Philip Morris International Inc. (NYSE:PM)
Consumer Analyst Group of New York Conference Call
February 18, 2014 01:45 PM ET
André Calantzopoulos - Chief Executive Officer
Jacek Olczak - Chief Financial Officer
Thank you, I’d like to welcome Philip Morris International that have been a great supporter of CAGNY, they helped sponsor a break earlier today. So thank you again to Philip Morris International for your support to CAGNY. Thank you.
I’d like to welcome CEO, André Calantzopoulos; CFO, Jacek Olczak will present for the company; Andre will be doing the presenting. Philip Morris has been a model of consistency for its underlying business although volatile effects trends are currently challenging supported earnings growth. To look forward the company discussing the strong fundamentals in this business, the potential for its next generation products and a strong free cash flow generation for its business.
So let me turn to André to hear more about those.
Thank you, Chris and it’s a great pleasure to have the opportunity to us attend this CAGNY conference here in Florida. Let me extend a very warm welcome to those joining us on the webcast. My remarks contain forward looking statements and accordingly I direct your attention to the forward looking and cautionary statement section of today’s press release, presentation and our SEC filings. Reconciliations of non-GAAP measures, included in this presentation to the most comparable GAAP measures, along with a glossary of terms are available on our website.
Our business fundamentals remain strong. We enjoy wide spread market share momentum driven by superior brand portfolio which in turn support a strong pricing power. The overall excise tax environment remains reasonable with positive structural improvement with further opportunities to enhance margin through our disciplined cost savings and productivity initiatives. We admittedly face harsh currency headwinds this year, particularly from emerging markets, but these markets are fundamentally attractive and remain key drivers of our mid to long-term profit growth.
Our Reduced-Risk Products represent a tremendous growth opportunity. Recently completed business development initiatives are accretive to our EPS and are enhancing our global business footprint. Finally, we are focused on generously rewarding our shareholders through dividends and share repurchases while being determined to maintain our single A credit rating.
Our 2013 performance was solid in a challenging environment. Our cigarette volume declined by 5.1% or by 2.7% excluding unique dynamics we had to content with in the Philippines. Net revenues adjusted OCI and adjusted diluted earnings per share or excluding currency were up by 1.9%, 3.4% and 10% respectively.
As expected, we ended the year with a strong fourth quarter. Cigarette volume declined by more moderate 1.9% excluding the Philippines. Net revenues, adjusted OCI and adjusted diluted EPS all excluding currency increased by 2.5%, 12.7% and 19.4% respectively.
On a global basis, cigarette industry volumes excluding China and the USA, decreased by an estimated 97 billion unit or 3% last year. The main contributors to the decline were the European Union region with its high unemployment and falling consumer purchasing power; Russia where there were substantial price increases and the Philippines which started from an excessive tax increase and a search in non tax paid volume.
In 2014, we forecasted slight moderation in the right of industry volume decline to between 2% and 3%. From a market share perspective, we gained 0.5 share points in our top 30 OCI markets excluding the Philippines. Our share momentum is underscored by the fact that our share of 35.2% in the fourth quarter was above our full year 2013 share of 34.9%.
In 2003 our market share increased in the EU, EEMA and Latin America and Canada region by 0.5%, 0.2% and 1.1 percentage points respectively. The decline by 0.4 percentage points in the Asia region excluding China and the Philippines driven by share pressure in Japan and Pakistan.
Let me now discuss our four regions in some key markets starting with the European Union. The decline in the EU's region cigarette industry volume accelerated in 2012 and 2013 to 6.1% and 7.5% respectively. During this period average unemployment in the euros to 10.9%. The recent upturn in European economy is encouraging, although it is yet to translate into meaningful hiring and purchasing power improvement. The rate of decline in cigarette industry volume moderated in the second half of 2013, the period when the unemployment rate remained flat. We also attribute this improvement to stabilization in related trade, a compression in the tax and price differential between cigarette and fine cut products and the acceleration in the rate of growth of e-cigarette in several markets.
At this stage we expect cigarette industry volume to decline by between 6% and 7% in 2014. This is still well above the underlying rate of decline of 2% to 3% due to societal trend. The rate of declines should therefore gradually moderate overtime and we remain confident that the EU region should eventually regain its position as a solid contributor to PMI’s OCI growth.
Our leading international brand that gather all key price points performed very well in the EU region in 2013. Premium Marlboro, below premium L&M, and Chesterfield as well as Philip Morris all gained share during the year. Since 2010 Marlboro has reinforced its leading position in the premium segment in the EU region growing by 0.9 points to 55.9% last year. Encouragingly, since 2011, when it declined to 13.6% the premium segment has increased in importance and accounted for 32.1% of the total EU region market in 2013.
