Earnings Call Transcript - PM Q4 2024

Operator, Operator

Good day, and thank you for standing by. Welcome to the Philip Morris International fourth quarter 2024 and full year results conference call. At this time, all participants After the speakers' presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automated message today's conference is being recorded. I would now like to hand the conference over to your speaker today, James Bushnell, Vice President of Investor Relations and Financial Communications. Please go ahead.

James Bushnell, Vice President of Investor Relations and Financial Communications

Welcome. Thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2024 fourth quarter and full year results. The press release is available on our website at PMI.com. A glossary of terms, including the definition for smoke-free products, as well as adjustments, other calculations, and reconciliations to the most directly comparable US GAAP measures for non-GAAP financial measures cited in this presentation are available in exhibit 99.2 for the company's form 8-K dated February 6, 2025, and on our investor relations website. Today's remarks contain forward-looking statements and projections 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? I'm joined today by Jacek Olczak, Chief Executive Officer, and Emmanuel Babeau, Chief Financial Officer. Over to you, Jacek.

Jacek Olczak, Chief Executive Officer

Thank you, James, and welcome, everyone. We delivered an outstanding performance in 2024, with all key elements of the business contributing strongly to deliver best-in-class organic scope and bottom-line growth. There has been significant acceleration in adjusted diluted earnings per share growth in both currency neutral and, equally importantly, dollar terms as we mitigated substantial currency headwinds. Our business outperformed the industry and consumer packaged goods overall, with growth across all categories, delivering our fourth consecutive year of positive volumes. IQOS continued its strong underlying momentum with excellent growth in Japan, robust progress in Europe despite the EU characterizing flavor ban and further strong growth in our global markets. Importantly, the growth of IQOS is increasingly profitable as the benefits of scale and pricing more than offset continued substantial growth investments including brand building activities and innovations on devices and consumables. This once again delivered strong growth in the US, as 2023 demand acceleration continued into 2024. This resulted in short-term supply challenges, which we have progressively addressed throughout the year, working towards our goal of matching existing user demand. As we unlock further capacity, we will be in a position to explore the full potential of this dynamic. Outside the US, shipments grew by 75% as we increased our global presence in nicotine pouches to 37 markets. Any Vyper. VIV is progressively contributing to growth with encouraging volume momentum in closed spots and strengthening market position with a premium offer. Our combustible business performed well on all metrics. We delivered double-digit gross profit growth in quarter four of last year, and around 7% organically for the year. Led by strong pricing, resilient volumes in certain markets, and ongoing benefits of our cost actions. Overall, our strong performance across all categories and regions drove meaningful operating leverage, notably in our smoke-free business alongside cost efficiency initiatives across the entire value chain. This enabled us to deliver operating cash flow and adjusted diluted EPS above our expectations at the start of the year despite ongoing currency and input cost headwinds. Our transformation journey and growth drivers have excellent momentum and we are confident in our ability to deliver sustainable growth and returns in 2025 and beyond. Over the past year, we achieved several key milestones in our smoke-free journey. Including the ten-year anniversary of IQOS and ZYN. Our smoke-free business is large, profitable, and growing fast. Our total smoke-free net revenues reached almost $15 billion in 2024. Combined with a strong combustible performance, our company also surpassed $10 billion in adjusted net earnings for the first time. Our smoke-free business reached 40% of total PMI net revenues in the fourth quarter, and around 42% of adjusted gross profit. As our transformation becomes increasingly profitable, in our top five markets, by operating income, around 60% of net revenues were smoke-free. We have deployed our smoke-free multi-category strategy across almost half of the 95 markets with smoke-free products and we closed the year with over 38.5 million estimated adult users across nicotine, oral, and e-vapor. Our smoke-free business surpassed one billion pounds including 644 million cans of nicotine pouches. The ZYN brand continues to resonate with adult nicotine consumers across the US, where it is the number one smoke-free brand and the fourth biggest nicotine brand and also grows internationally. We're also very pleased that the robust science and responsible marketing practices behind ZYN were recognized by the FDA through the recent marketing authorization of all currently commercialized US variants. Making ZYN the first and only authorized nicotine pouch brand in the United States. We remain at the forefront of increasing the understanding of smoke-free products and advanced tobacco harm reduction among consumers and regulators. We are encouraged by the increasing number of governments adopting tobacco reduction policies to incentivize switching to reduced nicotine products instead of continuing to smoke, which is a sound public health policy. A number of markets are also moving favorably with regards to robust regulation of nicotine pouches and e-vapor. Regretfully, there is also resistance in many places, often driven by ideology not fact, and therefore a considerable amount of work still needs to be done. While reaching important milestones is pleasing, after ten years, we are still in the early stages of transformation. With our strong brands and our innovative commercial capabilities, we have many years of opportunities and growth ahead. I look forward to sharing more with you at the upcoming CAGNY conference on February 19th. I will now hand over to Emmanuel to discuss our results and outlook in more detail.

