date market share was marginally lower at 44.6%. However, the premium brands’ share of our portfolio increased, driven by the 1.2 share points gained by Parliament, which reached a record market share of 10.8%.

Let me now turn to the EU Region, where June cigarette industry volume was stronger than expected and included a favorable inventory variance. Cigarette industry volume declined by just 1.2% in the second quarter and by 3.4% in the first half, compared to a 9.3% decrease during the same period last year.

The improvement in cigarette industry volume trends has taken place despite persistently high unemployment levels. We attribute the moderation to a slight decline in illicit trade, a slow-down in the growth of e-vapor products in many markets, relatively less out-switching to fine cut products, and some trade inventory movements.

We should also remember that the comparison with 2013 was easier in the first half of this year and, in addition, we’ve recently implemented or announced price increases in Germany, Portugal and Spain. Consequently, we’re expecting the full-year decline in the EU Region to be approximately 5%, which is a more modest rate of decline than the one forecast in June and a marked improvement on the 7.4% decline that occurred during 2013.

We continue to outperform the industry in the EU Region. Our Regional market share increased by 0.9 share points in the second quarter to 40.4%. We achieved share growth in five of the six largest markets in the Region and expect our positive momentum to continue throughout the year. Absent trade inventory movements, our market share would also have been up in Germany.

Our strong share performance is based on the strength of our key international brands. Marlboro remained resilient with a 19.4% regional share, despite the continued weak macro-economic environment. L&M grew by 0.3 share points to 7.2%, driven by an outstanding performance in Germany and continued share gains in Poland. Chesterfield performed particularly well, gaining 1.4 share points in the quarter to reach a regional share of 5.8%. Its market share has grown very rapidly since we repositioned the brand in Italy and it has also benefited from geographic expansion.

On a June year-to-date basis, our cigarette volume in the EU Region was essentially stable at 91.6 billion units. This was the key driver of the improvement in our adjusted OCI, excluding currency, during the first half of the year. Our pricing variance, on the other hand, was lower than in recent years, mainly driven by Italy, where we remain cautiously optimistic that the government will implement excise tax reform.

In the second quarter, we increased our market share in Italy by the 2 share points to reach 55.3%, as Chesterfield, which was repositioned in February to the super-low price segment, achieved a 10% overall market share, up by 6.5 share points, although with lower unit margins, while Marlboro’s share declined 0.8 share points to 25%.

On a global basis, pricing remained the key driver of our higher adjusted OCI during the second quarter. Our pricing variance reached $494 million in the quarter and $900 million in the first half, broadly in line with our annual historical average of $1.8 billion. Our strong second quarter pricing variance was led by Indonesia and Russia, but was partially offset by an unfavorable pricing variances in Italy and the Philippines.

We achieved a 2.1 point improvement in PMI’s adjusted operating companies income margin, excluding currency, in the second quarter, driven by pricing and helped by the timing of costs. Looking at our top 30 OCI markets worldwide, our share in the second quarter of 2014 increased by 0.2 points to 37.3%.

Marlboro is one of the key drivers of our favorable market share momentum. During the second quarter, Marlboro progressed to reach an international market share of 9.2%, excluding China. It gained share in three out of our four regions, with a particularly strong performance in the EEMA region. The decline in the Asia region was mainly attributable to Japan.

We remain committed to generously rewarding our shareholders through a combination of dividends and share repurchases. Our dividend yield last Friday was 4.4%, which puts us at the upper end of the range of our peer groups.

During the second quarter, we spent $1 billion to repurchase 11.6 million shares at an average price of $86.13 and continue to target spending of $4 billion during the full-year of 2014.

In conclusion, the second quarter was financially a strong one, helped by a favorable comparison with last year and hindered by some ongoing challenges in the Asia region. The results in the EEMA and Latin America & Canada regions were particularly strong, driven mainly by pricing, while better volume trends in the EU region enabled us to increase regional adjusted OCI, excluding currency.

Our business fundamentals are solid, although the comparisons are expected to be more challenging during the next two quarters. We will make investments behind the commercialization of reduced-risk products, roll out Marlboro Red 2.0, incur some underlying costs related to the optimization of our manufacturing footprint, and, overall, our spending this year is skewed towards the second half. This is already reflected in our EPS guidance and we remain confident in our ability to achieve a growth rate in adjusted diluted EPS of 6% to 8%, excluding currency, for the full-year 2014. Thank you.

I’ll now be happy to answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of David Adelman with Morgan Stanley.

