British American Tobacco p.l.c. Q2 FY2021 Earnings Call

Good morning everyone, I am Jack Bowles, Chief Executive of BAT, and I am here with Tadeu Marroco, Group Finance and Transformation Director. We are very happy to be here this morning, to present our 2021 Interim Results. I hope everyone listening this morning and your family and friends are well. Today, I will provide an update on our strong progress towards building A Better Tomorrow and creating the enterprise of the future. And Tadeu will share more detail on our performance in the first half, and outlook for the full year.

Thank you, Jack. In the first half, we have delivered strong progress against the key financial focus areas I set out last year. We have delivered over £900 million of total savings from Quantum to date with the £1 billion of annualized savings now expected 12 months earlier. Together with the value from combustibles this has enabled further investments to accelerate New Category revenue growth in H1. We remain confident in reducing the losses from New Categories by the full year with a clear pathway to profitability by 2025. This will be driven by maximizing our marketing spend effectiveness alongside scale benefits and the reduction in trade margins.

Thank you Tadeu. So, in the first half, we have generated excellent New Category revenue growth share gains across all three New Categories and our fastest growth in consumer numbers to date, delivering on our three operational priorities. This momentum is giving us increased scale. In New Categories, we are well on track to reduce full year New Category losses in 2021 with a clear pathway to our £5 billion revenue target and to profitability by 2025. As we reach our leverage target at the end of the year, our capital allocation flexibility increases. As we said in our preliminary results in February, 2021 will be a pivotal year. We are committed to transforming BAT to a high-growth multi-category consumer-led CPG with a reduced impact on public health and ESG at its core, creating value for all our stakeholders. Our established multi-category strategy is working and our transformation is accelerating. We are building strong global brands with Vuse, glo and Velo and continue to drive the digitalization of the whole business at speed. BAT is changing rapidly, powered by our ethos. We are creating the Enterprise of the Future. And I look forward to the second half and I'm excited about the future for BAT. Thank you for listening to this presentation. This presentation is available on our new website, which I'm pleased to say, has been recently upgraded. Thank you and I will now open it up to questions.

The first one comes from the line of Richard Felton from Goldman Sachs. Please go ahead.

Good morning. Thank you for the question. My first question is on the topic of cash returns. Your target leverage range is 2 to 3 times net debt to EBITDA. But Jack I think you've previously described being at 3 times as removing the straightjacket. So I just want to clarify how you're thinking about capital allocation. And would you be comfortable starting a cash return program and running your balance sheet, while you're still at the upper end of that 2 to 3 times net debt-to-EBITDA range? That's my first question.

Yes, thank you very much. First of all, I must say that we are very pleased with the momentum that we're having at the moment. And as we said, the end of the year is the time for these reviews. Of course, I mean, we like capital allocation. We've done it in the past. And we said very clearly that we will do, of course, the deleverage of the company. We're true to our dividend and we want to invest in the business. As you saw the investment in the business is paying off very well and will continue to do so. So by the end of the year we will review again the situation.

Thank you. My second question is quite a specific one on Vuse.

On Vuse?

You mentioned in the presentation that improved trade margin are one element of driving better profitability for your Vapour category. I was wondering if you could share some numbers around that please. I think you said that trade margins for Vapour were around about 40% at your CMD in March last year. Have you seen any material improvement in that over the last 18 months?

Yes. I mean, Tadeu is going to complete the answer. But I think what's very important with Vuse now is that we have scale. So we can go to optimization, we can reduce the trade margins and we can accelerate our growth. We have built a very strong brand and that is what is the most important. So people are coming back to the brand. But, Tadeu, do you want to add something?

Yes, the margins depend a lot on the country where you are and the channel that we are commercializing. One thing that I would say is that vape stores are very high margins at around 70% plus. And the trends moving from open system to closed system is leading the commercialization towards more convenience stores where margins are around 40%. That's the number we have quoted in the CMD probably that you have in mind. Now what's happening is that, first of all, we are increasing our presence in e-commerce and the margins in e-commerce are fantastic. The 40%, like you saw today, is already with subscription, which makes it even more interesting because there you have more loyalty and the margins are even three times more than what you sell in the convenience stores. And on top of that, with the leadership that we're acquiring now in places like France and the U.K., we are able now to renegotiate margins with some of these key accounts, moving from a specific, for example, percentage of revenue to a margin pay-for-performance, for example, which also translates into improved margins. So that's why we refer to profitability where we include trade margin management as part of this.

So we have a very clear path to profitability on e-cigarettes.

Very clear. Thank you.

Thank you. The next question comes from the line of Gaurav Jain from Barclays. Please go ahead.

Hi. Good morning.

Good morning.

Thanks a lot for taking my questions. So my first question is on the guidance for the year. So the first half revenue is about 8%, and full year guidance is 5% plus. So that will indicate a significant slowdown in the second half when I think, still you would probably have easy comps, especially in emerging markets. So could you just help us understand where you might see the slowdown?

