British American Tobacco p.l.c. Q4 FY2022 Earnings Call

Good morning everyone, and welcome to our 2022 Full Year Results Presentation. I am Jack Bowles, Chief Executive of BAT. With me this morning is Tadeu Marroco, our Group Finance and Transformation Director. I am proud to share with you today that we have reached an exciting inflection point in our transformation. Over the last few years, New Categories have rapidly become a significant part of our business and are now a strong contributor to our financial performance. As a result, last week we announced our new regional structure and management team realignment to drive us through the next phase of our transformation journey. Our presentation today will take on a new format. First, I will give some highlights of the progress. Tadeu will take you through the details of our results, highlighting how in 2022, we continued transforming the business, delivered strong financial results, and successfully navigated a challenging macro-economic environment. Then I will talk about how we are taking BAT’s strategy to the next level, and why we are confident in bringing forward our New Category profitability target by one year to 2024, as our transformation accelerates. As usual, once Tadeu and I have taken you through the presentation, there will be an opportunity to ask questions. Before we start, I would like to take this opportunity to give you an update on the progress of the transfer of our businesses in Russia and Belarus: As we have already shared, we are working as quickly as possible to transfer the businesses in compliance with international and local laws. We are now in advanced discussions with a joint management distributor consortium with a view to completing the transfer in 2023. Our priority remains supporting our employees in the affected areas and safeguarding their employment. Upon completion, BAT will no longer have a presence in Russia and Belarus. With that, I take it that you have all seen the disclaimer on slide two and Slide three. I am delighted to share with you today our progress and delivery against the three priorities we set out in 2019. We are delivering a Step Change in New Categories, enabling us to bring forward our profitability target, driving value from our combustibles business, and at the same time, significantly simplifying BAT, our structure, processes and ways of working to drive greater efficiency. Since 2018, we have grown our Non-combustible product consumer base by 30% on a CAGR basis, reaching 22.5 million in 2022 with again more than 4 million added in the last 12 months. And we remain confident on our target of 50 million consumers of non-combustible products by 2030. Over the last four years we have grown New Category revenue by a CAGR of 33% and we are confident in achieving our £5 billion revenue target by 2025, regardless of the transfer of our businesses in Russia and Belarus. Non-Combustible revenue as a percentage of Group revenue has more than doubled from 7% in 2018 to 15% today and grew by over 2 percentage points in 2022. So in just a few short years, with Vuse and glo, we have built two, one billion pound global brands. This is an enviable performance relative to any global CPG brand. In 2022, Vuse further built on its market leadership position in vapour and delivered a 3rd consecutive year of over 40% revenue growth. glo continues to outpace global THP category growth, delivering in excess of 25% revenue growth. In Modern Oral, Velo delivered another year of over 40% constant currency revenue growth and maintained its leadership position in Europe. ESG is at the center of our strategy. All this is supported by a clear environmental focus, underpinned by science for each of our New Category brands and is actively contributing to our Group sustainability targets. We continue to develop and publish a substantial body of scientific evidence. And we are investing in the R&D of products that have a lower environmental impact and improved circularity. This means we are seeking to design products that are easier to dismantle at end-of-life, improve ways to enhance reusability and recyclability, and convert to more sustainable packaging. More broadly, as we reduce the health impact of our business, we must also drive progress across all other material ESG areas. And in 2022, we appointed Mike Nightingale as our first Chief Sustainability Officer, implemented a new Double Materiality-led approach to inform on Sustainability Agenda and continued to embed sustainability across BAT. While we recognize we have a lot more to do, we are making very good progress. In 2022, we achieved our renewable energy use targets three years early, which is why we have increased our target to 50% by 2030. In addition, we are on track to reach our gender representation target across our wider workforce with women in management roles at 41%, and we are delighted to be included in the 2023 Bloomberg Gender Equality Index. Alongside this, our continued efforts have been recognized with the CDP 'A' rating in climate change and inclusion in the Dow Jones Sustainability Index for the 21st consecutive year. Central to our purpose is reducing the health impact of our business. In our established markets we continue to transform at speed, with non-combustible already representing over 30% of our revenue in a total of 11 markets, where we have been most active with our multi-category strategy and we expect more markets to exceed this 30% level in 2023 as we take our transformation to the next level. I am especially proud that since 2020, we have improved New Category contribution by nearly £700 million, while also investing over £4.5 billion. Our New Category model is now meaningfully contributing to Group results, and our progress to date makes us confident that we will achieve Group profitability in 2024, one year early. Our transformation continues to be fueled by combustible value growth. Over the last four years we have delivered robust revenue, profit, and value share growth, while significantly reducing complexity to drive further efficiencies. We have also delivered a total of £1.9 billion of annualized cost savings over the last three years through Quantum. We nearly doubled our initial £1 billion target. Project Quantum has enabled new ways of working that are now fully embedded within BAT. In addition, our strategy has enabled us to materially increase our free cash flow generation with four consecutive years of at least 100% operating cash conversion. As a result, we have been able to return a total of £19.2 billion to shareholders through dividends alone. Over the last four years, which is around 30% of our current market capitalization. We know that innovation and transformation are fed by a broad diversity of views and experiences. Over the last four years, we increasingly attracted new talent to BAT with over 3000 new capabilities hires focused on areas of Science, Innovation, ESG, Digital, and Data analytics. While at the same time we have accelerated our diversity agenda, with 47% of our new hires being female. We have also improved our new hire turnover to a level well below market norms. I am proud that our achievements are being recognized externally including most recently being certified a 'Global Top Employer' for the 6th consecutive year. So we have come a long way on our A Better Tomorrow journey and I am proud of what we have achieved. Our strong momentum has continued in 2022. I will now hand over to Tadeu, who will take you through the details of our 2022 financial performance.