David Adelman - Morgan Stanley

Hi, Jacek.

Jacek Olczak

Good morning, David.

David Adelman - Morgan Stanley

A couple of things. First of all, I realize you haven’t changed your outlook for the year, but the second quarter come in higher than the internal plan or was this what you more or less had envisioned?

Jacek Olczak

No, this came as per our plan. We knew and we have highlighted at the beginning of the year that we expect particularly strong quarter, partly driven by the comps, as you remember the growth rate in the second quarter of last year was 0.7% on EPS level ex-currency. So it was not really challenging comp which we’re facing, but also we knew that we will expect some continuous step-by-step improvements in the key markets where which we try to address this year. So you had the EU, Japan, Philippines, etcetera. So this all was baked in, so it came as expected.

David Adelman - Morgan Stanley

Okay. Secondly, two of your three major international competitors intend to make fairly sizeable investments in the U.S cigarette market to conventional cigarette market, and I’m just curious you obviously exited that market, but did their actions cause you to rethink at all the attraction and/or the risk of the U.S?

Jacek Olczak

Well, not really. I think we will make it very clear that the reasons are well-known, why we focus on an international market. We’re not looking in a conventional business at the U.S. I think our plans are very clear that, yes we do see U.S on the -- from the perspective of the reduced-risk products, but as the separate part of this strategy. So when it comes to the conventional cigarette, cigarette markets I don’t really see any impact in terms of our thinking of that transaction, which was I believe announced yesterday.

David Adelman - Morgan Stanley

Okay. Thank you very much, Jacek.

Jacek Olczak

Thank you.

Operator

Our next question comes from the line of Judy Hong with Goldman Sachs.

Judy Hong - Goldman Sachs Group, Inc.

Thank you. Hi, Jacek.

Jacek Olczak

Hi. Good morning, Judy.

Judy Hong - Goldman Sachs Group, Inc.

So a couple of questions. First, in the EU region, obviously you had called out the pricing variance being negatively impacted by the price reposition in Italy. So just wondering, number one, can you just quantify the Italy impact and whether the underlying -- the other market, the pricing variance has also slowed and then you’ve taken some pricing in some of the European markets, so would you expect pricing variance in the back half or EU to be much stronger?

Jacek Olczak

On Italy I think the Chesterfield repositioning obviously generated some negative pricing variance on the Italian market, but this is largely offset by the volume gains. So I think Italy is more of a question of the VAT absorption which we still have since the end of the last year and this is causing the negative pricing variance. And this is very much linked to the way to discuss or debate in Italy, the tax restructuring. Italy to quantify -- the total pricing variance for Italy would be in a range on the year-to-date basis, you’re talking in the range of about $100 million. But as I said, it’s more the higher component is the VAT absorption, just the repositioning of the Chesterfield, because you pick it up at the revenue level for the volume -- positive volume variance.

Judy Hong - Goldman Sachs Group, Inc.

Right. Okay. And then, other markets where you’re taking -- have taken more pricing so, broadly speaking if you take total EU in the back half pricing variance would accelerate more meaningfully?

Jacek Olczak

Well, just to conclude in Italy, if you would add to the pricing variance on the EU the negative coming from Italy, the EU would have already a pretty decent pricing variance for the first half of the year, okay, because Italy really depressed the pricing variance for the entire region. And I think overall for the PMI, the pricing variance is about equally spread between half of the years -- of the year.

Judy Hong - Goldman Sachs Group, Inc.

Got it, okay. And then the second question is relating to the situation in Australia and wanted to just get a little bit better understanding of what actions you’ve actually taken already in that market and whether there more actions to come in the back half and just if you’re detecting any sort of competitive responses now that you’ve responded to the competitive behavior in that market.

Jacek Olczak

Well, what we did in Australia is as of the end of the first quarter essentially we will have increased some promotional spending -- price promotional spending behind mainly two brands, Choice and Bond Street, which are the brands, which are competing in a low-price segment. In other parts of the low price segment and they’re being challenged by the discount segment or the lower part of the segment. So that investment there and our actions around this when we try to regain the competitiveness when it comes to the price point versus the key competitive brands. This is a free pricing in Australia, so the situation is pretty dynamic, and you appreciate that I cannot comment on any future price moves, but this is a price discounting situation when the price is being set individually by the key account by trade channel, by territory etcetera. So I mean, that situations may change and may turn -- may change pretty rapidly. So we will have to see. I mean, I think our share reacted as expected. We would have gain the share, especially behind this brands in the second quarter. As you remember, we lost some share significantly, some share in the first quarter. So, so far that part of the strategy works. Now well let’s see how the situation will prevail. I think what is maybe important to say that you’ve some brands already in the market discounted in the low price segment there to the level that they essentially yield about zero margin, okay. So I think once it reach that point, I think a fair question to ask is, isn’t that the moment when the logic should start prevailing while you start to balancing your profit versus volume objective.

