Earnings Call Transcript
Philip Morris International Inc. (PM)
Earnings Call Transcript - PM Q2 2020
Operator, Operator
Good day and welcome to the Philip Morris International Second Quarter 2020 Earnings Conference Call. Today's call is scheduled to last about one hour, including remarks by Philip Morris International management and the question-and-answer session. The operator provided instructions for participants on how to ask questions. Media representatives on the call will also be invited to ask questions at the conclusion of questions from the investment community. I will now turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.
Nick Rolli, Vice President, Investor Relations and Financial Communications
Welcome and thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2020 second quarter results. You may access the release on www.pmi.com or the PMI Investor Relations app. A glossary of terms, including the definition for reduced-risk products or RRPs as well as adjustments, other calculations and reconciliations to the most directly comparable U.S. GAAP measures, and additional heated tobacco unit market data are at the end of today's webcast slides, which are posted on our website. Unless otherwise stated all references to IQOS are to our IQOS heat-not-burn products. In addition, please note our estimates for total industry and market share for the quarter are subject to limitations on the availability and accuracy of industry data in certain geographies during pandemic-related restrictions. Comparisons presented on a like-for-like basis reflect pro forma 2019 results, which have been adjusted for the deconsolidation of our Canadian subsidiary, Rothmans, Benson & Hedges Inc., effective March 22, 2019. Today's remarks contain forward-looking statements and projections of future results. I direct your attention to the forward-looking and cautionary statements disclosure in today's presentation and press release for a review of the various factors that could cause actual results to differ materially from projections or forward-looking statements. Please also note the additional forward-looking and cautionary statements related to COVID-19. It's now my pleasure to introduce Emmanuel Babeau, our Chief Financial Officer.
Emmanuel Babeau, Chief Financial Officer
Thank you, Nick and welcome, ladies and gentlemen. I hope everyone listening to the call and those close to you are safe and well. Our main focus remains the health and well-being of our employees, their families, and the communities in which we operate. During restrictions, we have implemented stringent policies and measures to minimize risk for those who continue to work in our facilities and offices. For all our employees, including those working from home, providing guidance and support is also essential. We are now facilitating a gradual, carefully managed return to the workplace in some locations where local conditions and authorities' restrictions allow. The strength and spirit shown in this challenging time by the people that make up our organization continues to be a real inspiration to me and the PMI management team, and I'd like to take this opportunity to thank them for their outstanding efforts. I now turn to the business, which delivered a robust performance in the first half of the year despite the unprecedented circumstances of the pandemic. Most importantly, the continued momentum of IQOS was excellent with an estimated 15.4 million users at the end of the second quarter. Our commercial model pivoted rapidly to digital and remote engagements, while preserving high rates of IQOS user acquisition and brand retention. With volumes of heated tobacco units growing 24% in Q2 2020 compared to the prior year, RRPs made up almost one quarter of our net revenues. In addition, after two very difficult months in the quarter due to the pandemic, our combustible business is now improving. Industry volumes started to recover in June and the beginning of July, reflecting the gradual easing of confinement in many countries. The improvement was particularly driven by the EU, our largest region in terms of net revenue and adjusted operating income. The main enduring headwinds linked to COVID-related restrictions are the absence of recovery in duty-free; and in Indonesia, where this is compounded by pricing dynamics. Economic uncertainty remains and we all hope for no major resurgence of the pandemic. Notably, despite additional COVID-related expenses, our operating margin has been strong in both the second quarter and first half. This reflects the increasing mix of RRPs in our business and their improving profitability. Productivity savings in manufacturing across RRPs and combustible, SG&A savings from the pivot to digital, the elimination or postponement of certain lower priority projects and the operating leverage of higher RRP volumes all contributed. Indeed, it is no coincidence that the three regions where RRPs have a strong presence are driving this margin performance. We reached a truly historic milestone for IQOS, our mission and our future growth prospects on July 7 with the FDA's authorization of IQOS as a modified risk tobacco product. IQOS is the first electronic nicotine product to receive an MRTP order. Following a review of our extensive scientific evidence package, the agency found that an exposure modification order for IQOS is appropriate to promote the public health in the United States, demonstrating that IQOS is a fundamentally different product from combustible cigarettes and a better choice for adults who would otherwise continue to smoke. The agency concluded that issuing the order for IQOS is expected to benefit the health of the population as a whole taking into account both users of tobacco products and persons who do not currently use tobacco products. A critical enabler for the future growth of RRPs is the implementation of a differentiated regulatory framework that can help encourage adults who would otherwise continue to smoke to instead switch to better alternatives, in line with the harm reduction principle. The authorization allows a version of IQOS to be marketed with information confirming the validity of our scientific studies with regard to the significant reduction of exposure to the harmful and potentially harmful chemicals contained in cigarette smoke. The FDA decision and subsequent comprehensive post-market controls and monitoring, focusing on use prevention, provide an important example of how government and public health organizations around the world can implement an inclusive, science-based approach to help rapidly shift adult smokers who would otherwise continue smoking to better options while simultaneously guarding against unintended consequences. With investors increasingly focused on environmental, social, and governance aspects, I would like to highlight our recently published Integrated Report for 2019. The report covers a variety of important ESG topics and measures, including our business transformation metrics. Notably, our expanded aspirational targets now include new goals for the number of users of our smoke-free product in non-OECD countries and youth access prevention. The report is available on our website at pmi.com. Let's turn now to our strong performance over the first half of the year. This was clearly a very challenging period with disruption to many aspects of our operations, including our supply chain and route-to-market. I am proud to say that our organization has the strength and agility to withstand this with limited impact on supply to our consumers and trade partners. Despite these unprecedented headwinds across many of our key markets, our currency-neutral net revenues helped by a strong first quarter were close to flat versus the prior year on a like-for-like basis. Driven by pricing in combustible, manufacturing and SG&A efficiency and the dual RRP margin effect of growing weight and improving profitability, our adjusted operating income margin increased over 200 basis points to deliver 8% adjusted diluted EPS growth, all on the like-for-like ex-currency basis. I focus now on our second quarter performance. The effect of confinement on mobility impacted daily consumption patterns in certain markets, including those of