In 2013, we gained share in all six of the largest cigarette markets in the EU; France, Germany, Italy, Poland, Spain and the United Kingdom. In the EMEA region as a whole cigarette industry volume has been rather stable since 2010 with the exception of Russia which tackled and estimated 7.6% decline last year.
Growth has continued in a number of markets notably in the Middle East and North Africa driven by an increase in the adult population. We continue to witness adult consumer up trading to higher price cigarettes in the EMEA region. The premium segment increased from 18.1% of the market in 2010 to 20.5% last year with the largest mid-price segments also grew.
Over this period PMI has reinforced his leadership in the premium segment, thanks to the success of parliament and the resilience of Marlboro. Since 2010 we have gained 1.8 points to reach a 50.4% share of the premium segment last year. Parliament performance has been very strong, the brands has gained market share in a traditional strong hold in Eastern Europe and Turkey, as well as in markets in the Middle East when the brand was launched more recently.
Let me now focus briefly on EMEA’s most important market, Russia which accounted for 30% of the region’s cigarette industry volume last year. One of the key industry drivers in Russia has been the implementation of a multiyear at excise tax. Although the excise tax are sensible and the plan provides predictability, it also entails very significant price increases over the period, particularly at the end -- at the low end of the market, which have driven subsequent total market decline. The largest tax increase occurred this year, which combined with the weaker economy is projected to result in a market decline of 9% to 11%.
The rate of decline should lessen in 2015 due to smaller tax increases. In addition, the Russian government has publicly stated that it may further moderate the 2015 and ‘16 rates to combat illicit rate. In anticipation of the latest tax rate, we raised most of our maximum retail selling prices by 9 rubles per pack last December, though new prices only started to appear at retail this month.
Our strong pricing performance enabled us to expand our profitability at a high single-digit rate, excluding currency during 2015 and we anticipate the similar increase in 2014 excluding the contribution from our investment in Megapolis.
In Russia, we have a broadband portfolio covering the main price points. While other represented in the premium and above premium price segment, our Parliament continues to gain market share and segment share. Our market share increased from 25.5% in 2010 to 26.1% in 2015; [Lloyd] declined by 0.3 percentage points versus 2012 due to the slower implementation of new prices by certain competitors. We continue a strong support behind our portfolio, which in combination with a number of innovative activities should enable us to regain share growth momentum this year.
Let me now turn to the Asia region, which has shown a more sustained positive trend in cigarette industry volume despite the impact of a disruptive excise tax increase last year in the Philippines. Industry volume grew at a compound annual rate of 0.7% a year, excluding China. A 380 billion unit, the Indonesian cigarette industry is large in volume than that of the United States. Since 2008, industry volume has grown at a compound annual rate of 4.5% a year. However, the growth has been far from steady with two exceptional years in 2011 and 2012. In 2013, a weaker economy and higher inflation resulted in a slowdown to 1.9% and we’re currently forecasting growth of approximately 1% for 2013.
There are two important trends in the Indonesian market supported by the increased urbanization of the population. The first is related to taste. There has been a shift among adult smokers from hand-made kreteks, or [s-kreteks] machine-made kreteks or (inaudible), particularly the lighter tasting variant. The [s-kretecks] decline was exacerbated in 2013 by key brands such as Dji Sam Soe crossing important price points ahead of competitive machine made brand.
The second trend is a growth of the premium segment at the expense of the low price segment. The decline of the low price segment was exacerbated in 2013 at the removal of fuel subsidies and by food pricing increase.
We were successful in expanding our market share again in 2013. In six years, we have gained a total of 8.1 share point to reach the current level of 36.1%. From both the taste and type perspective, our brand portfolio is skewed towards the leading growth segments. Machine-made, lighter-tasting kreteks account for a growing 54% of our volume, while premium brands including Marlboro, which has a demanding share of the White segment make up 70% of our volume.
The machine-made full flavor and the mid-price segments represent opportunities for us as they account for 3% and 27% of our volume respectively.
The key brands that should ensure our continued market share growth are from (inaudible) which is at the core of our success and which increased market and segment share last year and machine-made Dji Sam Soe Magnum and U Mild which provide us with an opportunity for expansion in segments where we are currently under represented.
As we announced last November, we will be increasing our support behind our brands this year. Our second market in Asia that has strong potential for profitable growth is the Philippines. Like Indonesia, it benefits from a growing adult population and has witnessed continued economic improvement backed by an expanding steady stream of remittances from overseas Philippines (inaudible). While the initial phase of the Excise Tax Reform was unnecessarily disruptive, we’re encouraged that the gradual closing of the gap between price is a single one in 2017. They should comprise price gaps which would position us favorably given the most premium skew of our portfolio led by Marlboro and a national distribution network.
