British American Tobacco p.l.c. Q2 FY2024 Earnings Call

Good morning, everyone. I'm delighted to welcome you to our 2024 Interim Results Presentation. With me this morning is Soraya Benchikh, our new CFO, and Victoria Buxton, Group Head of Investors Relations. I will begin with our transformation highlights and the progress we have made against our key areas of focus over the last 12 months. Soraya will then take you through our financial performance in more detail. I will then return to talk more about our performance outlook before we move to the Q&A session. With that, I'd like to draw your attention to the disclaimers on Slides 2 and 3. So let's begin by looking at the way forward. Our first half performance is in line with expectations, and we are on track to deliver our full year guidance. In the first half of this year, we have continued to transform our business. We added 1.4 million smokeless consumers, reaching 26.4 million. Smokeless now accounts for 18% of group revenue, up 1.4 percentage points versus full year ‘23. Our focus on quality growth, balancing top and bottom line delivery, has driven a GBP165 million increase in new category contribution, and close to a 10 percentage point increase in our category contribution margin. Building on this momentum, we expect another good increase in new category contribution for the full year. We are committed to rewarding shareholders with strong cash returns, and I'm pleased with our progress in enhancing financial flexibility, enabling the initiation of a sustainable share buyback. This year is a key moment in our transformation journey, as we sharpen our execution, enabling us to navigate near-term market challenges and drive our sustainable transformation. Turning to the drivers of 2024 delivery. As we previously guided, 2024 is an investment year for BAT. In the first half, we have invested to strengthen our U.S. business, accelerate innovation momentum, and enhance capabilities that support our strategic delivery. This, together with lapping a tough comparator in APMEA, means we expect an acceleration in our second half performance. I'm encouraged that our new category launches and our first half U.S. investments are gaining traction. Together with the expected unwind of U.S. wholesale inventory movements related to the year-on-year timing of our first half price increase, I'm confident that we are on track to deliver our full year guidance. This time last year, I shared a clear set of objectives to sharpen our execution and build a more modern and agile BAT. Over the last 12 months, working together with our broader teams, we have made good progress across these six areas of focus. We will touch on some of these highlights in more detail as we go through today's presentation. While there is still more to do, we are making good progress, and I'm confident that the choices we have made and actions we are taking are the right way forward for BAT. And with that, I will hand over to Soraya to take you through the detail of our results.