Thank you Jack. I am delighted to share more details on how we have delivered on our guidance in 2022. I am proud to say, as Jack has highlighted, that we are accelerating the transformation of our business and delivering robust financial results while successfully navigating an increasingly challenging macro environment as we moved through the year. Our reported results were impacted by a number of mostly non-cash one-off items, including a full-year non-cash impairment of our businesses in Russia and Belarus, a provision recognized in respect of the DOJ and OFAC investigations, and restructuring charges driven by Project Quantum. These were partially offset by VAT credits in Brazil relating to prior periods. To better understand the key drivers of our performance, we will now focus on constant currency adjusted results, unless otherwise stated. In 2022, we delivered revenue growth of 2.3% driven by New Category growth of 37%, and a strong combustibles price mix of nearly 5%. Profit from operations was up 4.3%, driven by a reduction in New Category losses of nearly £600 million and continued Quantum savings. Altogether, we achieved a 150 basis points increase in our operating margin at current rates. This drove adjusted diluted EPS up 5.8%, or 12.9% on a current currency basis. Turning to New Categories, we delivered strong revenue growth with all three categories growing in excess of 25%, driven by share growth, innovation, and geo expansion. This demonstrates the importance of a global multi-category strategy with strong brands and great products, in the right markets. I will now share more details on our key category drivers. Full market shares across our key markets are available in the appendix. In Vapour, we extended our value share leadership position with Vuse achieving 35.9% in the key vapour markets up 2.5 percentage points. In the U.S., Vuse strengthened its number one position reaching 40.9% value share, up 8.4 percentage points. We expect further upside in the U.S. going forward driven by existing vapour consumers switching to products that receive marketing authorization from the FDA together with increased enforcement. In addition, given the excise advantage of vapour over combustibles, we see a strong runway of growth as consumers can benefit from significant savings. In Europe, our closed system value share, excluding disposables, grew strongly, and is now over 64%. In Canada, we extended our value share leadership position growing 8.9 percentage points to around 90%. We launched the Group's first connected vapour device, Vuse ePod2 plus driving increased pod consumption. Through our growing scale, we are making continued progress on driving profitability in vapour reaching a positive contribution in three of the five key markets in 2022. Growth in the global vapour category has accelerated driven by modern disposables which have expanded the category. We launched our modern disposable, Vuse Go, with a premium price positioning and volumes which are accretive to our ePod platform. We have rapidly rolled out Vuse Go and are already the value share number two in the UK, France, South Africa, and Germany. In addition, we are starting to see some accelerating poly-usage with modern disposables coming from THP, which creates a significant opportunity for us. We are approaching modern disposables in a responsible way supported by our well-embedded marketing practices including age verification processes for retail and take-back schemes. In THP, glo’s sequential revenue growth accelerated in the second half. Consumable volume growth outpaced the industry by 1.7 times. The continued momentum of glo Hyper drove category volume share in key THP markets up 1.4 percentage points to reach 19.4%. All key European markets continue to grow strongly. In Japan, glo’s volume share of the total nicotine market reached 7.4%, up 60 basis points, with a record glo share in December. glo Hyper X2 is delivering an enhanced product experience with positive early results in Japan. We broadened our price laddering with new Lucky Strike consumables, complementing our existing ranges. We have also expanded our multi-category offering with a Velo city pilot, delivering attractive margins. This further demonstrates the strength of our consumer-centric approach with more to come in 2023. Turning to Modern Oral where revenue grew strongly at 46%. In Europe, we remain the market leader in 15 markets, with aggregate European volume share broadly stable at 69%. In the U.S., the market remains small at around 2.5% of total nicotine value and highly competitive. Revenue was up, as we pivoted to drive value, reducing promotional support for the brand, and prioritizing investment behind Vuse. In order to be well-positioned for the future, we have submitted a PMTA for a new Velo product. We are also excited about the significant opportunity for Modern Oral in emerging markets. We are particularly proud of Velo’s performance in Pakistan, now our third largest Modern Oral market by volume. Enabled by powerful digital activations and innovations with local flavors, Velo has reached a monthly volume of over 40 million pouches. In 2022, we rapidly scaled up our business and moved to localized production in market, driving the lowest COGS across the Velo brand. As a result, Velo’s gross margins improved significantly during the year. Together with our other pilots this progress gives us confidence in our ability to unlock future emerging market opportunities. Alongside significant investments in our New Category transformation, we continue to explore opportunities Beyond Nicotine, notably in the fast emerging wellbeing and stimulation space. BTV has completed 22 investments since launch. In 2022, this included five new investments and two exits. We are building world-class R&D together with our partners at Organigram and we continue to explore opportunities to expand our cannabis ecosystem. This included a non-controlling minority stake in Sanity Group and an investment in Charlotte’s Web in 2022 as we continue to monitor changes in the regulatory environment. Our approach provides us with evolving capabilities for the future across both New Categories and Beyond Nicotine. Turning now to Combustibles, our volume declined by 5.2%, mainly due to the lower U.S. industry volume, exacerbated by the partial unwind of inventory in 2022 and the sale of our Iranian business in 2021. Cigarette pricing remained strong, up 10.4%, offset mainly by geographic mix. Together, this resulted in a 0.6% decrease in revenue. Group value share was flat with the continued strong performance in the U.S. and APME offset by lower value share in Europe and AmSSA. Volume share was down 20 basis points. Whilst our U.S. business was impacted mainly by macro-economic headwinds, our targeted portfolio of brands across price tiers enabled the delivery of a robust financial performance across APME, AmSSA, and Europe. Turning now to the regions, in Europe, New Category revenue was up 43%, driven total revenue up 7%. Europe is a true multi-category region. Non-combustible revenue already accounts for around 20% of total revenue and continues to grow fast. Combustible revenue grew 1.2% driven by strong pricing partly impacted by the reallocation of the North Africa area to APME. Profit was up over 7% with improving New Category contribution and further cost savings as a result of Quantum. In APME, New Category revenue was up 10%, with total revenue up 7.7%. Combustible revenue grew nearly eight percent with resilient volume benefitting from emerging market recovery post COVID. Profit was up 3%, with a robust combustibles performance partly offset by negative geo mix and the disposal of the Iranian business. In AmSSA, New Category revenue was up 48% and was a strong contributor to the revenue growth of around 5%. Combustible revenue was up nearly 4%, driven by strong pricing and resilient volume. Profit was up over 4%. Turning to the U.S., our total nicotine value share was up 40 basis points to over 37% driven by Vuse. New Category revenue was up 52%. Vuse continued to extend value share leadership and is the fastest growing brand in total nicotine in the US. Combustible industry volume was down around 10% mainly reflecting: post COVID normalization of consumption patterns, and macro-economic deterioration through the year. Our volume was down 15.5%, additionally reflecting the partial