Philip Morris International Management Discusses Q1 2011 Results - Earnings Call Transcript

Apr.21.11 | About: Philip Morris (PM)

Philip Morris International (NYSE:PM)

Q1 2011 Earnings Call

April 21, 2011 9:00 am ET

Executives

Nicholas Rolli - Vice President of Investor Relations & Financial Communications

Hermann Waldemer - Chief Financial Officer and Executive Vice President

Analysts

Judy Hong - Goldman Sachs Group Inc.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Thomas Russo - Gardner Russo

Christine Farkas - BofA Merrill Lynch

David Adelman - Morgan Stanley

Vivien Azer - Citigroup Inc

Jonathan Fell - Deutsche Bank AG

Rogerio Fujimori - Crédit Suisse AG

Jonathan Leinster - UBS Investment Bank

Rey Wium - Renaissance BJM

Operator

Good day, and welcome to the Philip Morris International First Quarter 2011 Earnings Conference Call. [Operator Instructions] I will now turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.

Nicholas Rolli

Welcome, and thank you for joining us. Earlier today, we issued a news release containing detailed information on our 2011 first quarter results. You may access the release on our website at www.pmi.com.

During our call today, we’ll be talking about results for the first 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, which for this purposes of the -- of this presentation also include our business combination with Fortune Tobacco Corporation in the Philippines.

Net revenues exclude excise taxes. Operating companies 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 U.S. GAAP measures at the end of today's webcast slides, which are posted on our web site.

Today's remarks contain forward-looking statements and projections of future results, and I direct your attention to the forward-looking and cautionary statements 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, our Chief Financial Officer. Hermann?

Hermann Waldemer

Welcome, ladies and gentlemen. We reported a very strong financial performance during the first quarter most notably, an increase in our adjusted diluted EPS of 14.4% excluding currency.

The events in Japan and North Africa while distressing, only resulted in temporary logistical disruptions for our company and did not have a material financial impact on our overall results in the quarter. Thus, again, emphasizing the advantages of our businesses truly global footprint.

As reflected early February, our organic volume performance was dampened by anticipated softness in Japan, Mexico, Pakistan, Spain and Ukraine, as well as by the events in North Africa. Indeed, these markets collectively soften the volume erosion of 8.4 billion units or 18.5%. All other markets contributing slightly more than 80% of our volume base grew their combined volume at an organic rate of 1%.

I am delighted to announce that we are increasing our reported diluted EPS guidance for 2011 by $0.20 to a range of $4.55 to $4.65 compared to an adjusted diluted EPS of $3.87 in 2010. This corresponds to an increase of approximately 17.5% to 20% at prevailing exchange rates and approximately 12.5% to 15%, excluding currency. $0.10 or half the increased guidance are attributable to more favorable prevailing exchange rates. The other $0.10 are attributable to an improved business outlook in several markets, including France, Germany, Indonesia, Japan, Mexico, the Netherlands and Turkey, partly offset as some additional investments in marketing and sales in slightly more conservative pricing assumptions.

As you are all aware, Japan Tobacco is facing significant supply disruptions as a result of the tragic events in its home market. It is our understanding that food supply will gradually be in place within the next few weeks. We, in turn, have taken all necessary measures to ensure that we have sufficient in market inventories to supply the market and fill the anticipated temporary vacuum that is likely to occur. While we have certainly witnessed a moderate lift to our in market sales in the last few weeks, you should know that there are still competitive products available for sale in numerous retail accounts. And accordingly, it is proving difficult to go up to full extent of the likely uplift in sales. As retail stocks of our principal competitor's product disappear, we will be in a better position to determine such levels.

We anticipate that the second quarter will prove critical in this regard. It will allow us to have a much better read on total consumption levels and whether or not, and to what extent consumers will return to their prior brand of choice.

At this point, we face significant uncertainty. But rest assured, that all actions are in place to optimize our entire supply chain. We have a positive momentum in the Japanese market but our share increased by 1.4 points to 25.6% in the first quarter of this year, driven by the success of consumer element innovative Marlboro line extensions.

Our slightly more conservative pricing assumptions are attributable to the continued economic difficulties in consumer affordability issues in such markets as Greece, Spain and Ukraine, and the need to react to certain competitive price moves such as selective tax absorption and repositioning, price discounting and delays in the implementation of tax driven price increases. Pricing will nevertheless remain the key driver of profitability growth at PMI, and our pricing variants in 2011 is expected to surpass the level achieved last year.

Overall, our competitiveness is strong and our business is in good shape. This is notably demonstrated by the results during the first quarter in our Asia region. Volume was up 14% in the quarter and on an organic basis it was down just 1.7%. Marlboro continued to perform strongly in the Asia region, with volume up 0.7% overall and by 5.5%, excluding Japan.

During the first quarter, we achieved volume and share gains in the key markets of Indonesia, Korea and the Philippines. In Indonesia, we expect industry volume to grow by around 4% this year despite the potential unfavorable impact of higher food prices on consumer disposable income. Our technical entry last year into the low price segment in several regions has enabled us to start to grow market share again. In Korea, we achieved a record market share of 17.8% in the first quarter. With both Marlboro and Parliament driving our success. In the Philippines, we expect the industry volume this year will be broadly in line with last year following tax driven price increases in January this year. Both Marlboro and Fortune are gaining share in this promising market, and we are making good progress in realizing our brand synergy savings.