daily income workers in developing countries and disrupted the retail trade. This led to significant industry volume decline in a number of geographies during April and May, which primarily impacted our combustible business. As expected, duty-free sales were weak. The March build-up of trade and distributor inventory largely reversed in the first part of the quarter, and we had to delay a few pricing decisions. This period also coincided with a challenging prior year comparison. Notwithstanding these challenges, our performance was better than we expected when we last updated our guidance on June 11. Currency-neutral net revenue declined 9.5% compared to our assumption of around the high end of minus 8% to minus 12%. Given this net revenue decline and the strong prior year profitability, we were pleased to maintain a stable adjusted operating income margin. This was supported by growth in the net revenues and profitability of RRPs and cost efficiencies. Combustible pricing of 3.3% also contributed and reflects robust pricing in many markets, partly offset by Indonesia and a strong prior year comparison in Turkey. Reported diluted EPS of $1.25 was notably better than the upper end of our previous guidance range, including a lower currency impact of $0.06. Our adjusted diluted EPS was $1.29, excluding reporting adjustments for asset impairment and exit cost, which represents an ex-currency decline of 7.5% compared to the prior year. There were three main drivers of this better-than-anticipated performance. First, the recovery of industry volume in June, notably in the higher-margin EU region, benefited our net revenues and margin. Second, IQOS user acquisition grew substantially in the same month with markets such as Russia back to pre-COVID rate and overall IQOS acquisition for the quarter only 35% below pre-pandemic levels. Last, we had the benefit of certain non-underlying factors. These include trade inventory movement in June ahead of tax and regulatory changes in Germany, Russia and Saudi Arabia, cost phasing, and a lower tax charge, largely driven by a reduced corporate income tax rate in Indonesia, as well as changes in our earnings mix. These factors accounted for approximately $0.10 of the better EPS performance. Before we come to guidance, I will outline some of the dynamics for the second half of the year. We expect a gradual underlying improvement in the combustible business coupled with continued robust growth for IQOS. The pandemic continues to present an uncertain operating environment with a potential for tightened restrictions in localized areas. While not included in our guidance assumption, there also remain a non-negligible risk of a resurgence in the virus and the return of national lockdowns. The full economic fallout of the various restrictions is also unclear. That said, we observe relative stability in terms of pandemic restrictions and improving visibility across a number of geographies in recent weeks. Conversely, visibility remains lower in some areas such as Indonesia and Latin America, in addition to the absence of any recovery so far in Duty Free, which as a reminder represented close to 4% of our net revenues in 2019. In terms of our cigarette business, while underlying industry volumes are gradually improving as restrictions ease, we assume that the return to a normal level of consumption occasion for consumers will take time. We do not assume significant widespread increase in down-trading with such dynamic currently concentrated in markets where a trend already existed due to elevated price gaps. It is reasonable to expect some delays in the timing of pricing in certain markets due to the pandemic situation. In RRPs, sales of devices and HTUs are performing strongly, reflecting the better-than-expected IQOS user acquisition and continued strong brand retention and conversion. Our unique commercial model has demonstrated the flexibility to accelerate the shift to digital and remote activity and we continue with a high level of such engagement in markets where stores are reopened. Despite the exceptional headwinds of 2020, we expect to grow our full year adjusted diluted EPS between plus 2% and plus 5% on the currency-neutral like-for-like basis. This corresponds to an adjusted diluted EPS range of $4.92 to $5.07, including an estimated unfavorable currency impact at prevailing exchange rate of $0.31. This forecast assumes a total industry decline of 7% to 9%, excluding the U.S. and China, and a decline in total PMI shipment volume of 8% to 10% on the like-for-like basis due notably to Duty Free and Indonesia. With regard to net revenue, in like-for-like ex-currency terms, we assume low-single digit growth, excluding Duty Free and Indonesia. Due to these two factors, our overall net revenue may see a modest decline. The forecast also reflects expansion in our ex-currency like-for-like adjusted operating income margin of more than 150 basis points. We expect the full year effective tax rate to be in the range of 22% to 23%, 2020 operating cash flow of at least $9 billion and $0.7 billion of capital expenditures. All these estimates assume that national lockdowns will not recur in our key international markets in the remainder of the year. Specifically for the second half, while underlying trends should gradually improve, we expect the recovery in our growth to be skewed towards the fourth quarter. This assumes the progressive easing of restrictions across the remaining markets with commensurate greater industry recovery towards the end of the year and the compound effect of increased sequential IQOS user acquisition. In the third quarter, we expect the reversal of certain one-time benefits from the first half, with an EPS impact of approximately $0.10 and a net revenue impact of around 1%. The continuation of headwinds in Duty Free and Indonesia, the timing of 2020 pricing in certain markets and the phasing in of costs are also included in our assumptions. We expect to see a good sequential improvement in reported net revenues in the third quarter, but a decline compared to the challenging prior year comparison. For adjusted EPS, also due to the timing of certain SG&A cost and the one-off items of the first half, we expect Q3 2020 to be broadly in line with Q2 2020. Sequential improvement in reported net revenue should continue in the fourth quarter although likely still in slightly negative territory compared to 2019. Growth in adjusted EPS will also be driven by a greater expected realization of cost efficiency from new initiatives. I will now cover our second quarter performance in more detail. As expected, our shipment volumes were weak, driven by the effect of marked industry declines on our combustible volume due to pandemic-related lockdown measures. Notable market contributors to this decline were Indonesia, Mexico and the Philippines, all of which were impacted by restrictions, loss of income for daily wage workers, and significant price increases. Conversely, our HTU shipment volumes continued to grow strongly to reach a record 18.7 billion units, driven by the EU region, Japan, and Russia. While overall volume in the quarter was weak, the sequential recovery seen in June and the beginning of July is more encouraging. Our combined June in-market sales volume was the highest monthly total this year and grew 2.8% compared to June 2019. Though this growth includes an estimated 3 billion unit effect from inventory movements, it mainly reflects better industry dynamics across many geographies, notably the EU region, which declined by 7.3% in Q2 overall, but grew in June. We are also encouraged by the sequential improvement in HTU volumes, which exhibited positive year-on-year growth throughout the quarter. This strong performance from IQOS means that heated tobacco units made up over 10% of our total shipment volume in the first half of the year as compared to approximately 8% in 2019 and 5% in 2018. While somewhat flattened in Q2 2020 by weaker combustible volume, we expect this proportion to grow over time as our positive momentum on RRPs continues. RRP net revenues reached $3.2 billion in the first half, reaching almost one quarter of PMI's total net revenue in Q2. IQOS devices accounted for approximately 8% of RRP net revenue