Judy Hong - Goldman Sachs Group, Inc.

Right, okay. Got it. Thank you.

Jacek Olczak

Thank you.

Operator

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

Chris Growe - Stifel Nicolaus

Hi. Good morning, Jacek.

Jacek Olczak

Good morning, Chris.

Chris Growe - Stifel Nicolaus

I just had two questions for you, if I could. The first would be, if you look at the EU, the first half benefiting from some inventory movements. How much of that reverses in the second half of the year? I guess, with the volumes being much stronger so far, do you have to see -- sort of a major inventory reductions occurring in the second half of the year?

Jacek Olczak

Small component, I think it was mainly in Germany, but you’re not talking about the very important component. So yes, there will be obviously some reversal in Q3. But I don’t think it would change our outlook when it comes for the full-year. Hence as you noticed, we have revised shortly after Investors Day while now having a full June data, we’ve revised our total industry outlook for the year to the 5%. So again, obviously that some inventory movements between the quarters.

Chris Growe - Stifel Nicolaus

Okay. And then just another question for you, if I could on Japan, which is that obviously the share of shipments was up in the quarter, but it also was distorted by inventory movements. I’m just curious like what’s -- is there a better metric or better measure for the ongoing share, if you will, in Japan this quarter 26.4%, is that sustainable or …?

Jacek Olczak

The way we’re tracking the performance, we look at retail off take at some key to change there, so -- but the share performance there is somehow reflecting the trend with sequential trends which we see on our adjusted churn. So we start -- we see the stabilization of the share over the last three quarters, maybe 0.1 down sequentially Q2 versus Q1, but it is all pointing to what we expected in the second half of the year, we should essentially have Japan share pressure behind this.

Chris Growe - Stifel Nicolaus

Okay. Thanks for your time.

Jacek Olczak

Thank you very much.

Chris Growe - Stifel Nicolaus

Thank you.

Operator

Our next question comes from the line of Bonnie Herzog with Wells Fargo.

Bonnie Herzog - Wells Fargo Securities

Good morning, Jacek.

Jacek Olczak

Good morning, Bonnie.

Bonnie Herzog - Wells Fargo Securities

My first question is on the Philippines. So despite progress being made with the tax underpayment issue by your main competitor, the market was still down quite a bit in the second quarter. Now how do you see this playing out for the rest of the year and when should we expect the market to stabilize? Then also do you think the tax stamps coming in? I think it sounds like in August now -- will fix or address the bulk of these problems?

Jacek Olczak

The market -- we have to be cautious when we talk about the total market size in Philippines, because we essentially have a better visibility on a tax paid market rather on a total market. Therefore, I think also in our slides we’re using the data on the consumption, the smoking incidence in a daily consumption, which gives a better feel what is happening for the total market covering both tax paid, non-tax paid. I think there was the distortion coming a little bit from what has happened in Q2 last year with the Mighty supplying the market and the Mighty level of supplying the market in the second quarter of this year. Hence you had a 14% decline. When it comes to second question, I think the tax stickers implementation is an important step in the whole portfolio of the steps which we wish the government should have already taken to address that issue. I don’t think tax stamps is the only element which is going to address that issue. I mean, as you know when we’re dealing with an under declaration, I mean you need to obviously demonstrate the same diligence and the vigilance when it comes to all the things that tax stickers etcetera. But we’re very pleased that this is coming to its fruition, to its realization, and I think it’s going to help in overall addressing the situation.

Bonnie Herzog - Wells Fargo Securities

Okay, that's helpful. Then I do have a second question on Russia. Could you give us a little more color on how Marlboro is performing in that country? And then in light of the price increases you took, could you talk about where price gaps are now? And are you seeing any changes in the consumer behaviors given the increases and then possibly from some of the smoking bans?

