British American Tobacco p.l.c. (BATS) Earnings Call Transcript & Summary

Okay. Good morning, everybody. Welcome to this fireside chat, welcoming on stage Tadeu Marroco, Chief Exec of BAT. I'm Damian McNeela, I'm analyst at Deutsche Bank. So I think we'll start off today, if you don't mind, you've been in your role for a couple of years now and a great deal happened over that time.

Can you sort of give us some insight into the sort of the key areas of progress that BAT has made in that time and particularly over the last 12 months?

Yes, sure. So thank you for having me here first. Yes, we have over a huge amount of progress over the last couple of years and basically backed by a new management team and a refreshed strategy. So when I came in as a CEO, I was very clear that we need to sharpen the execution and focus on key areas. So our -- we refreshed the strategy with 3 pillars. The first one is quality growth. And within the quality growth, we were able to rebuild the whole innovation ecosystem, leveraging very exclusive external partners knowledge that allows us to be now in the verge of being launching a breakthrough platform in HP as well as Vuse Ultra that we have just started to roll out. And we have now a very strong innovation pipeline for the medium and long term. We also managed to get New Categories profitability back on track 2 years earlier than the target that we had originally. And obviously, we brought back U.S. business to growth after 3 years. And after a series of commercial plans and drive also by Velo Plus launch that was -- and has been a success. So this on the quality growth on the sustainable future, we launched Omni, which is basically a manifesto to promote the debate around tobacco harm reduction and based on scientific evidence -- and this has been a very strong tool to open up doors with different stakeholders, policymakers, private and public sector and media in general. And finally, on the dynamic business, we enhanced our financial flexibility at the back of very strong cash generation. We also make a divestment of a small minority shares in ITC. And then we have reestablished the buyback program last year with GBP 700 million. We have just announced a revised number for this year of GBP 1.1 billion. And we got our leverage back to the corridor that we were aiming for between GBP 2 billion and GBP 2.5 billion in the back of last year. And after the Canadian CCAA settlement, we expect to be within this range by the end of next year. So all in all, very good progress that creates the -- laid the foundation for us to be able to deliver per guidance in 2025 as we just confirmed yesterday in the trade update. And in 2026, at the back of U.S. growth back to growth at the back of Velo doing exceptionally well, not just in the U.S. but outside the U.S., AME continue to perform well and lapping some difficult markets that we have this year like Bangladesh, plus a cost agenda that we have put in place, a new one that's starting next year of GBP 2 billion between '26 and 2030. We are well on track to be able to deliver our midterm guidance of 3% to 5% revenue and 4% to 6% operating profit.

Yes. Okay. I think you mentioned that, obviously, the U.S. has been a challenge. But yesterday, you did announce pretty decent results in U.S. combustibles. Can you sort of talk about the backdrop that you're seeing at the minute for the general sort of combustible space in the U.S., but also what's driving -- what's underpinning that sort of improved performance that you're delivering?

Yes, U.S. is a truly multi-category market today. We have approximately 55%, 57% of our smokers poly using and is 1/3 of the nicotine value pool, global value pool. So it's the cornerstone of the group at the end. So what we have done over the last 18 months is basically put in place a number of commercial plans to tackle our competitiveness in combustible. We have to correct some price index. We have to ladder some brands like a [indiscernible] to support our consumers. We had to increase our coverage at the back of a 10% increase in sales force. So we moved from 82% to 88% coverage. We have invested in data, so we could do proper and enhanced revenue growth management, but also direct-to-consumer with loyalty and award programs. So all that translates into a stable slightly growth market share, value share like we announced yesterday. If you strip out the deeper discount where we are not present, actually, we have a very sound growth in terms of share of 60 basis points, and we are very pleased with that. Obviously, being now a truly multi-category is important to be competitive in the other categories as well. So Modern Oral, with the launch of Velo Plus, we are very satisfied now that we have a product that we can fight in that segment. And the product is doing extremely well and the levels of trial and retention are very high. And we saw in a very short period of time, a lot of traction. And this is quite important because it's the fastest nicotine category growth in the U.S. today. So to be competitive and having an offer like Velo Plus in that market is quite important. Obviously, the Vapor is not a neglectable business. It's a GBP 9 billion revenue business. And the problem in that segment, in particular, is the illegal flavor disposables, and -- which accounts for something like 7%. So we had headwinds on that because all the growth is happening in that space where we cannot compete. So there is no level playing field at the moment in that. So Vuse is leading in tracked channels, but in the legal market that if anything, is shrinking, which represents a headwind for us. But we are cautiously optimistic with the new administration that there will be some levels of enforcement at the federal level. That's our expectation. And probably the FDA will be addressing that because we have now a new leadership at HHS, but also FDA CTP, and they are talking about tackling the problem in a more effective way. So we look to that with more optimism. But also, we are seeing movement from the states. We have now 17 states that have passed legislation in terms of established directories and enforcement. And when you look to states like Louisiana and Kentucky, we can see clearly a reduction in legal products and as a consequence, resurgence of the legal products and Vuse leading that. So all in all, we are well established in the 3 categories between combustible, vapor and modern oral. And vapor, as soon as we have some meaningful impact on enforcement will be a big boost for us.