in the second quarter due to a lower ratio of new user to existing user, given pandemic effect, longer replacement cycles and geographic mix, as in some countries, we still sell a substantial amount of the lower priced IQOS 2.4 Plus device. Turning now to market share. Our total international share declined by 0.1 point to 28% in the second quarter with higher share for heated tobacco units, which increased by 0.9 points to reach 3%, offset by lower share for cigarettes. Our market share was negatively impacted by Indonesia and the market mix effect of Duty Free, where volumes dropped sharply and our share is typically much higher than our overall international share. The cannibalization effect of out-switching to IQOS were essentially offset by positive impact elsewhere, and in markets where IQOS has a meaningful presence, our share increased with almost no exceptions. It follows that our combined market share increased notably in the EU region, Japan, and Russia. It's also true that in many markets Marlboro over-indexes to social consumption occasions, which were naturally lower during COVID-related confinements. We expect Marlboro share to recover as restrictions ease. Indonesia cigarette market saw an accumulation of headwinds in the second quarter. A pronounced impact from pandemic-related restriction on daily consumption added to the effect of tax-driven pricing and retail disruption. Industry volumes declined by 22%, excluding trade inventory movement whereas our shipments declined 28%. Our share decline can be attributed to three broad dynamics. First, within the Tier 1 segment, price gaps remain elevated, given our price leadership of the past 18 months and the delay in the enforcement of the minimum retail price. Combined with COVID effect, this has contributed to the end of performance of our premium-skewed portfolio despite better sequential performance from A Mild. The process of minimum selling price enforcement has started. Government inspectors have returned to the field. However, the full enforcement and subsequent trade flow-through of compliant product may not be complete until the fourth quarter. Second is the strong growth of the tax-advantaged below Tier 1 segment, which in conjunction with the tax-driven pricing and pandemic situation of 2020, has led to increased down-trading. This was designed for small players with production below a certain volume threshold. However, the segment is not operating within the spirit and intent of the law. With the segment now at approximately 25% of the market, this represents a serious threat to government excise revenue and the correction of volume-based tax tiers become urgent. Third, the stricter public mobility restrictions in urban areas, where our share is higher, has disproportionately impacted our portfolio. However, our market share sequentially improved in June, supported by strength of our brands. While we see signs of improvement in the market, the situation remains challenging. We now assume the total industry decline will be approximately 15% for the full year, reflecting progressive sequential improvement in daily consumption from the particularly weak second quarter. We are fully committed to improving our performance in this key market. We have a number of ongoing commercial initiatives to leverage equity of our brand portfolio through the remainder of the year. This includes the introduction of new variants in the growing SKT and full-flavor SKM segments such as the Dji Sam Soe 12 launched in March and Marlboro Filter Black 16 launched this month. However, with enforcement of the minimum retail selling price now underway, the main outstanding structural issue is the volume-tiered tax system, which clearly advantages growth of the super-low segment. In the status quo, this will have a significant impact on government excise revenue this year. We concur with public policy experts and economists that urge the government to create more predictability and a level playing field by reforming the multi-tier excise tax structure and enforcing the minimum retail selling price without exception across Indonesia. Overall, while short-term challenges remain, the structural headwinds in the market are addressable through government action. The headwinds directly related to the pandemic are likely to be temporary in nature and our brands are strong, giving us a solid platform to rebuild our share. I shift now to our RRP performance. We estimate that there were 15.4 million total IQOS users as of June 30, compared to an estimated 14.6 million last quarter. This represents the addition of around 4 million adult users since the same time last year, a phenomenal achievement given the circumstances. This reflects widespread user growth momentum across all key IQOS geographies, including Japan, the EU region, and Russia. We further estimate that 72% of this total or 11.2 million adult smokers have stopped smoking and switched to IQOS with the balance in various stages of conversion. We observe early indication that the propensity of smokers to switch to RRPs is trending positively since the pandemic began, and we will see how this develops in the coming period. We are also optimistic that the FDA's granting of the modified risk tobacco product order for a version of IQOS will contribute over time to better understanding of the heated tobacco category and the benefit of switching to IQOS compared to continued smoking. The overall share performance of IQOS HTUs continues to see excellent progress. Indeed, in international markets where IQOS has been commercialized, IQOS HTUs were again the third largest brand in the second quarter with 6.3% share, increasing from 4.5% in Q2 2019 on the comparable market footprint. This was achieved despite not having full national distribution in many markets. In the EU region, we added a record number of IQOS users in the second quarter to reach 4.3 million, an impressive performance given the context of the pandemic. This includes strong growth in Italy, the Czech Republic, Poland, and Germany, and in historically slower markets such as the U.K. where HTU volumes increased more than five-fold over the prior year quarter and Spain. National offtake share surpassed 1% in both of these latter markets despite limited distribution. Second quarter share of HEETS reached 3.9% of total industry volume, which was depressed by an estimated 0.2 points, due to consumer pantry loading effect. Sequential share increased by 0.3 point on an adjusted basis, with in-market sales volume 5% higher compared to Q1 2020. I also refer you to the appendix, where we show share for key EU markets and global key cities, which serve as a useful indicator for national share growth potential. IQOS continued its strong performance in Russia with its share up by 3 points to reach 5.9%. On a sequential basis versus the first quarter of 2020, HEETS share decreased by 0.6 points, reflecting a higher combustible market in the quarter due to increased daily consumption in the warmer months and a trade inventory build-up ahead of the July introduction of the track-and-trace system. A more reliable indicator is a sequential in-market sales, which increased by approximately 12% compared to 3% sequential growth in the first quarter. In Japan, our total reported share for heated tobacco units reached 20% in the second quarter, supported by line extension for both Marlboro HeatSticks and HEETS. IQOS users grew to an estimated total of 5.8 million, of which an estimated 4.3 million have stopped smoking and switched to IQOS. On an adjusted total tobacco view, including cigarillos and adjusted for trade inventory movement, the share for our HTU brands increased by 2 points versus the prior year quarter and by 0.7 points sequentially to 18.5%. Q2 2020 adjusted in-market sales volume for our HTU brands grew 4.9% sequentially. This helped drive growth of the overall heated tobacco category to second quarter total tobacco share of over 25%. In addition to strong RRP growth in existing markets, the geographical expansion of IQOS continues. Despite pandemic-related restrictions, we leveraged our digital capabilities to launch in four new markets; Austria, North Macedonia, Montenegro, and Saudi Arabia. This takes the total