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Philip Morris International (NYSE:PM)

Q3 2011 Earnings Call

October 20, 2011 9:00 am ET

Executives

Nicholas Rolli - Vice President of Investor Relations & Financial Communications

Hermann G. Waldemer - Chief Financial Officer and Executive Vice President

Analysts

Ann H. Gurkin - Davenport & Company, LLC, Research Division

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

David J. Adelman - Morgan Stanley, Research Division

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Vivien Azer - Citigroup Inc, Research Division

Erik A. Bloomquist - Berenberg Bank, Research Division

Jonathan Fell - Deutsche Bank AG, Research Division

Karen Lamark - Federated Investors

David Hayes - Nomura Securities Co. Ltd., Research Division

Chris Burritt - Bloomberg News

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

Operator

Good day, and welcome to the Philip Morris International Third 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. Thank you for joining us. Earlier today, we issued a news release containing detailed information on our 2011 third quarter results. You may access the release on our website at www.pmi.com.

During our call today, we will be talking about results for the third quarter 2011 and comparing them with the same period in 2010 unless otherwise stated. References to PMI volumes are for PMI shipments. Industry volume and market shares are the latest data available from a number of internal and external sources. Organic volume refers to volume excluding acquisitions. Net revenues exclude excise taxes. Operating 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 website.

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 G. Waldemer

Welcome, ladies and gentlemen. I'm extremely pleased to report that we achieved outstanding financial results in the third quarter. Net revenues, excluding currency and acquisitions, increased by 15.7%, and adjusted OCI, excluding currency and acquisitions, was 23.7% higher. Finally, adjusted diluted EPS reached $1.37 per share and grew by a remarkable 33%, excluding currency.

While these results were boosted by relatively easy year-on-year comparisons in the third quarter, we comfortably surpassed all our mid- to long-term currency neutral targets even excluding the whole of our business in Japan. And year-to-date, we are well within these targets.

Our business outlook has further improved since July, fully compensating recent unfavorable currency movements. This has enabled us to narrow our 2011 reported diluted EPS guidance to the upper half of our previous range, namely to $4.75 to $4.80. Compared to our adjusted diluted EPS of $3.87 in 2010, this translates into an improved growth rate, excluding currency, of approximately 17.5% to 19%, well above our mid- to long-term currency neutral growth target and approximately 22.5% to 24% at prevailing exchange rates.

Our third quarter volume was exceptionally strong. We achieved an organic cigarette volume growth of 4.4%, led by the Asia region, with an increase of 12.6% and EEMA with 4.8%. On a year-to-date September basis, we have achieved organic volume growth of 0.5%.

While there has been a lot of focus on Japan volume, I would like to emphasize that we achieved organic volume growth of 2.3%, excluding Japan, in the third quarter. Furthermore, on a year-to-date basis, the combined increase in our volume in Indonesia and Korea was nearly double that of Japan.

Our entire brand portfolio has performed very well. Every single one of our top 10 brands achieved volume growth both in the third quarter and year to date, be they international brands such as Marlboro, L&M and Parliament or leading local brands such as Fortune in the Philippines and Sampoerna A in Indonesia. I would like to highlight the remarkable performance of Parliament, whose volume was up 16.2% in the quarter and 9.9% year-to-date.

We are particularly pleased by the improved performance of Marlboro, which is gaining share on a global basis, excluding China and the U.S. In the quarter, Marlboro volumes increased at double-digit rates in both the Asia and EEMA regions. On a year-to-date basis, Marlboro has gained 0.3 and 0.5 share points, respectively, in these regions.

Marlboro's slightly share decline in the EU region reflects the pressure on the premium segments from continued economic difficulties in parts of Southern Europe as well as a moderate share loss in Germany. However, the brand gained share or was notably stable in Belgium, Czech Republic, France, Hungary, the Netherlands and Poland.

The share decline in the Latin America and Canada region marks the superb momentum of Marlboro across the region and is the result of the over-indexation of Marlboro in Mexico, where industry volume has declined at a double-digit rate since the large tax-driven price increases in December last year. This very good performance is evidenced by significant share gains in the 4 key Latin American markets: Argentina, Brazil, Colombia and Mexico.

Our excellent business momentum is reflected in our overall strong share performance. Year-to-date, our market share in our top 30 OCI markets was up 1.4 share points to 36.3%. In the quarter, we achieved a higher share in a clear majority of these 30 markets for an overall gain of 1.2 share points.

On a regional basis, our results in Asia, the growth engine of our company, were outstanding with net revenues and adjusted OCI, both excluding currency and acquisitions, up 39.1% and 75.1%, respectively. This was driven in particular by Indonesia, Japan, Korea and the Philippines.

We also enjoyed strong performances in the other 3 regions. In EEMA, net revenues grew 11.2% and adjusted OCI, 13.8%, both excluding currency and acquisitions. In Latin America and Canada, they were up 8.3% and 9%, respectively. Our results in the EU improved with net revenues and adjusted OCI, excluding currency and acquisitions, up 2.2% and 3.1%, respectively.

During the third quarter, PMI shipments to Japan reached 16 billion units, up 5.1 billion or 47.1% compared to the same period last year. The increase reflects the higher market share that we have achieved this year as well as easy comparisons due to the payback in 2010 of our distributor inventory buildup in the second quarter of last year in anticipation of increased trade and consumer purchases ahead of the October tax-driven price increase.