unwind of our prior year inventory movements, volume share loss, and lower retail inventory levels across the industry at year end. Over the last three years, industry volume has declined in line with historical levels at around 5% CAGR. The premium industry segment remained resilient with volume share declining by only 50 basis points. As a result of the increased impact of macro-economic headwinds, the low-end segment grew volume share by 90 basis points. In this challenging environment, our value share grew 10 basis points despite volume share declining by 30 basis points. Value share growth was driven by the continued strength of Natural American Spirit and Newport which together drove premium value share up 20 basis points. In addition, Lucky Strike was the fastest growing combustible brand in both volume and value share terms in the US, reaching an exit share of nearly 3%. This more than offset losses in Pall Mall at a total industry level. In 2022, our U.S. pricing remained strong, up 10%. At the consumer retail level, our average pricing in the year was up 5.6% lower than key industry peers and significantly below elevated consumer price inflation as we activated targeted commercial plans to support our consumers. Despite the more challenging macro-economic backdrop, our profit was up 3.5%, with operating margin up 330 basis points to 53.7%. This was driven by continued improvement in New Category contribution from both Vuse and Velo, alongside cost savings initiatives. Taking a step back to look at the broader U.S. context. U.S. consumers faced strong macro-economic headwinds in 2022 with record inflation, seven interest rate hikes, and high gas prices resulting in real disposable income falling by nearly 7%. Looking into 2023, we are starting to see some very early signs of recovery with gas prices stabilizing, levels of unemployment remaining low, and the gap between wage growth and inflation narrowing. Most notably, elasticities remain stable at 0.4 comparable to pre-COVID levels and affordability remains high. Through Revenue Growth Management, we have targeted investment in specific brands, channels, and states with price laddering across all brands. We expect the US economy to stabilize as we progress through the year and together with the remaining unwind of our 2021 inventory movements, we expect our performance to be second half weighted. With our multi-category strategy and strong portfolio of brands, we are well positioned to benefit from macro-economic recovery. Group operating margin expanded strongly, up 150 basis points on an adjusted current rate basis. We successfully absorbed increasing inflationary pressures and a 1.5% transactional FX headwind on profit. This was supported by our strong progress towards New Category and Quantum savings. Our improved New Category contribution was largely driven by increasing scale leading to operating leverage and further automation reducing cost of goods. With all three New Categories and all regions contributing. In addition, our growing brand equity has enabled us to increase pricing on both devices and consumables supported by insights from our digital tools. We have reached an inflection point in our New Category model. Having invested significantly in the base, we are now in a growth period where we can invest more and deliver improved profitability. In 2023, we will capitalize on our momentum, and further invest in our transformation to accelerate our innovation cadence and drive faster geographic expansion. With that we expect to continue to improve New Category contribution in 2023 and are confident in delivering our target of profitability ahead of plan in 2024. Alongside £1.9 billion savings delivered through Quantum, we continued to drive further simplification. Moving forward, we will deliver efficiencies through our established continuous improvement mindset to offset inflationary pressures and fuel our transformation. In addition, we are committed to reporting no further significant P&L impacts from adjusting items related to restructuring programs in the medium term. Turning now to EPS, we delivered constant currency adjusted diluted EPS growth of 5.8%. This reflects our robust operating performance, the benefit of the continued recovery in ITC post-COVID, and the share buyback which more than offset increased net finance costs and tax. The underlying tax rate was 24.8% and with existing tax rates, we expect a similar rate of around 25% in 2023. Operating cash conversion was strong at 100% reflecting our focus on cash delivery. As in 2022, we expect gross CapEx for 2023 to be below adjusted depreciation and amortization at around £600 million CapEx. We continued to reduce leverage within the 2 to 3 times corridor, and have a manageable maturity profile, with 97% of our net debt fixed average maturity of around 10 years, and close currency matching. BAT is sheltered from unprecedented interest rate rises but is not immune. While the majority of our net debt is fixed we have approximately 18% exposure to fluctuating interest rates when you consider cash holdings and refinancing. Our average cost of debt is 4%, which is below the current market rates, so we expect to see the impact of higher rates in our net finance costs in 2023 and moving forward. As a result, we expect 2023 full year net finance costs to be around £1.9 billion subject to both FX and interest rate volatility. The Board actively reviews our capital allocation priorities taking into account macro-economic factors and potential regulatory and litigation outcomes. Our framework includes continuing to grow the dividend with an average pay-out ratio of 65% over the long term, maintaining leverage within our target corridor of 2 to 3 times adjusted net debt / adjusted EBITDA, potential bolt-on M&A opportunities, and share buybacks. At this time, the Board has decided to take a pragmatic approach. Given our incremental investment plans in 2023 to further accelerate our transformation and in light of the uncertain macro environment, higher interest rates, outstanding litigation, and regulatory matters, the Board has decided to prioritize strengthening the balance sheet. This will provide greater business resilience while continuing to support future financial agility as we aim to reduce leverage more quickly towards the middle of our target two to three times corridor. We strongly believe that share buybacks have an important role to play within our capital allocation framework and we will continue to keep it under review as we progress through the year. Finally, in line with our long-standing commitment to dividend growth, we are pleased to announce a dividend of 230.9p for 2022 with growth in line with our constant currency earnings. Looking forward, 2023 results are expected to be driven by another year of strong New Category growth and a further reduction in losses, alongside a resilient combustibles performance, supported by continued efficiency savings and strong cash generation. We expect to deliver organic revenue growth of 3% to 5%, excluding Russia and Belarus, adjusted mid-single figure EPS growth, second half weighted, reflecting incremental New Category investment, higher net finance costs, transactional FX headwind of around 2%, and a second half weighted U.S. performance. When we think about the corridor for adjusted mid-single figure this year, it is a little wider than usual at 3.5% to 6.5%. This is because it is impacted by both the volatile macroeconomic environment at a timing of the transfer of our businesses in Russia and Belarus. Extrapolating current spot rates, we expect currency translation to be broadly neutral on full year adjusted diluted EPS growth. And finally, as already mentioned, we expect to continue to progress towards the middle of our 2 to 3 times leverage corridor. In summary, we have a clear momentum behind our New Category transformation, which is now a significant contributor to the Group financial delivery. The current challenges we face in the U.S. are mostly macroeconomic related and we expect stabilization from the second half of 2023. In 2022, our results have enabled us to return a total of £6.9 billion in cash to shareholders. In 2023 we are taking a pragmatic approach and prioritizing strengthening the balance sheet. Share buybacks will be kept under review as we progress throughout the year. And with that, I will now hand you back to Jack.