Thank you, Tadeu, and good morning, everyone. I'm Soraya Benchikh, CFO of BAT. Before we dive into the results, let me introduce myself. I’m Lebanese, and I began my finance career at Gillette and GE. I've spent many years at BAT working in Europe, Russia, Africa, and the Middle East. For the last 12 years, I've been in general management, with my most recent position as President for Europe at Diageo. After two months back at BAT, I’m eager to collaborate with Tadeu and the team on our transformation journey. As CFO, my priorities will be to ensure financial stability and allocate resources effectively. This involves supporting quality growth by balancing top and bottom line performance and targeting investments for better returns and consistent cash generation. My strategy will focus on understanding market trends and consumer needs, investing in innovation and R&D, increasing operational efficiencies, managing organizational change, and aligning with our sustainability goals. I am dedicated to transformative leadership and fostering creative, inclusive, and empowered teams. Transparent communication with stakeholders is important to me, and I look forward to sharing insights into our performance and future outlook. Now, regarding our first half results, these reflect the impact of our exit from Russia and Belarus last September, higher amortization and impairment charges from the decision to amortize the U.S. acquired combustible brands starting in January 2024, and a gain from the partial sale of our investment in ITC. To better understand our underlying business performance, we will focus today on organic, adjusted, constant currency results, excluding Russia and Belarus. Our group revenue was down 0.8%, while new category revenue rose over 7%. Profit from operations decreased by 0.9%, but diluted EPS increased by 1.3%. Although our group results have been affected by ongoing macroeconomic challenges in the U.S., we have made strategic investments, including enhancements to our U.S. commercial plans and new category launches globally to strengthen our portfolio for sustainable growth and value creation. Our wholesaler inventory movements significantly affected our first half delivery. Excluding these, our group revenue would be flat, and profit from operations would have increased by 0.5%. We expect these movements to normalize in the second half with no significant impact on our full year results. Diving into the key drivers of our performance, we achieved a 4.3% combustible price mix, with pricing increasing by 7.2%, albeit offset by a negative geographic mix, particularly in the U.S. Additionally, our operating margin remained steady, supported by improvements in our new category contributions and ongoing efficiency efforts, despite facing a transactional effects headwind of 1.8%. Excluding the U.S., we experienced a 4% growth in revenue and a 4.6% increase in profit from operations, aligning with our medium-term guidance. This reflects the robustness of our multi-category portfolio and the advantages of our global presence. In the first half, the revenue from new categories surged, driven by Velo's strong performance across all three regions. We anticipate further acceleration in new category performance in the second half due to the timing of our innovation launches, which we will discuss further during the presentation. Now I’ll provide more details about our key category drivers. As usual, market share information for our major markets is in the appendix. Starting with vapor, the fundamentals of the category remain strong. The number of vapor consumers is growing, with vapor accounting for 65% of active new category users. Views revenue climbed nearly 3%, continuing to contribute positively to the category. We saw significant revenue growth in Europe and APMEA, though this was partially offset by the challenges posed by illicit single-use vapor products in the U.S. and Canada. While we are losing market share in the U.S. due to the rise of illicit products, we are proactively working on regulation and enforcement efforts at both state and federal levels. In June, we submitted the age-gated Vuse Pro PMTA and received a marketing granted order for our Vuse Alto device and tobacco flavors last week, indicating that continued marketing of these products is appropriate for public health protection. Outside the U.S., we lead in value share in AME at 32%. Although the flavor ban in Quebec impacted our regional performance, we grew our value share in Europe by 120 basis points and saw revenue growth in APMEA of 48%, led by South Korea, New Zealand, and Indonesia. In heated products, industry growth is slowing alongside increasing multi-usage. Glo revenue decreased by 4%, primarily due to price adjustments in Japan and Italy in mid-2023 and pipeline developments in specific AME markets ahead of the flavor ban on tobacco consumables. However, Glo has begun to see category volume share improvements since December and is stabilizing, with a year-to-date decline of 20 basis points at 16.8% compared to 110 basis points in 2023. This improvement is attributed to positive initial consumer responses to our new innovations, Hyper Pro, and upgraded consumables. Regarding innovation, Hyper Pro signifies our entry into the premium HP segment, leading to improved performance in Japan and Italy with a volume share increase of 60 basis points and 70 basis points, respectively. We expect to witness an acceleration in our second half performance as we complete the majority of Hyper Pro rollouts and launch our tobacco-free consumables in 19 markets, outperforming competitor products. Next, turning to Modern Oral, this is our fastest-growing new category, with new markets without oral traditions accounting for a quarter of industry volume. In the first half, revenue increased by 49%, driven by growth across all regions and a rising category contribution. Our market share rose, with Velo capturing most of the growth in the Modern Oral category, holding a 65% volume share in AME. Velo's performance stands out through superior consumer acquisition and conversion scores, reinforcing its brand power in key markets. In the U.S., we are pleased with results from our Velo pilot, which has rejuvenated our national presence, leading to a 120% increase in revenue and a volume share of 7.6% in June—up three percentage points since December. The nationwide rollout of Grizzly Modern Oral also began in June after positive consumer feedback. It's essential to balance our top and bottom line delivery during this transformation. This is reflected in our rising contribution margin from new categories while we maintain our investment for future growth. New categories