number of markets where IQOS is available for sale to 57. Importantly, we still plan to expand our portfolio of smoke-free offering in the second half of the year with the launches of IQOS VEEV in the e-vapor category and of licensed KT&G product in select markets. To conclude on today's presentation, our growth prospects remain strong. The continued momentum of IQOS through the unprecedented circumstances of the COVID pandemic demonstrates the structural growth characteristic of RRPs and we are on track to reach our 2021 target of 90 billion to 100 billion shipments of heated tobacco units. RRPs now make up almost 25% of our net revenue and we expect this percentage to grow over time. With digital efficiency, operating leverage from scale effect, and productivity saving simultaneously driving up the profitability of RRPs, this is a very positive dynamic for our margin outlook. The historic milestone of modified risk tobacco product authorization for IQOS is a further testament to the integrity of the product and brand proposition and underlines the need for government to implement science-based regulation. In addition, after a difficult April and May, the industry recovery has now started, providing better visibility for the rest of the year. It is also now clear that the effect of the pandemic on the Duty Free business and the specific dynamic in Indonesia will persist for at least another quarter. These factors are reflected in our expectation of sequential improvement through the second half of 2020. We assume the global economic backdrop is likely to affect total cigarette volume and induce some down-trading in certain markets. This is a dynamic we have faced before in a variety of markets where we have demonstrated robust business performance. As a reminder, we expect the unprecedented declines in Q2 2020 to reverse next year easing comparison. We also remain committed to increasing our market share through the growth of RRPs and by maintaining our leadership position in combustible. This is supported by a continued sharp focus on costs. We remain on track to deliver our target of over $1 billion in efficiency by 2021 through both manufacturing productivity and SG&A savings. We have additional opportunities on top of this from changes in our post-pandemic way of working, including the acceleration of digital activities. Importantly, our balance sheet and financial position are strong and our commitment to the dividend remains unwavering. Last, when COVID-related headwinds abate, we expect to resume growth consistent with the currency-neutral compound annual growth rate in our 2019-2021 algorithm of at least 5% net revenue growth and at least 8% adjusted diluted EPS growth. Thank you. I am now happy to answer your questions.
Operator, Operator
Thank you. We will now conduct the question-and-answer portion of the conference. The operator provided instructions on how to participate in the Q&A. Our first question comes from the line of Chris Growe of Stifel.
Chris Growe, Analyst (Stifel)
Hi, good morning and nice to hear from you, Emmanuel.
Emmanuel Babeau, Chief Financial Officer
Good morning.
Chris Growe, Analyst (Stifel)
I would like to commend you for giving guidance for the year. I know there's uncertainty, but we certainly appreciate your outlook even amidst the uncertainties in the market today. So, thank you for that. I had a question if I could first of all on the IQOS performance. Obviously, it was very strong in the quarter. I'd like to understand how you approached your IQOS investment. Did you pull back on that in the second quarter? Obviously, some of the stores were closed, and did you restart that in June in the third quarter? Just to understand kind of the momentum behind that product line as we move into the second half of the year.
Emmanuel Babeau, Chief Financial Officer
Yes, Chris. Well, of course, IQOS remains our top priority and we are focusing our efforts and investments behind IQOS. So, even in this challenging environment, we kept investing behind IQOS. Of course, we had to take into account the evolution of the environment and there were a number of investments that had to be postponed because they were no longer making sense. There were launches of new products that we were working on that we had to delay. So, there were clearly versus initial plan some reduction in the investment, but we absolutely stayed committed to keep increasing investment behind IQOS. I would say for me, the good thing of this Q2 and the H1 as a whole is that we see that the investments are getting an increasing return as we are, first, on what I would call the fixed part of the investment, the structure that we have to invest behind our RRPs and IQOS, we are growing volume. So, we amortized this investment over a larger volume and sales. So, we decreased the fixed cost, if you want, and we increased profitability through that. And there is also a variable part on the investment in terms of consumer acquisition or retention. Here I would say through the crisis, we have certainly been accelerating the usage of digital customer experience and ways to engage with them in a more efficient, more digital manner, and that is going to be more scalable, that is going to reduce this variable cost per user, which is also very good news for the future of IQOS and IQOS profitability.
Chris Growe, Analyst (Stifel)
Thank you for that, and I have just one follow-up question if I could. And in relation to pricing, which was a little stronger than I had expected in the quarter, which was great. I'm just curious, you talked about maybe delaying some pricing decisions. Are those just a delay? Have you had a pull back on pricing decisions as you've seen some down-trading in some markets? I'm just curious how you approach the pricing dynamic there?
Emmanuel Babeau, Chief Financial Officer
Yes. Well, of course, we have to take into account the environment when it comes to price increases. It is clear that in markets that are severely disrupted, where the trade is disrupted, where there is some very challenging evolution in some places because of the lockdown, we have to revisit plans for increasing price. It doesn't change the potential of price increase that we absolutely retain and that once the COVID has passed, we will continue to implement. But clearly, in this environment, we are seeing that we planned increases in a normal environment that are neither, I would say, desirable nor doable in the current environment, and that could include some delay and I think we are flagging that for Q3, where there was last year a number of price increases; and this year, I think it could be more skewed towards Q4 when things are normalizing hopefully.
Chris Growe, Analyst (Stifel)
Okay. Thanks so much for your time.
Emmanuel Babeau, Chief Financial Officer
Thank you.
Operator, Operator
Our next question comes from the line of Gaurav Jain of Barclays.
Gaurav Jain, Analyst (Barclays)
Good afternoon. Thanks a lot. I have three questions. Number one is that in EU, you are talking of an acceleration in June, particularly in IQOS, and we know that there was a menthol cigarette ban in May. So, was there any benefit that IQOS saw, because it is still available in flavors, especially you are highlighting Poland, which is a big menthol market? So, I was just curious on that. My second question is on your guidance, and your assumption is that there are no further national lockdowns during the remainder of 2020. I appreciate you are not commenting on 2021, but if we were to assume that that's the case in 2021 as well, then Q2 '20 will create a very favorable comp because you had national lockdowns in Q2 '20 and most likely there won't be. So, could there be a year in 2021 when volumes are flattish for you? And my last question is on your travel retail business. Can you talk a bit more in detail as to what exactly it is? Because we know travel retail is not big in U.S. and you're not there in China. So it does seem that a lot of it is probably within EU travel. So it is that what we should focus on, what are the travel dynamics within EU to be able to forecast what's happening in your travel retail business? Is it like 50% of your business is intra-EU travel or 30% or 40%, is there any way to quantify it?