Jacek Olczak

Well, when it comes to the price gaps because Russia essentially is having price increases, the same absolute amount per pack across the price segment. So, it’s not much change over price gaps -- price gaps in absolute terms, but obviously the price gaps in the relative terms tend to close. When it comes to consumer reaction, the price increase which we announced in May, as I said in my remarks we’ll kick the market around this time early August. So we will have to wait a month or so to have the reading how consumers -- what is the reaction of consumers. I think we shouldn’t our outlook for the market, total market size for this year. I think there is a 9% to 11% range of decline for this year is valid which factored in the impact of the two price increases this year, and also in this forecast it’s factored in the impact from smoking restriction in public places.

Bonnie Herzog - Wells Fargo Securities

Okay. Thank you, Jacek.

Jacek Olczak

Thank you, Bonnie.

Operator

Our next question comes from the line of Erik Bloomquist with Berenberg.

Erik Bloomquist - Berenberg Bank

Hello, Jacek.

Jacek Olczak

Hi, good morning.

Erik Bloomquist - Berenberg Bank

Good morning. Couple of questions. Firstly, following on in Russia. I was just wondering if you could confirm that you’re still seeing substantial up-trading, as it looks like Bond Street was actually taking a bit more share, say, relative to Parliament. And then related to that, I was wondering two things, if you're -- what you’re estimating is the effect from the greater smoking restrictions or is that going to be relatively modest? And how are you characterizing the risk of a greater tax increase than in the current rolling through your plan, say in next year or in 2016?

Jacek Olczak

Up-trading in Russia, and because you’re talking about the market which has a relatively high -- absolutely in the relative price gaps. So the up-trading is better -- you’ll see up-trading better when it comes to the two segments next to each other. And I think you’ll still see up-trading in the market. So it’s not straight up-trading from the lower price product going to the premium product, but in the segments next to each other I think you’ll see some uptick in the volume. Hence the performance of the Parliament and also performance in the -- of our brands. I mean usually our brands will tend to occupy the upper part of each respective segment. The smoking ban, I would say like there’s -- I mean we have experience in other markets from implementation of a similar regulations, similar restrictions. Yes, you’ll have some impact at the beginning, usually it comes to the moderation later on when consumer adjusts to the new consumption pattern or accommodate the fact there might be places or occasions when they cannot really smoke. As I said this is all factored in our 9% to 11% forecast for the total volume decline. And the key driver behind this 9% to 11% is that, price increases on the back of excise increases which we’re taking this year. So, most of this 9% to 11% is the elasticity driven impact on the total market rather than accounting from a smoking restriction. And the third part of your question, we have now the second year where Russia is dealing or the Russian government is approaching the taxation of the cigarette market through this three year plan. Every year the rates are getting reconfirmed around November I think in their legislative process, I mean do mind the Cabinet. Every year they reconfirm the next two years, and they bring a rate for the third year in that plan is a rolling over plan. So we’ll see how they reconfirm the rate this year. I mean, so far the government was very pragmatic in setting this rate, on one hand balancing -- they desire to increase the tax level, but on the other hand recognizing the unintended consequences namely the illicit trade which they wouldn’t like to have in that market, quite right. So, I mean so far, I don’t see anything which would change my opinion why the Russian Government should not act pragmatically this time. But let’s see, I mean we’ll have to wait until November.

Erik Bloomquist - Berenberg Bank

Okay, thank you. And then just a short follow-on on Australia. Where do you see the low and super low price segments stabilizing as a percentage of the market? Are we looking at those continuing to rise over time or do you think that they will kind of reach a natural ceiling and then stabilize?

Jacek Olczak

Well, the prices in Australia overall the cigarette prices in Australia are pretty high. But I haven’t seen that in other markets of the comparable maturity when the lower, super low price segment will take it all. I mean there is always medium segment, there’s always a premium segment. Usually the markets may go into polarization, so it’s more the questions of the medium brand slowly being eroded by the low, super low price segment and the premium somehow holds its position. I mean, obviously in Australia we’ll have to take it for the lances of the plain packaging and some equity presumably erosion of the brands. But I don’t think it’s a 0-1 game. I don’t think the whole market is going to go through the discount segment.

Erik Bloomquist - Berenberg Bank

Thank you.

Jacek Olczak

Thank you.

Operator

Our next question comes from the line of James Bushnell with Exane.

James Bushnell - Exane BNP Paribas

Hi, thanks and good morning.

Jacek Olczak

Good morning.

James Bushnell - Exane BNP Paribas

I have, firstly, a question on Europe, please. Firstly, could you give a bit more detail on the price increase in Germany? I think previously you raised prices and then pulled one, so just how much is that and does it differ by brand at all? And also, what do you see as the outlook for pricing in Europe as we go through the rest of the year? Here, you have outlined that Italy is the drag, but what about elsewhere? Would we expect that to improve in H2?