Thank you Tadeu. At the start of today’s presentation, I highlighted the significant progress BAT has made since the launch of our purpose-led A Better Tomorrow strategy in 2020, building a New Categories’ consumer base, growing powerful global brands, and developing capabilities for the future. The speed of our transformation over the last three years means that now is the time to take BAT’s strategy to the next level. In 2022 we have shown that our multi-category model is working, meaning that we can both continue to invest, and deliver improved profitability. In this final section, I will share how we are getting Fit for Growth with our new operating model. This means that alongside investing more, we will also be investing smarter. Enabling us to accelerate New Category profitability and reach our target one year early, while also preparing the business for sustainable long-term profitable growth. Firstly, let me remind you of the opportunity. Total Nicotine industry revenue is growing, with a 3.5% expected CAGR to 2025. This means an additional £11 billion revenue at industry level. 75% of this industry growth is expected to come from New Categories with a forecast of 15% growth CAGR. This is supported by the growing number of New Category consumers increasing from around 80 million today to an estimated 130 million by 2025. The percentage of smokers interacting with New Categories is growing fast especially in established New Category markets. Variations between markets are largely driven by regulatory environments, alongside differing consumer tastes and pricing relativities. Sustainable New Category growth is also supported by consumer demographics. In established New Category markets, Solus usage is now above combustible levels among adults under 45. This shows the clear potential to make a significant positive impact on public health and deliver sustainable high-quality growth. Alongside accelerated decline in cigarette Solus usage in established markets, poly-usage within New categories is growing fast. This means that with our consumer-centric, multi-category strategy, we are well positioned to capture future growth. So the opportunity is big. Given the significant variation in New Category development across markets, we must prioritize our investments smartly and focus our activities and resource allocation to maximize the returns. We must be fit for growth. Following our comprehensive strategic review, we have taken the decision to further simplify the Group to enable even greater collaboration, and faster decision-making. Our new organizational design will be based on fewer, larger business units, reducing the number of regions from 4 to 3, and business units from 16 to 12. This led to the senior management changes and realignment announced last week. And we are further optimizing our footprint. Phased over the next two years, we plan to exit around 30 smaller markets, where we don’t see a near-term opportunity to execute our New Category strategy. When completed, this means we will be selling at least 20 billion fewer cigarettes annually with a limited impact on our P&L. This will enable us to increase profit and unlock cash through resource reallocation into markets which generate higher returns. Should the conditions and the opportunity for New Category products materially change, then we will reconsider our presence in these markets. In addition, we have identified six different market archetypes to guide strategic choices and resource allocation. We understand that markets vary significantly by category maturity, driven both by consumer tastes and preferences and more importantly by different regulatory environments. We continue to work hard to engage with regulators around the world, to help inform them of the science that supports the potential benefits of smokers switching to reduced risk products. New Categories already represent a significant percentage of the revenue and growth in a number of archetypes, and we expect these archetypes to be dynamic over time. Overall, we are getting fit for high quality sustainable growth. Together these projects and initiatives will deliver a reduction of over 3,000 roles in the next couple of years with the majority of this effort happening in 2023. Moving forward, we will leverage the foundations created by Quantum. We will keep delivering efficiencies through our established continuous improvement mindset with an ambition to generate at least £1 billion additional savings over the next three years. These savings will help the business continue to offset inflationary pressure, fund New Category investment and improve New Category profitability. We are committed to building A Better Tomorrow. As our transformation journey gathers pace, we are further sharpening our operating model, enhancing our agility and continuing to build new capabilities. We are transforming BAT into a high growth, multi-category, consumer led, CPG with a reduced impact on public health and ESG at its core. I am confident this will create value for all our stakeholders. Thank you for listening. I will now open it up to questions.