Emmanuel Babeau, Chief Financial Officer
Thanks for the questions. So, you're absolutely right. As you all know the menthol ban came into force on the 20th of May. And really, that means that it has played over the month of June. I think it's premature to say that we have benefited from that. As you know, we have an under-exposure to the category. So, that is probably a positive evolution for us in terms of evolution of the market. I would not say that the IQOS evolution is obviously impacted by that. I cannot exclude that it has been helping a little bit, but I would say IQOS in the EU behaved well through the quarter; once again underlines the strength of IQOS in the EU through this second quarter. And I would expect probably Q3 to bring more answer on the impact of the menthol ban both on IQOS possibly and on the impact on the rest of the combustible category. On the guidance question, if you allow me, I'm not going to enter into the comment of 2021 now; we'll do that in due course. But I can say that indeed we have a depressed Q2. We have a market Duty Free that is very severely impacted by the COVID-19 crisis, and if things were back to normal next year, that would globally mean a favorable basis of comparison. But at this stage, I will keep with this simple fact-based possibility, if this was a scenario being confirmed, and in due course, of course, we'll share with you what it could mean for our '21 outlook, but it's too early to comment. On travel retail, EU is certainly important, but I think we have a global exposure. You're right, we're not in the U.S., we're not in China, but it doesn't mean that we're not benefiting from U.S. and Chinese travelers when they're traveling to other airports. So, EU area is important, but our exposure is much broader than that, and therefore, it cannot be summarized to European exposure. I don't think we give that split, but I can tell you that this would be approximately 12% if I was to characterize it.
Gaurav Jain, Analyst (Barclays)
Sure. But what I was curious is that is it like 50% of your businesses is intra-EU travel or 30% or 40%, is there any way to quantify it?
Emmanuel Babeau, Chief Financial Officer
No. Well, I don't think we give that split, but I can tell you that this would be approximately 12% if I was to characterize it.
Gaurav Jain, Analyst (Barclays)
Okay, brilliant. Thanks a lot.
Emmanuel Babeau, Chief Financial Officer
Thank you.
Operator, Operator
Our next question comes from the line of Bonnie Herzog of Goldman Sachs.
Bonnie Herzog, Analyst (Goldman Sachs)
Thank you. Hello. I wanted to circle back on the new user acquisition and just hoping you could give us an update on the progress you've made on the digital front in terms of some of the virtual guided trials you mentioned and really how that's impacting consumer engagement? And then, I'd be curious to hear what percent of your new users are coming from digital at this point?
Emmanuel Babeau, Chief Financial Officer
Thanks, Bonnie for the question. Of course, we can share what we can share both by the way for confidentiality reasons because it's part of the recipe of the success and as we gather the information, clearly, we've been accelerating on engaging with our customers through digital. So the initial model, as you know, was not only, but first centered around personnel contact through shops, through coaches and engaging into explaining to smokers the benefit of switching to IQOS. We had started this before the COVID crisis. But, of course, in markets where lockdowns meant people confined at home, we had to accelerate the plan on digital engagement and to develop all the tools through all the digital contacts and people were, of course, at home using a lot of Internet to develop full interaction and full capacity to contact first, explain, follow and, of course, using a totally remote experience for our consumers. So, I'm not able to give you a precise percentage because it's quite sensitive, but I can tell you that we see the percentage of IQOS customers fully managed through digital increasing very fast and becoming very important. And, of course, the beauty of that is that it is easily scalable at a cheaper cost, which was probably more difficult when it was a full human-related experience. And again, I think that this H1 2020 will remain a landmark for our IQOS business for a number of reasons; the MRTP decision is one; the improvement on profitability on the RRP business is another one; but certainly, the acceleration of our digital model on acquisition and on retention for our IQOS customers is another one.
Bonnie Herzog, Analyst (Goldman Sachs)
That's really helpful color. And I think it's pretty impressive just thinking through how this has really accelerated your efforts potentially in just your learning. So, as I think about what you were able to do in the quarter and during this environment in terms of acquiring more new users than you originally expected, does it suggest that your quarterly new user rate, which has been about 1 million new users each quarter in the last several quarters, do you think that this could step up as the world starts to reopen? In other words, have you learned something new in terms of strategy to accelerate the conversion?
Emmanuel Babeau, Chief Financial Officer
Well, I would not go as far as to say that we are now at a stage to give a precise step up, but it is certainly confirming that our ambition is absolutely legitimate. We are confirming the 90 billion to 100 billion stick target next year, and this is going to come from the continuation of a very strong acquisition of new IQOS users. No doubt that this digital play is going to help us achieve that goal, and as I said it's going to do that at a cheaper cost, which is definitely good news.
Bonnie Herzog, Analyst (Goldman Sachs)
Now that's great. And then one final question from me, if I may. I just wanted to touch on the MRTP that you received and I just want to hear from you maybe next steps in terms of if there are chances to get to the next level of reduced risk approval. Just wanted to understand that from the FDA and then timing, possibly. And then wanted to maybe better understand how you might use what the FDA granted in terms of altering or modifying your marketing plans going forward? How you might try and include that? Thank you.
Emmanuel Babeau, Chief Financial Officer
Thanks, Bonnie. Well, as you all can imagine, this MRTP authorization is fantastic news and I would say both for us and for the consumers because I think it's a game changer. It starts by validating all the scientific evidence that we have put together, and it's going to be an important element in how we communicate. On your question on the next level, of course, the FDA has left the door open to continue the dialog with them on precisely the next level. We intend to do that in the coming months. The question is whether the reduced risk authorization for marketing can come through a modified claim or through providing additional studies or maybe a combination of both. That's what we intend to discuss with the FDA in the coming months and, of course, we are impatient to have this dialog with them. On what it means globally, we hope it's going to start the discussion on whether IQOS and heat-not-burn technology is a better product than combustible cigarette. I think that it's a very important confirmation. And it really should put the focus on how we make this better alternative for the smoker as fast as possible, and in the broadest possible geographies. We think that as the FDA is recognized as a highly regarded regulator, their decision provides the right approach, where they are both dealing with review of reduced harm on tobacco product and at the same time, the continued restriction on tobacco usage. We think that this is the right approach that we are going to be able to share with other regulators and we are hopeful that people will look at this decision and will draw conclusions on that. Let's be clear, we already have this type of decision with several regulators in the world. So we think it's just going to amplify that. And we are beyond the U.S., where now we have the authorization to market as a reduced exposure product. We are already in other countries communicating on that reduced exposure of our IQOS product. So it's going in the right direction to, I think, really define what should be the right priorities, and hopefully, it's going to accelerate things globally.