Our financial results in the Asia region were excellent, as net revenues up by 11.6% and adjusted OCI by 34%, both excluding currency and acquisitions.

The other market in the Asia region that has been in the news recently is Australia that the government has released an exposure draft of its Plain Packaging Bill, which would mandate Plain Packaging in 2012. It has opened the consultation period on the matter through June 6. PMI is firmly opposed to such emission as there is no credible evidence that it will achieve any reduction in smoking rates and the government has ignored the fact that it may actually be counter protective to public health. Plain Packaging will lead to price erosion over time and will further encourage the growth of illicit trade, which already increased in Australia by over 25% in 2010 according to a recent Deloyed [ph] study. Plain Packaging will also result in the illegal confiscation of our trademarks and branded assets in violation of international trade laws and treaties. Unlike other governments which have focused on establishing whether there is evidence to demonstrate that plain packaging would have public health benefits taking into consideration issues such as competition, trade and legal implication as well as the likely impact on illicit trade. The Australian government seems to be forging ahead without due consideration of any of these important issues. PMI will take all measures it deems appropriate, including recourse to the courts if necessary to oppose the Australian government proposal.

Our overall performance was also very good in the Latin America and Canada region despite the significant impact on volume of the disruptively large excess tax increase that occurred in January in Mexico. Industry volume in Mexico during the first quarter was down by 27%, though the underlying decline is estimated to have been about 14%. Marlboro and Benson & Hedges have remained resilient, with Marlboro reaching a quarterly market share of 50.3%, up 1.6 share points. Across the region, Marlboro has been performing strongly with markets share gains in all key markets. On a regional basis, strong pricing of over 15.7% increase in adjusted OCI and a 1.9 point improvement in adjusted OCI margin, both excluding currency.

While the economies of most emerging markets have now almost fully recovered, those of Southern Europe remained depressed with unemployment still continuing to climb, most notably in Greece, Portugal and Spain. Industry volume was down by 25% in the first quarter in Spain, as the situation was exacerbated by the introduction of a total indoor smoking ban, tax driven price increases, a reduction in trade inventories and a sharp increase in contraband off a low base. For the full year, the industry volume in Spain is forecasted to decline by around 15% and consumer down trading is expected to continue. It is worth noting that competitors have introduced or repositioned plants below the kick-in level of the minimum excise tax and have, thus, not rolled over the full effects of the most recent excise tax increase. Greece continued to be a drag on PMI results in the first quarter, with industry volume down 10%, consumer down trading due to a large price gaps and a difficult comparison as this market was not impacted by a large tax increases until the second quarter of last year.

While there have been recently structural improvements in the excise tax system, one crucial reform remains to be introduced, an effective minimum excise tax. In addition, a highest specific-to-total tax ratio would also benefit government revenues. Excluding just Spain, industry volume in the EU region in the first quarter was down 2.5%, in line with a longer-term consumption decline trends.

PMI net revenues in the EU region were down 3.5% and adjusted OCI by 2.3% in the first quarter, both excluding currency. This was driven by the lower industry volume and the decline of 0.4 share points on a regional basis. We expect our performance in the EU region to be helped this year by structural excise tax improvements implemented by governments in France, Greece, the Netherlands, Sweden and the U.K. following the new and improved EU excise tax directive that will be enforced through 2018. In addition, both Germany and the Czech Republic has implemented multi-year excise tax programs calling for regular reasonable increases. The first step in the German tax increase program will take place this May. PMI has announced a €0.20 per pack of 19 cigarettes price increase across its portfolio while the pure pass on require €0.04 for Marlboro and €0.11 for L&M. This will be a benefit to profitability in the German market and our decision to eventually follow competitive moves by also offering discounts on large excises enabled us to regain 0.5 share points in the first quarter to 35.7%. Thanks to the continued stellar performance of L&M and a stable Marlboro share. In parallel, we increased our share in the important German fine cut market by 0.9 points to 14.9%. In both Italy and France, industry volume was stable in the first quarter. In Italy, Marlboro has been performing well. Its quarterly share was down just 0.1% to 2.5%. And more importantly, it's share amongst young adult smokers or YAS defined as legal age minimum 18- to 24-year-olds has been growing again following the launch of Marlboro Gold Touch and remains well above about its market share.

In France, a slightly improved market share performance has been driven by the continued growth of the premium priced Philip Morris brand, who's quarterly share grew a further 0.6 points to 8.2% and the brand YAS share has reached 16%. More generally, we have witnessed greater resilience of Marlboro across the EU region with share of just 0.1 point in the quarter at 17.8% and notable gains in Belgium, Hungary, the Netherlands and Poland. And a strong momentum continued to further 0.2 share point gain to 6.1%, driven not only by Germany but also by Greece, the Netherlands, Portugal and Sweden.

Our volume in the EEMA region decreased by 0.8%, driven by the continued industry decline and low and share losses in Ukraine, as well as some temporary logistical disruptions in North Africa, partly offset by favorable comparisons in Romania and Turkey where the large excess tax increases in January 2010 but none this year.