Yes. And on that point on enforcement, I think there's been a shift in language, I think, from FDA and government agencies. But have you seen any real evidence of any change in the level of enforcement that's going on at the minute? Or is that something that's still to come, do you think?

It is still to come because they are all very new in their new roles. I think that is natural that they are taking some time even to understand the dynamic. I don't think that the FDA alone can do much. There will be a need to have a multi-agency task force on that. They need to work with customs because a lot of these products come from the ports, but they are all imported -- mainly from China. They need to work with DOJ to address, for example, very specific distributors. There are not many that are responsible for all the distribution across the country. And also, they probably need to address the approval system that they have today that clearly is not working because the U.S. consumers today is the last to experience all these innovative products, which could be exactly the opposite.

Yes. And Vuse outside the U.S. is performing pretty well. Can you sort of talk about some of the sort of market dynamics that are happening outside the U.S. for Vuse?

Yes. Outside the U.S., what we are seeing is that rechargeable device are back to growth. And this positions Vuse very well because with the latest innovations that we have introduced at the back end of last year, we are now very competitive also in the rechargeable segment. And our market share, for example, [indiscernible] in France is 57%. In the U.K., it's 35%. Vuse is doing extremely well in places like Poland, like Spain. And we have just launched Vuse Ultra in Canada, which is our attempt to create a more premium subcategory within vapor. So there is a lot to go still, but we believe that we are well positioned outside the U.S. to keep growing and keep leading the market.

Yes. I think at the CMD last year, you highlighted the depth of the innovation that is happening across the entire organization. And in particular, one of the areas that's been one of your focuses is improving the heated tobacco offer. Can you talk about the advances that you've made in the new Hilo product and what the expectations are for the second half when you sort of go to market more broadly?

Yes. Hilo is clearly a breakthrough for Glo. And for the first time, we have an offer to be able to address the AWAP, the above weighted average price subcategory within heated product, which accounts for 80% of the value. So far, we haven't developed any platform in Glo that could allow us to participate of this more, I'd say, a premium part of the category. So we have now a new platform with a new completely renewed heating mechanism. We have renew consumables that translates into a much more satisfaction. And actually, I think that is the closest you can get from -- moving from cigarettes towards this category of heated products. We also have a new display that is very interactive and a connected device that will be very unique to the market. So when you pull all this together, we think that we have a very strong offer, competitive offer that we have been testing in Serbia since the end of last year with very good results, encouraging results. We have 50% more consumers to the Glow franchise. A lot of them coming from FMC cigarettes. That's what we want to promote the conversion from smokers to these products because of the profile of risk. And -- but also from competition. So we will be rolling out in the main key value pools starting now in June throughout the second half of the year. And our expectation is to be able to make inroads in that premium side of the category where 80% of the value sits.

Yes. You mentioned in your sort of opening answer the importance of the pouch category and Velo is the market leader outside of the U.S. Can you just talk about some of the sort of the key dynamics in perhaps the traditional markets where Velo is obviously very strong, some of the newer markets as well outside the U.S. for Velo?