Our ability to take advantage of this potential, hinges on the resolution of the biggest issue facing us today, namely the under declaration for excise tax purposes of the volume of our main local competitor Mighty Corporation. Based on official tax statistics and niche and baseline data, we estimate that the company declared to the Bureau of Internal Revenue less than half of the volume of cigarettes that sold in 2015, resulting in a significant loss of government revenues and providing Mighty with the ability to maintain artificially low prices for its brands. This has prevented us from being able to operate on the level playing field, hurting both our market share and profitability.
We’re relentless encouraging the authorities to act decisively. The plant implementation now proceed in June of this year but the system of fiscal tax expense should help to address this issue. The encouraging development in the Philippines in 2015 has been the resilience of adult smoker demand. While tax pad industry volume declined by 15.6% to an estimated of 86.3 billion units, Nielsen baseline data indicates that actual consumption was essentially stable at around 102 billion units. This occurred despite a 27% increase in weighted average retained price.
Finally, let me turn to Japan. Our market share declined in 2013 by one share point to 26.7%. Our market share of 25.9% in the fourth quarter was somewhat adversely distorted by the pipelining of new competitive launches. In January this year, our market share was 26.2%. We have two strategic priorities in Japan: the first is to drive innovation through diversified mentholated product offerings that are particularly relevant progressive adult consumers, the second is to address growing consumer demand for smoother products with less older and after taste in the more traditional but sizable non-menthol segments. This entails the series of product and brand image related activities across our portfolio underpinned by judicious investments.
The menthol segment in Japan has been a key area of innovation driven principally by Marlboro. The segment has grown from 22% in 2008 to 26.3% last year behind the success was the innovative highly refreshing non-capsule and capsule products. These new products accounted for more than half the menthol segment by 2013. During this period, we successfully launched Marlboro Black Menthol and Capsule Marlboro Ice Blast followed by Marlboro W-Burst, the first double capsule in the market.
Base line expansions enabled us to increase Marlboro segment share from 26.2% in 2008 to 31% in 2012. Lark successfully participated in the segment where Lark Mint Splash, Hybrid and Ice Mint. In 2013, Japan Tobacco entered the capsule segment in a meaningful way for the first time and launched a series of other highly mentholated products under its flagship Mevius brand.
This enabled Japan Tobacco to increase Mevius share of the menthol segment in each it was under represented from 7.5% in 2012 to 13.5% last year. As such, the competitive situation in the menthol segment in 2013 can be seen as somewhat unusual, especially in combination with the significant promotional support deployed during the year behind the name change from Mild Seven into Mevius.
We have a number of initiatives in the pipeline driven by Marlboro which overtime will allow us to reinforce a leadership position in this very important segment. Regarding the non-menthol segment that represented 73.7% of the market in 2013, Lark was the prime beneficiary of adult consumer in switching during the period when Japan Tobacco was enabled to fully supply the Japanese market.
Since then, more traditional consumers return to their original brand germinating in 2015 with a name change of Mavis. Lark was a most impacted brand in our portfolio. Our objective is to restore our portfolio’s appeal to this consumer segment through innovations that attract [safety] trend.
Regarding Marlboro, the rollout of the Don’t Be A Maybe, Be Marlboro campaign this year and subsequent deployment of Marlboro architecture 2.0, which I will cover later today will reinforce the franchise as a whole and should further support Marlboro Clear, launched last September.
We are taking a similar approach for Lark and are increasing our support behind our portfolio. I will complete my regional review by highlighting a strong performance in the Latin America and Canada region. Our yearly share grew by 1.1 point last year to 38%, while our share increased in Argentina, Brazil, Canada and Columbia and remained stable in Mexico.
The key driver of our share momentum is Marlboro. The brand increased its regional share by 0.4 percentage points to 15%, an increase of share of the expanding premium segment by 0.8 percentage points to 45.1%, underpinning our strong global fundamental, with the strength of our superior brand portfolio and in particular reinvigorated Marlboro.
In 2013, excluding China and the Philippine, Marlboro gained share in all core regions. The three key drivers of Marlboro’s renewed market share momentum consisting of in March 2008 have been the development of a new architecture, consumer element innovation and the new Don’t Be A Maybe, Be Marlboro marketing campaign.
In 2008, we expanded the reach of Marlboro thanks to an architecture that unlock the potential of the brand and allow the three pillars to expand in all relevant consumer segments. We have successfully introduced consumer relevant innovation across the three lines. In total, our new introductions generated a volume of 35.9 billion units in 2013 and accounted for more than 12% of Marlboro’s total volume. To put this volume in perspective, it was greater than the total brand volume of Chesterfield or like a TRY and close to that of (inaudible).