Our third quarter market share of 27.9% was distorted by competitive trade reloading following shortages of their products through August. We do not expect shipments to the trade to mirror consumer demand until at least the fourth quarter and possibly, only in the first quarter next year. We remain, nevertheless, optimistic that we should be able to retain considerable additional market share.

Our confidence is based on our ability to maintain a consumer offtake share in convenience stores, such as Lawson, at a level slightly above 30% in September and early October, after all competitive products were available to consumers again. This compared to a pre-earthquake share in these outlets of around 26%.

The other important element that we expect to be able to confirm in the fourth quarter is the evolution in the total market. We now forecast that industry volume will decrease this year by no more than 15%, a much lower rate of decline than the 20% forecast at the beginning of this year.

Our business is also doing extremely well in Indonesia. Industry volume growth in the quarter was well over 10%, driven by increasing consumer purchasing power, limited inflation, higher consumer confidence and positive demographic trends. Our volume rose 22.5%, and our market share reached a record level of 31.2%, a gain of 2 share points. This very strong performance was led by Sampoerna A, which increased its market share by 0.9 points to 12.1%. Pricing remains robust, and we expect the government to continue to implement plans to simplify the excise tax structure. All these trends are very encouraging as Indonesia is a very profitable market with significant potential for further growth.

Our market share in Russia was up slightly in the quarter through August to 25.8%, behind Parliament in premium, Chesterfield in the mid-price and Bond Street in the low-priced segment. Our volume in the third quarter was down 3.5% due to distributor inventory adjustments as well as the impact on the total market of recent price increases.

During the fourth quarter of this year, we expect the Russian Parliament to approve the new roadmap for excise taxes on tobacco products. This calls for increases that are higher than originally planned yet still expected to be manageable, with 2 steps in 2012.

PMI volume in Turkey rose 21.6% in the third quarter, and our market share reached 45.7%, a gain of 3.9 points led by Parliament in premium, Muratti in mid-price and L&M in the low-price segment.

While the market has stabilized so far this year, we expect the recently announced excessive increase in the ad valorem excise tax rate along with an ineffective minimum excise tax to cause considerable disruption. We will continue, therefore, to vigorously put forward our rational arguments for a more balanced excise tax structure in Turkey.

Germany has benefited from more robust market volume trends this year. Total market volume in Germany was actually up 0.3% in the quarter for cigarettes and 3.8% for fine cut, continuing the positive trend of the first half of this year. Our cigarette volume grew by 1.2% in the third quarter, and PMI gained 0.3 share points to reach 35.2% thanks to the continued strong growth of L&M, which remained the fastest growing brand in the market and was able to more than offset the decline of Marlboro. PMI also gained share in the fine cut segment.

Of even greater importance, our profitability has been enhanced by the price increase that we implemented in the second quarter of this year following the May excise tax increase. The next tax step will take place in January 2012.

We have tremendous business momentum in France, where the overall market has remained stable so far this year. In the third quarter, we further increased our market share by 0.4 points to 40.4%, driven by the strong performance of our premium brands: Marlboro and Philip Morris. Furthermore, we achieved market leadership in the fine cut market, with a share of 25.2%, thanks to the successful launch into this segment in February this year of Marlboro. The brand reached a 6.8% segment share in the third quarter.

Finally, we have just announced the price increase of EUR 0.30 per pack across our whole cigarette portfolio. This should enhance our profitability going forward.

Spain remains a troubled economy with very high unemployment and a difficult tobacco market. Industry cigarette volume is forecast to decline at least 15% in 2011. The pricing situation was resolved in September when we increased our retail prices by EUR 0.25, bringing Marlboro to its previous level of EUR 4.25 per pack and L&M to EUR 3.75. This should enable our profitability to recover.

With the temporary exception of Spain, the pricing environment continues to be very favorable. This is highlighted by the $564 million in pricing variance that we achieved in the third quarter this year and the $1.6 billion year-to-date. During 2011, we have implemented or announced price increase in the majority of our key markets including: Australia, Indonesia and the Philippines in Asia; Algeria, Russia, Saudi Arabia and Ukraine in EEMA; France, Germany, Italy, Poland and Spain in the EU; and finally, Argentina, Brazil and Canada in the Latin America and Canada region.

Our outlook on costs remains very favorable. Current tobacco leaf crop prices are stable to slightly declining on a worldwide average basis. Tobacco and direct material cost increases are very moderate and broadly in line with inflation and are being offset by our continued productivity efforts. We expect to comfortably exceed our $250 million pretax target for cost savings this year.

The combination of strong pricing and limited cost increases has enabled us to continue to grow our superior adjusted OCI margins. On a PMI-wide basis, our adjusted OCI margin, excluding currency and acquisitions, reached 47.3% in the third quarter, a gain of 3.1 points.

One of the reasons for the absence of downward pressure on prices in our industry is the important role of excise taxes and the desire of governments to continue to grow revenues. This can be achieved through a judicious combination of reasonable excise tax increases, structural enhancements and higher prices. There have been improvements in excise tax structures in several markets this year, and some countries have adopted multi-year tax plans, including Germany and Indonesia.

While government deficit financing needs point to renewed pressure on excise taxation as a source of additional revenues, most governments appear to have understood that large disruptive excise tax increases do not improve revenue-generating capabilities over the mid to long term. We do, however, expect some countries to seek to generate higher revenues by increasing VAT, which will push prices higher, though this should be manageable.