Emmanuel Babeau, Chief Financial Officer

Thank you, Jacek. I will start with the headline financials for the year. As Jacek said, this was a truly outstanding year of growth across our business, as the rapid progress of IQOS and ZYN was complemented by emerging growth contribution from Veeve and ZYN internationally at a much improved combustible performance. We delivered in line or above our last communicated expectations across key metrics. Organic net revenue growth of plus 9.8%, adjusted IMS and shipments of HTUs, and convertible pricing of plus 8.7% were strong. Excellent total shipment volume growth of plus 2.9%, including zinc and combustible volumes performed at the top end of our expectations. Coupled with accelerated cost efficiencies, this led to better than expected plus 14.9% organic operating income growth and plus 15.6% currency neutral adjusted diluted earnings per share growth. Our clear focus on delivering performance in dollar terms was reflected in the plus 9.3% growth in adjusted diluted EPS. As a result, we achieved record operating cash flow of $12.2 billion which was significantly above both our initial and most recent forecasts supported by excellent profit delivery and favorable working capital. Combined with strong adjusted EBITDA, this allowed us to significantly improve our leverage ratio which I'll come back to later. We closed the year strongly in Q4 with organic net revenue growth of plus 7.3% despite the impact of timing and comparison effect most notably related to red sea disruption the EU characterizing flavor ban for HTUs and pre-launch Iluma iDevice shipments. This was driven by total volume growth of plus 2.3% alongside positive smoke-free mix and robust pricing. Combined with the operating leverage and manufacturing efficiencies, we delivered close to plus 12% organic operating income growth and plus 10% currency neutral adjusted diluted EPS growth. In dollar terms, adjusted operating income increased plus 15% and adjusted diluted earnings per share grew plus 14% to $1.55. This includes a positive currency impact of six cents which reflects an unfavorable transactional impact in the prior year in Argentina as well as a move to hyperinflationary accounting in Egypt, which also had a negative impact on our organic growth of around one point on net revenues and two points on operating income. The non-cash impairment of our RBH equity investment had no impact on our adjusted financials. In the future, we may benefit from Airbnb's dividend income but we do not include any impact in our 2025 forecast at this time. Let's take a step back and consider 2024 in the context of the last few years. Our organic top line delivery has been consistently strong since the pandemic and further accelerated this year as both smoke-free products and combustibles stepped up their trajectory. Clearly, 2024 was also a standout year for adjusted diluted EPS growth. The profitability of our smoke-free business accelerated due to the operating leverage of IQOS increasing scale favorable unit economics, pricing, efficiency, and the impressive accretion from ZYN's rapid growth at superior US margins. We also benefited from a notably robust combustible performance which provided important structural support for our transformation journey. These dynamics are further demonstrated by the organic top line and gross profit growth of both categories in the year. Our smoke-free business accelerated to plus 17% net revenue growth and plus 23% gross profit growth reaching close to $10 billion in gross profit. This drove an impressive plus 330 basis points of organic gross margin expansion fueled by the factors I just mentioned. On the combustible side, net revenue and gross profit grew organically by plus 6% and plus 7% respectively, leading to plus 60 basis points of organic gross margin expansion. Our combustible business is once again contributing positively with pricing and cost efficiency more than compensating for the third year of significant input cost headwinds which we expect to ease in 2025. I would also note that adjusted gross margins for smoke-free products were plus 490 basis points higher than combustible in Q4 and plus 270 basis points higher for the year overall at 66.6%. While we continue to target gross margin expansion in combustibles, we expect this gap to grow over time as we continue to drive profitable growth from smoke-free products, investing in new market brand building and innovation. Taking a closer look now at our volume performance, we delivered our fourth consecutive year of shipment growth up plus 2.3% in the fourth quarter and close to plus 3% for the full year. Including our nicotine vapor business in equivalent units, this growth was plus 2.4% and plus 3% respectively. Our total 2024 smoke-free volume growth including ZYN was plus 13.5% or 19 billion unit equivalent acceleration compared to 2023. For IQOS, we delivered HTU adjusted in-market sales growth of close to 13% and shipment volumes of 139.7 billion, both broadly in line with our expectations. Adjusted IMS growth accelerated in H2 to close to 14%, essentially in line with our target of plus 14% to plus 15%. This includes dynamic growth of close to plus 11% in Europe with strong momentum across the large majority of markets. As I touched on earlier, Q4 HTU shipment growth includes the impact of additional shipments in the prior year to prepare for the EU characterizing flavor ban and the phasing effect of additional shipments to Japan in H1 notably due to retail disruption. Our oral smoke-free business grew 2024 shipment volume by plus 24.6%, including ZYN's US growth of plus 51% to 581 million cans. Snuff and moist snuff volumes were stable. Cigarette shipments grew by plus 0.6%, approximately in line with the estimated growth of the international industry. The growth of the cigarette market can be largely attributed to growth in markets where smoke-free products are not permitted such as Turkey, Brazil, and India. Excluding such markets, we observe a low single-digit decline consistent with historic trends. Our strong full-year top-line growth of almost plus 10% was again achieved through a combination of volume growth, pricing, and the positive mix impact of the shift to smoke-free products. Pricing contributed plus 6.2% reflecting almost plus 9% combustible pricing and plus 2% for smoke-free products. Smoke-free also drove a positive mix impact of plus 1.9% with higher net revenue per unit of both IQOS and overall smoke-free products contributing plus 2.2% to overall group top-line growth for the year, demonstrating ZYN's role as a meaningful accelerator. As in prior years, geographically, we were negative primarily due to combustibles, but to a lesser degree given robust networking growth. Moving down to adjusted operating margins, we delivered full-year organic expansion of plus 180 basis points and plus 100 basis points in dollar terms, comfortably achieving our objective of expansion on both bases. This reflects one Q4 with operating income margin expanding organically by plus 140 basis points as gross margin expansion, driven by SG&A investment. Full-year gross margin increased organically by plus 160 basis points and by plus 120 basis points in dollar terms. SG&A grew plus 20 basis points of margin expansion enabled by cost efficiency actions despite significant reinvestment in commercial support. We delivered over $750 million in gross cost efficiency for the year, discussing productivity across smoke-free and combustibles and continuing back-office savings. This places us well on track for our 2024-2026 target of $2 billion. Focusing on our smoke-free business, we grew our estimated user base by over five million people in 2024, reaching approximately 38.6 million legal age users as of December 1st. This includes an estimated 2 million IQOS users, 5.7 million ZYN users, and one million users. I am pleased to report robust IQOS growth of plus 3.4 million users versus prior year, and plus 1.5 million during the year. This growth is both based and consistent with recent years, despite limited new market openings and the EU characterizing flavor ban. Overall, added plus one point five million users year on year driven by this continued strong traction among legalized nicotine consumers in the US, despite the flight concern.