Jacek Olczak

In Germany the price increase was on average €0.20 per pack. As you remember Germany has various stick counts for per pack sizes, the pack of 19’s and the larger packs, boxes. So per pack, individual SKU the price might be slightly different. But on average its €0.20 across the portfolio in Marlboro to the low priced -- lower priced L&M and Chesterfield. When it comes to pricing, in Europe again I think we should look a little bit at the pricing in Europe excluding Italy, because Italy is really dragging the price in Europe low. And I said earlier answer I think one of the questions that the pricing impact of Italy is in the range of about -- in the tune to $100 million for the first six months of this year, and that’s significant. You will add it back to the realized pricing and you’ll see that the pricing in Europe is not as being perceived by some that we’re falling a little bit behind. I mean in all other markets the pricing was taking -- a lot of pricing was taking at the beginning of the year usually around the tax rate increases that is especially the case in Central Europe, Poland. I said on the -- during the remarks today we recently took also the pricing in Portugal, in Spain. So, I think the pricing in Europe would have to take a little bit of different view on Italy and the rest, because the rest of Europe in my opinion is not looking as low as one could see.

James Bushnell - Exane BNP Paribas

Okay, thank you. And just to come back on the Germany price increase. Do I see now that that’s slightly different to your previous increase that was then pulled back in terms of price caps between different size packs or is it the same?

Jacek Olczak

No. I think -- no, I think it’s the same with the same principal. Okay, so sorry I don’t want to say its 100% the same because maybe there was some completely irrelevant fine tuning on one or two SKUs by the same principal, its €0.20 across the board on average.

James Bushnell - Exane BNP Paribas

Okay, thank you. And my second question was just on Korea. What from your perspective is the likelihood of a tax raise anytime soon? If it is an 80% rise in average prices which is one of the proposals that we’ve had, do you think that would still be good news after any short-term disruption?

Jacek Olczak

Well taking into considerations that no one almost remembers when Korea had raised the tax last time. I think this would be a good news, but we’ll have to see how it unfolds. I mean, we’ve heard in the past also some rumors or some initiatives even to raise the taxes in Korea and this has not materialized. So, I think myself, I’m more cautious about when Korea will have a tax increase. Well we’ll have to see.

James Bushnell - Exane BNP Paribas

Okay. Thank you very much.

Operator

Our next question comes from the line of Michael Lavery with CLSA.

Michael Lavery - CLSA

Hello.

Jacek Olczak

Hi, good morning.

Michael Lavery - CLSA

Just a few question’s on Indonesia. I'm curious with the 2% first half category growth what -- and with the easier comparisons in the back half, why you expect the deceleration to -- second half basically flat to give the 1% category growth. Is there some kind of headwind here you expect or consumer pressure or how do you see that unfolding?

Jacek Olczak

Well, I mean we see so at the beginning of the year, first half of the year some deceleration in the GDP growth. So we’re always looking at the macros in order to feel more comfortable with the total industry outlook. But I agree that 2% year-to-date growth rate for the market versus our forecast of 1%, one could say that there is a potential for an upside. And I would have to confront, there is a potential for an upside. I think I need one more quarter or at least one or two more months to reconfirm that Indonesia is moving to -- the total market is moving to the better growth rate. I mean its good news for us, but I think it was very clear in the remarks that despite the fact that the market is year-to-date 2% we still think for the 1% growth for the full-year.

Michael Lavery - CLSA

Then just looking at your market share, you've got the 60 basis point decline in Dji Sam Soe and the 60 basis points share from Dji Sam Soe Magnum Blue, so obviously that nets to zero. And you've got the increase over 1 point in U Mild, only slightly offset by Marlboro, but your total share is down over 1 point. So how do we reconcile that as Dji Sam Soe Magnum, the non-Blue down pretty significantly?

Jacek Olczak

No, Dji Sam Soe in the machine made both Dji Sam Soe Magnum and the Magnum Blue in the machine made segment it’s actually growing as expected very nicely. So, increasing our share in this, in the machine made part of the market. Dji Sam Soe in the hand-rolled version, the challenge is, under one hand this consumer is going to the machine made but the prime challenge which the brand faces this year is the price point, well as you see it’s above the round price point while the competitors are approaching, but its still technically slightly below that price point. So I think in Q3 we should see that sort of a headwind for the Dji Sam Soe to being removed. And one more comment if I may, when you look at the Marlboro share in Indonesia, this is all weighted to the total market, right by the white cigarettes market, a non-kretek market and a kretek market are not necessarily highly interlinked markets which in the one cigarette market. So, I mean you’ll have sometimes the fluctuations on a Marlboro share just because the total market growth which happened last quarter came obviously for the kretek as the main driver. So the rate of the kretek market will sometimes give you fluctuations on a Marlboro share.