Every year, there are, nevertheless, still a few governments that continue from time to time to introduce very large and disruptive excise tax increases. As I mentioned, this happened last week in Turkey, and additional surprises remain possible as it is still early in the budget process in many countries.

When it comes to plain packaging, we believe that there is no sound evidence that such a regulation would reduce consumption, smoking incidence or youth smoking or provide any other public health benefit. Indeed, plain packaging would undermine public health objectives by lowering prices and increasing illicit trade. In addition, it would violate intellectual property protections and breach international trade obligations. We, therefore, do not believe that plain packaging regulations should be widely adopted by other governments outside Australia.

Though the proposed bill has not yet passed the Senate, the Australian government seems intent on ignoring these adverse consequences and on introducing such a regulation. We are, therefore, vigorously pursuing several legal avenues to challenge this unreasonable proposal and protect our valuable brands.

During the third quarter, our free cash flow increased by $577 million or 25.6% to $2.8 billion. Excluding currency, the increase was $363 million or 16.1%. The increase was driven mainly by our excellent business results. On a year-to-date basis, our free cash flow was up more than $1.6 billion to $9 billion.

Our confidence in the underlying strength of our business and our ability to continue to generate a growing cash flow is reflected in the 20.3% increase in our dividend that we announced last month.

As of the close on Tuesday, our dividend yield stood at the very attractive level of 4.6%. Since the spin in March 2008, we have increased the dividend by 67%, an achievement that few companies have matched over a period that included a major financial crisis, significant currency fluctuations and an acute recession.

During the third quarter, we spent $1.4 billion to repurchase a further 21.2 million shares. Since the March 2008 spinoff, we have now used over $20 billion to repurchase nearly 400 million shares at an average price of $50.81. Over the same period, we have paid out over $14 billion in dividend. So in total, we have returned nearly $35 billion to our shareholders.

In conclusion, PMI had an outstanding third quarter. Organic volume grew by a remarkable 4.4% with half this growth outside Japan. This was driven by the very strong performance of all our main brands, led by Marlboro and Parliament.

Our market share momentum remains very strong. Net revenues and adjusted OCI, excluding currency and acquisitions, were up 15.7% and 23.7%, respectively. Adjusted diluted EPS, excluding currency, increased by 33%. Pricing environment remains very favorable, and the vast majority of governments continue to act rationally on excise taxation.

Our business outlook has improved further since July, enabling us to narrow our reported diluted 2011 EPS guidance to the upper half of our previous range, namely, to $4.75 to $4.80, this despite recent unfavorable currency movements. Compared to our adjusted diluted EPS of $3.87 in 2010, this corresponds to an improved growth rate of approximately 22.5% to 24% at prevailing exchange rates and approximately 17.5% to 19% excluding currency.

And finally and perhaps most important, we have demonstrated again our focus on shareholder returns and shown our confidence in our bright future with the board's decision in September to increase our dividend by a further 20.3%.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Bonnie Herzog with Wells Fargo.

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

I just actually wanted to touch on Japan. You mentioned you feel comfortable that you're going to be able to retain around a 30% retail share in the market. So I was hoping you could give us a few more details on what you're seeing in this market in terms of the consumer purchase patterns and then maybe also relative to what JT has been doing to take back some of their share.

Hermann G. Waldemer

Okay. The published shares that you see there are also -- I mean on JT's side, the shipment shares, these now in the quarter or year-to-date, are not really representative yet. I mean, it's simply the fact that, of course, the pipeline on JT's product had been empty and has been reloaded now to whatever JT considers to be a necessary level of their volumes. So in terms, really, of what sticks with the consumer, we simply have to wait a little bit until those shipment shares will equal really consumer offtake shares again, which -- as has been the case in the past. For now, I really think that the consumer offtake shares which we measure in the C-stores give you the best indication. This is, of course, not a national average. This is a snapshot. And also, in those stores, our shares before has been slightly higher than the national average. But we continue to see, even now in the beginning also of October, the very latest numbers, and we, of course, look at them every week, that our shares continue to be slightly above 30% with Marlboro shares in there being stable. So therefore, I mean, that, of course, makes us feel good about the retention shares that we will be able to keep and which will form a much better basis from which to grow going into next year.

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

Okay. And then in terms of your overall business in Asia, it's obviously doing quite well even excluding Japan. It appears, in general, the economy and consumers are faring much better in Asia than the rest of the world, especially when we look at your margins. Excluding currency and acquisitions, I think it's up -- they're up almost 10%. So hoping you can again just drill down a little deeper, maybe give us a few more details on what the key dynamics are here, specifically in Indonesia and then Korea, maybe long-term growth rates you expect in those key markets.

Hermann G. Waldemer

Yes. Indonesia -- Asia, overall, as I said on the prepared remarks as well, is the growth engine of our company, but Asia -- it's not Asia alone. We are also having very decent results in the other regions. Take the EEMA region. Take the Latin America region, but also take the EU region, where we have returned to OCI growth. So whilst the growth rates are the strongest in Asia, the business is doing very well also elsewhere. Now going precisely on the question on Indonesia. While we have a country which has none of the European problems that European governments are facing: Very strong macroeconomic indicators, GDP growing, inflation under control and unemployment down, growing population, of course, as well. And all that taken together leads to a cigarette market that is, year-to-date, growing a bit more than 10%. I mean, this market is marching towards a total size of, probably at one time, reaching 300 billion cigarettes. So it's a huge market, actually the second most important in terms of size of Russia. At the same time, the tax outlook is manageable. Excise taxes go up. They go up slightly above inflation. They are bringing the tax tiers, over time, together. They are willing to do away with that loophole on using new legal entities to benefit from lower-tier tax advantages. And we are having an excellent portfolio in the market, where not only Sampoerna A, which is the best, but also Dji Sam Soe is doing fine. U Mild is growing. So we are doing really well, and we have actually also good price points on our individual brands when it comes to the prices that those are being sold by retailers on a stick basis.