Jacek Olczak, Chief Executive Officer

Zooming in now on IQOS. Home user momentum is reflected in adjusted IMS volume with 2024 growth of over 16 billion units in line with the prior year despite this growth being in line with the five year average and more than one billion units above when excluding contributions from markets launched in the current fiscal year. Importantly, following the rollout of Hyco Cinema and with increased scale of the business, the profitability of IQOS is growing strongly. In this way, this year with the index product contribution over time as compared to previous years. As we've explained before, the outcome cost of the business to consumer operation results in a declining impact on per user over time as the user base grows in the market. This is a dynamic we expect to continue in the future. Turning to IQOS in Europe, as expected, HTU adjusted IMS growth accelerated strongly in H2 to almost plus 11% following H1 progression of around 8%. This resulted in robust plus 9% growth overall for the year, despite the significant disruption of the characterizing flavor ban. This double-digit adjusted IMS growth was driven by strong progress in a number of markets, including growth of around 20% or more in markets such as Bulgaria, Greece, Germany, Romania, and Spain. While growth was less dynamic in Poland and the Czech Republic, recovery in Italy is ongoing following the implementation of the flavor ban, although at a slightly slower pace than expected. The continued momentum in the region drove Q4 adjusted IMS growth of plus 9% to 10.6%, with adjusted IMS volume reaching 13.5 billion units on the fourth-quarter moving average. Inflow shipment volume increased by just 6% against prior comparisons, which included additional volumes related to the implementation of the flavor ban, notably limited. This is generally a consistent pattern of short-term disruption followed by a return to the pre-ban growth trajectory. Following an impact of around two billion units in 2024, we expect a 2025 impact of around one billion on goods shipment and IMS, including annualization effects. We continue to roll out the IQOS Iluma and new consumer variants such as Vydia to more markets, providing an increasing test profile and presence.