Michael Lavery - CLSA

That's helpful, thanks. And then on the hand-rolled price points, have you seen a better balance in how the competition looks. I know some of those have crossed the same (indiscernible) mark, but it's a little scattered sort of regionally or by channels and things like that. So, is that looking like that's more consistent now across the competition?

Jacek Olczak

No, this is as we’ve predicted that there will be a -- there’s a time needed when in a pricing [ph] [stats] in the region by region etcetera, these brands or the SKUs will go in across this price point. So some have already reached, crossed, some are still hanging slightly below. I think the Q3, as we predicted initially is about the time when the Dji Sam Soe should have that price point pressure behind the (indiscernible) or in front.

Michael Lavery - CLSA

Okay, now that's great. And then just last question on Indonesia, as you’ve mentioned in the release how the optimizing production was -- contributed higher costs, but certainly it seems like if you're optimizing production that would be a better cost profile. So, is it right to assume those are one-time and how significant was that and is that behind you now?

Jacek Olczak

Well Indonesia is optimization or production is essentially to manage the capacity between hand-rolled capacity and the machine made capacity. So, it’s a little bit different that optimizations which we undertook in Australia and in Holland, in Bergen op Zoom. Yes, that’s it. So they’ll have some cost associated with managing the hand-rolled capacity not transforming the hand-rolled to July capacity into machine made capacity.

Michael Lavery - CLSA

Well, I guess, I'm just trying to understand what that is. Do you have an ongoing cost, like do you just have idle factories of people making hand-rolled that aren't producing – I mean, what’s the cost that hit in this quarter, is it a one-time plant closure cost or is it something ongoing?

Jacek Olczak

Well these are the costs associated with the down siding. So they don’t really qualify into reporting adjustments therefore we have not carried out in our reconciliation from a reported to adjusted result, they sit in our underlying numbers. But the cost is essentially about what we need to unfortunately the results were the termination of the employment of hand-rollers and there are smaller and creating a capacity on the machine in the factories which are producing machine made cigarettes.

Michael Lavery - CLSA

Okay, now that’s helpful. So even if we keep it in the adjusted number, can you give any sense of what the magnitude is in terms of how to think about the comparison next year?

Jacek Olczak

No, but what we’ve done is, if you remember not in the case of Indonesia but if you remember in Q1 of this year we have said that our cost associated with the closure of the plant in Australia would be $0.03 out of $0.01 was recorded in Q1 which was reporting adjustment and the $0.02 which will pick up later on, but not as reporting adjustment. Now I will have a boss, which also I’m incurring some costs which do not qualify by U.S GAAP rules as the reporting adjustments. I will incur this cost this year in order to complete this project. So, in total if I take all the projects together in my underlying results, you’re talking about the $0.02 to $0.04 which I associated with the cost of a closure or adjusting the -- or factoring the footprint and the capacity optimization.

Michael Lavery - CLSA

Okay, thanks. That’s helpful.

Jacek Olczak

(Indiscernible) underlying. This is not part of the reporting adjustment.

Michael Lavery - CLSA

Right, Okay. And then just on the Netherlands plant closure, that scales if I believe for September 1st, if that goes as planned some of that benefit would come in fourth quarter of this year, correct?

Jacek Olczak

Very small, I don’t think -- no, this will not be material, because you’ll need to take September 1, with the location of the production. You obviously having rent rates, in the meantime which we already produce etcetera. So this will not materially impact this. (Indiscernible) pick up the full impact of boss of a better (indiscernible) some restructuring next year 2015.

Michael Lavery - CLSA

So it would lag even if the plant is closed for three or four months later this year. There wouldn’t be a savings benefit really in 2014?

Jacek Olczak

No, but I will have as I mentioned before I will have also some cost associated with the closure of that plant which I mean my underlying results, the net of this project you will not see the material impact of that thing. Actually I will be more out weighted on the cost than the benefit which I may pick up for the literally few weeks of this year.