An important parallel step was the modernization of the Marlboro communication campaign and promotional platform including modern media. We develop the Be Marlboro campaign that skillfully expresses the timeless Marlboro values of freedom, authenticity, confidence and leadership in a way that is fully relevant to today’s adult smokers and their evolving preferences, their occupation and communication style. With the new campaign that has been rollout in more than 50 markets worldwide, Marlboro inspires adult smokers to be decisive, trust themselves and follow their inspiration.
There are three ways to react when phased with a decision, yes, no or maybe, Marlboro does not believe in maybe. Encouraged by the positive consumer reaction to such significant changes, we decided to move to the next level of the brand evolution, which we call Marlboro Architecture 2.0.
The objective is to further expand the brand’s appeal and in particularly lot of Marlboro Red to relatively on top consumer segment. Anticipate trends for what's smoother taste yet [cessation], even amongst full flavor smokers enhance criminal in a more minimalistic at [unisex] style and incorporate other tangible benefit in a way that squarely confirms Marlboro’s category leadership.
Consequently, Marlboro 2.0 entails new pack design and incorporates smooth textile characteristics, blend the patience and new filter design. The deployment will be led by our flagship Marlboro Red and will be gradually expanded to three pillars there you see the new Marlboro Fresh line up.
Clearly Marlboro Red will undergo the most impressive improvement, expensive consumer research labs with over 20,000 participants in a variety of geographies had confirmed that the new Marlboro Red offer meets or exceed this current smokers’ expectation and significantly increases the brand's appeal to competitive smokers.
We are currently conducting pilot city test in Europe, with initial excellent results. The global rollout should begin this year led by the European Union. And rollout will be supported by a specific communications campaign and newly developed consumer engagement tools.
We are confident that this important innovative development is the core of our franchise. We'll significantly reinforce Marlboro Red position with the undisputed brand of reference for our young adult smokers and provide further momentum for the Marlboro Gold and Fresh pillar in the years to come.
Of course innovative line expenditures will continue to underpin the brand’s growth. One example under the Gold pillar is Marlboro advanced in Asia. This line expansion has a research filer for an ultimate smooth taste with less and on their enough to take. The new product generated high awareness and trial in its prelaunch markets of Malaysia, Singapore and Taiwan.
The strength of our brand is the foundation of our strong pricing power which remains the key driver behind our margin and OCI improvements. As we explained last November, we believe that our historical annual average pricing variance of around $1.8 billion has not placed an undue strength on volume trend, as it entailed an average annual price increase of about 3.5% per time.
Although pricing is a complex market specific argument, we remain confident into the long-term sustainability of our pricing strategy. In 2013, we achieved the pricing volumes of $2.1 billion. This was above our historical average, reflecting the timing of tax driven price increases and unusually large gains due to inventory movement most notably in the Philippine.
In 2014, we expect this inventory related gains to be lower. Consequently this year’s first quarter EPS growth rate excluding currency is expected to be below our average for the year. However price, and it has not been the only driver of our margin improvements.
In 2013, our cost base was approximately $17 billion. Without productivity initiatives and cost savings, this cost base will grow 3% to 5% a year as a result of raw material price fluctuations, inflation especially in emerging markets and commercial investments. Our productivity gains aim to limit this growth to between 1% and 3% a year on average for the next two to three years, excluding cost related to reduce these products.
We have just successfully completed a $300 million annual productivity savings program and targeted similar level of savings in 2014. (inaudible) business fundamentals are solid, we are not immune to exchange rate movement. The current strong currency headwind (inaudible) we raise is investor concerned. Nevertheless, it is not the first time that this has occurred in time and again we have witnessed reversal.
In 2013, we faced unfavorable currency impact of $34 on EPS level. This was attributable almost equally to emerging market currencies and the Japanese yen. Our 2014 EPS guidance issued earlier this month included an unfavorable currency impact and the then prevent prevailing exchange rates of $71 about 60% of this was attributable to emerging markets.
Emerging markets are very important to PMI and a key driver of our future growth and profitability. Many of them has favorable demographics with a growing adult percolation. Consumer pressures empower is increasing at a faster pace in most developed countries, showing adult smoker up trading to what is still a relatively small premium segment in many markets. The excise tax regime tend to be predominantly specific, which typically favors our more premium secured brand portfolio. In addition emerging market are generally less consolidated and we face a wide range of local competitors from which we can either gain share organically, but with whom we can enter into business development initiatives.