Bonnie Herzog, Analyst (Goldman Sachs)
Thank you very much.
Operator, Operator
Our next question comes from the line of Robert Rampton of UBS.
Robert Rampton, Analyst (UBS)
Hello, three questions from me. The first is on Indonesia, can you help me understand where the Indonesian market should be from a revenue perspective? If price enforcement takes place, should revenue perspective reach 2019 levels, but from a lower volume base, or is that market just going to deliver 20%? Has that revenue from that market been rebased down 20% due to the lower price tier ratio with these results?
Emmanuel Babeau, Chief Financial Officer
Hi, Robert. If I understand well your question, you're asking what we should think about Indonesia beyond the COVID crisis and what we should understand. Let's be clear, you have really two dimensions that we need to explain on the situation in Indonesia. The first one, of course, is everything related to the COVID crisis. To start with, remember that we started the year before the COVID crisis flagging the fact that Indonesia would be difficult in 2020. There was a double excise duty increase at the beginning of the year. We have been leading the price positioning in the market for quite a while in Indonesia and we have not been increasing price at the end of 2019. So, that's what's creating difficulty and we were saying that this difficulty would last until the minimum retail selling price is implemented. Then the COVID crisis started, and obviously, that has been creating a total disruption of the market. We have seen what we have seen in other new economies with impact on the consumption driven by daily wage workers, reducing their daily average consumption. This has been impacting, and as we flagged, it has been probably more impactful in urban areas than in the countryside. We have seen some down-trading as there were some pressure on purchasing power and there has been also in regions of the market some evolution to certain categories where we have a lower representation again in line with down-trading. On top of that there was this second-tier system on the excise duty corresponding to low volume companies that are benefiting from a much lower excise duty and which can generate a price differential of 40% to 50% versus the Tier 1 system. So it's very substantial. We talk about a market where this segment can enjoy a significantly lower price. And, of course, at the time of down-trading consumers have been looking for cheaper alternatives, and this market was supposed to stay at a very low level because this was supposed to only be granted to very small levels of production. There has been some abuse on the way this has been played, and this second tier category has reached in Q2 25% of the market, which as you can imagine on something which was based on reduced volume was not at all the intention, and that has further disrupted the market. Now when we see these various headwinds that we have been facing, what can we expect? First, regarding the minimum retail selling price implementation, it has now started. It's going to be implemented through Q3, but we don't expect it to impact Q3 substantially, and therefore, we can expect to see the benefit of that in Q4. So that's going to be a first element that is going to improve the situation. Second, we are, of course, active in trying to make sure that we develop our brands and we launched offers in the most dynamic part of the market, and I've been referring to Dji Sam Soe and Marlboro on which we are launching extensions in dynamic parts of the market. We expect globally as the COVID crisis passes and we know that next year economists are expecting a strong rebound of the Indonesian economy, so we expect globally also the pressure on down-trading to reduce as the economy is improving; the daily consumption to also improve, so that should help the trend. And the last element that, of course, we don't control is this second tier category where we will need and we think is going to happen because otherwise, it's going to massively decrease the income of the country, but there is a need for reform to limit the benefit or change the structure of the excise duty depending on the value categories. At the end of the day to create a level playing field for all players to operate on an equal basis and we are certainly hoping that it's going to happen as soon as possible. If everything that I've just described happens, there is no reason why we cannot rebound in Indonesia and be back to our market share that we experienced in the past years. Our brands are extremely strong. We have an incredible commercial machine in the country, and all that are, of course, the strengths on which we will build our rebound in the coming quarters.
Robert Rampton, Analyst (UBS)
Great, thank you.
Emmanuel Babeau, Chief Financial Officer
Thank you.
Robert Rampton, Analyst (UBS)
My next question is on down-trading, and I know you flagged Indonesia and that you don't expect down-trading going forward, but can you flag which markets you have seen down-trading? Is it mostly emerging markets?
Emmanuel Babeau, Chief Financial Officer
Yes. What we flagged is that down-trading may have accelerated in a few countries where it was probably already visible before the crisis started, so we talk about Turkey, we could talk about Mexico. These are typically in addition with Indonesia. These are the markets where we have seen increased pressure on purchasing power triggering down-trading. Now for the future, of course, nobody knows what's going to be the impact of the economic crisis that everybody is forecasting. We've been there before, so that will not be the first time that we are managing a very tough environment and we have shown in the past that we have an absolute capacity to manage this kind of environment with agility, with headroom and with the levers to manage this kind of environment. So we will adapt to the situation.
Robert Rampton, Analyst (UBS)
Great. Thank you very much. That's it for me.
Emmanuel Babeau, Chief Financial Officer
Thank you.
Operator, Operator
Our next question comes from the line of Michael Lavery of Piper Sandler.
Michael Lavery, Analyst (Piper Sandler)
Thank you. Good morning. Can you update on the HEETS launch in Japan? And you called out a little bit of mix pressure that surely would have come from that, and we saw the share gains, but maybe give us a sense of how it's tracking relative to your expectations and what sort of margin impact that has on your business there?
Emmanuel Babeau, Chief Financial Officer
Sure, Michael. Japan is at the forefront of what you can expect in many countries as it gets more mature on the growth of heat-not-burn and IQOS. I think it makes sense to have several offerings for the customers. In Japan, the market performed well. In H1 and in Q2, we have been growing double-digit on our shipments and end-market sales in Japan for heat-not-burn globally. It's a market that continues to grow very nicely, and certainly HEETS has been a contributor to that. The fact that we are playing with both Marlboro and HEETS enables us to really capture maximum opportunity in the market. We see a very positive trend on HEETS, which has captured close to 4% of the market. So you see that it's already a sizable part of our RRP business in Japan, and that bodes very well for what we can do with two brands in the country.