We will now take our first question from Nik Oliver from UBS. Your line is open, please go ahead.

Good morning. Thanks for the question. Good morning, guys. I had two from my side. First one on the U.S. On the minus 15.5% combustible performance, is it possible to disentangle how much of that was industry the inventory moves and then some of the share losses that you mentioned? And then I guess, as we look forward, is the better way to think about the U.S. in terms of total nicotine share as opposed to just focus on combustibles? That's question one. And then question two just on the...

We start with this one. I mean first of all, we are having a very strong portfolio in the U.S. And as you know, we've grown in the last three years value share, volume share, and profit and operating margin. So our position in the U.S. is extremely strong. Now related to the 15% versus the 10%. Of course, you saw that we have lost a little bit of share. But the premium is very resilient, only losing 50 bps and the low is not growing more than 90 bps. At the same time, the price elasticity is 0.4%. So I think that the market is very resilient. When you see the average of the last three years, you see very clearly that the average reduction in terms of volume has been around 5%. So you saw that we lost a little bit of market share, okay? That's fine. And then we said last time that we had around £200 million in terms of stock that we would have to unwind and now we are doing that at pace, and we are at halfway through the journey related to that. So I think that we're going to do a further enhancement of our performance in 2023. The second part of your question is related to looking at total nicotine. And you're absolutely right. I mean the reason why our performance in the U.S. is strong, it's because we have a very resilient combustible business. The macros are now improving. So you will see improvements related to the macros in the U.S. that will benefit the size of the market. And the second thing is our performance in terms of new categories is just stellar. I mean remember three years ago, everybody said that we will never take a position related to e-cigarettes. Now we're not only the leader, but we are the leader in the U.S. with price index to competition at 140. So we are doing extremely well, and we're continuing to grow in terms of New Categories. So I think that looking now holistically at the total market is something that makes total sense moving forward.

That's right. And just to be clear about the 15.5% and the 10%, most of the gap is related to the unwind of the stock addition being a surprise because we have flagged that a year ago.

So I'm confident in the progressive recovery of the U.S. market and our strong position in terms of our portfolio. I mean, we have at the upper end of the market, you have American Spirit that is super premium, if you want to call it this way. There is growing share and value share. And you have the most successful launch in the VFM with Lucky Strike, which is now reaching three points of share. That's the most successful launch in the last at least 15 years in the U.S. So we have a very well-balanced portfolio. And now we have to do price laddering through the different brands in order to make sure that we help the consumers to navigate. Also always remember, the U.S. is a very large market, and I spoke about price elasticity at 0.4. You have to remember that some prices in some states are at $11 and some are $6. So there's a lot of gamuts of different markets. And you see that the price elasticity, in average, is 0.4. So I think that we have a very strong business over there that has grown share and value share in the last three years. And the operating margins are going in the right direction. We are delivering 3.5% profit growth in 2022, and we are confident in the U.S. business.

Great. And just one final question from me before I hand over. Regarding the lack of a new buyback this year, that was quite a topic of discussion among investors this morning. In the press release, you mentioned that this would be reviewed during the year. Could you share some thoughts on the reasoning behind not announcing one now and what changes would need to occur for that to happen later this year?

Yes. Nick, we have been focused on cash generation at least for the last three, four years in a very intense way. That's reflecting our conversion being consistently at 100%, and we managed to deleverage the company to the corridor of 3 to 2. But we are still in an uncomfortable position to be at the high end of this range. And the world has changed. We have very high levels of cost of capital today after 7 interest hikes in the U.S. alone throughout 2022. Our cost of capital is much higher than before, and we are still seeing a lot of volatility in that environment. So one thing that we would like to observe more clearly is where this will stabilize. For sure, when the Board takes a decision in terms of capital allocation, it's always looking ahead. And from the regulatory side, the litigation side, you note that we have provided for investigations that we have around DOJ or FAC and we still have to pay for those. We don't know exactly when these get concluded. We expect to be in 2023, but it's not completely up to us. And also, we have a CC88. There is a mediation processing in place. I cannot comment further on that. But in the medium term, we have to prefer the company for that. So the reason why we want to accelerate to land in the mid of the range is to create this space so we can have a more resilient balance sheet and much more financial agility moving forward, and this is a benefit for us in the medium and long term of the company.

I mean to speak clearly, since three years, we have done a lot of transformation. We have done a lot of acceleration in terms of our business. Now we have the possibility to decide. Last year, we did $2 billion of share buyback. The interest rates are going up. Deleveraging is important, taking care of our balance sheet. We want to be in that corridor of three to two and to accelerate faster to the mid of that corridor. That's the pragmatic way of looking at it. And frankly, share buyback, we are convinced with share buyback. We did 2 billion last year, and we will review in the course of the year. And we'll make the decisions as we see pragmatic to do so and continue on that journey. I like share buyback.

Great. Thanks so much, Jack and Tadeu. That was very clear. Thank you.

Next up, we have Richard Felton from Goldman Sachs. Your line is open, please go ahead.

Good morning, Jack. Good morning, Tad. My first question is a follow-up on U.S. combustibles and your relative performance. So the numbers you've given in your prepared remarks, 10% industry decline and the 15.5% decline in your portfolio, is on a full year basis. Now if I think about the second half specifically, it does look like that gap versus the market has got a little bit larger. So my question is, what has sort of driven that? Where are you seeing the relative weakness in your portfolio? And what actions are you taking to narrow that gap into 2023? That's the first question.