Well, first of all, I think what's important to consider is that we have strong momentum and that momentum will continue to build on. Then the other thing is, I prefer to be reasonable and to have the space, as we were referred to earlier, a very straightjacket in the past and we have a bit more space to invest in the business. You see that there is a very strong result in terms of combustible and in terms of new categories growth. I think that the second half of the year is going to be comparing with higher comparators of the second half of last year, which was very strong, and we are reaffirming our guidance.

Sure. Thank you.

Thank you very much.

The second question I have is on the US market.

Yes.

So look, your pricing right now is ahead of competition. And we are seeing in the recent data that you are beginning to lose share on the US cigarette side of things. And then when I look at the amount of investment you are doing in new categories if I look at, for instance, your Modern Oral realization in the US, it's a fraction of your key competitor there. So if you keep increasing prices in cigarettes at a level which is ahead of competition to fund these new category investments, isn't it a risk that you are carrying that at some point in time your share losses in the cigarette market just accelerate?

Yes. I think it's a very good question. What you have to consider is available income and income in general in the US is quite strong. Price elasticity is 3.4 as it was last year. And what you see is you have a huge resilience of our brands in terms of market share and we're growing premium share in the US. So we are always doing the balance. As I said, it's one of the key priorities of the group, which is extracting the value of our combustible business and that's what we are doing. So we're taking more pricing than competition. We are having all the tools that we need in terms of digital to make decisions shop-by-shop, city-by-city, state-by-state and at the national level and by channels, and we are able to grow our value share. So I think that the fact of having these tools that allow us to navigate through all this allows us to take more pricing than competition and continue to grow value share. So, of course, we're reviewing that all the time with the US team. But I must say that the performance in the US has been extremely good. We're growing share in premium.

Okay. And my last question is just on device launches in glo. So your competitors are launching new devices in the next month. And they have laid out a roadmap of how we should think of device launches that every year there is iteration or in every three years there is a major change in platform. How should we think about device launches in glo this year and over the next few years?

Of course, there will be innovation. I must say that we were the first to launch the new device with Hyper. The use of induction heating highlights the quality of our innovation. We have made significant improvements to our consumables and will continue to do so in the coming months. In a competitive environment, while others may launch new products, we are capturing a significant portion of the growth in the category wherever we operate. Remember, we mentioned in the presentation that we are currently present in only half of the markets where THP is sold, so there is plenty of room for us to grow. I believe our stick prices are very competitive and align well with the competition.

In the index, yes.

Yes. In terms of the index, and I think that we have a very good formula for the consumer. As you saw in the charts in every market that we have launched we are growing share significantly and at pace, capturing more than our fair share of the growth of the category. We have now 16.1 million consumers in new categories. Who would have said that two years ago? I remember vividly, and sorry for taking the opportunity, but two years ago when Tadeu and myself stood up and we said we're going to transform the group, have a new purpose and develop the company to a new pace. I mean, everybody said yes, right strategy, but let's see the result. Now let me tell you in the second half of the year, we grew the three categories of last year. We grew the three categories in terms of volume by around 50%. We do the same and even more this time and we have a record of 2.6 million consumers additional in this half of 2021. So we have momentum, we have the right products, we have the innovation to come and it's a competitive environment. Yes, let's enjoy the competition. Remember also that in terms of e-cigarettes, we're the leaders worldwide and in the US where we're weak. Two years ago people told me, there is no way you're going to take a position in the US, okay? Now we are a leader in 20 states in the US, out of the Modern Oral now, out of the 18 markets that we are in, we are leaders in 16. And we had a gap in Modern Oral in the US. We acquired the products that we needed. We've put our brand behind it and we grew 10 share points in the meantime. So we're in consumer acquisition mode and we are delivering the revenue at 50% growth.

That's very helpful, Jack. Thanks a lot.

Thank you very much.

Thank you. The next question comes from the line of Rey Wium from SBG Securities. Please go ahead.

Hi, Jack, Tadeu. Thank you for the opportunity.

Hi. How are you?

All good, thanks. I just want to start off with the vapor category, I mean obviously loss-making and you indicated you're working towards profitability by 2025. But I mean is there any color that you can give us in terms of costs relative to revenue? I mean what is the extent of the costs relative to revenue? Are costs basically like currently double of revenue, or is it a little bit less? And maybe just on that if you maybe can just give us sort of a steer, which markets do you think will achieve profitability first? So that is my first question.

Thank you very much. Tadeu?