Premium brands accounted for more than 40% of our regional volume for the first time since the last quarter of 2008 with increased volumes for both Marlboro and Parliament. The Russian market was influenced in the first quarter by the impact of rampant food price inflation, resulting from last summer's heat wave and drought as well as by cigarette price increases. For the full year, we are forecasting industry volume will decline moderately and consumer up trading may be more modest than originally expected. Our volume declined by 0.8% in the quarter and a 25.5%. Our 2011 quarter on share was up compared with the fourth quarter, but down 0.2 share points year-on-year. This was driven by the timing of the implementation of tax driven price increases as well as increased price gaps at the bottom of the market.

In Ukraine, we have observed the market contraction and the greater polarization with growth in the premium and super low price segments. PMI is underrepresented in the latter, and consequently, we lost 3.6 share points through the end of February compared to the same period in 2010. We have started to address the share issue by strengthening on schedule.

The Turkish economy has been performing very strongly. During the first quarter of this year, industry volume in Turkey was down by a modest 2.1% compared to last year, and the market was significantly impacted by large tax driven price increases. Our volume increased by 10.4%, driven by Parliament, Merit and L&M.

Net revenues and adjusted OCI in the EEMA region were down by 1.7% and 4.4%, respectively, both excluding currency. However, also excluding the tax price influence in Q1 2010, adjusted OCI would have grown at a double-digit range.

Our good share momentum continues. In the first quarter this year, our share in our top 30 OCI markets increased by 0.5 points to 35.8%. Our market share momentum supported by the strong performance of our two key premium brands: Marlboro and Parliament. Marlboro volume declined by 2.9% in the quarter, driven by the specific issues I mentioned about Japan, Mexico and Spain. In all the other markets together, Marlboro volume was up 0.5% in the quarter and the brands global market share trends continues to improve.

While many consumer goods sectors are being impacted by significant increases in the cost of raw materials, we are expecting stable U.S. dollar prices for the 2011 tobacco leaf growth, driven mainly by a larger crop in Brazil. Direct material prices are also stable so far this year despite higher energy costs. For the full year, we expect manufacturing costs to increase probably in line with inflation, partly offset by our $250 million annual productivity and cost reduction target, which we are fully on track to achieve.

Strong pricing, most notably in Japan, as well as our continued focus on productivity improvements, resulted in an increase of 2.2 points during the first quarter in PMI's adjusted OCI margin, excluding currency and acquisitions. Our free cash flow increased by 22.6% in the quarter to $2.2 billion, and by 21.1%, excluding currency, driven by higher net earnings, lower pension contributions and lower cash exit costs. We continue to focus on reducing inventory levels, though it should be noted that year-end working capital requirements remain subject to the level of tax price increases and our success in convincing elements around the world to implement strict forestalling regulations.

During the first quarter, we spent some $1.36 billion to repurchase 22.2 million shares at an average price of $61.21. We continue to expect to spend about $5 billion in total this year on share repurchases.

In summary, our results this year so far has been very strong and our business outlook is favorable, though the positive impact of Japan is difficult to measure at this time. We will increase our investment behind our portfolio of leading brands and are being slightly more conservative on our pricing assumptions to ensure that we remain competitive in our key markets. We have raised our 2011 reported diluted EPS guidance by $0.20 to $4.55 to $4.65 to reflect our positive business momentum and more favorable exchange rates, and we will continue to use our strong cash flow to generously reward our shareholders.

Thank you. I will now be happy to answer your questions.

Nicholas Rolli

Operator, can we take questions please.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from Judy Hong with Goldman Sachs.

Judy Hong - Goldman Sachs Group Inc.

First, in Japan, So I think you said total cigarette market was down 16.4% in the first quarter. So it looks like that's coming -- that is in the 20% decline that I think you projected at the outset of the year, and it also implies that March was even better than the run rate in January and February. So have you seen any changes to just the underlying demand decline post the earthquake? And then what are you assuming for the market decline as a whole for 2011 at this point?

Hermann Waldemer

Okay. Yes, we have previously assumed and annualized the 20% decline annualized, i.e. October last year to September of this year. Your number on the year-to-date actual 16.4% is correct. I think we better look at the year-to-date February number, which is 17.1, 17.5 percentage points down because there has been already some consumer hoarding of product in March [indiscernible]. But yes, there is of course an improvement over all. From thereon, of course, what is going to be the effect of the tragic events itself that's very hard to predict. But let's put it this way, we don't see accreting in the market.

Judy Hong - Goldman Sachs Group Inc.

Okay. And then just in terms of your assumptions that’s embedded in your guidance as it relates to any market share gains that you might experience as a result of Japan Tobacco's disruption. At this point, given it's difficult to gauge, are you embedding any upside in terms of the market share situation in Japan?