Emmanuel Babeau, Chief Financial Officer

Looking at the toxicity of textures in Europe, we reached a number of important milestones with Budapest achieving over 40% share, Rome over 30%, and London approaching 10%, and Madrid not far behind. Japan delivered outstanding results yet again with adjusted IMS growth of close to plus 13% in both the quarter and the full year to reach an adjusted market share of thirty point six percent. This was supported by continued schedules of Tera and Thinka, as well as a positive fraction of the IQOS Iluma device as we reached over nine point five million adult users. Cost per share in Tokyo for the overall entertainment category reached fifty two point eight percent in December. With the addition of cheese vodka and Amamad suites in the ten cities and five pictures exceeding the fifty percent share on the national level. Forty-seven percent of the total industry is now outside of Europe and Japan, adjusted in-market sales continued to grow slowly in Q4. Promising growth in several markets will be respected by TCT shares in Saudi Arabia, Indonesia, and Mexico. Continuous innovation is a key driver of these goals, with stereo variant and capsule in Indonesia driving an uplift in the quarter and some good initial results from the trial of our lower tier offerings. IQOS continues to perform well in payroll, though off the chair performance was impacted by the dynamic of the convertible market, where competitors' supply normalizes and the very strong prior quarter following the lawn.

Jacek Olczak, Chief Executive Officer

As we start to harness the strength of our multi-category portfolio, drive sales of IQOS, ZYN, and other products. Coming out to the US where our IQOS would be the first campaign, our team is progressing well. We expect to comment on direct sales of devices and HTU in our spin around the end of Q1. We are seeing high interest from consumers with over four thousand added smoker on our way. As we learn from this initial consumer engagement, we are planning the rollout of the pilot for the city. As you know, our focus will be on selective adult consumer engagement and giving awareness to category and brand education in the adult consumer market. We do not assume any significant volume from US IQOS before the launch of IQOS Iluma and we continue to hope for an FDA authorization in HP 2025. Turning categories now to ZYN where we continue to see demand supported by Q4 new achievements with growth of plus forty-two percent, totaling one hundred sixty-five million cans. Despite ongoing production limitations, this reflects an acceleration to a new record sequential increase of plus sixty million cans. On a full-year basis, shipment volumes grew by plus one hundred ninety-six million cans versus 2023. Highlighting both the magnitude of growth and the tremendous effort made to maximize our production capacity.

Emmanuel Babeau, Chief Financial Officer

The category share incrementally improved to second place, reaching sixty-five point nine percent in Q4 as we progressed in increasing production further supported the growth of the category. Indeed, category growth slowed, considering the summer peak of our supply constraint as shown on this chart. As the situation started to gradually improve, ZYN was again leading and outpacing the category. I am pleased to share that underlying demand for games from adults continued to grow in Q4, and was higher than previously estimated. We continue to experience some out-of-stock issues at retail, and while production capacity continues to increase, we now target full normalization sometime in the second half of 2025. We continue to target around nine hundred million cans for the full year from our Kensington facility and as supply continues to improve, we will look to further extend growth beyond our existing consumer base to other legal entities. Our greenfield site, which is what I do, is due to come online in early 2025, and we believe we are well positioned to capture this potential over the coming years. Responsible regulation of the industry is fundamental in supporting sustainable future growth for the dynamic category. We are therefore encouraged by the recent FDA authorization for the marketing and sale of all the nicotine pouches currently marketed in the US, following extensive evaluations. As mentioned, this makes them the first and only authorized product in the market. Among several considerations, we have a substantially lower amount of harmful constituents than other smokeless tobacco products and a low use of cigarettes. The FDA's authorization marks an important step in the protection of public health by recognizing the role that these products can play in providing better alternatives to traditional tobacco products.