Yes. When analyzing the numbers, BAT represents a mix of different markets at various stages. We're already seeing positive results in three categories in specific markets. For instance, in Japan, our THP category is profitable. In Canada, our vapor category is on the verge of profitability. In Modern Oral, most markets have also reached positive territory because this category has a quick payback period of about 15 months, with high margins that are more competitive than current cigarette margins, and it doesn’t require a device. We're making rapid progress in margins for vapor. We previously discussed trade margins, and our key lever now is the cost of goods sold. As we scale up, we're transitioning from manual to automated production lines, resulting in significant cost reductions across the group. We're very satisfied with our progress in vapor margins. THP margins are appealing compared to cigarettes, though there may be some challenges from excise taxes. However, we also have opportunities related to the cost of consumables. It's about attracting consumers, and as Jack mentioned, we are in consumer acquisition mode, with increasing conversion rates. We're excited because when consumers try our devices, they enjoy the vapor liquids or THC consumables, leading to growing loyalty. The losses we've discussed are primarily driven by digital and consumer-related factors. The timeline I mentioned refers to our journey of expanding into different regions, but we already have markets that are turning positive.

Always remember, we speak about digital and digital is extremely at the core of BAT. And not only in marketing, where we have now databases with 12 million consumers of new categories, we have three times more than that in terms of combustible consumers, but it's also going through the whole supply chain. It is also going through the whole way we operate. And that has huge benefits in terms of enabling us to deliver the savings of Quantum where we have put the £1 billion to £1.5 billion now, and the acceleration of consumer engagement and that has allowed us to be far more effective. So, now that we have scales, we can build the brands to have very strong and very effective brands, supported by digitalization. That will in turn give us the profitability in these New Categories. We say already that despite the size of the investments that you saw last year and this year that we are going to start to reduce the losses this year, which is a very, very good milestone. So, consumer acquisitions start to reduce the losses. NTO is growing very fast. So revenue up 50%, not a bad score, across the three categories a very, very good score. And we'll continue our road to profitability. The pathway to profitability per category is absolutely clear. Question?

Thank you.

Thank you very much.

The next question comes from the line of Jemima Benstead from Citi. Please go ahead.

Hello.

Hi. Good morning.

Good morning.

Good morning, guys. Thank you for the presentation. Most of my questions have been answered, but just a couple more. My first one is on emerging markets. You obviously saw very good growth in H1 and that contributed to your full year industry volume upgrade. I know you flagged the tough comps in the second half, but can you talk a bit about the ongoing drivers of momentum in the second half and how we should think about price/mix developing? Thank you.

Yes. Tadeu will address price and mix. Regarding emerging markets, as you may recall, there was a significant slowdown last year due to the pandemic. However, in the first half of this year, we observed a recovery in these markets. While emerging markets account for 25% of our revenue, they represent more than 50% of our volume. We have seen very strong performance across our businesses in this area. It is important to note that this varies by country; for example, South Africa still faces challenges due to lockdowns and illegal trade. Overall, emerging markets contribute more volume, which does affect margins, but the performance has been very strong. This success enhances our performance in the combustible business. Tadeu, please provide additional insights.

Yes. In terms of pricing, we are seeing similar levels of pricing that we saw in the previous year. There is not much excise ad hoc happening. We had one in Russia. We had another one in Indonesia. These are the outliers, I would say. We are not seeing this across the patch. And hence, the price/mix is not much different, because we're also not seeing much of the acceleration in terms of down trading. We have seen some punctual movements in terms for example Brazil, where illicit trade reduced. And we absorbed more volume in the low-end. And hence the mix gets a bit impacted by that. But this is more volume coming from illicit, to the more low-end of the market. Overall, illicit is slightly better in the first half of the year, which is a positive as well. And so I would say that these are the major trends.

Thank you.

So it's more the geographical mix. The pricing is very strong.

Thank you. And then, just my second question just a clarification around guidance please. You quantified the GBP170 million impact from the excise changes in Australia. I just wanted to check was this magnitude previously included within that mid-single-digit constant currency EPS growth guidance that you've already given, or are you facing a greater headwind but you're still able to deliver the EPS guidance? Thank you.

I mean, before Tadeu gives you a broader answer on that, in the time of COVID and in the time of the business where we are in, where New Categories are developing quite fast. And where combustible business is enjoying a strong pricing environment. There are pros and cons or there are ins and outs. And the fact of Australia is something that is happening. And because we have a very strong top-line growth, we are able to manage this and to continue to invest very strongly in our business. I think I was referring earlier to a straightjacket. Now we have more space to be able to take care and to cater for these kinds of things, and to move on. Tadeu?

Jack is absolutely right. The strength in our business's top line comes not only from volume recovering after COVID but also from the acceleration of New Categories, which account for one-third of our revenue growth. Additionally, the cost-saving initiatives and the acceleration of the Quantum program allow us to absorb challenges, including a significant shock of GBP170 million. This is beneficial for the market in the long run, though it does impact our revenue in the second half of the year, particularly related to excise. When we guided for mid-single-digit growth, we factored in this impact. Furthermore, transaction FX this year is double what we experienced last year. While some companies in our sector provide guidance excluding transaction effects, we include them in our constant guidance. As a result, we expect a 2% shock from transaction effects affecting our mid-single-digit guidance. Additionally, since the start of the year, India has faced challenges due to COVID, affecting ITC performance. This has resulted in minimal movement between operating profit and EPS for BAT this year. That summarizes our mid-single-digit target outlook.