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

Okay. That's helpful. And then just one final question on currency headwinds that you'll be facing as we head into 2012. What can you tell us about what you're expecting and maybe any of your hedging strategies? Can you give us an update?

Hermann G. Waldemer

Okay. I mean, now, for this year, where we had forecast $0.25 currency favorability still around the second quarter earnings call, that has been reduced now, and we're now at prevailing rates. We expect $0.20 for the year. Well, that's pretty much the number that we have year-to-date. So therefore, I wouldn't talk about unfavorable currency in the fourth quarter, because actually, at prevailing rates, the fourth quarter of this year is going to be a currency-neutral quarter. We will see what the actual rates will be, but at prevailing rates, you could expect a currency-neutral quarter. Going into next year, who can forecast the currency rates of next year? I can't. I would only say we have so much focus these days, again, on the problems in Europe and around the euro. The focus will come back on the United States as well. That's what I would predict going into the -- into next year.

Bonnie Herzog - Wells Fargo Securities, LLC, Research Division

All right. Will you have an update on the fourth quarter call?

Hermann G. Waldemer

Well, we will, of course, when we do -- when we come to the guidance for 2012, which will be on the fourth quarter call in February of 2012. There, of course, we will give the updates on what currency assumptions will be the basis of our guidance then.

Operator

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

David J. Adelman - Morgan Stanley, Research Division

First, Hermann, can you talk about the implicit outlook that you're making for the fourth quarter? It looks to me like on a local currency basis, the new EPS guidance would only imply fairly modest underlying operating profit growth.

Hermann G. Waldemer

No. I mean, David, there is no concern or no watchout that I would have to raise here for the fourth quarter. I mean, the fourth quarter is -- traditionally has always been a quarter where more of the expense is occurring than in earlier quarters of the year. That's normal. That's nothing new. That's every year the case. I mean, we give full year guidances. And as I just said, I mean, the $0.05 of currency unfavorability, we have compensated with even further improved business outlook. And as of now, at prevailing rates, the fourth quarter would be a currency-neutral quarter. So no watchout. Nothing to worry about. Look at the full year guidance, which I believe is a very, very strong guidance and an expression of our confidence in our business and into our future as well.

David J. Adelman - Morgan Stanley, Research Division

Okay. And then secondly, Hermann, is the excise tax increase in Turkey the single most challenging one you're going to have to endure, looked at over the last several years, taking into account sort of the nature, the magnitude of the increase, the relative importance of the market, your performance in the market and so on?

Hermann G. Waldemer

Well, I mean, no, I wouldn't say that. It is, of course, disruptive, a disruptive excise increase. It is bad news. But a year ago, we have been discussing Mexico. I wouldn't make much of a difference between the 2 at the end of the day. What I would add and say on Turkey, well, I mean, this -- the excise increase is, of course, a problem for all the competitors. This excise increase is not benefiting the government. I'm convinced about this is not generating really for the mid- and long-term solid increased revenue base. The only one party benefiting from that would be people that sell at the very lowest end of the markets, which is not the international companies, at about TRY 4 per pack, because at that level, their allover need is only 1/4 of what it is at the premium end. This doesn't make sense for the government either. At the same time, we, of course, can expect now a steep reaction -- at least in the first months, a very steep reaction of the tax paid markets. We certainly can expect an increase in the illicit rate. These are all really straightforward, rational arguments which give me the hope that there could be a second step later in the process in this story.

David J. Adelman - Morgan Stanley, Research Division

Okay. And then 2 other quick things, Hermann. Have you had any mediated discussions as of this point with Australian authorities subsequent to the filing of your plan? Anything substantive?

Hermann G. Waldemer

Yes. We have had that discussion during the negotiation period, which has ended under the Bilateral Investment Treaty between Hong Kong and Australia. However, no solution could be found in that discussion, unfortunately.

David J. Adelman - Morgan Stanley, Research Division

Okay. And then lastly, Hermann, looking out now in the EU over the next several years, how comfortable -- how confident are you that you can grow your operating income in that market over time in light of the fact that presumably, there's going to be a difficult economic backdrop? There'll be, presumably, government austerity measures. The governments will certainly be looking to increase excise taxes as a source of revenue.

Hermann G. Waldemer

Okay. I mean, there are, of course, the markets that we know already, like Spain, which are already in difficulties as of today. However, there are a couple of positive aspects to the EU business, really, because you asked the question in a longer context, in a 2-, 3-year context. First, it is really encouraging to see that we see clearly moderating total market declines. So in the quarter or in also year-to-date, we talk about 3.6%, 3.7%. And actually, on a year-to-date basis, half of that is just Spain. So, i.e. all the other markets together are declining not even 2%. Germany is growing. France is stable, and Italy is almost stable. So that's pretty good. What will the austerity measures do? Well, the point really is what will unemployment do. We have seen that, of course, a steep increase in dramatic levels of unemployment, like in Spain, have an impact. I do not see Spain happening everywhere in Europe. This is very overdone. I don't think that's going to happen. So then on excise tax pressure, could be. Of course, I can't exclude it. But given the financing needs of those governments, I would rather see pressure on general VAT increases. In Europe, those could happen, of course, affecting all products, including our products. That being said, a VAT increase has always been manageable at the end of the day in the past. Why wouldn't we be able to manage it -- to manage through these occasions also going into the future.