Michael Lavery, Analyst (Piper Sandler)
Okay, great. Thanks. Could you also just clarify, in Indonesia, you gave color that in your guidance thinking you don't expect enforcement of minimum prices at least until September? As far as 4Q goes, what's your base case thinking? Is your thinking reflected in guidance that there is no enforcement all year, or is there built-in some assumption that does improve?
Emmanuel Babeau, Chief Financial Officer
No. What is taken in the guidance is essentially that we should have a large part of the benefit in Q4. So, we're not expecting anything in Q3, but we think a large part of the benefit of having minimum retail selling price should be seen in Q4.
Michael Lavery, Analyst (Piper Sandler)
Okay, great. And just one last one. On Mexico, where the government has banned the import of heated tobacco devices, can you just give us a sense? You had just been getting underway there with your IQOS launch. So it's sort of maybe hitting it before it hits momentum, but how you navigate that and how does that look?
Emmanuel Babeau, Chief Financial Officer
You're absolutely right, Michael. The good news is that we had the right level of inventory before this ban happened. So we are not facing out-of-stock situation. Of course, we hope it is not going to last too long because we are not saying that we have inventory for several years, but for the time being, it's not an issue. We are hopeful that Mexico is going to look at the FDA decision and that will influence their decision on import restrictions. But it's not targeted to IQOS specifically. So we're just unfortunately here the victim of a broader decision. Hopefully, they will come back on that one rapidly and that will allow us to resume the export to Mexico of devices.
Michael Lavery, Analyst (Piper Sandler)
Okay, great. Thank you very much.
Emmanuel Babeau, Chief Financial Officer
Thank you.
Operator, Operator
Our next question comes from the line of Adam Spielman of Citi.
Adam Spielman, Analyst (Citi)
Hi, thank you very much. I've got three questions for you. The first one is really about EPS guidance. In June, you forecasted EPS at below $1.10, it turned out that was wrong by about $0.20 for the quarter that ended in June. You're now giving guidance with a $0.15 range. And I just wonder why you think that range is appropriate given your inability to forecast even a month ahead accurately.
Emmanuel Babeau, Chief Financial Officer
I understand, Adam. Thank you for the question. Let's face the reality of numbers, it's not $0.20 because what we are saying is that we have, I would say, a big half of that amount that is coming from one-off factors that's going to be compensated in Q3. So it's not as if we had missed the landing, it's just that a number of factors that we could not anticipate at the beginning of June happened at the end of June and that helped the landing of Q2. There is approximately $0.08 to $0.09 that we delivered above the anticipation at the beginning of June and I would say, that's because the month of June has been very important, because in fact, we all realized that all the lockdown and the confinement lasted until beginning of June when things were gradually released in many geographies, and even if there were still a number of disruptions, I think that June was giving us a pretty good visibility on what we could expect for the coming months. And that's really on the basis of that that we have come to this capacity to come with this vision and guidance for the full year. So again, June has been important, the learning of June has been important and the miss has not been $0.20 but rather around $0.10, and of course, the first weeks of July, as we've been saying, are confirming this kind of understanding of the environment in which we are for the time being.
Adam Spielman, Analyst (Citi)
Okay. And implicit in that answer is there won't be a sort of unexpected $0.10 movement by the end of December. And I suppose that's an interesting point. Does that mean to say that you also basically if it looks like it's going $0.10 above, you'll somehow control it, or is it that there could be at the end of December, as there was at the end of June around $0.10 movement?
Emmanuel Babeau, Chief Financial Officer
I don't have a crystal ball, so I'm not able to tell you whether this kind of thing could happen. I think we're coming with a carefully considered range for the landing with a number of scenarios behind it and I think that's encapsulating several possibilities, pluses and minuses. With all the information that we have, the right guidance and the right vision for the landing, and I'm not able to say more. If there are things that we haven't been anticipating in our various scenarios that happen, that can always occur, of course, and the last months are here to remind us that we are not able to anticipate everything, we'll see. But for the time being, with all the information that we have, the June through mid-July data, we think that this is the right guidance for the end of the year.
Adam Spielman, Analyst (Citi)
Okay. Thank you very much. And it's a question that's really tough to answer than I phrased it. Can I talk about something completely different, which is the growth of margin, specifically in the RRP portfolio. So, you said in this quarter, you've been really pleased, partly because RRPs are a higher percentage of the whole business, but also within that, RRP margins have gone up, partly because you moved towards digital. And I guess the question is, within RRPs, how should we think about margins? Do we think that you got to a good level and it will grow more modestly, or do you think each quarter we can see really impressive gains in RRP margins for the next couple of years?
Emmanuel Babeau, Chief Financial Officer
Adam, it's a fair question. Let me start by reminding what is the model of IQOS and RRPs. It starts with the consumable that are enjoying today higher value on the per stick basis, which is intrinsic to this RRP business. On the HTUs we are also improving manufacturing productivity, and therefore when you look at the gross margin on the HTUs, there is positive evolution. Then you have the devices, which are a smaller percentage of the total, but material. On devices, margin by type can be different, but we sometimes accept a lower margin because it's part of the investment to acquire new customers. And then below that you have the machine to acquire and retain customers, and on that machine we are going to improve as we grow the top line on RRPs. We gain in efficiency, we use more digital, and we are polishing the machine, increasing the strength of the engine while reducing the cost of the engine. So that's going to keep playing positively. You should expect us to keep growing the margin on the RRPs gradually in a meaningful manner as we continue to grow on IQOS and RRPs. That's certainly our objective. I won't comment on whether it will be an equally impressive uplift in 2021 specifically, but we believe that we have significant headroom to keep improving margin.
Adam Spielman, Analyst (Citi)
Okay, that's fine. Thank you very much.
Emmanuel Babeau, Chief Financial Officer
Okay, thank you.
Operator, Operator
Our next question comes from the line of Vivien Azer of Cowen.
Vivien Azer, Analyst (Cowen)
Hi, good morning. Thank you. My first question is on Marlboro. I appreciate the commentary around some modest down-trading that you had already been seeing in markets like Turkey and Mexico. I'm just trying to square that comment with the assertion that you believe that Marlboro market share will recover given its outsized exposure to social occasions. So, just wondering how much of the market share pressure is coming from down-trading in select markets that have a high degree of exposure to Marlboro versus the reduction in social occasions? Thanks.