Hermann Waldemer

Okay, I'll give you the elements. But let me say in general first, that, of course, there are scenarios possible, and of course, scenario plannings. We have not taken the most conservative one. We have not taken the most bullish scenario that you could take. We kind of went into the -- some middle ground, and that is a net-net means for the past half of the increased business guidance is attributable to Japan. Now let me give you a little bit the elements there which go into, which at the same time make it so hard to give a clear cut on. So but I'll try to do my best to describe the situation. I mean, yes, year-to-date share, we said that's up to 1.4 to 25.6%. In March itself, the share was up 2.9 points to 26.5%. So essentially, it looks like we cover more than 60% of JP's temporary losses of there, but now of course to estimate today what the retention level is going to be thereafter is impossible to predict now. I would say only one thing, I would expect it to be lower given the market Japan, given the Japanese consumer than it would be otherwise in another market somewhere in the world. And then when it comes to the potential volume benefits of that disruption, well, of course, the first question mark is how long is the disruption going to last. So how many of the SKUs will come, how quickly back into the markets, actually how efficient JP can be with the replenishment of the product pipeline, then we have seen -- we have mentioned that in the prepared remarks that we have fairly high retail stocks out there, higher than what we originally have thought. So consumers who are searching for their brand. So when that comes together, of course, what we made sure already in the first year for the March, but mostly now in the second quarter. Then of course we have the products available in the Japanese markets, but the shipment number that you see is of course only the number essentially driving of course the financials of shipments from our factories to our importer that is not the number of in market sales or even of consumer uptick. So all that together, these are the elements and that gave us the conclusion I mentioned it at the very beginning and that leads to net result of about half of the increased business guidance is assumed to be attributable to Japan.

Judy Hong - Goldman Sachs Group Inc.

Okay. That's helpful. And then just your commentary about taking a little bit more conservative pricing assumption and then more investments behind your brand. Is this a little bit of a different posture just in terms of the last 2 or 3 years where you’ve really focus on more on getting the pricing utilization at the expense of volume? And it is there a little bit more urgency at this point to make sure that you're getting some of that volume back or the volume decline to show some moderation in some of these more challenging markets?

Hermann Waldemer

No. I mean the first and most important points to say yet again is that we continue to expect that our pricing variance 2011 is going to exceed the pricing variance of 2010. Already there, I think, tells you a lot. Also in our general approach, they know me saying that the earnings per share are more important than cigarettes per share for the shareholder. Also that conviction has not changed. The thing simply is I have been discussing and reporting on skirmishes here and there already in the past, and we see a little more of those connected brand repositionings and other technical moves. And to those, you simply then have to respond and we have to protect your competitive position. I'll give you one example, maybe if you look to Russia where we had announced the price increase in December, wherein the market with new prices in January. Other competitors have made public, their decisions, later on. And still today, kind of we see now the last competitor coming into the market with new prices right now in April after an announcement in January. This is the type of thing.

Judy Hong - Goldman Sachs Group Inc.

All right. Okay. Thank you.

Hermann Waldemer

You're welcome.

Operator

Your next question comes from the line of David Adelman with Morgan Stanley.

David Adelman - Morgan Stanley

Two things I wanted to ask you. Two different markets. First, in Russia, there's been some chatter in the press from different politicians about the prospect of a fairly substantial multi-year excise tax increase in that market. What's your read on what's really happening and what's likely to happen once you get beyond 2011?

Hermann Waldemer

Okay. Well, the discussion essentially has started for final tax decisions for January 2012. As you know, there is an existing law in place that brings the ad valorem rate as of January 1, 2012, from 7% to 7.5% and specific from 280 RUB to 360 RUB. That is a 30% increase of a specific component, and the discussion that was very much in the media was to double the increase of its specific component eventually from 30% to 60%. So it is the start of a discussion, final decisions, I would not expect them before the end of the year, October, probably even November of this year. This has been -- this would have finalized, but what you hear there in the press is by no means final.

David Adelman - Morgan Stanley

Okay. And then, Hermann, I wanted to ask you -- Australia with respect to Plain Packaging, can you give us some sense of the relative strength of your arguments with respect to x appropriation intellectual property, the confiscation of your business if they do implement Plain Packaging in that market versus the strength or the relative strength of the legal arguments in your defense that you could bring forward in other developed markets if other markets were to pursue similar types of legislation.

Hermann Waldemer

Well, let me describe a little bit the situation there. I mean for understandable reasons, I would not want to go into the legal strategy here, but I can give the parameters. So it's not only Australia. It's also the U.K. that go through a consultation period right now. The difference being that in Australia, it's a consultation on a draft legislation whereas in the U.K., it's a matter of concept. In Australia, the government appears to be predetermined. In the U.K., this all appears to be following a normal regular process. In terms of now expropriation of trademarks confiscations of our business, you raise one of the three critical facts that governments must look at and that also Australia must look at because there are, of course, litigation possibilities both under Australian law and under Australia's obligations under international treaties and laws. So those are the 2 avenues. That litigation situation and the leading situation has actually not changed compared to the time when Australia itself and also the U.K. before had been looking at the situation. And in both cases both in Australia and the U.K. the head comes to the conclusion not to implement the measure. So you would think still that whether is no change in facts, but also should be no change in outcomes. So much of the background, but please bear with me it would not be wise to go into discussion of the legal strategy itself.

Operator

Your next question comes from the line of John Fell with Deutsche Bank.

Jonathan Fell - Deutsche Bank AG

I have two things as well. First of all, a quick one. Was there any trade loading in Germany in advance of the tax increase in EU? And secondly, you referred to -- to invest more in your brands and marketing, are there any particular regions or countries where you think there's a need to not just spend versus what it is now?