Yeah, maybe an additional point, I mean, I said very clearly that the three priorities of the group are including the fact of going for value share, but when important and adequately we'll differentiate, the right way. We'll make sure that our business is continuing to foster, because this is delivering the money that we need in order to continue to grow our business. So this is for the sustainability, that 50% growth in terms of New Categories and that, 16.1 million consumers that we have in New Categories. Thank you.

Thank you. The next question comes from the line of Karim Ladha from Independent Franchise Partners. Please go ahead.

Good morning, Jack. Good morning, Tadeu.

Good morning.

Thanks for taking my question. So your operational execution since taking the helm has been strong. And as shareholders, we've been impressed with your ability to both invest in your next-gen platforms as well as to deliver solid earnings growth.

Well, thank you.

The market though is not giving you credit for this. You're trading on just eight times EBITDA. And at GBP28 there is opportunity to create enormous value by buying back stock in size and doing so before your investments in next-gen platforms start to materialize in your financial results. And of course, you'll be in a position to buy back shares next year, as your leverage comes down. But given the burden of your dividend, your buyback capacity will be just GBP2 billion to GBP3 billion a year. And we understand that your dividend is important to a portion of your shareholders, but overall shareholder value creation must be your guiding principle rather than catering to the needs of a specific subset of dividend-focused shareholders. For example, if you halved the dividend in 2022 your buyback capacity increases to £5 billion a year. You could buy back half your shares in just five years. So with that context, our question is, under what circumstances can we expect you and the Board to reconsider the dividend in the short term, in order to more aggressively pursue buybacks to drive long-term shareholder value?

Yes. Thank you very much for your question. I think it's an interesting question and we're reviewing this subject on a regular basis. I think that I said very clearly that capital allocation will be reviewed at the end of the year. And the end of the year is not so far, we're in July. Yet, you have always to consider the net debt to EBITDA that we have and the investment we are making into the business. So I think that the long-term sustainability of the company is the first priority that we have. Of course, it's a very attractive tool to be used. But as we said, it's going to be towards the end of the year. Tadeu, do you want to add?

Yes, we are truly dedicated to providing returns to our shareholders, and we view dividends as a key method for achieving that. The Board also understands the importance of share buybacks, which is why we have implemented them in the past. This is a longstanding practice for BAT. As mentioned in the presentation, we are a strong cash-generating company, and we anticipate producing £40 billion in cash over the next five years. This gives us numerous opportunities for capital allocation. However, our immediate focus is on maintaining a dividend payout of 65% while continuing to invest in the business, particularly in New Categories, as seen in our recent acquisition of Organigram and other companies through our corporate venture arm. We will also prioritize paying down debt to reach our revised leverage target of three to two on the balance sheet. As Jack indicated, this will grant us more flexibility to reassess our capital and cash strategies, which is an ongoing process.

So we really do understand your interest and it's about a short time frame towards the end of the year.

Great, thanks.

Thank you very much.

The next question comes from the line of Alicia Forry from Investec. Please go ahead.

Hey, good morning.

Hi, good morning to you both. And thank you for the detail on the New Categories' profitability. That's very helpful. My first question is on the Modern Oral category and specifically, on the US I mean volumes up 450% but revenue up only 29%. I appreciate you're in customer acquisition mode. But is this dynamic primarily actions that you're specifically taking or reflective of the broader category? And how long do you expect this customer acquisition phase or dynamic to persist for you? Should we expect this category in the US to become profitable within the next 18 months, or is it a unique situation that will take longer? That's the first question.

Okay. Thank you very much. I think what you have to be cognizant of is it's a small category in the US it's 1.6% of total nicotine. Then, we had a gap in terms of the portfolio. So, we had a very little share of that segment, which we didn't like because we're the leaders in the rest of the world in terms of Modern Oral. So we acquired the company that we needed. And I must say that it is quite normal, now that you have, I would say, three players that are actively pursuing this segment that you will have promotions and consumer acquisition. I think we're doing two things at the same time because we know that that category is interesting to the consumer. One, is geo expansion. And as Tadeu said we went from 6,000 to 80,000 outlets and we'll continue to grow the outlets. Then we'll go more for active distribution further than numerical distribution. And at the same time we are building the brand. And we know already that in terms of marketing parameters we are very well rated and our awareness is already at the level of the leader in the category. So we are growing 10 share points in the category. You have to go fast in these categories, in order to benefit from the geo expansion and the fact that it's a new category in the market for the consumers. So I think that it is playing completely in our hands, to make sure that we grow to a sizable position. When then you can have scale, you can have economies of scale, you can have distribution effectiveness and your brand building is taking over from your consumer acquisition. So it's a very normal journey. How long will it last? That's a good question. Let me grow my share for a few more periods and then I will tell you where we stand moving forward. That can be a profitable category. But again, it's 1.6% of the total nicotine market in the US.