Yes. We are seeing nicotine pouch growing not just in traditional oral market, but also in markets that has no oral tradition at all. Today, 20% of the volume sits outside of the oral traditional markets. And the levels of average daily consumption and incidents are still growing. So you have a place like, for example, U.S., where because of the lack of satisfaction of current offers and Velo Plus that should change this dynamic with a product with more moisture that we see that resonates well outside the U.S. The average daily consumption is still 2.5 pouch. So there is a massive space to grow when you consider that the U.K. that is a known oral tradition is between 5 to 6 pouches. And when you go to the Nordics, which is a more traditional oral market, it is 9 to 11 pouches. So you can see how much potential there is in the U.S. as soon as the consumers will get a more satisfying product. So this is a category that we are seeing, and we are very satisfied with that because it's the closest you can get from a nicotine replacement therapy in terms of risk profile. There is no inhalation. It's very affordable because you have a number of markets in the world today, for example, that you sell cigarette by stick because of affordability. They don't need to pay the device. You can sell a sachet with few pouches, for example. And that's the reason why we have a launched in place like Pakistan and South Africa is getting also a lot of traction. So you can socialize the tobacco harm reduction agenda even for markets where affordability might have been a problem.

And can you talk a little bit about the sort of the profit profile that you're seeing from your next-gen products and how that contributes into your sort of medium growth -- medium-term growth ambitions?

Yes. The final objective is to replicate the levels of profitability we have in cigarette in these new products. And Modern Oral in nicotine pouch, if anything, the levels of profitability is even higher than the ones that we have in cigarettes. And HP is -- when you are dealing with the more premium segments that I was referring to is, again, you can easily replicate the margins that you see in cigarettes. And vapor is not as much as the cigarettes at this point in time. And that's the reason why we are trying to create more of this premium subcategory within vapor, even though we are in that category not to compete with a very volume low price offers, but we want to differentiate ourselves and Vuse Ultra is exactly an attempt in that direction.

Yes. And in terms of the sort of -- you mentioned again sort of the Omni, the launch of Omni and it's sort of -- it does feel that BAT is sort of changing the way it approaches the narrative around who the organization wants to be. Can you sort of just talk a little bit more about what Omni is trying to do and perhaps give us a few examples of where that sort of really sort of resonated with some key stakeholders.

Yes. Omni is an attempt for us, first of all, to be a bit more proactive in the way that we engage in terms of tobacco harm reduction; and b, it's an attempt to avoid the bias between that's what BAT is saying and because what we do with Omni is basically public, a number of research done not just by BAT and -- but also third-party research that confirm in a scientific basis, the evidence that the noncombustion has a much different level of risk profile, much lower risk profile compared with combustion because there is a lot of misunderstanding around the nicotine and because the culprit of the health problems generate sits on the combustion of the product. So when you move this towards offering, those consumers that want to keep using nicotine an alternative without combustion, then you really reduce substantially the risk profile. So that's what Omni tries to achieve and trigger in that sense, a debate with regulators and different stakeholders around that. The fact is that regulators that don't embrace tobacco harm reduction, in essence, what they are doing is postponing the conversion of cigarette smokers towards these new products and also open up the door for illegal products because we still see a number of markets today where none of these products, unfortunately, can be commercialized, but it's inundated by illegal products. So we also showcased those cases in the Omni, where examples of markets that has done this properly. For example, Sweden is the one that in Europe has embraced oral 2 decades ago and will be the first one probably to achieve what they call smoke-free country with the level of incidents today sitting at 5.3% following WTO, if you are 5% or lower, you are considered smoke-free country. And as a consequence of that, for example, lung cancer per capita is the lowest in Europe. If you translate that into Europe statistics, it's 3.5 million lives that would be saved in 10 years' time. So in the opposite of the spectrum, you have countries like Australia that ignore all that, basically ban vapor where 9% of the population is vaping. So it's basically all illicit. And at the same time, they are making inroads in the legal market of combustible with new regulations and massive ad hoc excise that just move consumption away from the legal markets towards the illegal markets. So today, 75% of nicotine consumption in Australia is illegal. So that's a good example of how not to do things. So we are trying to illustrate all those in Omni. So we launched in the U.K. last year. We have just rolled out in place like Pakistan, like Italy, Croatia, Japan. And whenever we launch in those particular local markets, we see a lot of interest from private, public sector, policyholders and also media in general, which is exactly what we want.