are significantly contributing to our group results as we leverage increased scalability and efficiencies. We anticipate substantial year-on-year improvements in new category profitability in 2024. In combustibles, we observed a 6.9% volume decline on an organic basis, driven by wholesaler inventory movements in the U.S., market exits, and supply chain issues in Sudan. Excluding one-offs, our volume decreased by 4.7%, but we gained 30 basis points in volume share from strong performances in key markets like Brazil, Bangladesh, and Pakistan. Despite a 10-basis point value share decrease due to our commercial actions in the U.S., we benefited from value share increases in AME and APMEA, resulting in a net 20 basis points gain. Revenue was down 2.6%, driven by the U.S., but offset partly by robust performances in AME and APMEA, which delivered 2.2% combined revenue growth. In the U.S., total revenue dropped 7%, primarily due to combustibles performance and the illicit market's effect on vapor products. We have actively invested in enhancing our portfolio, concluding most of our planned investments in commercial initiatives during the first half, which we'll detail later in this presentation. Adjusted profit from operations fell by 5%, largely due to declining revenue, but efficiency gains helped expand our margins by 100 basis points. Adjusting for wholesaler inventory impacts, revenue was down by less than 5% and adjusted profit from operations fell by 2.6%. Industry volume for U.S. combustibles dropped by 10%, or approximately 9.5% on a sales to retail basis when excluding inventory movements. Beyond long-term market decline trends, industry volume was significantly affected by macroeconomic pressures and the rise of multi-use products, particularly from the growth of illicit single-use vapes. Our combustibles volume dipped by 13.7% before considering industry declines, mainly due to wholesaler inventory movements; without the deep discount segment, the industry decline was nearly 11%, closely matching our adjusted volume decline at 11.4%. While our volume and value share have seen slight declines year-to-date by 10 and 30 basis points respectively, I am encouraged that our commercial strategies are yielding positive signs of recovery. We have increased our volume share by 10 basis points since the last half, largely owing to a 90 basis point gain in the premium segment, and have started regaining value share, offsetting the previous decline by a 20 basis point increase in premium share, reaching our highest level in four years. With this progress, and when adjusted for inventory movements, our combustibles contribution has improved compared to the last half year. Looking beyond the U.S., AME is a versatile multi-category region, where smokeless products account for 25% of regional revenues and over 50% in 11 markets. This result reflects strong performance alongside a 5% revenue increase, driven by robust sales in combustibles as well as impressive Modern Oral performance, which increased by 47%. Excluding Canada, vapor revenues in AME increased by 15%, and our adjusted profit from operations also rose by 5% as we mitigated inflationary impacts through efficiency gains. In APMEA, we maintained resilient performance relative to a strong prior year comparison. Total revenue grew by 2%, with combustibles revenue slightly up by 1% due to favorable pricing despite declines in Australia and supply chain issues in Sudan. Revenue from vapor and Modern Oral experienced significant gains, propelled by market expansion and progress in emerging markets. HP revenue faced challenges due to prior year price adjustments in Japan. Smokeless products now constitute 18% of regional revenue in our active markets, with adjusted profit from operations rising by 4%, driven by strong pricing and efficiency improvements. Returning to our group performance, our operating margin remained unchanged as we effectively countered high single-digit inflation and a nearly 2% transactional FX headwind with enhanced profitability from new categories and ongoing efficiency efforts. Inflation mainly pertains to leaf costs, which we anticipate easing in the second half. Focusing on EPS, we achieved an organic constant currency adjusted diluted EPS increase of 1.3%. Our performance benefitted from lower net finance costs, tax rate adjustments, and share count reductions, although this was tempered by a decrease in our share of ITC profits. Our underlying tax rate stood at 24.4%, and we maintain an expectation of around 25% for the full year based on current tax rates. BAT is a strong cash-generating company, with a cash flow conversion of 78% in the first half putting us on track for over 90% conversion for the full year, bolstered by our ongoing improvements and resource optimizations. Due to the timing of leaf purchases and MSA payments, our cash flow tends to be skewed towards the second half. We anticipate full year gross capex around GBP600 million, which is below adjusted depreciation and amortization. This projection is revised upward from our earlier guidance of GBP550 million, reflecting our expansion in production capacity in the rapidly growing Modern Oral segment. We are progressing well on de-leverage and anticipate being within our target range of 2 to 2.5 times by year-end. The interest rate landscape has shown improvement, with lower rates and tightening credit spreads impacting our net finance costs positively. Consequently, we now forecast our full year net finance costs to be around GBP1.7 billion, subject to risks related to interest rate fluctuations. As we continue our transformation, we prioritize disciplined capital allocation and strong returns for shareholders. We are committed to a progressive dividend and are moving forward with share buybacks, with additional GBP700 million commencing in 2024 and GBP900 million the following year, enabled by monetizing part of our ITC stake. Looking ahead, we are strategically investing to drive sustainable growth in the medium term. Our first half performance was shaped by ongoing macroeconomic pressures and our commercial action investments. We are optimistic about an accelerated second half and expect to maintain low-single digit growth in organic revenue and adjusted profit, despite experiencing a 2% transactional FX headwind for the full year. Based on current spot rates, we foresee currency translation posing a 4% headwind for full year adjusted profit growth. Beyond 2024, we aim to improve our performance progressively to achieve 3% to 5% organic revenue growth and mid-single digit growth in adjusted profit on an organic constant currency basis by 2026. With that, I will hand it back to Tadeu. Thank you.