Michael Lavery - CLSA

Okay, now that’s helpful, thanks. And then, I know Australia has been covered a bit, but just one last question there if we can. Can you just help us understand some of the dynamics? It seemed like even with plain packaging coming in, this didn't -- there wasn’t any real issue over the first kind of 13 months during last year and when it started in December. And now certainly it looks like it's a different picture in 2014. What started all this? I mean what was kind of the trigger that made the issues for you become something you would call out and is it directly related to plain packaging, value brand erosion happening maybe more quickly than people might have thought or can you just explain some of those -- kind of what started all this?

Jacek Olczak

Well, I mean what started, when I start discounting was much earlier in the market in plain packaging. So, the market always was correct arising by some level of a discounting when people were essentially buying down the price for a consumer at the retail level. What we have observed that towards the end of the last year frankly speaking, there was an increased discounting activity by some of our competitors. So, when we look at our share erosions which I think was pretty visible in the first quarter I mean it was obvious decision that we had to react, stay competitive and not allow the shares to further decline. So yes, there is obviously the element of the plain packing in the whole thing, but I think we couldn’t just attribute the current situation entirely to plain packaging but plain packaging clearly but the fact that somebody took away your trademarks, erodes the equity of my brand. I mean, erodes the equity of my product. So there is an element of the thing, how much you would attribute to this, I mean it’s difficult to say at this stage. You cannot ignore it, but this is not the only element which was, which is happening there. This is all in the context of very significant tax increase which took historically in the last year and also will happen this year in the market, because last year September you had 12.5% extra tax increase – excise tax increase. We in September of this year we will have another 12.5% additional excise tax increase. I mean that obviously makes the end of year after, so it makes the significant price -- it drives to the significant price increases. And obviously as the market already had the cigarettes at the price of average of about $17 per the pack of 25 of the 25 cigarettes, you’ll have a natural sort of a tendency to go into the down-trading which can be further fueled if you active discounting, because you open the gap. Maybe if you look at the market and you realize that the price gaps are in the range of $6 to $8, I mean that’s the price level per pack in many other markets. And in Australia we have the price gaps of that margin issue, obviously because the underlying prices per pack are already pretty high. But $6 or $8 sort of the erosion in the mix is already pretty significant.

Michael Lavery - CLSA

Okay, great. Thank you very much.

Jacek Olczak

Thank you.

Operator

Our next question comes from the line of Owen Bennett with Nomura.

Owen Bennett - Nomura Asset Management

Hi, Jacek.

Jacek Olczak

Hi, good morning.

Owen Bennett - Nomura Asset Management

And just a quick one, I’m just wondering on the EEMA top-line performance, how much of this was driven by the change in Egypt business structure? How long will this benefit continue before it lapse or was it more a one-off influence in the quarter? Thank you.

Jacek Olczak

Okay. There was an impact of that in Egypt obviously because of the business structure but there was an underlying growth in Egypt and the entire, very strong quarter for the region very much driven by the price came not only from Russia but came from North Africa, some other markets in Egypt. Egypt played the critical role, but this is in addition of us now reporting Egypt the difference due to the business structure change this year.

Owen Bennett - Nomura Asset Management

Okay. Thank you.

Operator

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

Vivien Azer - Cowen and Company

Hi, good morning.

Jacek Olczak

Good morning, Vivien.

Vivien Azer - Cowen and Company

In terms of the improvement in the EU, I appreciate fully that you are waiting to get the full June results before you have the confidence to raise your guidance for the region. I was curious if you could speak to the sequential trends through the quarter, and if there was any one or two key markets that really kind of drove the improved outlook relative to what you had offered at your Analyst Day?

Jacek Olczak

Just to clarify, we’re not giving guidance at the segment level Vivien, so we’re giving an outlook when it comes to total market, right?

Vivien Azer - Cowen and Company

Certainly, yes.

Jacek Olczak

But that’s -- no, I mean we’ll look at the June results. I mean the markets which we -- I mean all of the market essentially confirmed what we’ve seen over the last five, six, seven months depending on the market trends. If you look at the total market trend they are three markets which are today somehow lagging behind in terms of declined rate should be better i.e. lower than the entire region. One of this market is, France. So we have to watch it, but I don’t think its going to change dramatically total EU picture. And the two other markets they are relatively smaller market, is Greece and Hungary. So, I have three markets which I wish would follow the trend line of the rest of the region. But even in absence of this I think EU as we announced today in my remarks EU outlook for the full year is close it’s around 5% and its based on the sequential improvements which we saw.