Hermann Waldemer

Okay. In Germany, well, it definitely remains to be seen. Certainly, we've seen all ready now some uptick in consumer purchases but you refer to trade. Well, we will have to see what individual competitors have done, i.e. what their respective stocks of old tax, old price volumes will be. That's -- I don't know. We will have to see what the outcome there is.

Jonathan Fell - Deutsche Bank AG

But nothing that impacted you abnormally in the first quarter?

Hermann Waldemer

No, not in the first quarter. No. Actually if there is something, it is probably within the second quarter and will have washed out by the end of the second quarter. And your second question on investments, well, this is very, very specific and we talk about individual, large markets where we see consumer response and will immediate return. So it's not just spreading a little bit more money over there.

Jonathan Fell - Deutsche Bank AG

Are there any particular regions where you see those opportunities? Or are they are really sort of global but individual as well?

Hermann Waldemer

You would look at probably at the Asia and the EEMA region where there is going to be bigger growth potential of course.

Jonathan Fell - Deutsche Bank AG

Okay. Thanks.

Operator

Your next question comes from the line of Christine Farkas with Bank of America Merrill Lynch.

Christine Farkas - BofA Merrill Lynch

My question for you -- or two questions for you. Firstly, you talked about half of the increased business guidance outlook coming from Japan. I'm wondering if you can elaborate perhaps on where the other half of that business outlook is coming from.

Hermann Waldemer

Okay. The other half would be a series of markets. Some example's here. Yes, the first one Germany. You heard about the price. You also heard about the improved share performance. Another one would be Turkey, where turkey has come fairly quickly out of the crisis they were in last year and market size declined of 2% only in the first quarter is a good sign in our share performance. It's really doing -- we are really doing well in the market again, thanks to a complete portfolio. So we are doing pretty well there in terms of shares. Mexico, well, we had expected decline there, a market reaction. If you're kind of take out of the 27% decline in that market in the first quarter, if you take out really the trade load effect over year end and if you take out also additional cylinders that you have in this quarter compared to last year, then you're either in the 14%, or say, in the 13% to 15%. But that's better and the second good news in Mexico really is that the premium segment is holding on very well. You see a Marlboro share is growing. Premium is holding on better than the low end. So no down trading in the market. That's good news as well. Indonesia, we're already doing well share performance, pricing we have implemented market size growth fairly nicely. France, good news essentially a stable market and now improved share performance as well. Holland will be another example of very solid share performance. So it's in a number of places...

Christine Farkas - BofA Merrill Lynch

Okay, so it sounds like rather than just better than expected performance in the first quarter, there's some sustainable reasons for your outlook in a number of markets for the rest of the year.

Hermann Waldemer

Absolutely.

Christine Farkas - BofA Merrill Lynch

Okay, and my second question really has to do with Romania. Just because you called out the market as seeing reduced illicit trade. And I'm wondering how that’s being accomplished successfully. Is that sustainable and are there other regions that could follow suit?

Hermann Waldemer

The other situations in terms of illicit trade has improved quite a bit. This ones been about 30%. I would say this is probably has gone down in the range of 10 percentage points. Well, let's put it this way, it is always a sequence of 2 things, first, you need to attract the attention of everyone including the governments, which we did in Romania, which is well [ph] other places as well. We'll take Canada that was another example that you first need to get their attention and then you need the willingness of government to put enforcement behind. And we have seen that in both countries as well again both Romania and Canada. So it's the 2 elements.

Christine Farkas - BofA Merrill Lynch

Okay. That's helpful. And just a quick follow-up on pricing. You did talk about Russia as an example where there’s some repositioning of competitive brands, and that perhaps might lead to some more conservative pricing on the aggregate. But I'm wondering if it's really quite isolated to Russia or any other markets where you feel this is necessary rather than a broad statement of product positioning in pricing around the world.

Hermann Waldemer

No. It's a little bit more skirmishes, as I said, in selective repositionings and other tactics, Russia was one example. I give you another one, I mean in Spain -- you see I mean -- the minimum tax kick in is at EUR 3.66 and we have prices in the market at EUR 3.40 and EUR 3.35 even. So there is a year absorption of the last tax increase. So that's just another example or remember the one that we have been discussing earlier which was the discounting on the big and so called maxi packs in the German market. So it is hidden there. It is skirmishes here and there. But again, really look at our first quarter pricing variance which is very strong and all set of statement that the sum of the pricing variance 2011 is going to be greater than the one of 2010.

Christine Farkas - BofA Merrill Lynch

That’s very helpful, Hermann. Thank you.

Hermann Waldemer

Thank you.

Operator

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

Christopher Growe - Stifel, Nicolaus & Co., Inc.

I had two questions for you to follow up on Japan. Not to continue harping on that, but I wonder, just curious you gave a number at a presentation, I think it was you, that about some amount of product you have in the market, I think it was $10 billion sticks sort of in Japan, and I wondered if there was, I think, that number. So I guess, I'm curious you have a long lead time to get a product into that market. Has there been a quicker draw down because of the consumer response, are you able to keep up with the inventory needs in that market?