All these elements encourage the factor expansion of margins in emerging markets, which today on a per unit basis on about half the level of those in developed markets. Our leadership position and a superior portfolio of international brand placed us in a strong position to benefit from this trend. In fact non-OECD markets use care as a proxy for emerging markets have significantly outpaced OECD markets in U.S. dollar terms from both a net revenue and an adjusted OCI perspective.
In terms of volume, non-OECD markets have been drawing an important both for the industry and for PMI. And by 2013 they accounted for 69% of cigarette industry volume and 61% of PMI’s volume. The growth in financial terms has been even more retroactive with non-OECD market now accounting for 47% of our net revenues and 41% of our adjusted OCI.
I firmly believe that the strong long term presence in these markets is a must given the immense growth opportunity they represent. Our greatest growth opportunity lies in the area of reduced risk products. The term we use to (inaudible) to product that have the potential to reduce individually and population harm. 2013 is going to be a pivotal year. So let me take you through some of the key milestones that will bring us to our first national launch in 2015.
In 2012 we carried out exploratory clinical trial that gave us the confident that we were on the right track. Last year we initiated a further eight clinical trials, we will start receiving top-line results from these trials during the second quarter while the final reports will be available towards the end of the year.
This year we will also initiate the remaining two longer term clinical trials. The data from these studies will be an important part of our evidence package aiming to demonstrate that switching to our platform one product reduces the risk of developing smoking related diseases and approaches the risk profile of smoking (inaudible).
In 2013 we conducted consumer trials in Japan and Italy with very positive results. These were four week user studies with a larger presented sample of close to 1,000 adults. In Japan after an initial one stick trial 54% of the responders declare that a positive purchase intention which is far higher than that normally recorded in this market with new cigarette. By the end of the test 30% of those who took part in their home usage trial had adopted the product. In Italy 68% of the responders declared a positive purchase intention and 12% adopted the product following the four week usage test. The product has broad appeal across different adult smoker profiles be it in terms of taste or price. In both tests the results largely surpass our expectation and provided us with valuable insides.
During the first half of this year, we'll continue with our perception and behavioral studies regarding the packaging and labeling of platform 1. City test will be carried out during the fourth quarter. The objective is not only to test consumer reaction in a real life environment, but also to validate our supply chain and after sale service approach.
We then proceed with any necessary fine tuning in readiness for our first national launch of Platform 1 in 2016. We'll produce the tobacco hit sticks in our factories and outsource the Platform 1 electronic.
Last month, we announced that we are building a new manufacturing facility near Bologna, Italy, but along with the pilot plant in the same area will provide an annual capacity of up to 30 billion unit. The associated capital expenditure are up to 500 million unit. We expect the plant to reach full capacity in 2016.
We'll start with Greenfield facilities for the production of Platform 1 hit sticks and Platform 2. As the technology and processes mature, we will be transforming knowhow to our existing manufacturing facility for capacity expansion and the production Platform 1 hit sticks and Platform 2 will be integrated in them.
Overall, regarding reduced-risk products, we've been pursuing a comprehensive portfolio approach to address different adult consumer preferences and exploit a variety of technological approach.
(Inaudible) heat not burn tobacco containing product Platform 1 is a more advanced. However Platform 2 which is a also a heat not burn tobacco product, which is much closer in look and feel the cigarette as it uses and end lid depress carbon heaters rather electronic and it has similar potential risk reduction benefit. A test launch is about one year behind that of Platform 1.
We believe that e-cigarettes in the meaning of a nicotine containing aerosol created through the vaporization of a liquid has the potential to become a viable category in the future. However, the current generation is a much slower nicotine delivery profile than cigarettes and our own platform. This combined with a weaker pace explains limited adult user satisfaction and reduced adoption rate. We believe that we should be able to overcome these limitations over time and have focused R&D resources on the development of such next generation e-cigarette.
We’re also continuing to develop the acquired Platform 3 technologies, which uses a unique chemical process to create a nicotine containing aerosol. Furthermore we’re exploring additional platforms in anticipation of evolving consumer preferences and the changing technology landscape. As previously disclosed we’ll increase our reduced risk product related expenditures in R&D operations and commercial activities by more than $100 million this year in order to meet our ambitious schedule.
Let me remind you of the magnitude of the opportunity. We estimate the potential adult smoker volume base to be approximately 1 trillion unit in the initial stage. If we assume a conservative 3% to 5% initial full adoption rate, platform one has the potential to generate incremental sales equivalent to some 30 billion to 50 billion unit net of cannibalization. After the start up phase we expect to be able to generate unit margins on platform one equivalent to those of cigarettes as platform one to generate additional margins of $720 million to $1.2 billion overtime assuming the same excise tax rate as for cigarette. While the positive influences of a commercialization of over the use of product may take a few years to impact the bottom line. Before business development, initiatives that we completed recently will already be accretive in 2014.