Thank you. If I could follow up on Modern Oral in APME where volumes were up 500% appreciate off a very small base. But it's a region where we perhaps have a bit less visibility on that category. Can you discuss, as far as you're able to your strategy for expanding Modern Oral in that region perhaps some markets that you're targeting and government attitudes etc.?

Yes. I've always said that Modern Oral in terms of consumers makes a lot of sense for emerging markets because you don't have a device. The return on investment as Tadeu, said is very quick. You'll need to have local manufacturing because that's not a product that travels extremely well with the level of moistures and everything. But the reality is, we have a very strong base in terms of emerging markets and we see that in terms of consumer affinity. There are lots of markets between Africa and Southeast Asia, where you have a lot of permeability and receptivity from the consumers. So we are doing pilots and tests and launching in some markets in order to learn more. The thing also is you have to craft and you have to sit at the table with the regulators in order to have a regulatory framework that allows us to have sustainability in the establishment of that category. So, I think that there's a huge benefit for the consumers because most of the time they cannot afford devices before they get into buying consumables or buying pods. And it is a strong add equation with the palate of the consumer and the ritual is well accepted. So, it's a question of pursuing in the development of these places. So you will have places like Southeast Asia and some places in Africa, where it will grow very fast. We have to set the frame and establish as we go along. Always, in all the New Categories, what we've done is, there is a difference between speed and rush. I want high speed. I don't want rush. I want the possibility to establish and to learn and then make the investment because I want to have a rational approach in terms of resource allocation in terms of the three categories and in terms of the different geographies.

Thank you. I’ll pass it on.

Thank you.

Thank you. The next question comes from the line of Jon Leinster from Societe Generale. Please go ahead.

Hi, good morning gentlemen. I have a couple of questions. First, regarding Japan, there was a tax increase last October that you absorbed. There's another tax increase coming this October. Given these changes, are you anticipating another significant tax absorption on heated tobacco, or is the situation now fairly equalized?

Are you referring to our pricing position in Japan, or...

Yes, you have clearly absorbed the tax increase in October as they transitioned to a weight-based system.

The situation in Japan is straightforward. Glo has increased its market share and total nicotine share, capturing a significant portion of the growth in the segment. We are pleased with the results in Japan and are present across various price points, similar to our competitors. Our current pricing is competitive, and if there are tax increases, we will make decisions at that time. However, the momentum we have right now does not require us to be overly aggressive in this environment. I’m not providing pricing guidance; I’m simply stating that our strong brand is experiencing rapid growth and attracting many consumers. We are capturing more than our fair share of the segment’s growth and will continue this trend. We are already established in multiple price points and will maintain that.

Okay. Really I guess really the point of the question was whether the tax situation in October this year would be unfavorable to glo vis-à-vis the other competitors and perhaps the way it was in the last year?

Yes. In the past, you're absolutely right. The characteristics of our products means that the equalization of tax hit us disproportionately because we had a lower level of incidence of excise. We were before in a super slim product. And the difference between weight base as to the weight that they changed, the way to calculate the tax means that the hit in terms of incidence for us was higher than competitors. So we had to absorb some of those excise otherwise we'll be out of the market in terms of price competitiveness. Our decisions moving forward will be around the tax that we know, how we have been pan out but also competitive landscape. So we haven't made the full decision yet. We still have some months to go and we'll be analyzing where we stand in terms of competitors and making a final call on that.

Thanks. Secondly, I have a general question. You've mentioned the potential cost reductions in marketing, trade margins, and cost of goods sold related to NGP. Can you provide a broad overview of which of these areas is the most significant?

I would say that the three areas are extremely important. The most important one is scale, which drives the elements we discussed. Tadeu, do you want to add anything? Yes.

This is a category specific question. Sorry I missed your first...

New Categories in general.

In the new categories, the trade margin is definitely more significant in the vape segment. However, it is not as substantial in the orders related to the THP within the Modern Oral space. As Jack mentioned, the cost of goods sold is impacting every area. The savings we are achieving by transitioning from a more niche position to that of a global player are substantial. This will be a major driver for us as we move forward.

We have now the scale that we need as a foundation as a bedrock in order to continue to accelerate the development of our New Categories and we will do so. Scale is critical. Now we have the bedrock then we continue to build on that foundation.

Just to follow up on that. Are you seeing – I mean, you've talked in the past about automation particularly from the supply base. Is that now starting to come in particularly in vaping, or is that still handmade?