Hermann Waldemer

Yes, we are keeping up with the inventory needs. Yes, sir. I mean, our effort is coming out of the European factories, you are correct. By ship, that's a long way. By the air freight, it's quicker. And we have to take a recourse to air freight in order to get some volume in.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Okay. And then I wondered if there was any potential to spend a little more heavily in Japan perhaps to use some of the benefit or windfall, whatever you want to call it, to try and sustain some of this market share. Is that part of your thinking for the remainder of the year for what you could do in Japan to potentially hold onto some of this market share?

Hermann Waldemer

Yes. But I mean, Japan, of course, in terms of spending overall already before any of that happened is one of our focused markets in there as I was just illustrating the air freight that is also cost some additional costs. If you simply have due to the situation there this is distribution and logistical costs. We will certainly also do everything we can in terms of brand support as we saw our shares are developing very, very nicely. However, really, I think, the Japanese situation, with the country in trouble, believes to different average behavior of a consumer then it would be the case elsewhere. So I believe that the retention levels probably will be lower and there will be in another country? To what extent? Some of them, of course, we will be able to return I would think. To what extent, that today is just impossible to say.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Okay, and then just one follow-up for you and that's on the premium segment in general. In particular, I was looking at Russia where Marlboro’s down and you clearly outlined a few factors that could be leading to that as some of your competitors have not passed along some of the price increase. But just generally across the premium segment, I saw a good performance overall on the Parliament brand for you and Marlboro itself has had a few troubled market. It looks like it's doing quite well. Would you characterize this is being still serving up trading market you're still seeing broadly across your business?

Hermann Waldemer

Yes, I would say -- I mean, if you -- now going beyond Russia and talking about a worldwide picture, then yes. Since if you go back to say probably middle of 2008, i.e. before any of the crisis hits and you compare it to today, then you would have seen a shift -- from a very moderate shift maybe 1% to 2% from premium and mid to the low ends. Now talking total worldwide volumes for half range. But actually if you would look at that more recently, say, over the last three to six months, then you would have a slowdown or even a stoppage of that effect, and I believe we are at the point there now where there's improved economies around the world. Our premium portfolio will serve us very, very well. It’s just there are still a couple of markets out there, the known ones, where like in southern Europe where the situation is still difficult, but overall, I clearly see a return to our trading over time.

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Okay, thank so much for your time.

Hermann Waldemer

You're welcome.

Operator

Our next question comes from the line of Jon Leinster with UBS.

Jonathan Leinster - UBS Investment Bank

A couple of questions. First of all, just on the Western and the Canada region, can you give us a bit more detail about why profitability is so strong, given that Mexico is -- volumes are so heavily down -- Mexico is by far, your biggest profit center there.

Hermann Waldemer

Well, Mexico is a very profitable market and the price increase has helped. So that is certainly a good part of the reason for the strong performance. It's not only Mexico, it is also the profitable markets in that region, take Canada where you had again an increase in development market size or you take Argentina where we continue a stellar performance and I'll audit the market share essentially in the range of three quarters of the market. So there are others, but Mexico is an important.

Jonathan Leinster - UBS Investment Bank

So Mexican profits are still well off despite the volume decline?

Hermann Waldemer

Say it again. So Mexico...

Jonathan Leinster - UBS Investment Bank

So Mexican profits are still well off despite the volume decline?

Hermann Waldemer

Yes, they are [indiscernible] by the price increase.

Jonathan Leinster - UBS Investment Bank

Okay, and going back to Russia, I mean, as you pointed out the volume declines of Marlboro and L&M are noticeable is that due to the actual segments that premium and the mix price of the L&M being down or is that more of a brand-specific decline? And if it is brand specific, particularly if L&M, clearly we launched that a couple of years ago. What's the next step trying to stop Winston?

Hermann Waldemer

Well, of course, you're referring to delayed increases of tax driven price increases before so it's easy to grow share at the level of price. Going back now to the portfolio itself to our portfolio. In the premium segment, let me remind you that actually Parliament in Russia is a bigger brand than Marlboro, actually also with much higher margins than Marlboro and Parliament is doing very, very well. Marlboro itself, yes, to be self-critical here, yes, we need to do more work on the brand Marlboro in the Russian market, and we have plans in order to strengthen the brand going forward into this year. From there you go to Chesterfield which is a strong, higher- and medium-price brand. L&M which had suffered over the last couple of years, that too. That is not an easy situation and then you go to the next one to Bond Street that we have had tremendous increases, i.e. we have the best target train international low-price brand in the market. And then if you go further down, actually as we speak, there is now a lot of price competition going on at a very low end, which is also very low margin and at that time the trends like Java [ph] and others which are at very low prices.

Jonathan Leinster - UBS Investment Bank

But it sounds like the decline there is from L&M. This brand relative in sort of segments specific, and it's like -- given we launched L&M a couple of years ago is there anything more that you can do?

Hermann Waldemer

Yes, I was mentioning -- I was saying that yes, we have to work on L&M to do, we have work to do on Marlboro to do, but then it goes to segments then the story is different. Overall, in the premium segment, we're speaking about Parliament, the segment itself premium is doing well and we are having a good share in there, medium including Chesterfield we are doing well and now there is simply intense price competition as well at the very low end, which is chasing market share for not much margin.

Jonathan Leinster - UBS Investment Bank

Okay. Thanks so much, guys.

Hermann Waldemer

You're welcome.

Operator

Your next question comes from the line of the Rogerio Fujimori with Crédit Suisse.