The net positive impact, this year at an EPS level is expected to be approximately $0.10 taking to the consideration the opportunity cost of reduced share repurchase.
Going forward we expect our contribution to our profitability growth to increase. Acquiring a 20% stake in Megapolis commenced a relationship with the largest tobacco products distributor in Russia and provides opportunities for further infrastructure expansions and operating efficiencies, but to strengthen the ability of our product outside the larger urban areas.
Our business deals in Nigeria and Egypt are part of our strategy to significantly reinforce on a competitive position and enhance our participation in the local pools in North Africa and the Middle East which we consider to be significant growth areas for our business going forward.
Cigarette industry volume in North Africa is estimated at 139 billion units. After a temporary decline in 2012 due to the disrupters related to the Arab stream; industry volume has resumed its growth trend reflecting mainly the expansion in the adult population. Egypt and Algeria accounted for a combined 80% of this volume. Even before our investments we have very successfully grown our business in North Africa.
Our market share increased from 13.5% in 2008 to 26.5% last year. The key drivers of our 13 share point expansion have been Marlboro, which gained 8.7 share points and L&M, which is up 4 share points. We spent $2.3 billion on these four business development initiatives. Last year we spent $6 billion on share repurchases and our outlay on dividends was $5.7 billion.
As a result, on our cash outflow was $14 billion. Our free cash flow in 2013 increased by $990 million to $8.9 billion, excluding unfavorable currency impact of $420 million. This translated into net financing requirement of $5.1 billion taking advantage of favorable conditions in the bond market we increased our total debt last year by $4.8 billion to $27.7 billion while simultaneously reducing our weighted average interest rate to 3.8%.
We’re intent on maintaining our single A credit rating and recognize that we’re approaching the high-end of ratio and supporting it. In fact, of the exchange rate prevailing at the time that we announced on 2014 EPS guidance earlier this year, the impact of currency on our forecast EBITDA and free cash flow is projected to be approximately $1.4 billion and $1.1 billion respectively. This combined with our recent business development investments has laid us to scale back our share repurchase target to $4 billion in 2014. We are committed to share buyback and our operating corridor is defined on one side by the upper limit of our credit rating and on the other side by providing 100% of our free cash flow to our shareholders through dividend and share buyback. We intend to operate within this corridor in the future.
Since our spin in 2008, we have repurchased 26.4 of the shares outstanding at that time. This is a significantly higher percentage any of the other companies in our compensation survey group. Over the same period we increased our dividend rate by 104.3%, this is a faster increase than all the companies in our compensation survey group with the exception of McDonald’s.
We are maintaining our dividend target payout ratio at 65%. As I said earlier this month, the decision on the actual payout ratio in any given year is a Board decision that takes into consideration multiple factors. If you look at our history, we have a track record of rewarding our shareholders with general dividend even during volatile times. At the end of January our dividend yield stood at 4.8%.
In summary, this is an investment year during which we will address some of the key market specific challenges that I described today. If the Philippines, we’re pleased with recent development and expect to significantly low our profitability over time. We are encouraged by the moderation of industry volume declines in Europe. We have solid share momentum and plan to introduce a number of initiatives including the roll out Marlboro architecture 2.0.
And in Japan, we are addressing our market share pressure which should moderate already this year. These factors give me the confidence that as of 2015 and beyond, we will be able to meet our annual currency neutral net revenues and adjusted OCI mid to long-term growth target of 4% to 6% and 6% to 8% respectively. Our ability to leverage strong adjusted OCI growth to a currency neutral 10% to 12% at the adjusted diluted EPS level will depend on the size of our share repurchase.
Our confidence is further supported by the strength of our business fundamental, our global market share leadership, our superior brand portfolio, our strong pricing power, the moderation in the growth of our cost base, reasonable excise tax increases and improvements in structure, our strong track record in completing business development projects that provide us access to additional pools and strong cash flow generation.
Finally, while not expected to make an immediate significant financial contribution, reduced-risk products provide us with a unique opportunity for accelerated profitability growth over the long-term and allow us to enter markets in a meaningful manner, that are essentially close to us today.
Thank you for your interest in our company, Jacek and I will be now happy to take your questions.
You talked a little bit about the Philippines, could you give a sense -- there has been some pricing increases competitively, the government is making some moves and trying to right the tax situation. Could you give us sense of what it looks like for both in terms of what you expect needs to happen to get back to sort of normal or healthy environment? And then relative to that what is included in your guidance for this year?