Yes. And I guess sort of it does lead on to the next question I was going to ask, which is around regulation. And my question would be around -- obviously, you've highlighted Australia has been a way of not to do it. Are there any examples of where you think the sort of the regulators have got it right and which are -- provide the sort of the blueprint for other companies or countries to follow?

Yes. We spoke about Sweden that clearly is working nicely, and you don't need epidemiological studies. Like I said, is evidence is there. And we have even markets like U.K., for example, that has been adopting a very progressive way of stimulating the conversion from cigarette to vapor. There is an issue about enforcement there that they are trying to address now. And because I think that things like retail license, for example, to avoid minimum age participation in that category is important to be implemented with the proper enforcement. We have places like New Zealand that have adopted a legislation that has reduced substantially the incidents of smokers in the market in supporting vapor, for example. And Japan, half of their consumption today is in heated products, which has, again, a very, very lower risk profile compared with cigarettes. And we have here in Europe, markets like Italy that has embraced, for example, the multi-category with proper regulation, regulating nicotine pouch properly, stipulating, for example, maximum level of nicotine, minimum age to purchase and proper -- they have a proper retail license system as well. And so there are more and more examples. We have been -- since Chile now open up for vapor because they thought that has been inundated by illegal market in Chile. So we are -- and even the U.S., when we see the FDA, they always are very supportive of the tobacco harm reduction. And they have publicly said that nicotine is not the culprit of the health hazards that cigarette brings, and they believe on the risk continuum. So there are more and more evidence that supports the adoption of tobacco harm reduction in a way to address the problems related to cigarettes.

Yes. And just sort of if we look at the combustibles business, I mean, clearly, at the start of the year, we had sort of Bangladesh and the new excise increases there, and you've sort of touched on the high levels of excise in the reforms in Australia. Can you just talk about the impact that they've had on the combustibles business, but also then talk about the areas where the combustibles business is performing well outside the U.S.

Yes. Yes, Bangladesh was a very unique situation because they have not just increased massively the excise and the minimum price in cigarettes, but they have increased duties and VAT and a number of other items. And as you could imagine, with the affordability of population, and this is translating into a massive volume decline, and we expect something like 15 billion sticks reduction because we see this consumption migrate towards areas that probably the government will be very keen to do something about, which is illegal products and so on. So Bangladesh is one of these -- we spoke about Australia because of these few thought measures that they have been implementing. They are about to introduce another ad hoc increase in September that on top of a very draconian regulation that they have implemented since 2012. Consumption, though is pretty much the same, 14% of output consuming cigarettes. They are just moving from legal markets towards the illegal markets. But we also have markets where consumption and the business is still in a very favorable way. For example, Brazil has been addressing the problem with illicit for some time. At certain stage, the illegal market in Brazil went up for more than 50%. Today is well below 40%. So it's in the 35%. And this translates into the legal markets being supported by that. And we see some other markets as well in Europe with very stable levels of consumption of cigarette.

Yes. Last week, you announced a small sell-down in the stake of ITC. And I guess you were asked on the call yesterday, but I think it's a worthwhile question repeating is, is the stake in ITC a strategic stake? Or is it a financial stake?

We consider this as a strategic stake and because, first of all, it's India. So it's India because of the size of the market, because of the demographics, because the socioeconomic expectation that we're having in India when a new project, for example, GDP per capita growth. And the fact that ITC is a brilliant outstanding company in India. They have a massive distribution power. They are a leader in cigarettes. So we have a multilayer, multi-years, multi-decade relationship with ITC. We have commercial relationships with them in the leaf department. We have in the IT side as well. And we are very optimistic that in certain stage, we will open up for new categories. And we would like to preserve them a relevant stake in ITC as a consequence of that, to work with them with having the products that we have developed outside India at certain stage in India in partnership with ITC. So that's why I mentioned that the Board will be making decisions about our stake in ITC. But clearly, we see this more strategic, and we want our desires to continue to be a relevant shareholder in ITC.