No, no it is coming in automate – it's still coming. It is sorry – it is coming now and we've already started that. And we are building the lines accordingly for automation. And automation – as I said scale is the most important. That's what I was missing in the equation a year ago. Now, I have the scale that I need in order – in the three categories to do automization, to do rationalization, to do digitalization of the supply chain. Then on the side of the product itself, I can do now RGM. As Tadeu said, now 75% of the business is on RGM and that's extremely important for us. So then it becomes a self-fulfilling prophecy of a business that is growing at pace. And we'll continue to invest because, as I said, we will invest a lot of money this year. As you saw, we invested £360 million in the first half of the year, which is more than the increase that we did last year. So that comes on top. And we continue to accelerate. And at the same time, we will have a reduction of our losses at the end of the year in New Categories. So I think that's why I'm speaking always about the pivotal year. This plus the three net debt to EBITDA gives us the possibility really to charge ahead in terms of our development and we're very proud of the results.

Yeah. Thank you. And lastly, currency transaction I think you said is 2% of EPS this year. As you look forward into sort of – particularly into 2022 given the hedging policies are we likely to see a sort of similar currency transactional impact in 2022, or is it more favorable?

Well, this is a…

Your crystal ball is at work.

Yeah, this is a difficult question. At the end of the day, the – we are seeing a lot of the weakness coming mainly on those emerging markets where we have to import goods for example for our inputs for our product costs in hard currency and where it's mostly where we see the transaction. They are badly hit now because of the COVID. So it's – your guess is as good as ours. But at the end of the day, the large goods say, if you have an improvement situation in COVID and who knows what will happen in COVID, maybe there will be some recovery in those markets and hence a less impact. But I have to say this is a tough one for us to forecast.

Okay. Thank you very much for that.

Thank you very much for your question. Thank you.

Thank you. The next question comes from the line of Jared Dinges from JPMorgan. Please go ahead.

Good morning.

Good morning. Hi, Guys. I know, you've done very well in terms of THP volumes. It's well ahead of peers now.

Thank you.

And the volume share gains are definitely positive to see. But I want to ask about your THP revenue. So in the first half actually your constant currency revenue growth in THP it was just in line with your key peer, which implies that you guys aren't actually gaining any value share in the category despite the launch of glo Hyper. Can you maybe talk about when you'll be out of investment mode on devices and maybe when we can expect price/mix in general in THP to turn positive? Thanks.

Two years ago, there were doubts about my ability to secure a position related to THP. Now, we are discussing our impressive growth rate. I believe this is a much more favorable situation for BAT. I must highlight our performance in THP, where we've achieved a pricing index of 92% or higher for consumables, which is quite commendable. We are seeing share growth everywhere, even though we are only operating in half of the markets where THP is sold. We are making significant progress. Naturally, we are investing in consumer acquisition for our devices, much like everyone else in the industry, depending on the regions. While I won't go into exhaustive details, there is substantial potential for us in THP. Two years ago, many thought we wouldn’t reach this point, yet we are experiencing a remarkable acceleration in THP volume, exceeding 50% growth in the second half of last year and nearly 100% in the first half of 2021. We will continue this momentum. It's about striking the right balance in brand growth, and as reflected in our marketing indicators, our brand awareness is rapidly increasing. We are focused on acquisition and will maintain this approach, but we've also established a path to profitability for THP. Tadeu?

Yeah. I just want you to have a look on the vape side. For the vaping, we had this type of gap a couple of years ago. And if you see now they are getting much closer and – because it's working, and you would expect this – because at the end of the day glo Hyper is in the market a bit more than a year just. So, we are in a very emerging phase of our level of investment different from vapor where we have been for some time. And the dynamic of vaping is probably will be mirroring what we'll be seeing in the THP side. The good thing is like I mentioned before we are increasing conversion. And that's the most important indicator for us. So, we are making the investments, the investment is paying back. It's not that if you take it out, we lose it, because the conversion is there and this translates into loyalty and then we have a business that is sustainable over time.

Okay, just to clarify, there's no specific timeframe for how long the investment mode will continue on devices, but you'll keep investing as long as you're expanding. Is that correct?

Yes. Ultimately, we are in expansion mode, and we are present in half of the markets where THP operates. There is still much more to come. Our numbers will consistently reflect different stages of investment.

Yes, that's the point different stages which means that in different geographies, you will see different things. But we are in growing the category and growing our share of that category which we are doing strongly in the first half of the year.

Got it. Thanks guys.

Thank you.

Thank you. The next question comes from the line of Sanath Sudarsan from Morgan Stanley. Please go ahead.

Good morning.

Good morning. I have a couple of questions. First, could you provide more details on the NGP investments made this year and how they compare to those made last year? Additionally, can you clarify whether the NGP business or losses in the first half were lower than last year?