Okay. The situation is the following in Philippines. As I said, the pricing of our main competitor is for some brands has been below even the pass on of the excise tax, so including this. And it’s price gap management. Because the price gap on a per peso, on a peso per stick basis ahs increased at the beginning of last year. Now as I said, the encouraging fact is that as of November, Might primary brand had business 70% of their portfolio, they came up in price, where they should be essentially at the beginning of 2013, but they have not yet passed the 2014 tax increase and 30% of their portfolio is still under price that is below tax. So, it is encouraging. I think we’re moving in the right direction, but I still I see all the portfolio moving in the right place and closing the gaps, you cannot really declare victory.
Now you're right in saying that the government is putting increasing pressure and the issue is becoming increasingly public and I think difficult to sustain over the long-term. Having said that, I think over the long-term once this situation is corrected, we have a very favorable tax system. The gaps will close. We should not forget we have essentially 100% of the premium segment and not far from that mid-priced segment. So, over time as we gain pricing power, I think the Philippines will be a very significant contributor. The precise time of this happening, I don’t know. But all is know is that as of 2016, the situation will be better but for this year it’s probably the worst.
Okay. André, my first question is your long term volume growth algorithm of 1%, do you expect to get back to that at some point; and if so when; and if not how comfortable are you with pricing power offsetting that or essentially could drive your top line going forward?
Okay, I don’t expect to come back to 1% growth this year, next year or really let’s be realistic, before Europe recovers and we some improvement in other place. Now, the fact that -- however I believe we will see the recovery in European Union, which has been an important drag on our volume. I think markets like emerging markets, markets like Indonesia and Philippines have seen that volumes (inaudible) given the demographics of the countries and the potential they have, I still believe that there is volume potential there, I cannot tell you the exact time.
As I said that the fluctuation of plus, minus one is not the big impact on our bottom line. I think as I explained, our pricing and strategy although you cannot generalize, pricing is very market specific, I think we’re optimizing our pricing whenever we can. Of course we take into consideration consumer purchasing power, affordability, price gaps, but I think the way we’re under situation is working very well. And the encouraging factor is that we have very reasonable tax regimes, we have multi-year tax plans that give us predictability and I think there is still room for improvement in the tax factor of some of our major markets like Italy I mentioned in my earnings call. France, Spain and Turkey, which we have still very highly (inaudible) regime, which, if we change them, of course they help the bottom line, I’m certainly confident that we can maintain the strategy.
André I wanted to get your pulse on your confidence in the 2014 business plan, because if I go back to November, you outlined the 6% to 8% local currency target and since then from my perspective buying trends have gotten better in Europe, still down, but not declining as quickly; in the Philippines there is better tax compliance; and in Japan, it was a foregone conclusion that there would be net pricing contingent on the Ministry of Finance approval, obviously you and JT have proposed price increases. So I’m pushing you to raise your targets for the year today, but if do you feel more confident in that -- in those earlier forecasts now than you did that?
Well, when I did the forecast, I was feeling confident, more comfortable about the forecast, otherwise we have not made it. (Inaudible). Look, I don’t think much has changed since two weeks ago, I think the upsides are clearly in the Philippines. By the way I wouldn’t call it tax compliance have become, I would say the prices have become better tax compliance still not, but that’s okay.
I think European Union shows signs of improvement, actually January you cannot read the quarter in January, but came out even better from the last quarter. If I am not mistaken we are net of corrections for inventory movements about I think it was 5.2 decline so a sequential improvement that’s encouraging.
To me it’s a bit early to call it, as I said; I prefer to see the entire quarter and then clearly that may have been an upside. And Japan, the process, I want to remind everybody the process is still ongoing, still requires Ministry of Finance approval and has taken to consideration comparative brand prices.
As I tried to explain during the earnings call, however you look at it this is not going to have material bottom-line impact because even the prices are implemented as we submitted them, but then we have cost related to some incremental share loss and some promotional support to the price level or they don’t coming in we hover around 3% that the Ministry of Finance requires, but then you don’t have this cost. At Japan for this price step at least it is not a material impact.
André when you first introduced the Marlboro brand architecture you told us that this helped the individual lines to be defined more correct and precisely, it helped the Marlboro market share Marlboro volume. What will 2.0 do? Is it just a different pack or will the incremental benefit be similar to what we saw before?
This is more focused on Marlboro Red. If you remember in the previous line up, Marlboro Red was probably variant that went through the lease, I would say improvement or re-bump and rightly sold, it was clearly the flagship brand of the company.