Operator

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

Judy E. Hong - Goldman Sachs Group Inc., Research Division

The -- in terms of your guidance, Hermann, if you looked at this year, the underlying x currency growth of 17.5% to 19% growth, is there a way that you can sort of point out how much of that was what you would characterize as sort of a one-off impact as a result of what happened in Japan or any other situation that you would sort of characterize as one-off?

Hermann G. Waldemer

Well, I wouldn't characterize anything as a one-off. I would say Japan has been an example of us seizing a business opportunity that presented itself in an optimal manner. And a price skirmish in Spain, also, well, that's part of business. What can you do? I wouldn't call this one a one-off. This is just part of the business on the good and on the bad side. Now really, going to Japan in more detail, well, we can -- let's try to quantify a little bit what is the year-to-date benefit of us seizing this business opportunity. I think the fairest way of doing that is that you take our year-to-date shipment share. That is about 31.5%. Our going-in share prior to the events was about 25%. That's a rounded share gain of 6.5%. On a total market of $144 billion, that gives you roughly $9.5 billion in volumes. You apply the very decent margins that you estimate for the Japanese market. You deduct from that substantial air freight cost that was well above $100 million. You deduct from there other cost and investments. We are right now at a very competitive situation in the fourth quarter. And we, of course, do everything that we need to do to support our brands. You take off the tax rates, and you arrive at something in the range of $250 million net of tax or something in the range of $0.15 on an EPS basis. I have done a similar calculation at the end of the second quarter. It was about $0.10 to $0.12 then. I hope that helps.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

It does help. And I guess the context is more really looking at 2012, because -- and part of that, I guess, depends on how much share you retain in Japan, because we'll be lapping some of the benefit you saw in Q2 as a result of this -- the disruption. But I guess your point is if you take the year-to-date number of 31.5% and if you sort of think about that 30% that you're seeing at the offtake trend, that would sort of be the comparable number just on -- in terms of on the volume side. And then I guess on the pricing side, though, because in 2011 you also saw the benefit of the price increases in Japan and the volume decline coming in better than expected. So is it fair to think about that was -- that's also a partial benefit to your 2011 earnings growth in terms of x currency basis and then the comparison in 2012 is not as positive, I guess, depending on what the tax situation unfolds in Japan.

Hermann G. Waldemer

Exactly. I mean, the most important point, you just said it, well, what is going to be the tax and price situation going into 2012, which is very hard to predict now. I think it's easy to predict that the market decline will be much more moderate than what we have seen this year, because nobody expects a tax and price hike of the dimension that we have seen in October 2012. Where it stands now in terms of tax in Japan is that the DPJ tax council has come out with a proposed law of JPY 40 per pack to be discussed with opposition parties, which we're against. In recent discussions, we also have heard that eventually, excise tax could be excluded altogether from the financing of the reconstruction package. However, let's be clear here. Even an exclusion from that package does not mean an exclusion of tax measures in the ordinary budget. So we will have to see what's going to come out in terms of tax and thereafter, in terms of price, because well, the central approval by the Finance Ministry of price increases is also still in place. So a lot of question marks at this point in time. We will see the outcome, but you mentioned it. I mean, we will, of course, start the year in Japan from a much stronger base than we have been starting the year in 2011.

Judy E. Hong - Goldman Sachs Group Inc., Research Division

Okay. And then, Hermann, just following up on David's question about EU region. I guess just in terms of the persistent market share losses that you've been experiencing and obviously, more the macro challenges and the fact that you're more exposed to the premium segment than others, are you rethinking sort of your brand portfolio strategy in any meaningful way to be a little bit more aggressive in some of the value segment? I think you talked about this a little bit at your analyst meeting, but just wanted to get an update on how you're thinking about sort of share versus maybe a mix or profit in that region.

Hermann G. Waldemer

I mean, we certainly want the EU region to return to OCI growth. Now in the European context, we have seen a number of markets, their brands over the last years have been repositioned to the low end. We have answered that in the markets, where it was necessary, this brand out of our portfolio. I mean, Germany is a much different situation than it has been a couple of years ago. We have Marlboro there. Yes, but we also have today there an L&M, the fastest growing brand in the market. The market -- the brand with the highest young adult smoker share in the market, and we are right now complementing that with Chesterfield at the same price level in the German market. Taken all together, well, the market share in the German market actually has been growing. So our team there, and we have a very strong team in Germany, is doing an excellent job, and it begins to pay off. If you move over to France, that's a different situation there. There, actually, we have 2 growing premium brands. Both Philip Morris and Marlboro are doing extremely well in an otherwise stable market. The market where we are underrepresented at the low end, clearly, is Italy, where our share at the low price segment of the market is well below our overall total market share in the market. So it's a marketing, it's a brand challenge. It's a sales challenge, but we have the portfolio to do something there. And it's not that we wake up to it now. We do something already for the last years.