Thank you, Soraya. I would now like to spend a few moments outlining the opportunity and pathway ahead for BAT and why we are confident we can deliver an acceleration in our second half performance. There are four clear accelerators that we expect to drive our second half delivery. Improving U.S. performance, innovations in all three new categories, and driving double-digit revenue growth for the full year. In addition, we are lapping a softer comparator in APMEA and expect a continuous strong performance in AME. As a result, we remain confident in delivering our guidance for 2024. Looking at the U.S. premium segment, we can see a clear correlation between consumer sentiment and premium segment volume trends. Historic macroeconomic shocks have had a significant impact on consumer sentiment, and this in turn has driven accelerated decline in premium volumes. However, over time, as consumer confidence levels improve, premium volume decline typically stabilizes, returning to a more normalized level. Although the U.S. market continues to evolve, we believe this further supports our outlook for improving U.S. delivery over the medium term. A key feature of our industry in recent years has been the strength of the deep discount segment, as consumers look to make their dollars stretch further. We are now starting to see deep discount volume growth slow dramatically, with market share remaining broadly flat since the third quarter of last year. At the same time, the branded value segment has grown volume share, with BAT increasing its segment share led by Lucky Strike. While we have not assumed a macro improvement in our full year guidance, we believe this early indication of low-end consumer recovery could provide a tailwind in the medium term. I want to share some more color on the portfolio actions we have taken, and why we are confident these will drive an improving performance moving forward. In premium, we have invested in Newport soft pack in key investment states, creating a ladder portfolio which has driven a recovery in Newport's share of the total premium segment. This has enabled us to drive a 30% reduction in smokers switching out of the Newport brand family, resulting in an 80% reduction in low-end growth in the 19 states where Newport soft pack has been deployed. Taking a step back, we have a balanced portfolio of brands across all price points. Through our commercial initiatives, we have driven consistent value share gains in both the premium segment with Natural American Spirit and in the branded value segment with Lucky Strike. Natural American Spirit's distinctive brand positioning in the super premium segment benefits from a highly loyal consumer base, while Lucky Strike, relaunched three years ago, remains the fastest-growing cigarette brand in the market. A key element of our commercial investment has been expanding our contractor distribution universe over the last 12 months to reach 88% coverage. This has significantly improved our competitive position by offering more of our retailer partners increased sales force support. This has driven a 2.3 percentage point increase in volume chain in these newly contracted outlets with share gains across our brands. In addition, this has led to a 1.6% decline in the deeper discount segment in these outlets. Altogether, with this previously announced commercial initiatives now in place, we are confident that our actions will drive a better second half performance in the U.S. and further strengthen our portfolio over the medium to long term. Turning to regulation. We continue to advocate for more appropriate regulation and enforcement of new categories, especially in U.S. vapor. During the first half, we saw an increase in enforcement action from the FDA with increasing fines, import refusals, and seizures. In addition, the U.S. Justice Department and FDA recently announced the creation of a task force designed to harness the enforcement capabilities of multiple federal agencies to combat illicit products. However, the success of legal products is dependent on the FDA doing more to tackle illicit vapor. To support this, we continue to advocate for the publication of a PMTA list, which would provide clarity to all market participants. I'm pleased that just last week, the U.S. International Trade Commission announced it will investigate our patent infringement complaint against the manufacturers, distributors, and retailers of single-use illicit products. In addition, the ITC continues its investigation of our complaint against the unfair import of these illicit products. Clearly, the pressure for enforcement is building. However, much more needs to be done to drive a meaningful impact over the medium term. At the state level, Vapor directory or enforcement legislation has now been passed in 13 states, meaning once implemented, 31% of the tracked vapor industry volume will be covered by state directories. In Louisiana, the first state to implement a vapor directory with significant enforcement in October 2023, we are starting to see listed product volume decline with views out of capturing the majority of the volume flow back into the legal segment. As a blueprint, Louisiana is a powerful example of what can be achieved. However, it's important to note that the scope of vapor directories and regulation differs materially by states and that much more needs to be done to ensure effective enforcement of these regulations. Turning now to our Heated Products. As Soraya shared, we are starting to see a turnaround in glo performance driven by Hyper Pro. With the majority of our launches now in place in the first half, we are confident we can build on this momentum through the rest of the year. The step change in performance is clear, with volume share gains in key HP markets, Japan, Italy, and Poland. Our Pro device has a premium price positioning, and the launch of our upgraded consumables has enabled us to take price increases in key markets. Importantly, since December, our value chain in these key markets is now growing faster than our volume share, reflecting the strength of our innovations and commercial actions. So what has driven this turnaround? I have been very transparent that we needed to do more to strengthen our HP performance, and this all begins with better products. Leveraging our consumer insights, glo Hyper Pro and consumables are resonating strongly with consumers across key attributes such as brand equity and perception. It is also driving an increase in average daily consumption amongst global consumers. These launches are the first step in our enhanced innovation pipeline for Heated Products, and that's a significant driver in the progress we are making to improve glo's category contribution. In Vapour, we have started to roll out exciting innovations with significant launch plans for the second half. Vuse Go 2.0, our newest single-use vapor delivers improved sensorials with superior heating technology. Importantly, this is our first device with a removable battery which, together with the device lock, directly addresses key sustainability and safety concerns. We continue to upgrade our rechargeables experience with our new Vuse Go Reload device, which pairs with our improved views flavors. Vuse Go Reload provides the flexibility and convenience of single-use products with a rechargeable device. And earlier this month, in the U.S., we entered the emerging zero nicotine space with the launch of Sensa. Putting all this together, we are confident these innovations can drive improved Vuse performance in the second half. In Modern Oral, we are reinvigorating our U.S. portfolio. I'm delighted by the performance of our refreshed Velo brand expression in our New York pilot, which has driven volume share up 7.2 percentage points to June versus pre-pilot levels reaching 16.5 percentage. As a result of this success, earlier this year, we commenced a national rollout of refreshed Velo. Utilizing our consumer insights, we continue to innovate to broaden our offering and appeal to both traditional auto consumers through Grizzly Modern Oral, and internationally, by enhancing our flavors range. As you can see, we have exciting new innovations in markets in each new category to drive our second half acceleration. I am encouraged that our new category launches and our first half commercial investments to strengthen our U.S. combustible portfolio are gaining traction, which, together with the unwinding of U.S. wholesaler inventory movements, I'm confident will drive an acceleration of our group performance in the second half. As a result, we are on track to deliver our full year guidance. In conclusion, 2024 is an investment year for BAT. We are sharpening our execution to navigate near-term market challenges and set the business up for a stronger future. We will continue to reward shareholders throughout our transformation driven by consistent cash flows, disciplined capital allocation, and strong shareholder returns. While there is much to do, our focus on quality growth is building momentum, and I'm confident this is the right approach to ensure we deliver long-term growth and value creation. Thank you for listening. We will now be joined on stage by Victoria for the question-and-answer session.