Yes. Okay. And one of the things that sort of that sell-down aided you to do is to sort of increase the buyback, as you mentioned. Can you just talk a little bit more about the moving parts of getting the net debt into the 2 to 2.5x range? And then what we should expect in terms of shareholder returns when you get there?

Yes. I think, first of all, is what to highlight that from 2023, by the time we get to the end of 2025, there will be more than GBP 17 billion returned back to shareholders from BAT. So -- and this is a combination of a progressive dividend policy, and we reaffirm that. So we carry on continuing to increase our dividend in sterling terms. It's a consequence also of the buyback that we have just restarted in 2024, and we are now moving to GBP 1.1 billion, and we said that will be a sustainable buyback moving forward. Now we also want to have flexibility to pay down debt and to do some bolt-on acquisitions like Velo Plus Villous that we have done last year. So any particular year, when we establish back our midterm algorithm of 3% to 5% revenue, 4% to 6% operating profit, you would expect on our free cash flow to be around GBP 80 billion. So GBP 5.5 billion of that will be paid around dividends. And then you have the balance, which will be a combination of the buyback and continue to pay down debt and having the flexibility to do some M&A acquisitions, bolt-ons, mainly on the patent side to strengthen our position in the new category space. So we believe that we have always needed to preserve the corridor of 2.5 to 2 by the end of next year. And remembering that we have a headwind to face in terms of this ratio as soon as the Canadian settlement is being signed, which we expect to be the case in the next -- in the second half of this year. So -- and the reason why we sold the stake in -- we did an extra divestment is exactly to support that and to support this flexibility. So I think that's where we get to next year, probably the leverage will not be a major issue anymore for us.

Yes. Okay. That's very clear. If we just sort of turn a bit to current trading. Yesterday, obviously, we had a good update from you. you're expecting revenue to grow slightly faster, I think, underpinned by the good U.S. performance, but you kept your adjusted operating profit growth guidance the same, consistent as it was previously. Can you just talk a bit about some of those moving pieces within that and why that stayed the same?

Basically, because today, this is a deployment year that we said. So we had an investment year in 2024. We have this year the opportunity to start rolling out innovations that we have never had the chance before, premium vapor product, a breakthrough device in HP, Velo Plus that is doing extremely well. We didn't want to compromise that. So that's the only reason. So we have a more supportive revenue, but we want to keep investing for the long and medium and long term of the business. So that's basically the reason.

And then given the sort of the investments that you're making and the acceleration you're expecting in the second half, can you talk about the confidence you've got in being able to sort of get back to the sort of medium-term growth ambitions that you've set?

Yes. The growth -- when you go to 2026, we expect to build on this revamp of the U.S. situation that we have managed to get to. So, like I said, we expect to go back to -- after 3 years, go back to profit and the top line -- positive top line in 2025. So we want to build on that in '26. There is no reason why not to expect that AME continues their excellent performance that they have demonstrated over the last few years. We'll be lapping problematic markets like Bangladesh, for example. for next year. We have this -- with the cost agenda that -- with a new intention of an additional GBP 2 billion of savings from '26 to '30 that kicks off next year. And obviously, we expect Velo to continue to grow in the U.S. and outside the U.S. And Velo by the end of this year will be very material for our numbers as well by the time we close the year.

And is it worth sort of just clarifying your expectations for the improvement in U.S. illicit backdrop within that sort of achieving that target?

Yes. This is not factoring in. And -- but like I said, I'm cautiously optimistic that in between the states legislation now that we are seeing now, the 17 states that I referred to is equivalent to 1/3 of the vapor market in the U.S. that has some sort of legislation in terms of directories and enforcement with different various degrees. I would say the blueprint is the Louisiana, Kentucky, where you're already seeing a very meaningful impact in the illicit and the counterbalance to that, an increase in legal vapor. And -- so we expect this to carry on in other states, and we expect to see some federal actions on that. If that happens, it will be a plus for us to build on. But we cannot rely necessarily on that. And that's why we are trying to guide without necessarily counting on those initiatives.

Yes. No, that's pretty understandable. And in terms of -- I think, as you said, '24 was an investment year. This year is a deployment year. We should start to see the benefits in '26. How do you feel about the sort of the business or the shape of the business as we move kind of beyond '26, 2030, moving towards that 2035 ambition?