Operator

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

Jonathan Fell - Deutsche Bank AG, Research Division

Two things. On Japan, Hermann, you mentioned that you weren't sure whether or not shipments would be coming into line with consumer offtake until Q4 or possibly Q1. Does that apply to the industry as a whole or your own business as well? And I was wondering if you could just talk a little bit more around the factors which create that uncertainty still.

Hermann G. Waldemer

No. You see, I mean, it certainly is not coming from our side, but I simply don't know what the individual inventory situation of competitors is and to what extent they bring volume into the market, to what extent they think that this is the inventory levels that they need. So therefore, I'm just -- I can't know if those will be already the going-in and going-on volumes that are really consumed by the smokers every month. So there...

Jonathan Fell - Deutsche Bank AG, Research Division

Okay. With regards to your own business, there's no -- the reason to believe that shipments and offtakes should match each other more closely in the fourth quarter.

Hermann G. Waldemer

Absolutely. We had no disruption. We just delivered a little more than we usually did. But we kept our business going all through, but there is nothing of that nature on our business.

Jonathan Fell - Deutsche Bank AG, Research Division

Okay. And then just a quick question on the EEMA region, where you had quite a nice volume recovery in the third quarter. I'm assuming Turkey will reverse. But I'm wondering about Ukraine as well, which had strong growth in the quarter. Does that reverse in the fourth quarter, i.e. is the third quarter impact undone? Or does it just normalize in Ukraine?

Hermann G. Waldemer

Ukraine is now normalizing. Q3 of this year, actually, in terms of comparison benefits from a very weak Q3 of last year. Q3 2010 had to de-load after the July 2010 price increase, which had a load in Q2 of 2010. So therefore, I mean, we are benefiting in Q3 now from these relatively easy comps. And we are now kind of out of that, and we should see now a situation that normalizes in the Ukrainian markets. Let's hope that we have no new disruptions, nothing on the horizon. Ukraine is one of the markets where you never know.

Operator

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

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

I just had a couple questions for you. I guess I wanted to better understand. You've had, obviously, a nice windfall this year in terms of a profit benefit from foreign currency and certainly, some very good performances in Japan. And I just want to understand the extent to which you are, if you will, reinvesting back in the business. You've mentioned some brand building activities, of course, in Russia. I think it's been -- that's been ongoing this year. I wonder if there's a little bit more color you can give on that. And then also, again, are you investing back in Japan or other markets to take advantage of some of this benefit you have coming through to your earnings?

Hermann G. Waldemer

Okay. I mean, we really don't run our business different if the currency is in our favor or is temporarily against us. We always invest into our brands, into the growth of the future, specifically in Russia. I mean, Russia is big. Russia is not just Moscow and St. Petersburg. So we need to do more there in terms of work for our brands. We want to do also -- to do more there in terms of our infrastructure given that Russia is such a large market, a very profitable market with tremendous potential going forward. So we put the necessary money behind. We are not doing any short-term swings here. This is a strategy that we started to pursue last year, that we are pursuing this year and will continue to pursue also next year. In Japan, it's -- there it's really the fourth quarter is, of course, in terms of point-of-sale presence, in terms of point-of-sale actions, after all the competitors being backed before their products in the market, a highly competitive situation: fight for shelf space, fight for small promotional offers that you make to your consumers. However, please, let's all not forget there is fixed retail prices in the Japanese market, i.e. one-off on prices or buy 2 get 1 for free. All of that does not exist and is not allowed in the Japanese market.

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

Okay. That's helpful. Just one follow-up then on the Russia activities. I'm just curious if those -- obviously, it's a broad brand building activity, but obviously, Marlboro has been quite weak there. So is it targeting that brand? Is it -- explicitly that's -- it could help your performance in that market.

Hermann G. Waldemer

Yes. We are not happy, I've said that before, with the performance of Marlboro. I mean, it's just 2% share of market in a market that big and that important like Russia is, of course, disappointing for Marlboro, and we definitely think that Marlboro can do more. There is -- again, there is a marketing challenge. It can be that we have such little volumes for that brand in the markets. We will invest behind. We will build the brand equity, and we want to bring that brand also on a growth trajectory as in so many other markets in the world, in most markets in the world, actually.

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

Sure. And just the last follow-up would be on Spain. In this quarter, you had, obviously, the ups and downs of pricing. And I'm just curious, so you had about a -- it was 10% decline roughly in the category volume in Spain in the quarter. Do you think that weakens a bit just due to the price realization that's now coming through in the fourth quarter? Is that, again, one that could look more like cases that we saw like in Q1 and Q2, where that market was down pretty aggressively?

Hermann G. Waldemer

Yes. I mean, the Q3 market might now be influenced a little bit here and there by retailers loading some competitor volumes ahead of their price increases. So I think you'd best look at the year-to-date one. And the full year estimate is, I don't know, 15%, 18%, something in that range. So yes, it's a continued steep market decline driven by the economic situation there. It will not continue at those rates forever. We will see. We will have to wait now for a new government. We will have to wait for the measures, budgetary measures. I was mentioning VAT. We will see. Whatever the new government will want to do, the price skirmishes that we have had in the market, of course, have so far kind of prevented us to reap the benefits of earlier price increases. Well, I said the skirmishes are over, so at least that benefit should accrue now.

Operator

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

Erik A. Bloomquist - Berenberg Bank, Research Division

If we could circle back on just the overall EEMA organic profit growth. That accelerated quite noticeably in Q3, 14%; 5%, Q2. How much of that is simply due to PMI slowing up its brand spend back? How much of that is just due to the markets' very strong pricing and volume growth? And then related to do that, is PMI happy with where L&M is in the EEMA region? Or is there still more work to do?