Thank you, Tadeu, and good morning, everyone. Tadeu and Soraya will be very happy to take your questions. I will now hand over to the conference call operator.

Thank you. And our first question today comes from Rashad Kawan from Morgan Stanley. Please go ahead.

Hey, good morning, Tadeu and Soraya. Thanks for taking my questions and congrats on the results. A couple for me, both on the U.S., please. On the combustibles market, if I compare to '21, where you laid out the impacts to the market, what you have in the full year, the key deterioration is coming from higher elasticities. Is that purely from increased poly-usage, you think? Or is it just less volume of smokers are cutting back given the pricing environment, a weak sentiment overall? I guess have you seen a material change in consumer elasticity in U.S. combustibles? And then my second question is on Modern Oral again in the U.S. I mean the acceleration we're seeing a bit of a surprise, to be honest, given you still don't have your more superior obviously European product in the U.S. Is it just about the brand refresh you've done? Are you benefiting a little bit from the shortages by one of your peers there? Any more color on what's going on in U.S. Modern Oral, I think. Thanks, again.

Okay, Rashad, look, on the U.S. combustible, we are not seeing a massive deterioration in terms of elasticity in the cigarettes. What is impacting us in the industry as a whole is a combination of a very difficult macro environment. Remember that we came from the pandemic times of a lot of support from the state and federal level to consumers that was really reversed completely, was taken out completely. And at the same time, the consumer got heated by very high levels of inflation and very high levels of interest rates as well and put mostly low-income consumers under a lot of stress financially. So this clearly has an impact, and it's reflecting the consumer sentiment. That's why we show in our presentation, the correlation. Now there are the obvious drivers for that, such as the proliferation of the illegal vapor single-use products in the U.S. And the category continues to grow despite the fact that the legal part of it is actually reducing now, with all the growth compensating the reduction on the legal side and going into those illicit, and this is putting more pressure on that. So these are the major drivers, and that's why we are seeing this high single-digit industry decline in the U.S. It's good to note that we are seeing some first green shoots in terms of the macroeconomics. The inflation is coming down. Weight inflation is catching up and narrowing the gap with the overall inflation. We are seeing a small uptick in consumer sentiment more recently, and this, combined with a potential Fed move in terms of reduced interest rates by the end of the year, could all be positive more towards 2025-2026. Now your question about poly-usage is the right one, because at the end, we are seeing more poly-users dynamic in the U.S. market. So remember that before the pandemic, we used to see secular decline in the U.S. around 4% to 5%. I think that this high end of the range now will be, as soon as things stabilize on the macroeconomic side, become the low end of the range, a new range around 5% to 7%. I would say that is the best guess that we have moving forward when things start stabilizing. And we see at least a minimal level of enforcement on the illegal products. Now regarding the Modern Oral question you are referring to, look, I think that most of the driver of the improvement has had to do with our new expression of the brand, because we piloted since Q3 last year in New York, and we were already seeing some traction there before seeing any type of distribution issues with competitors in the market. So obviously, this more recent case probably is also helping to drive some growth in our offer. But you have to remember that we already grew in New York at the end of last year. And that's the reason why we decided to do the national rollout in the first quarter of this year. And for sure, we have now Grizzly also in a new offer. It's early days. Of course, we saw a lot of consumers of Grizzly actually moving our interest in these new emerging segments. And we are trying to contemplate this within a very strong brand power, which is Grizzly in the U.S.