Rogerio Fujimori - Crédit Suisse AG

Two quick questions about Australia. First, you see this segment still far more profitable than the premium segment in your non-OECD markets. And second could you please just remind us about the price positioning along the region that projects in those shipment trials, are bigger brand there?

Hermann Waldemer

Okay. First segment, yes. What's called super low in Australia is still very, very profitable. That's correct, and we still used the margin of a premium brand elsewhere. But the positioning of the other brands are mid-priced to premium-price brands. So we are present across the market. But overall, in the market, yes, there is a certain trend towards the lower end. But as you said yourself in the beginning, this lower end is still very profitable end.

Rogerio Fujimori - Crédit Suisse AG

We covered Japan but could you also talk about the shape of the quarter for their key markets that drag the good volume performance in the first quarter? I just wanted to have an idea of the effectuates. I just wanted to have an idea if things are going worse, stable or better, particularly places like Ukraine and Spain? Thank you.

Hermann Waldemer

Okay. Concretely now on the Ukraine -- so you want me to comment on the Ukraine or more on the overall volumes things around the world? What is the question?

Rogerio Fujimori - Crédit Suisse AG

It's more of the -- particularly on the markets that drive your performance in the first quarter. And I think you talked about all ready about Japan. So I think the ones left are mostly Ukraine, something else [indiscernible] will be appreciated. Thanks.

Hermann Waldemer

Okay, absolutely. Ukraine first. I mean, on one end, this is of course a country which has actually very good macroeconomic trends right now. However, when it comes to the cigarette market, then the price increase effects on the market on the consumer are simply not over yet. So I mean for the price that you buy today, a low priced product you could have bought a bit more than two years ago. You could have bought a super premium Parliament brand, so that's really what's happening in the market. As a consequence of that, you really see polarization of the market. You see the premium segment almost stable. Actually our share are doing very, very well. But then, in particular, in our case, you see a very competitive low-price brand and for us share losses at the very low price range, so there is intense competition really at the low end completely polarizing market in there. So that's pretty much the situation in the Ukraine. It will come down -- calm down over time but it is a difficult situation right now, and there are many price promotions actually in place in that market. Now moving over to Spain, what I would say Spain is still very difficult because there are too many negatives at play for the economy to start with. We still have a stagnating GDP. We still have unemployment at 20%. Actually, 1.3 million households out of 17.3 million households total in the country, I was told actually in this 1.3 million households both partners are unemployed, just to give you an impression of the problem. So not surprisingly, consumer confidence is low and the only positive for the economy overall is a recovery in tourism. So in that context, it's not a surprise that the cigarette market is really depressed not to the level of the 25% that you see in the actual numbers of the first quarter because there is an important trade stock reduction in there as well, and there is the effect of a total smoking ban in all the countries of Germany [ph] of this year in there as well. So probably 15% is a better number for the full year. One filament [ph] also you see in the market now beginning in particular in the South, we have made a recent self study in 3 of the Southern cities, Seville, Malici [ph] and Paris there almost 25% of the consumption were not Spanish tax paid products. So that is about double what it was a year before. That's just a snapshot that by no means is representative for Spain's total market, it has always been higher in the South than anywhere else. But that's also of course something adding into the problems, and in such a situation, it is not a surprise that you see down trading in the market and even more so, of course, the more you go South, the more down trading you see. So that's a good presentation on Spain.

Rogerio Fujimori - Crédit Suisse AG

Thank you very much, Hermann.

Operator

Your next question comes from the line of Vivien Azer with Citigroup.

Vivien Azer - Citigroup Inc

Not to belabor the point, but I wanted to circle back to Russia and in particular on your expectations for excise tax increases as they stand now. If memory serves, I believe you guys are looking for roughly a 22% increase in 2012 and another 50 basis point increase in 7.5%. I'm just wondering, as is stands today, do you think that's adequately conservative? I believe it falls notably below the 30% to 40% increase JT looking for.

Hermann Waldemer

Well, I would say that I have to say again -- I mean, you have one fixed point here which is the existing law. Ad valorem 7% to 7.5%, specific from RUB 280 to RUB 360. The most discussion about the doubling of the specific element, but this is a discussion and you will hear many more people giving their input in this -- into this discussion until the end of the year. At this point in time, I feel it is impossible to predict the final outcome. As I said earlier, I mean, don't expect a decision there before October or even November of this year. We are only in April. So a lot of water is going to go down the wall guards [ph] and we know that.

Vivien Azer - Citigroup Inc

Okay, fair enough. The other question that I have on Russia, given your market share trend this quarter presumably before the skirmish that corrupted in April from one of your competitors, it seems like there has been a resumption to a certain extent in down trading in the market. And if that's right that surprises me, given your commentary last month on the stabilization. And I know you highlighted, the up trading could be prohibited by price increases, but it's still kind of surprises me. Is there anything else that kind of caught you guys off guard a little bit in terms of the consumer trend because the food inflation that was almost a year ago? So I'm surprised by the change in tone.

Hermann Waldemer

Yes. I mean, it is the price increase effect. I mean, as we highlighted earlier and you mentioned it. There is of course a certain effect in there. Don't forget that really the recovery of the economy lies to see it in the big cities of Russia. It hasn't really reached the countryside yet. And in that context the rising food prices are a concern because those have gone up quite a bit after last year's summer heat and the drought thereafter and the hardest problems that occurred as a consequence. So it is those two elements.