Hermann G. Waldemer

Well, if you look -- I mean, if you look at the brands there, and now we talk EEMA region as a whole. Then in the third quarter, I see a Parliament growing 15.9%. I see a Marlboro growing 10.2%, and all our premium brands then together by 10.5%. That's pretty good, I would say. If I then look at L&M, which yes, has left -- or has had problems in Russia. But if you take L&M for the EEMA region, it's up 6.1% and on a year-to-date basis, 3.8%. So no, our portfolio is doing pretty well. The negatives, you have a lot of heritage brands. But the future, of course, and the profitability is not in the previously local acquired brands. It's in our international brands in that part of the world. So pretty happy about the overall performance of our portfolio, thanks to Duhair and Gatness [ph].

Erik A. Bloomquist - Berenberg Bank, Research Division

Okay, super. And then following up in slightly more detail on the plain packaging situation in Australia. Is it fair to expect that the Senate does pass both bills in November? And then has PMI selected and started the formation of the arbitration tribunal at this point?

Hermann G. Waldemer

Well, the vote in the Senate hasn't taken place. We will see when it takes place. As the Health Minister herself has said, it might -- or that probably will lead to a delay in the implementation date. We are, of course, ramping up the legal cases that, as we said, we will vigorously pursue all the avenues, the bilateral investment treaty case but also other avenues, domestic and you name it. So we are, of course, in full swing to be ready for this situation.

Erik A. Bloomquist - Berenberg Bank, Research Division

Okay. And then lastly, circling back on Turkey. It looked like, from news reports, that PMI took basically TRY 2 per pack price increases, more than you needed perhaps in low-price but not enough to pass it through in premium. On a portfolio basis, is PMI roughly whole? Or is there a negative impact from simply not being able to pass through all of the increase in the premium segment, where PMI is very strong?

Hermann G. Waldemer

Well, I think I said earlier, if you have brands at the very lowest end of the market that have an allover need of TRY 0.7, whereas it's TRY 3 around at the premium end, then it's no longer a mathematical exercise and you have to protect your entire brand portfolio, which is what we did. But as I said earlier, I would still hope that there could be a second step in that story later, because the rational arguments are clearly on our side.

Operator

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

Vivien Azer - Citigroup Inc, Research Division

My first question has to do with the EEMA region and the favorable trade inventory shift that you saw in Saudi Arabia, and if you can offer some more color on that, please.

Hermann G. Waldemer

Well, Saudi Arabia is an important and very profitable market for us. A year or 2 years ago, we had some share problems there. We are doing well. We have implemented a price increase in the otherwise very, very profitable Saudi Arabia market. So that's really what it is.

Vivien Azer - Citigroup Inc, Research Division

Okay. Just in thinking about FX, and I fully appreciate that it's so hard to know kind of where currencies will go from here. But it might be helpful if you could just give us a reminder, please, from a transaction standpoint where your biggest cross-rate exposures are.

Hermann G. Waldemer

Well, I mean, let me answer it that way. We have a huge basket of currencies that play into the overall results. This year, year-to-date, the currency that is bringing the biggest variance, positive variance, is the yen. Last year, on the total year results, it actually was the Indonesian rupee, i.e. telling you, in none of those years it was actually the euro, although the euro, of course, plays also a role. And then you have emerging market currencies that are also of significance being the ruble, I said the Indonesian rupee, the Turkish lira, the Mexican peso. These are all currencies that go into that basket. So we have a broad basket of those worldwide currencies.

Vivien Azer - Citigroup Inc, Research Division

And the exposure to those currencies, it's equivalent on a translation versus a transaction basis? Or do you have an outside -- outsized, excuse me, exposure to one or a small group of them from your assets?

Hermann G. Waldemer

I mean, at the end of the day, I mean, as I said, we run the business on a constant currency basis. And you will not find us ever into any speculative hedges, what I call income hedges. So that's the way we run it: no speculation, and run the business the same way, the proper way if currency is in your favor or if it's temporarily against you.

Vivien Azer - Citigroup Inc, Research Division

Fair enough. My last question has to do with the health of the consumer in the EU. And I'm just curious, as you went through the quarter, did you see any trends that would have reflected kind of deteriorating consumer confidence, accelerating trade down as you worked towards the end of the quarter or anything like that?

Hermann G. Waldemer

No. Honestly, I mean, all the media coverage that we see these days on Europe, that doesn't have an impact on cigarette consumption. Even declining stock prices on the equity markets don't really change consumption. Steep increases in unemployment will change consumption. Spain was an example of that last year. My own forecast will be that I wouldn't see Europe collapse. It's just a bit too much focus on the European problems at this point in time. It will shift to other parts of the world.

Operator

Your next question comes from the line of David Hayes with Nomura.

David Hayes - Nomura Securities Co. Ltd., Research Division

Just on Brazil, I know it's a smaller market for you in Lat Am. But obviously, there's going to be this tax change that's proposed in February. I was wondering whether you got any more details on that and specifically, I guess, whether the change in structure is in some way beneficial for your competitive position in that market. I seem to recall there could be a change there that potentially helps. And then just in Korea, obviously, good share gains there. But I just wanted to confirm that you're still pricing slightly below BAT and JT in that marketplace. I think they're pricing up earlier in the year. And then finally for me, just on cost saves. Obviously, you made the point on the presentation that you're confident of exceeding the current plans this year. I just wondered whether you can give us any kind of indications on what plans might be for next year in terms of whether more cost saving or similar levels of cost saving as you're achieving in 2011.