Thank you very much.

Thank you. We now move on to a question from Gaurav Jain from Barclays. Please go ahead.

Hi, good morning. I have three questions. So first one is for Soraya. So if I look at your FX guidance, there is a 4% headwind, and that has been a structural issue with BAT given your presence in so many emerging markets. It was an issue for a lot of other FMCG companies, and we are now hearing from several companies, including Philip Morris, Unilever, Coke, that they're targeting dollar EPS growth or a pound EPS growth. Is that something which BAT would also like to move to that instead of just a constant currency EPS growth, actually try to have meaningful pound EPS growth?

Sorry, Gaurav. Apologies. I didn't hear the last part of the question. If I understand correctly, are we confident that we can drive EPS growth on constant terms? Was that the question? And current terms?

No. Clearly, you can achieve EPS growth on a constant currency basis. However, it has been challenging to achieve pound EPS growth due to FX being a structural headwind. We are noticing that some of your peers, like Philip Morris, are beginning to discuss hard currency EPS growth. Is that something that BAT should also consider? Tadeu, perhaps you can share your thoughts on this as well.

Yes, I am confident, Gaurav, that we can drive EPS growth on current terms. Do you want to add, Tadeu?

Gaurav, it's important to note that our figures involve transactional foreign exchange. Some of the companies you mentioned report numbers at constant currency, which actually exclude transaction effects, creating a larger gap between constant and current figures. In years like the ones we are experiencing now, where a lot of valuations stem from emerging markets, it is challenging to imagine that we can completely counterbalance that. However, as Soraya mentioned, we should be able to achieve that in the medium term based on current standards.

Sure. Thank you. Then the second question I had is on your NGP revenue and volume and how it has panned out in 1H. Your heated tobacco volumes organically are down, and they were down in Japan as well. And you had a lot of price repositioning in 2H '23. And your e-cigarette business is also down. So do you think it makes sense to direct more of the investments into e-cigarettes and away from heated tobacco? Otherwise, both segments are down.

The situation in the AME region has been impacted, which we mentioned in our presentation due to stock movements we made at the end of last year in preparation for the flavor ban in tobacco heated products. This requires us to start selling non-tobacco flavored products in some markets. When adjusting for that, AME experienced a revenue growth of 2% and a volume increase of 7%. If we account for these adjustments, the volume growth would be in double digits. I am very pleased with the progress we are making. For instance, in Poland, we hold a 34% market share in the category, and we are seeing improvements in challenging markets like Italy and Japan. It's important to remember that last year, I was very clear that we did not have a competitive THP product, and we focused on enhancing our competitiveness in that area. We successfully signed an intellectual property agreement with PMI earlier this year and have developed a significantly better product. The statistics I presented today reflect these improvements. Considering the average penetration of these devices, the enhancements in average daily consumption, conversion, and retention will continue to grow leading up to the end of the year. Additionally, we are building our pipeline for other platforms. Therefore, I believe we should be investing. We are overcoming a challenging period mainly caused by our lack of competitiveness, but I am confident that we have started to enhance our competitive position in the THP segment.

Sure. Thank you so much. And my last question is on e-cigarettes. Clearly, it's very nice to hear that you have received the PMTA. Could you just remind us what's your PMTA pipeline now on e-cigarettes in the U.S., and clearly Vuse is doing pretty well internationally. So how should we think about future PMTAs?

We have received approval for the tobacco flavors of Alto, Vuse, Ciro, and Solo, which represents the largest number of PMTAs approved in the U.S. to date. We are currently contesting the menthol version, which is why we continue to sell it, as we believe we have sufficient data for the FDA's consideration. We have received a stay and are hopeful for a review in the future. Last month, we submitted the PMTA for our age-gated device, which includes not only flavors but also fruit and menthol flavors. This PMTA is particularly important to us, and we are optimistic that, given its age-verified nature, the FDA will expedite its approval. This PMTA is essential for reintroducing flavors that are critical in encouraging smokers to transition from cigarettes to vapor in a responsible manner.

Thank you so much.

Thank you. And up next we have Richard Felton from Goldman Sachs. Please go ahead.