Vivien Azer - Cowen and Company

Excellent. Well, that’s certainly good news. Just a follow-up quickly on Indonesia, I appreciate why you’re holding your guidance I think that makes a lot of sense. I was curious whether embedded in that was an outlook for any change in the fuel subsidy, I know we’re still waiting to see how the presidential election unfolds as they count the ballots, but it does seem like that might be a reality in that market very late into ’14?

Jacek Olczak

To my recollections, there is not much I haven’t -- I don’t really recall there was discussions about any changes to the fuel subsidies recently until -- unless I’ve missed something, but I don’t think so. On the presidential elections, all fine and we will have to see how does it unfold and how what’s the new direction -- political direction there. Now I was much more -- we’re much more looking into the GDP development, the pricing development etcetera and based on this we’re trying to the best of our knowledge to estimate the market growth. But as I indicated a moment before, I do admit that with a 2% year-to-date our 1% outlook it maybe too cautious. We will have to see. I mean, at this market -- as you know is a market which has a lot of stick sales, the levels of the sales and the consumptions can pretty rapidly change in these places. So we will have to see.

Vivien Azer - Cowen and Company

Yes, that makes sense. And lastly, maybe it is still too early, but I was wondering whether you wanted -- could offer any commentary as you go into your city tests on the iQOS, can you dimensionalize for us how you’re thinking about the pricing of the iQOS system relative to other competitive novel tobacco systems and their respective markets of Japan and Italy?

Jacek Olczak

You know me; I’m a great fan of iQOS. I’m using this product. I wish I could share this with you, but I can’t.

Vivien Azer - Cowen and Company

Fair enough.

Jacek Olczak

One thing when we talk about the iQOS, which is also to explain a little bit our cost variance this year. And I know that I’m bridging from your questions to something else, but its important to remember that the two test markets on iQOS will happen in Q4 this year, okay. And this obviously will also contribute -- one of the contributing element when we will have a less favorable cost towards the end of the year versus the previous period -- previous year.

Vivien Azer - Cowen and Company

That makes perfect sense. Thank you very much.

Jacek Olczak

Thank you.

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

Adam Spielman - Citigroup

Hello. Thank you very much for taking the question.

Jacek Olczak

Hi. Good morning.

Adam Spielman - Citigroup

Good morning. It’s a question about Italy and the outlook for changes in the tax situation there. Now, I believe or I’ve seen that there was an announcement, I think in the last day or two, of what I believe is a very small increase in tax, but an increase nonetheless. And I was wondering, first of all, if you could just confirm that I’m right, that it’s pretty marginal. And secondly and perhaps more importantly to comment, if you can, about how you think and when you think there will be a substantial change in the tax situation in Italy? Thank you.

Jacek Olczak

You’re absolutely right. There was a very small almost cosmetic sort of a change which resulted in I think a 0.1 -- I know it’s a 0.1 incident increase. The increase, the specific the minimum excise tax on cigarette by a €1 and the minimum excise tax on the fine cut products by €3. So this is -- there is some sort of a legacy coming from still last year and just Italy was pretty late in translating this into the tax rate. This has nothing to do with the tax restructuring which in our understanding is that the government is debating as we speak. So we will see how does it unfold. I mean, I think there are number of people who are recognizing that the tax structure which Italy has today is pretty archaic. I mean it doesn’t stand to the market requirements both on the government revenue side -- very much on the government revenue side, but also into overall market. So let’s see.

Adam Spielman - Citigroup

When would you expect to have news on a substantial reform?

Jacek Olczak

Well, because it is Italy, the expectations with regards to time you have to be pretty flexible.

Adam Spielman - Citigroup

Okay. But this calendar year, I guess?

Jacek Olczak

As I said it’s Italy, so we will have to see.

Adam Spielman - Citigroup

Thank you.

Jacek Olczak

Thank you.

Adam Spielman - Citigroup

Thank you.

Operator

Our final question comes from the line of Erik Bloomquist with Berenberg.

Erik Bloomquist - Berenberg Bank

Thanks for taking that. I was actually -- I had the same question as Adam. So I’m all sorted. Thank you.

Jacek Olczak

So I will give the same answer, I guess.

Erik Bloomquist - Berenberg Bank

Superb.

Operator

And at this time, we have no further questions. I’d like to turn the floor back over to Nick for any additional or closing remarks.

Nick Rolli

Thank you very much. Thank you all for joining us. That concludes our call for today. If you have any follow-up questions, the investor relations team is currently in Switzerland. We’d be happy to talk to you. Thanks again. Have a great day.

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