I remember always I'm French I'm a bit slow. So, I can go only question-by-question. And even that question, I will speak between the first half for me and the second half. So, the first half of the question was sorry?

Just more color on the NGP investments you made this year and how do they differ versus what you made last year.

Okay. So, we said in the previous periods that first we were in an initial phase two years ago of building the capabilities and building the R&D. Now, we are in the phase of acquisition of consumers and building the brands. So, we are really in the phase of building the brands. And I must say that we've done a lot of investment in terms of THP. So, what has changed if you want compared to last year full year is that there is more on THP at the moment than there was before. But you saw also that the total number has increased by £360 million. So, we are putting the money where we need to put it in terms of consumer acquisition and brand building because consumer acquisition alone is not enough. Now, we are in the phase of building the brands and having the right levels of awareness and having the right level of brand content.

Yes. One of the differentiations for example from one year Sanath is more on the listing fees. As we are expanding into new markets, you have to pay listing fees when you get into for example new key accounts and so on. So, this is a natural movement when you do. But the bulk of these extra investments are the traditional market investment building the brand like Jack referred to. This is the digital bit. This the social side of it, the social media side of it and so on. So, that's more or less the...

That's clear. And also just I hear about the guidance being for the losses to reduce in the full year for NGP. Has that happened in the first half also?

No, this didn't happen in the first half because we have been weighted in the first half of the year and hence you see the operating margin in a very big drag coming from new categories. This is a consequence of that. And getting the consumers it will pay off in the second half.

Yes, you'll probably see this drag to reduce in the second half as a consequence of that. But the fact that has been weighted in the first half means that our reduction loss will materialize in the full year. We have a clear pathway for profitability across categories and total new categories. As we begin to achieve scale and gain momentum over two consecutive halves of the year, we can fully explore this. Digital is significantly aiding our brand building and modeling efforts. We allocate resources every month, which requires considerable time from Tadeu and me to ensure effective navigation of this process. We are pleased with the progress we are making.

Just one more comment on this because it's important for you to notice that some of these gross investments are reducing the revenue side. It's not that it's all related to below revenue. So when you see our revenue numbers they are at net of some of these investments that we are referring to.

Got it. Yes. Thank you. The second question is just about understanding that you have done an incredible job with the cost savings and achieved that a year earlier.

Thank you.

You've now guided for a higher number of cost savings. But what we've seen over the last two years is this cost savings basically being absorbed into NGP investments. Is that something we should continue to expect probably for this incremental cost savings that you're going to now deliver? And probably there's even more to come. And then, in terms of how can – or when should we think about NGP business becoming self-sufficient in terms of funding for its own promotions etc., along with being lost – reducing your losses?

Yes. First of all, I mean these cost savings you have to see them in two ways. First, it's increasing the efficiency and adding new capabilities to the business. Hiring people, we've hired more than – now to date since we started that journey a year ago, a bit more than a year ago, 500 new managers joined the company in capabilities that we didn't have before. So it is simplifying and increasing the efficiency of our business, giving us the new capabilities, and at the same time saving a lot of money. Now that saving of a lot of money, I'm very adamant on the fact that we're going to continue to accelerate and that's now £1.5 billion instead of £1 billion. This gives me the flexibility to invest in the business or to allocate where I need to allocate that money. So we start from the genesis of the financial algorithm we will deliver. Yes? That's the kind of the line in the sand. Then we look at our New Categories and we see all the money we need to invest. And I don't think Tadeu in 2021, once we said no to a valid acceleration plan in terms of investment and we do resource allocation every month, so that's kind of the waterline. But first, it is about developing the business and making sure that we have the resources that we need. So we use that money either for additional investment in new categories or for the things that we need or headwinds that we can face as we spoke about earlier this morning. Tadeu?

Yes, that's absolutely right. So these savings will be primarily to invest and to deliver our financial commitments. That's what you expect. In terms of the journey, we said 2025, this will be the self-sufficient position that you are referring to. This give us the space for us to make the rollout, the geographic rollout the investments that we need to up to that point. But more importantly is that the losses that we had in 2020, last year start reducing from this year. So from now until 2025, when you get this self-sufficient situation including all levels of costs that are involved in the category including R&D for example, we will be earnings – will be earnings accretive for the group because we will be reducing loss over time. So there will be two drivers for us to benefit from in terms of allowing us to deliver their financial commitments. One is the saving agenda. Like you rightly pointed out even after Quantum, we're going to have some levels of continued modes of saving, continuous improvement moving forward but also the reduction in losses in New Categories coming forward.

Thank you. So just to understand this in a simplistic manner, the line in the sand on your financial algorithm can actually move ahead and move higher?