Vivien Azer - Citigroup Inc

Okay, fair enough. My last question has to do with your Marlboro market shares in the EU. Certainly you know, I know, so many markets make up that whole number, but it strikes me as potentially troubling that you've seen 2 sequential quarters of market share losses from Marlboro. I'm just wondering if you could drill down a little bit into how to break down for Marlboro and the line extension that you’ve been putting into the market?

Hermann Waldemer

Okay. Let me give you some information there on Marlboro -- how it performs in the EU region. By variance, those numbers had -- I wouldn’t know by heart, but at the end of the day, they are part of the Marlboro franchise and we do those for incremental volumes but also for the halo effect on the entire brand. Now essentially going into it if you look at the EU, I’m at -0.1, I think I justifiably call an overall state of performance in the EU, albeit it's true that they are considerable market variations within the EU. Poland would be an example where the market share of Marlboro nicely up more than one share point to about 10.5% share. That is clearly up trading and that is in effect that you will see also elsewhere. So there's up trading potential for Marlboro in central Europe’ let me call it in general. Then, I would say you have markets where you have a stable situation in terms of market share Germany and Italy. They will both be down 0.1 to 21.2% and 22.5%, respectively. Then I would say you find other markets that are continuing to grow on an already high basis. That would be Belgium growing 0.7 to 25.1%. And most importantly, Netherlands is growing actually again, 0.7 to 34.9%. That's not too bad. And then you have a loss category of markets very clearly see the effects of a down trading environment, and that would be Spain, Portugal and Greece. Spain, we are down quarter 1 versus quarter 1 down 0.4. It would be even down if you compare more recently to Q3 of last year. Portugal, down 4 percentage points to 18.4, temporary again price increases due to delayed implementation of excise tax, driven price increases of competitors. And Greece again down trading environment where the brand is down 2.4% to 19.3%. So down trading environment stable and growing the number of sale and up trading invaded more the central European part. I think that's the categories that you find within the EU region.

Operator

Our next question comes the line of Rey Wium with Ren Cap [Renaissance Capital].

Rey Wium - Renaissance BJM

Just a quick question regarding the production costs. Regarding the full manufacturing cost increase more recent in inflation. But if you look at the first quarter numbers, your cost of sale actually declined by 3.2%. I was just curious to know if there was any specific factors in the first quarter that resulted in a lower -- in a reduction in the cost of sales?

Hermann Waldemer

Well, I mean -- overall, inflation that is a worldwide average that is something about 2% to 3% so that's the range. As you know, we have productivity programs in place. In terms of major components of our cost of goods sold, that's of course first of all and most importantly, leaf. That's about 25% of our cost of goods sold. On average is leaf and on a yearly basis, last year, it was $3.5 billion. So within leaf now, you have leaf price increases. We all remember the situation in 2008. That is absorbed. That's no longer the problem today. The leaf price increases for this year that we still expect will be about 2/3 of what they have been in 2010, and now they are essentially driven by the currency strength of the underlying Brazilian real in the leaf price, which then currently is in dollars of Brazilian leaf, that's the most important thing. But against that, so of course also our productivity measures. So that's what I can say on leaf. On direct materials which is about 25% in there, that is essentially stable. And then of course you have conversion costs. Where you have productivity running against percent of the increases that you of course have to give and give to you [indiscernible] so those are essentially the components. But overall, I feel pretty good about it, I must say.

Rey Wium - Renaissance BJM

Yes, but I was just curious about calculations that create -- that your production cost basically in the EU region declined by 6%. That's quite an incredible performance. I was just wondering if there was any specific one sort of factor that benefited that?

Hermann Waldemer

That is probably -- I must say that must be the effect of the Philippines that are included now. Yes, that's it. Of course, if you compare to last year and this year and now you have all the Philippine sector in there which of course on average have a lower cost base then...

Operator

For final question comes from the line of Thomas Russo with Gardner Russo Gardner.

Thomas Russo - Gardner Russo

You had mentioned that you will have a synergy savings coming from Philippines over the year. Will those be part of the $250 million? Or is that on top of the $250 million that you were citing originally. It's first question. And the second question has to do with any further color on forestalling, which you mentioned steps are taking forward, but where else are you still seeing that?

Hermann Waldemer

Okay. The productivity and the synergies out of the Philippines is of course part of our total number because the Philippines are part of our total business. The second question forestalling. I mean we have made quite some progress in a number of countries and forestalling the most effective measure always being at the so-called sell by dates. Remember, 2 years ago it must have been were you had really big problems in Poland that’s solved today. So it is essentially 1.5, 2 months delay only. So there is simply further room for improvement also in markets where it's already existing. I was mentioning Russia before, well, that’s certainly is a country that would be on our priority list. But you also can always do better in other markets and that is already in place. Portugal would be an example from a second credit rate.

Thomas Russo - Gardner Russo

Thank you, Hermann.

Hermann Waldemer

You're welcome.

Operator

That was our final question. I'll now turn the floor back over to management for any closing remarks.

Nicholas Rolli

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

Operator

Thank you. This concludes today's conference call. You may now disconnect.

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