I think that we are -- with this innovation ecosystem that we have just -- I just referred to and our positions in key geographies because we are really a truly global company with a very strong presence in the U.S. When you, for example, launch a product like we did in December with Velo Plus and a few months later, you are in more than 100,000 outlets just demonstrates how powerful is the distribution from Reynolds in the U.S. So we have a very strong presence in the U.S. We have a global presence across the world, and we have a presence even in India through our associates. So we'll be building on that geography to mitigate eventually some headwinds that is natural to happen in one point in time. But we'll be building on that. And with this renewed innovation pipeline and the strength that we are now trying to get to in heated product that is a $9 billion category in which we have just one. So there is a lot of white space for us to go, plus the fast having, in my view, the best product in the fastest-growing new category that is out there, which is nicotine pouch with Velo and build on that, plus our vapor business that is a leading brand that also have at the back of a proper enforcement, a lot of opportunities to grow. So we see completely feasible our possibility to get in a decade to the 50%.

And in terms of -- I think at the CMD, sort of one of the things that I took away from it was you're trying to be a much broader consumer type business with things like RAI and some of the investments you're making elsewhere. Can you talk about how they fit into that sort of longer-term vision for the organization?

Yes. It's important also to not shut the doors to beyond nicotine space for us because at the end of the day, you should be thinking about BAT as a kind of stimulant company where nicotine is one of those. Obviously, for the next 3, 4 years, the focus will always be nicotine, but there's so much business opportunity there. But we are trying to learn basically. We are trying to learn in the space of well-being stimulation. We are trying to learn in the space of cannabis. That's why we make that investments in Organigram. And Organigram as a company is moving out of combustible to noncombustible use of cannabis as well. And we are learning a lot from them. So I think that those investments at this point in time is basically for us to build an optionality and learn more for the future. But the medium term is pretty much focused on the nicotine space.

And is there anything that you sort of see out there that would be interesting that isn't currently in the portfolio?

Well, look, we keep looking, but the fact is that the size of the price for us in all fronts in pursuing our purpose of converting smokers out of cigarettes towards these products that we have now the possibility to offer them that we didn't have in the past because today, we have the technology to do it, and we have consumers' mindset pretty much supporting that movement. And you see this in a number of other industries as well. And we cannot give up that. So the focus really for us is that how we convert them, making this massive positive impact on society, at the same time, increase the sustainability of the company moving forward. And this is resonating nicely with our major stakeholders, which is our employees as well. They are all arriving in the office and excited about being able to make a change, a positive impact as well.

One of the questions I get asked a lot is, how is the nicotine space going to look in 5 to 10 years' time? And I find it very difficult to answer with any real conviction. Have you got a better answer for people?

Look, nicotine is highly addictive and it's not without risk because if you have cardiovascular issues, blood pressure, you shouldn't be using like you shouldn't be using other type of stimulants. And so that's the reason why it should be sold for adults. It's not a product that should be in the hands of underage. And -- but clearly, it's a stimulant that attract a lot of consumers. And today, the good news on that is that with the caveat of the risk that I was referring, and they should be aware of all that so they can make their mind, there are clearly ways to use it in a much safer way than before, which we have never done before. So this is creative space for nicotine in the future that probably you will be seeing more and more because it's a stimulant that has been used now for decades and will be the case moving forward.

Yes. So you're not sort of indicating that pouches are going to be the biggest, most important category. It's going to be multi-category across -- it depends on the market.

Yes. Look, I think personally that pouches can be a highlight of this future because like I said before, it's affordable. It's the lowest risk of all of those categories but there is no inhalation, the closest you can get from nicotine replacement therapy. And I think that this can resonate and we are seeing that with a number of consumers even in nontraditional oral markets. So if I had to make a kind of a prediction, I would say that the relevance of nicotine pouch is -- will be much higher than the others. And the good news is that we are very well positioned. BAT is very well positioned in that space.

Yes. Well, I think on that positive note about the strength of Velo and your place and pouches, I think we'll leave it there. Thank you very much, Tadeu. Thank you very much, everybody.

Thank you.