Hermann G. Waldemer

Okay, Brazil first. Yes, there is a new excise tax law there which should provide a more level playing field over time. It's not immediately. It is phased in over time and that system then would eliminate the -- I only can call it absurd difference in taxation linked to packaging, if the cigarette is in a box or in a soft pack. So yes, a level playing field is always something good for us and beneficial and fairer going forward. Moving over to Korea. As I have said before, I mean, the real challenge in Korea also is to find a multi-year tax plan and tax structure plan in that market, and that actually prevails for us over short-term profitability considerations. And the third one on cost savings. Well, we have had a one-year target, because that keeps an organization focused. You'll see that the focus has paid off. As we expect, it's too early to say for next year. But yes, there will be a target for next year as well. We will talk about that in February.

Operator

Our next question comes from the line of Ann Gurkin with Davenport.

Ann H. Gurkin - Davenport & Company, LLC, Research Division

I wanted to circle back on Russia a little bit. Given the tough volume results in Russia, is there a need to increase investment behind brands in Russia? Or is there a change in the consumer behavior? Can you just address that a little more?

Hermann G. Waldemer

No. I mean, on our side, yes, we want to do more on our brands, because we simply think that we can do better. When you come to -- when we talk about overall volumes that the Russian market has slightly declined last year at about 2%, I would say. For this year, I would expect a little less than 2%. But there is, of course, the consequence also of the fairly frequent price increases that happened in the market. So in that sense, consumers have been forced to upgrade quite a bit because prices over the last 3 years have come up quite a bit at the low end. This would be a combined average growth of the prices in the range of 25%.

Ann H. Gurkin - Davenport & Company, LLC, Research Division

Okay. And then as we look into '12, and you've talked about this a little bit on the call, but is there a growing challenge from numerous excise tax increases in different markets? Is it more of a challenge than maybe expected at the beginning of '11 as we looked out to '12? Is there any kind of comment you can give to that?

Hermann G. Waldemer

Well, excise taxes are a challenge every year. They are the single most important factor playing into our business. We have had a year, 2009, with 2 surprises; '10 with 5 surprises; '11 with 1. And now we have had recently one for Turkey, which will go into 2012. We have managed through those in the previous years, and I really think that we will be able to manage through 2012 as well. Bad news can always happen. However, thanks to our global footprint, we have always been able to balance the unexpected bad with unexpected good. So I think that should be the case going forward as well. That's simply the advantage of such a broad global footprint as we have it.

Operator

Our next question comes from the line of Karen Lamark with Federated Investors.

Karen Lamark - Federated Investors

My questions have been asked.

Operator

Your next question comes from the line of Chris Burritt with Bloomberg News.

Chris Burritt - Bloomberg News

By Bloomberg's measure of profitability, Philip Morris I think ranks second in the S&P 500. And I know this is kind of a broad question, but how do you keep that rolling? And what's the biggest challenge to that performance?

Hermann G. Waldemer

Well, I mean, the key, if you like, the bigger picture here and therefore, I mean, going into the future, well then, they start -- what is the starting point here? The starting point for PMI at this point really is that we are having a blockbuster third quarter and that we are guiding to an excellent year 2011, i.e. we are and will be entering 2012 with really strong business momentum. Our confidence is expressed in the recent 20% dividend increase. Now going into 2012, on the key question there, the first one, we have built the financial crisis, triggered an economy crisis. We have had that on the call. We will see what the economies do in parts of the world. It's not going to be the same all over the world. But PMI is a company that has been able to deliver in the good and in the bad times. And we have a portfolio to do that in the good and in the bad times, because it covers all price points. The second key question always is will governments make rational excise tax decisions? We believe yes, but hiccups can happen. Turkey will always happen. But net-net, we think we expect them to be manageable. The third one is probably really market sizes overall. I don't expect big changes in the trends there. I mentioned before that the EU declines are moderating, that in the big Russian market, I see only a slight decline. In the very big Indonesian market, we see strong growth. In the big Japan market, it will depend a bit on the tax. Then the other point would be -- the fourth point probably is the pricing environment. Will the rational pricing environment continue? I believe yes, that -- and I believe that Spain was the exception to the rule. And contrary to other consumer product companies, prices in the cigarette industry, our prices usually stick, because governments around the world do not want to see cigarette prices coming down. The next point is that you have always to do your homework and keep your cost under control, which is what we are doing. I have elaborated on that. Then we are a tremendous cash flow generator. We have generated, over the first 9 months of this year, an average of $1 billion in free cash flow per month, $9 billion year-to-date. Our cash flow generation capabilities are unchanged, and also, our shareholder orientation is unchanged. So -- and the last point, I mentioned it before on the question before, our global footprint always allows you to balance the bad with the good because of a global scale. So I think these are the ingredients that make up business success. And we are working hard, and we have been working hard to get where we are. And we will keep on working hard to deliver for our shareholders also in the future.

Operator

At this time, we have no further questions. I now like to turn the floor back over to Mr. Rolli for any closing remarks.

Nicholas Rolli

Thank you for joining us on today's call. If you have any follow-up questions, you can contact the Investor Relations team here in Lausanne. Thank you very much, and have a great day. Thank you.

Operator

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

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