We will take these decisions as we go along. I think that we have reached a point now where we're getting close to that pivotal year that I was speaking about before, which is net debt to EBITDA around three and delivering our financial algorithm and growing the New Categories in terms of consumer acquisition and revenue with the path to profitability. And we'll make the calls as we go along. I'm a long-term person but I like a lot, very speedy growth and not at the detriment of the financial algorithm. So I'm balancing all the different elements. We spoke about a very straightjacket two years ago. And now I have a bit more space so I can accelerate and do the right things. I have the right products. There will be some headwinds. There will be some things that are happening but I will have more defense mechanism if you want in order to handle that. And the fact that our base in terms of New Categories now is a bedrock solid foundation with 16 million consumers and growing revenue by 50%, gives me the ability to continue to power forward.

Okay. Great. Thank you very much.

Thank you.

Our last question for today comes from the line of Patrick Folan from Redburn. Please go ahead.

Good morning.

Hi, good morning. Thanks for taking my questions. My first question is on the Btomorrow Ventures, which is quite interesting especially being part of the Beyond Nicotine.

Yes, thank you. That's something that we've created, Tadeu and myself I think the day we arrived. We said, we want to have a venture capital capability in the company in order to be able to acquire capabilities that we don't have. You don't have to do everything inside. Acquiring capabilities, acquiring technology and acquiring the different pieces of the puzzle that creates your ecosystem to be able to continue to grow and especially related to R&D and to brands and products.

And is this the main focus for pushing the Beyond Nicotine strategy, or can we expect potential M&A investments outside of this venture unit?

Yes. I mean what you have to consider is there's a lot of internal capabilities that we have. We have very competent people like David O'Reilly that is driving science in the company very capable people like Paul Lageweg and all his team that are driving New Categories. And I think that in R&D in science and in marketing we have the capabilities that we need. So, it's an accelerating mechanism that venture capital arm in order to get the missing pieces of the jigsaw. So we have a lot of internal pieces of the jigsaw. We do a lot of investment in BAT in terms of Beyond Nicotine. And we acquired what we need to complete the full puzzle. We have defined three clear consumer spaces that we want to be in. We have a frame of reference in which we want to operate. By the way I gave that frame of reference in terms of where we want to be in terms of Beyond Nicotine, two years ago in the Investor Day. So I go back to the deck yes and you will see that we're extremely consistent in what we are doing. So I think that we're in the right space related to that. First of course, we have an established business in New Categories that is working very well. And we're doing the test and we're doing the development that we need. As I said in my presentation it covers the whole gamut of the capabilities that we have to have. And we do pilot tests as we go and we have a lot of knowledge further and beyond only nicotine. We have given in the full year last year results a lot of understanding in terms of the areas in which we are working.

Okay. Great. My second question is I believe you mentioned that one billion cigarette packs will be carrying messaging to switch your consumers to your NGP portfolio. Can you elaborate more on that?

Well, I find it very important. You have to be consequent. I'm there to transform with the team. I'm there to transform BAT and reduce the risk for the consumers. So very clearly when you're selling cigarettes, you have the I would say the obligation to communicate to the consumers that you're having on combustibles that there are other products that are available. Yes? It's not by forcing consumers to go somewhere that you will have the right attitude and behavior. Everybody that has done five minutes of marketing will tell you that. You have to inform the consumers and to attract them into these new categories with the right understanding of these reduced risk products. And I think that's the way it works. So we are putting in one billion of our packs because you have a lot of limitations related to geographies where you can put something. There's lots of countries where you cannot put an insert on a pack or you cannot promote even if it's New Categories nothing you cannot promote anything from the pack. So all the countries where we can and all the countries where we have the capabilities, we put inserts or EN code or everything that we can in order to bring the consumers to informative websites or even to the products directly if we can because I strongly believe that we will in time transfer the consumers from combustible to these New Categories. And the development of these new categories will improve as we go along. We have a strong pipeline of innovation and I'm very proud of that. Did I answer your question?

Yes. And I was just wondering is there any target markets you have for that messaging on the cigarettes?

I would say that the blanket approach is the right way to go. You have to inform as many consumers as possible. After that, we have our capabilities and there are regulations in different countries. But as a default mechanism everywhere, I believe it's important to transition consumers from combustible products to new categories.

Okay. Yes.

And until everybody has migrated, I'm going to extract value on combustibles until there are smokers that are legally paying taxes in the different countries.

There are no further questions in the queue. So I'll hand you back to your host Jack Bowles to conclude today's conference. Thank you.

Thank you very much. We are very proud of our results in the first half of the year, just as we were proud of last year's results. This time, it’s about growing revenue in multiple categories. We are very pleased with our first half results. Our multi-category strategy is working, and our transformation is accelerating. We are building strong global brands and embracing digital across the group. BAT is changing rapidly, driven by our ethos. I am excited about BAT's future. Thank you for listening, and I hope you have a safe and enjoyable summer, better than what we are experiencing in the UK right now. Thank you very much. Goodbye. Thank you, Tadeu.