Emmanuel Babeau, Chief Financial Officer
Well, Vivien, you're right that you have two drivers behind Marlboro and Q2 has been a difficult quarter for Marlboro, losing some share both because of down-trading in a few markets and also, to a large extent, in many markets where Marlboro has a big market share because of the social occasions that have almost entirely disappeared during Q2. At the same time, there are markets such as the Philippines, where Marlboro has been growing nicely. So, it's a mixed picture. When it comes to down-trading, it's often mid-pricing moving to lower pricing, and the biggest impact on Marlboro we see is this absence of social moments where Marlboro is an important brand. We hope that will enable a good and fast rebound for the brand as restrictions ease.
Vivien Azer, Analyst (Cowen)
That's helpful. Thank you. My second question is on the IQOS development and looking quickly at your number of users and juxtaposing that against your volumes, it seems like perhaps there is a little bit of degradation in terms of average volumes per user. Is that a function of just new countries coming online and customers needing to ramp their consumption, or is there a structural shift in terms of per capita consumption in new geographies relative to existing IQOS geographies?
Emmanuel Babeau, Chief Financial Officer
Vivien, I'm not sure that we have any information that would clearly point to that. Q2 has been impacted globally in the tobacco market by a lot of disruption that has potentially influenced daily consumption and that maybe in some markets it can have an impact. But frankly, we have no data pointing to a structural shift in average volumes per user based on the data we have for Q2.
Vivien Azer, Analyst (Cowen)
Understood. Thank you very much.
Emmanuel Babeau, Chief Financial Officer
Thank you.
Operator, Operator
Our next question comes from the line of Pamela Kaufman of Morgan Stanley.
Pamela Kaufman, Analyst (Morgan Stanley)
I just wanted to ask how you are thinking about the puts and takes of the current excise tax environment. There has been a number of developments during the quarter, including the Saudi Arabia VAT increase and Germany VAT reduction. So, what is the impact of these tax changes? And are you passing them through to consumers? And I guess looking forward, what is your outlook for excise taxes as a result of the economic environment and what did you see in the past following prior economic downturns?
Emmanuel Babeau, Chief Financial Officer
Thank you for the question. As a general rule, yes, we are passing on tax changes whether on excise duty or VAT. More important is what we can expect in the coming quarters in terms of tax environment. It is true that many countries are going to face higher budget deficits because of the crisis and the temptation could be there to try to find ways to finance it. First of all, this type of decision is usually made in the fourth quarter of the year. So probably end of Q3, beginning of Q4, we will know more. But my sense is that versus 2008-2009, the environment is quite different and many governments are rather trying not to depress consumption, and you know that when you increase price, at the end of the day, you're not too sure about the net impact on revenues. Therefore, it remains to be seen what's going to be decided. If we do see excise increases, we've seen that in the past and we've shown our capacity to manage such increases. But I reiterate that it could be quite different this time and that is at least what we are hearing from a number of politicians and governments.
Pamela Kaufman, Analyst (Morgan Stanley)
Thank you. And then I was wondering if you could provide more color on the trends that you saw exiting the second quarter. You highlighted that there was a particular recovery in Europe. And can you comment on what trends you're seeing across other regions? And then, I guess more broadly, how are you thinking about the volume trends across markets in your 7% to 9% industry volume forecast for this year? I guess what are the differences between emerging and developed markets and the drivers behind that forecast?
Emmanuel Babeau, Chief Financial Officer
Sure. We have been seeing a gradual improvement of the market as global lockdowns eased. That does not mean we're back to normal, but markets are operating in a more consistent manner with less disruption. That's why we expect Q3 net revenue to be a sequential improvement versus Q2. It doesn't mean year-on-year growth, and in addition to that we have some negative impact coming from H1 that will play on the top line. Many markets remain disrupted and will continue to be, such as Duty Free and Indonesia, and others impacted by restrictions and economic effects. We expect mature economies to show resilience and less disruption compared to emerging markets, generally. In Q4 we expect continued sequential improvement though Q4 could still be negative year-on-year. We are distinguishing between sequential trends and year-on-year comparisons.
Pamela Kaufman, Analyst (Morgan Stanley)
Thank you. And just my last question. Russia has been an important market for IQOS growth. Can you comment on what you're anticipating from the economic environment and its impact on IQOS adoption in Russia? And what has been the performance for your super premium HeatSticks launch?
Emmanuel Babeau, Chief Financial Officer
IQOS has been doing very well in Russia in Q2 in this environment. There was some impact from restrictions, but we continue to grow share for IQOS and we are pleased with the evolution of our RRP in this market. The Russian market resisted relatively well through this COVID crisis and we are pleased with IQOS development. We expect IQOS market share to keep growing and we will continue to perform well on IQOS. The good news is that we also maintained market share in combustible at the same time, which was a nice achievement.
Pamela Kaufman, Analyst (Morgan Stanley)
Thank you.
Operator, Operator
Our final question will come from the line of Owen Bennett of Jefferies.
Owen Bennett, Analyst (Jefferies)
Good afternoon and hope you are all well. I'll keep this very quick. I just wanted to come back to the sequential industry volume improvement in the EU in June. I was just wondering is it possible to break that out between cigarettes and IQOS and what was the main driver there? Thank you.
Emmanuel Babeau, Chief Financial Officer
We did see in June, with the end of the lockdown in many countries, an improvement of the trend. IQOS has been doing well through the quarter, and we have seen some acceleration in June. There was also acceleration in the combustible business as it had been quite impacted by lockdowns in some geographies and improved in June. Markets are not equal and markets impacted by lower tourism were more penalized, such as Southern Europe. Overall, the trend in Europe at the end of the quarter was one of improvement across both IQOS and combustible, with differing magnitudes by market.
Owen Bennett, Analyst (Jefferies)
Okay, very helpful. Thanks very much.
Emmanuel Babeau, Chief Financial Officer
Thank you.
Operator, Operator
And that was our final question. I'll turn the floor back over to management for any additional or closing remarks.
Nick Rolli, Vice President, Investor Relations and Financial Communications
Thank you very much for joining us today. That concludes our call. If you have any follow-up questions, please contact the Investor Relations team. Thank you again. Stay well and have a great day.
Emmanuel Babeau, Chief Financial Officer
Thank you all. Talk to you soon. Thanks. Bye.
Operator, Operator
And thank you, ladies and gentlemen, this does conclude today's conference call. You may now disconnect.