To clarify, it's challenging to analyze the first half of the year due to various changes in the U.S. We discussed the reduction of inventory, but it's important to note that we also launched our TAU system in the first half of 2022. Leading up to this, we needed to increase inventory. Consequently, the actual reduction of inventory became evident more in the second half of the year. This is why there is a noticeable difference between the two halves. Additionally, this explains our expectation of a stronger performance in the second half of this year as we are comparing it to the first half of last year, which was influenced by the stock buildup associated with the TAU system launch in the U.S. I wanted to make this point clear. As the macroeconomic conditions became clearer in the second half, we began implementing commercial strategies accordingly. As mentioned in our presentation, we have been more proactive in our revenue growth management, making detailed pricing decisions at the state and channel levels. We are now working with different price points and are ending the year in a much more competitive position. We observed improvements in our market share performance in Q4 compared to Q3, indicating some stabilization, and we aim to continue this growth into 2023 as we move forward.

In the major market players, we have managed to maintain our market share more effectively than our competitors amidst a challenging pricing environment. The pricing adjustments made by the industry in the third and fourth quarters were significantly lower than the general consumer packaged goods sector. Consequently, our pricing strategy has been more consistent in the latter half of the year, which provides us with some flexibility in terms of pricing for 2023. Overall, the market has contracted, and while we often discuss the impact of oil prices, the issue extends beyond just disposable income; Americans are shopping less frequently. This decrease in shopping frequency for everyday products contributes to a decline in the total market. However, I am optimistic about our performance in the premium segment, where we are experiencing growth. The level of down trading has been manageable, and with a price elasticity of 0.4, I believe our portfolio positions us well. I am confident about our prospects in the U.S. for 2023, particularly in the latter half of the year, as we address stock challenges and anticipate macroeconomic recovery. It is also important to note that in the total nicotine market, which includes e-cigarettes, our performance is very strong. The cost for consumers to access e-cigarettes is lower than for traditional cigarettes, which further bolsters my confidence.

Thank you. That's very helpful. My follow-up is going to be on e-cigarettes in the U.S. So obviously, very impressive performance on views on a top line basis and on improving profitability, but my question is on the volume performance of U.S. paper. Looking at the numbers on the second half, it looks like volume growth did decelerate a little bit. So my question is, how to think about the growth drivers for Vuse in the U.S. moving forward? I mean, should we expect it to be continued to be pricing-led growth? Or are there more investments that you need to make to reaccelerate the volume performance of Vuse and, I suppose, the overall category? That's the follow-up. Thank you.

Yes. It's important to note that a new category has emerged in the U.S., specifically disposable products with synthetic nicotine, which has seen rapid growth, particularly in non-organized trade. This has attracted some cigarette consumers to these new products. However, it has also created an additional pool of consumers. The FDA is now looking to regulate this area, which will provide us with more opportunities during this transition. Interestingly, traditional vapor pods continue to grow; they're not replacing one another. There will be increased regulation on synthetic nicotine products, creating further growth opportunities for us in the coming years. Not only do we have the strongest brand in the market, but we also have a price index of 140 compared to our nearest competitor, and our growth is ongoing even as the market grows at a slower pace. The upcoming regulations from the FDA provide us with additional room for expansion. Overall, we're optimistic about the future of e-cigarettes in the U.S., and our profitability numbers reflect that success.

Thanks very much.

Next up, we have Rey Wium from SBG Securities. Your line is open, please go ahead.

Good morning, Jack and Tadeu. Also just two questions from my side. I just want to quickly focus on the combustible market share. You mentioned it was down 20 basis points. So it's a bit of a reversal of what we've seen in prior years. And I know you mentioned it is the U.S., but in your report, you also state that the market share was lower in AMSA in Europe. So I was just curious about where you've seen market share declines and what you can do to reverse that in the combustible side?

Yes. I think that the first thing to consider is that 2022 has been a year where there were more tensions in terms of pricing across the globe. Let's put it this way. Then also, you had the macroeconomics that we are hurting the consumers in the second half of the year. So I think that what we start to see in the last quarter is that resilience is transforming again into growth in terms of volume. And there is more benign pricing environment, i.e., the pricing is coming through. As I said earlier, always remember a lot of FMCG, CPG company, took a lot of pricing in Q4, then it’s different for us. We took reasonable pricing because consumers buy every day, and we can continue to take that pricing. So we see the volume and the pricing in a good environment for 2023.

Yes. I want to commend our resilient combustible business. In 2022, we observed a worldwide decline of 1.2% in FMC THP. Specifically, the decline for combustibles was about 2%, while emerging markets were fairly stable. We experienced volume growth in strong markets like Brazil, Bangladesh, Malaysia, and Vietnam. Even in challenging environments like Italy and Spain, we still saw volume growth despite macroeconomic headwinds and inflation. Regarding our market share, we are not overly worried. There were some specific instances, particularly in Brazil, where we implemented price strategies and focused on value. In Turkey, the macroeconomic conditions led to an increase in illicit trade, impacting our share as we have a significant presence in the lower end of the market. This situation is localized, but overall, the important takeaway is that we are witnessing a very resilient business globally.

I have a question about the interest guidance of £1.9 billion, which seems rather high to me. My calculations suggest an average coupon rate of about 5%. Is this tied to expectations of lower free cash flow this year? I'm looking to connect the two points.

Our interest cost is projected to reach £1.6 billion in 2022. For 2023, we anticipate an exposure of about 18%. We're looking at some refinancing, and previously we could refinance at rates of 4% to 4.5%, but those rates are now higher. While they aren't as elevated as they were in October because the market has softened this year, they are still significantly above our average cost of capital. Additionally, our working capital needs have increased, with the cost of CP markets and bilateral agreements rising markedly since the start of 2022. This creates a noticeable gap between past and current rates, coupled with our existing financial commitments and maturities. All these factors contribute to the 18% of our needs, leading to the forecasted interest guidance of £1.9 billion. It's crucial to highlight this, as we will experience an annualized effect in 2023, which is a one-time issue, helping us establish a new baseline going forward.