Thank you. Good morning. Two questions from me, please. My first question is on vapor outside of the U.S., where I think volume was down almost 10% in H1. Is there any color or detail you can share on the drivers of that and whether those drivers are one-off in nature? Or there's more structural headwinds that we should be aware of? Then my second question also on new categories. Look, I'd really like to understand how you're thinking about growing revenue versus improving profitability from here? Because if I take a step back and reflect on your performance over the last few years, you've missed your guidance on revenue, but profitability has improved much better than you had been previously guiding for. So looking forward, how do you think about managing your P&L for that part of the business? And how do you balance investing in further growth but also improving margin? Thank you.

Okay. So I will take the second question. In regards to your vapor question outside the U.S., it is pretty much impacted by Canada. This is basically Quebec that introduced a new legislation, limiting the amount of 1 ml to 2 ml and banning all flavors other than tobacco without any enforcement. So what we saw in the following days was this proliferation of all these illegal products bringing back big tanks full of flavors and for sure, there is no level playing field, and that's the consequence that you are seeing there in Canada. So in a way, it's a one-off until the regulators wake up and try to enforce properly or review the regulatory element to that. That's why when you see the second pillar of our strategy, it's all about tobacco harm reduction, it is about having evidence-based points of discussion with key stakeholders, regulators, policymakers to avoid this type of very misleading regulations to be put in place without proper enforcement. So if you strip out Canada, in reality, AME has as a region grown 15% in revenue. And this was without any impact of all these products that I show in my slides, the Vuse Go 2.0, the Vuse Go Reload. These are all reaching the market now in May without any time constraints in terms of the shares or performance that you saw in the performance this early today. And the other markets that we are quite excited about markets like New Zealand that has now moved to a more well-sounded regulatory environment and is allowing us to properly compete in the markets. We are gaining a lot of traction with our offers in New Zealand. And also Korea, that is quite exciting. We are the market leaders in a very short period of time in Korea. And we also have prospects like markets in Indonesia. So overall, it's basically, in summary, a consequence of the regulatory impact in Canada.

Okay. I'll take the second question. In terms of balancing revenue growth and margin expansion, as you might recall, I mentioned that our priority is really to balance top and bottom line growth. And we're really looking to do this by continuing to invest, but more so targeting our investments in all the categories that have momentum, but also where there is more value, be it in categories or in geographies. So we're targeting investment, what you will see is we'll continue to balance both top and bottom line. This is evidenced by the fact that in the first half, we showed that we've increased category contribution by more than I think it was around GBP167 million. And that's expanded category contribution by 10 margin points, 10 percentage. So as we go forward, and into the full year, we will continue our targeted investments. And as Tadeu mentioned, we are very second-half leaning in terms of innovations coming to market. So we will have quite a lot of investment in the second half, but you will continue to see our category contribution increase year-on-year. And this will be a really big priority for us going forward to target our investments and accrete our margins.

Great. Thank you.

Thank you. And from UBS, we have Faham Baig with our next question. Please go ahead.

Good morning, team. A couple from me as well, please. Could I go back to the increased poly-usage that you're seeing? I think 1 of your competitors mentioned that the consumer conversion rates on vapor are lower than that seen in heated tobacco. I just wanted to get your perspective on what you're seeing on the conversion rates between the two categories and how you generally see the prospects of the categories? And the second question goes back on to U.S. vapor. I know you've previously quantified the growth of the overall category and the impact on cigarette volumes. If you could just remind us on that? And by when do you assume that the increased enforcement efforts by the FDA could negatively impact the development of these disposable products. And if you can touch on this, you've highlighted some benefits in Louisiana as well. What about the other two states that have implemented the registries, Oklahoma and Alabama maybe what you're seeing there would help as well.

On the issue of poly-users, we previously shared some statistics comparing vapor to HP during a conference last year. We don't see a significant change in conversion rates between these two categories. We disagree with the notion that one has a notably stronger conversion rate than the other. It's important to note that vapor accounts for 65% of consumption in the emerging no-combustibles market and is experiencing rapid growth, unlike THP, which is slowing down, primarily due to the rise of poly-users. This contraction isn't solely due to vapor; there's also significant growth in the Modern Oral category. Regarding U.S. vapor, we have mentioned a 2% decline attributed directly to the rise of illegal products. We haven’t observed a decline in growth overall. Contrary to some media reports, we believe these headlines have not positively influenced the market. The share loss we experienced in vapor is primarily due to illegal products within tracked channels, which continue to expand. It's challenging to predict when we will see enforcement changes. We were initially anticipating a conclusion to the PMTA vapor process from the FDA by the end of June, but that deadline has shifted from the previous year's December date. We still haven't received clarity on this, which is why I emphasized the need for the FDA to finalize this process to clearly state what is permissible. This clarity could significantly aid enforcement, especially against illegal vapors in tracked channels. Louisiana has made remarkable strides in regulation, leading to a significant reduction in illegal products, which has greatly benefited Vuse. However, the other two states, Oklahoma and Alabama, do not have the same level of regulations and are not experiencing reductions to the same extent as Louisiana. Nonetheless, there is potential for improvement in regulation in those states as they develop. Louisiana's introduction of an excise tax has funded proper enforcement, and their legislation is notably more comprehensive than that of the other two states.