I think we don't change Marlboro Light with given the size of the brand. I think the objective here is to change and adapt the image perception of Marlboro in certain markets or anticipated in other in terms of smoother sensation and image need even of the full flavor smoke. And in some markets, Marlboro has been perceived Marlboro Red as harsh and a bit urge. Okay we corrected this partly with Don’t Be A Maybe campaign.
I think also we need to adapt the product and the packaging and clearly the fixtures there don't make justice to the pack and maybe next time characteristics we have or they want to interested some products here that you'd see, but it also entails gradual improvement in their taste of the brand.
The encouraging factor as I said is that, wherever we taste the brand, its course extremely well. In spite the fact that the step is fairly big. So, the objective here is as I said to take the brand in line with the consumer needs and some markets anticipate them and I am very optimistic that this will enormously help the brand going forward especially when I thought.
Thank you. I’ve got two questions. The first is just a quick follow-up on the Philippines where I think press reports last week indicated that the Philippines Tax Authority indicated that burden of proof rests with PMI in terms of bringing kind of maybe into tax compliant, is that right and was that part of your calculus in terms of thinking the better turnaround in the Philippines?
I am not sure, who indicated it.
That didn’t make any sense.
This is clearly an issue between the government have to do their job and the company concern, okay. We just pointed out certain clear discrepancies between what which is public knowledge is what the company declares and I’m going to mail some sales and we the share actually. And you know also the customs as you heard recently have closed one of their bonded warehouses that might which was used to declare product as for experts that they never less be count.
Perfect. Thank you for that clarification. To my actual question, in terms the commentary about your long-term earnings growth algorithm, I know you’re lot of clear on volumes and pricing and OI. As you think about the benefit from share buybacks going forward, I mean sort of your earnings growth historically has come from that and you caveated that earnings growth going forward will be dependent on buyback. Why not take the plus 10 to 12 off the table or actually down a little bit because the accretion that you are going to get from buybacks going forward similarly will not be as meaningful?
I think the most important in any company is what is the fixed basic slide. I think we are in a rather exceptional situation just now with the currencies and their impact. What I outlined in my presentation to you is that you have [triple] effect of course you do have an EBITDA impact of the currency 1.4, you will lose $2.8 billion of all in capacity and $1 billion additional in cash flows that’s $3 billion out that means that will perpetuate. So I think we maybe I think even a year below the 10 to 12 and in the other year above, it’s very difficult for me to predict today how this is going to look like. But we all know if we are good on delivering the 6 to 8, the 10 to 12 maybe achievable.
We’ll take one more question, Nick, one more.
So one more in terms how you express disappointment in terms of share is Japan, so I just wanted to really better understand strategies in place in terms of really getting the market share improvement there. If you look at Marlboro’s share with menthol versus maybe it’s the share, I mean Marlboro still double the size it maybe, so it sounds to me like you still have a pretty challenging situation from a competitive perspective.
So a little bit more color in terms of what you are doing? And then of the operating income short fall in 2014 versus your guidance, how much of that is actually going into Japan in terms of the spending increased?
Okay. I mean clearly I tried to explain that one or give more color. What happened in 2013, we had a number of events. First of all, as you all know Japan Tobacco made a very important spent in changing the name of (inaudible) and the second thing is that we entered for the first time in a capsule and high manipulation segment. They have not anticipated significantly in our segment.
There was only one launch with [Tennessee] more than a year before that didn’t work very well. So you have the combination from very big marketing and promotional support, to support the name of the brand and entry in the same year in a segment that they have not participated before.
I think these are rather exceptional circumstances, because you don’t have the segment five times in your life and there is. And so I think these particular circumstances are not going to be perpetuated in 2014.
Now having said that, our share is under pressure and I think our share will be below this year, I don’t know exactly quite, but significantly. I don’t think, I think we can stop the decline this year, but I don’t think we can reverse even the initiatives we have, I think the strategy I described covers two point.
First of all we continuing - but also we work on the image of both Marlboro and Lark to increase their appeal to what I would call the more traditional part of the Japanese society. We should not forget that the highly mentholated and capital product attracts the more progressive part. Where still a large part of a Japanese consumer like more smooth product – and I think in terms of direction Marlboro 2.0 does exactly this, I think that will help in the years to come and with similar plans to work as of this year on Lark, but I cannot tell you more than this.
So it will take a bit of time, but I think in terms of you compare 2014 to 2015 clearly as we lap this year, the impact of Japan we will smoothen out in 2015. So that’s a net positive because this year Japan on its own as I said in November more than 1% growth point impact on us and that I don’t think will be repeated in 2015.
We will leave it there. I will forego my question there Nick. Thank you to Philip Morris and thanks for your time and your sponsorship with the conference.
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