In terms of cash conversion, we've maintained an average of 100% over the last three years, consistently achieving 95% or higher. We are committed to this goal. Last year, free cash flow after dividends was £2.1 billion in 2021 and increased to £2.7 billion in 2022, reflecting our ongoing efforts. Our Quantum program originally aimed for £1 billion over three years, but we delivered £1.9 billion and plan to invest another £1 billion in the coming years. We are moving towards a position where our financials align well with our business strategy, and we are accelerating our transformation. Looking ahead, we will evaluate our balance sheet this year while maintaining a corridor of 2 to 3. I am very confident in the quality of our business. We are making informed decisions to drive the company's growth and sustainability in the future.

Thank you very much.

Next up, we have Jared Dinges from JPMorgan. Your line is open, please go ahead.

Yes, hi everyone. First, can you discuss the impact you anticipate from the California flavor ban on your overall portfolio? Also, do you have any early data or insights from that region?

Yes, good question. I mean California represents around, what, 5% of the total market in the U.S. and it's a market that we are looking at, of course, very carefully. It's very difficult to read the early signs in the California market because you had a lot of stock movements in December. As you know, the ban came in on 21 of December. There was still a lot of stock that was available in the shops in January. So you'll have to wait until April or May in order to read all this. If you look at the size of the market and the way the market is faring at the moment, it's robust, but you have to offset all these movements in terms of stocks. Our brands are doing well. We've launched new SKUs and e-cigarettes are doing very well also. So we'll have to navigate all this. And it would be too early or too confident from my side to say that the job is done. It's going to happen in the next few months. And I'm optimistic in terms of the solidity of the business. Remember, in all the different geographies where you had that kind of things that happened, in Canada, in Europe, in Turkey, or in other places, the retention rate was around 95% and more. And then on top of that, you had related to New Categories, another increase in terms of retention rates. So the jury is out, but the start is very good, but very mixed in terms of numbers. You would not be able to find your ducklings in there because it's all stock movements, trade, availability in trade. There are the key accounts, the organized trade that has been more speedy in terms of stopping these products. General trade is very important in California and that is less measured accurately. So, give it a bit of time. But I think that is going to be a good outcome for us.

Got it. And then maybe switching gears over to THP. It was another good year, but I noticed in the second half of the year, especially the price/mix was weaker, especially in Asia. Can you talk maybe a bit about what's driving that, especially given that you had the launch of Hyper X2 and good device sales? I would have thought you would have had a mixed boost from that?

Yes. As you see, I mean, we have now close to £3 billion in terms of new category revenues to a point that represents 50% of the total company. And you saw that in the different categories, vapour grew very fast, and the percentage of growth of THP has slowed down a little bit, and there is more price competition within the different segments. So you have different competitors that have come in at different price points, different product offerings. So I think that there's a bit more of internal competition in the segment. I must say that we are very happy with our performance, and we continue to plow forward. We're only in 50% of the markets that are carrying THP, as we speak today. So we still have a lot of geo expansion to do, and we're improving our pricing as we go along our price index as we go along. So I think that we have a very good start with glo X2 in Japan. It has reached a record share in December, and we grew during the year. So there is more intense competition, but we have a lot of space to grow in. And when you look at, for instance, Europe, that is nearly 50% of the total market, I mean, we are doing extremely well and growing fast. Overall New Categories, as we said in the presentation, in 11 markets where we have already 30% of our revenue that is there, yes, for the total company. So we are strong, and we'll have an innovation pipeline that is strong, not only in 2023 but also in 2024. So we have more launches that are coming, and we are doing the rollout of X2 that is very well accepted by the consumers. It's smaller, it's lighter, delivers more flavor. And we've done a lot of improvement also in terms of the consumer models. So I'm confident.

In Japan, as well as in Europe, every product we sell in THP has higher margins than our combustible products. Even the newly launched Lucky Strike, which we introduced to enhance our market offerings, has better margins than combustible options. This presents a financial opportunity for us to strengthen our business in these regions. We are pleased with the progress we've made in all categories margin-wise throughout 2022. In the consumables side of THP, margins exceed those of combustible products. The same is true for Modern Oral, and globally in vapor, we've achieved a 50% gross margin compared to approximately 68% for cigarettes. In the U.S., the margins are even higher. This significant improvement is contributing to a reduction in losses. We are moving towards a more sustainable business model that distinguishes between selling cigarettes and these alternative products.

I mean we took the view three years ago to do multi-category. And that's starting to pay off because you have more interaction between the different categories. Tadeu was speaking about the fact that there is now a relation between THP users and Modern Oral, for instance, or in other markets, THP with Vapour. Just remember that the number of consumers in Vapour is close to double the ones in THP. And this is interesting to see that increased interaction between the categories. So being truly multi-category as we’re now and having done that for three years gives us a head start in terms of being able to serve better the consumers, and we have now a profitability that is coming through in vapour. So all they put together gives us a very strong position, where, again, I insist, we said we will invest in '23 and in '24, and we prioritize that because as we saw, we can grow volume and revenue faster and reduce our losses by £600 million. Guys, it's not a small thing. When we said a few years ago that we will be profitable in 2025. People said, ha-ha. Now we're saying we're going to be profitable in 2024, and we're going to continue to invest more because we have the brands, we have the capabilities. We have reorganized the company three times in a row. Not redoing everything every time, no, it's blocks of transformation that we did Quantum 1, Quantum 2, and Quantum 3 to be able to do what we are doing as a transformation today in order to accelerate the delivery. So we're on big guys. I mean, we really believe that the strategy not only is paying off, but is putting really the company forward in terms of delivery of our transformation and accelerating the delivery. Of course, at the same time, you have the net debt to EBITDA, you have to take care of that. Your balance sheet and everything. So we continue to invest hard and continue to plow through. I'm on the mid-to long term. Tadeu and myself, we see these numbers all the time, and of course, we want to do the best for the business, and you will see us for some time.