Thanks, Tadeu.

Thank you. And we now take a question from Damian McNeela of Deutsche Bank. Please go ahead.

Hi, good morning, everybody. Two for me, please. Just firstly, just on the U.S. combustibles business. You've indicated that contracted coverage has moved from 82% to 88%. Just wondering what a reasonable level of coverage would be for the U.S. and how long it would take you to get there. And then just more generally on how happy you are with the progress that's being made in the commercial organization in the U.S. and whether there's any more that can be done to drive an improvement in performance there? And then the second question is just on, Soraya indicated an incremental GBP50 million going into Modern Oral capacity. I was just wondering if you could give us an indication of how much headroom those investments gave you going forward, please.

On the coverage, we evaluate the investment and returns from our retailers. We're pleased with our current standing, which is why I mentioned that most commercial plans have been finalized. We increased our sales force by 150 representatives to support these plans and have significantly invested in data analytics and revenue growth management systems. These efforts, along with price adjustments and other strategies, have helped us reach our goals. Recently, we've seen improvements in both volume and value share, particularly in the premium segment. This positions us well to take advantage of market recovery and better enforcement against illicit products. It’s worth noting that nicotine consumption in the U.S. remains stable, but there’s growth in areas where we currently do not participate. The illegal vapor market accounts for more than 6% of the category, translating to approximately GBP60 billion in potential revenue once enforcement improves. The Modern Oral category is also emerging, despite us not yet having our top products available in the U.S., pending PMTA approval. We’re making progress with the products we currently offer after recent adjustments. Modern Oral is gaining traction globally, particularly in markets without a prior oral tradition, leading to significant growth. In AME, outside the U.S., our products have captured over 7% of this growth. We are well-positioned with strong brands that resonate with consumers, and once we can fully launch in the U.S., it will present a great opportunity for our group. I will let Soraya address the CapEx question.

In terms of the CapEx, yes, we're always enhancing. As you can see, the trajectory of Modern Oral has been very impressive. I mean, in the first half alone, we grew 47%. So we're always looking to further invest to enhance capacity, both for the U.S. and in Europe. So we have revised our CapEx investment this year from GBP550 million to GBP600 million.

Okay. Thank you.

Thank you. And with that, I'd like to hand the call back over to you, Victoria, for any questions via the webcast.

Thank you. We do have a couple of questions from the web. Soraya, this one is probably for you. How much of the raw material increase was leaf costs versus FX? And how much do you expect this to unwind over the next six months and over the next year?

We experienced a significant rise in leaf costs. The increase in raw materials was approximately 9% to 10%, while leaf costs rose by about 14%. However, we anticipate a sharp decrease in the second half of the year, with most of it expected to normalize by next year. This increase has negatively impacted our overall operating and gross margins related to combustibles, but we hope for an improvement next year.

Next question is, will the payments impact our buyback plans next year?

Okay. So the payments, which are GBP0.8 billion over four years, the amounts yearly have been well known to us, and they have been fully taken into account in our forecast when we actually announced our buyback resulting from the sale of our ITC stake. And we committed to GBP700 million, which we started in March, and we will be doing the buyback of the remaining GBP900 million to make up the GBP1.6 billion from the ITC stakes out.

So apologies, we don't appear to have any more questions from the web. If you didn't manage to ask a question, then please don't hesitate to contact the IR team and we'd be delighted to help you. So I'd now hand back to Tadeu for some closing remarks.

Okay. Thank you for listening today and for your questions. I hope you can all see this year is a key moment in our transformation journey. I'm confident that the target investment choices we are making and the right decisions to deliver long-term growth and value creation. I look forward to keeping you updated on our progress, and I hope to see many of you at our Capital Markets Day being held at our innovation center in Southampton on the 16th of October. Here, you have the opportunity to see firsthand how our teams are focused on reducing the health impact of our business and enabling BAT to deliver long-term sustainable value for all our stakeholders. Thank you very much.