Next up we have Gaurav Jain from Barclays. Your line is open, please go ahead.

Hi. Good morning, thank you. I have three questions. So first, Tadeu for you on the restructuring charge in the comment you said. So last year, BAT had restructuring of £770 million. And over the last 12 years, it is £400 million on average. And now you are saying, going forward, it will be zero. So if I had assumed a £400 million restructuring charge for next year, your adjusted EPS growth will be high single digit. Is that the right way to think about that it?

Good one.

First of all, regarding the £770 million you mentioned, we highlighted in our announcement that this includes a factory closure in expensive locations. We are also shutting down operations in certain markets, like Egypt and Yemen, which come with tax liabilities that need to be addressed. As Jack mentioned, with the various market archetypes and factory closures, we anticipate nearly 2,000 employees will be leaving over the next few years, primarily in 2023. This is also included in the figures. You are correct in noting that with the conclusion of Quantum, we will no longer incur restructuring adjusted items. This should positively impact our cash flow because those adjusted figures will be excluded. However, we will still face some cash outflows, and there are additional noncash items to consider. We expect to see significant cash benefits starting in 2024, though much of the provision will lead to cash outflows occurring in 2023.

Sure. My second question is on the NGP breakeven guidance for FY'24. And a lot of people are concerned about the U.S. e-cigarette business because see, 30% of your NGP is U.S. e-cigarettes, where the FDA has given two Vuse vibe menthol variants and MDO. And they also commented that Vuse was second ranked in the FY'22 youth prevalent survey. So most likely Vuse Alto menthol will also get an MDO and maybe a tobacco product also gets an MDO. So with all this regulatory uncertainty, how certain are you that you will hit NGP breakeven, in FY'24?

Yes. To be clear, we do not expect NGP profitability to accelerate in 2024. While it's a valid question, it's important to note that consumers are increasingly engaging with our portfolio and brands. Currently, we have 22.5 million consumers, which is just a small fraction of the 80 million available in the market. This indicates significant growth potential for us, especially against competitors. Additionally, the FDA is continuing its regulatory work, which has been progressing slowly due to their high volume of tasks. This means that new regulations will likely come in at a gradual pace. We have historically adapted well to regulatory changes and are confident in our strong brand presence. Growth opportunities are substantial, but these changes involve lengthy processes with litigation and discussions, and there is still uncertainty regarding outcomes. We remain committed to ensuring profitability in New Categories by 2024, and while profitability could occur sooner, we prefer to invest wisely to grow our business base. Last year, we reduced losses by £100 million, and this year we aim to further reduce them by £600 million. Our goal is to keep growing, as we have 80 million potential consumers now, with plans to expand to 130 million. The market is indeed complex, which has been advantageous for us since we have effectively improved our combustible products over the last three years. We have appointed a Board member to focus on this category, aiming to reduce the number of cigarette users across approximately 30 markets. Additionally, we plan to cut costs by about £1 billion through restructuring aimed at better category management. We are ensuring that our financials remain robust to allow for continued investment. We are generating profits and reinvesting those resources into the business, and that is our strategy moving forward.

Yes. The only add to what I would say to your question is that the FDA has embraced the risk continue. So you would believe that all the decisions they will take is actually aligned with that and not incentivize consumers should go back to cigarettes.

I think it's a very important point of Tadeu. The fact that they give PMTAs to e-cigarettes means that it's a less risky product recognized, yes? So it starts there. So that gives a lot of traction also in the rest of the world.

Okay. Sure. My last question is regarding a new competitor entering the U.S. market next year with a heated tobacco product. You filed for the glo Hyper PMTA in December 2021, if I remember correctly. When can we expect that PMTA to come, and would you launch soon after in the U.S. market?

Yes. First, it’s important to look at the combustible business piece by piece. This segment is very significant in the U.S. because it supports daily operational costs, allowing for investments in growth. Secondly, 20% of the market is already in New Categories, predominantly e-cigarettes, which is intriguing from a margin perspective. Regarding THP in the U.S., despite being on the market for two years, it hasn't gained traction due to high tar levels. Ultimately, the key is understanding our position in New Categories in the U.S. We have a foothold in all three categories and ongoing PMTAs that should mature over the next couple of years. It’s essential to analyze what's happening in the market now, what’s expanding, and focus on mid- to long-term strategies. I’m confident that, similar to trends observed in Europe with THP and e-cigarettes, e-cigarettes will continue to thrive in high tar markets. Japan presents a different scenario with its low tar nicotine consumers. To succeed, we need to ensure that our products are scientifically validated. Currently, we are working with products that have been in the market for a while, and this approach requires time for proper scientific development. I’m excited to report that New Categories are experiencing growth in the U.S., presenting more opportunities in the next three to five years. Our recent results indicate that New Categories, particularly e-cigarettes, are playing a crucial role in our profitability and financial performance, which is encouraging.

Sure. Thank you so much.

It appears that there are no further questions at this time. I would like to turn the conference back to Mr. Jack Bowles for closing remarks.

So thank you very much for joining us today. I'm very proud of our performance in 2022. Our results show that we are transforming the business at speed and delivering strong results in a challenging macro environment. We expect 2023 to be a stronger year with organic revenue of between 3% and 5%, led by new categories and stronger combustibles. While higher interest costs and our exit from Russia and Belarus, means that we are guiding mid-single figure NPS for this year. We are also making active choices as our New Category growth model continues to accelerate and deliver. This means that we will invest more and achieve new category profitability in 2024, one year early. We have made choices, and this is the right thing for us to do. I'm excited that building on the strong progress that we have made today will continue to transform, driven by our brands, our capabilities and determination to drive long-term value creation for all our stakeholders. So thank you very much for listening, and have a very good day.