Jacek Olczak, Chief Executive Officer

We remain committed to driving industry standards in the twenty-one prevention. This policy and initiative are designed to help prevent access. Additionally, combating trade initiatives that compete with our products remain a core priority, and we dedicate a significant level of resources to prevent this. ZYN also has an exciting future outside of the US, while still in its very early stages. International nicotine pouch shipments grew by twenty-seven million cans or plus seventy-five percent. We already see strong volume momentum in international markets which include Pakistan, South Africa, Mexico, the UK, and others. We launched nicotine pouches in six new markets during the quarter, reaching a total of thirty-seven worldwide, including Italy, Romania, and Australia. Utilizing e-vapor, we continue to see strong consumer traction behind Veev, which holds the top sweet spot proposition in thirteen European markets, and has the number one position in five, including Italy. Veev plays an important role within our multi-category strategy as an increasingly trusted choice for smoke-free users, serving as a source of incremental growth. Our primary focus for the combustible business is to maximize value over time while supporting the growth of the smoke-free portfolio. Pricing and cost efficiency are the key drivers of performance, while maintaining our category leadership. We delivered another robust volume quarter, with growth of plus one point one percent. All regions contributed to twenty-four organic net revenue growth, of plus six point two percent, with gross profit increasing by ten point eight. Full-year pricing of plus eight point seven percent includes contributions from Germany and others. We expect organic twenty twenty-five pricing to normalize to plus five to plus six percent, reflecting GDP growth and higher inflationary accounting.

Emmanuel Babeau, Chief Financial Officer

In twenty twenty-four, category share was flat in Q4 with positive contributions from Turkey and India offset by declines in Egypt and Indonesia, with continued growth in the below tier one segment. On a full-year basis, we grew category share by plus zero point one points reaching an all-time high for both Marlboro and our global brands. This brings me to the outlook for 2025, where we expect another year of strong growth from all categories driving top and bottom line delivery. We anticipate the fifth consecutive year of positive volumes with growth of up to plus two percent, notably driven by another year of strong growth in smoke-free products at around plus twelve percent to plus fourteen percent. In closing, we expect the continuation of strong momentum with absolute growth in HTU adjusted IMS volume expected to be at a similar level to 2024.

Jacek Olczak, Chief Executive Officer

The expression goes, we expect shipping growth to be broadly in line with this double-digit trajectory, subject to the usual inherent volatility of shipment timing and inventory. We expect ongoing strong growth dynamics within the US in the cutting pouch category. Despite the supply constraint I mentioned earlier, we forecast a US volume shipment range of seven hundred eighty to eight hundred twenty million cans for the year, supported by capacity expansion. This represents another year of sequential acceleration in volumes, with an expected increase of two hundred to two hundred and forty million cans compared to the one hundred and ninety-six million cans increase. This supports the total PMI forecast of plus six to plus eight percent organic net revenue growth. This includes a headwind of over a hundred basis points due to higher inflationary accounting energy and the technical impact of implementing a new financial model in Indonesia below tier one premium. The change in Indonesia has no effect on revenue moving down to the P&L.

Emmanuel Babeau, Chief Financial Officer

We expect ongoing small clinic effect operating leverage and cost efficiency to drive double-digit adjusted operating growth, with growth of plus ten point five and plus twelve point five. This includes single-digit gross margins. With those gross and adjusted operating margins forecast to expand in both organic and adjusted terms to seventy-six hundred. We expect SG&A costs to increase broadly in line with net revenue on an organic basis as we invest behind our smoke-free products. We forecast currency neutral adjusted diluted EPS growth of plus ten point five percent and plus twelve point five percent.

Jacek Olczak, Chief Executive Officer

This factor is in line with essentially stable net interest expense and an increase in our corporate tax rate to approximately twenty-two point five to twenty-two point five percent due to tax increases and global minimum tax, and the mix of international earnings. In dollar terms, we forecast growth of plus seven to nine percent to a range of seven dollars four to seven dollars seventeen. This includes an unfavorable forecast currency impact of twenty-two cents at revenue exchange rates, primarily driven by the growth trends of the dollar mitigated by our local currency adjustments. For the first quarter of 2025, we expect a strong start to the year with net revenue and operating income growth growing in line with our full-year objectives despite the leap year comparison. We forecast HTU adjusted IMS growth of around plus ten percent which factors in the large annualization impact from the easing flavor ban in the quarter with progressive improvement. We forecast shipment volume of thirty-five to thirty-six billion for HTUs and one hundred seventy to one hundred eighty million cans for USU. In project Q1 adjusted diluted EPS of one dollar fifty-eight cents, including a negative currency effect of four cents at the revenue rate.

James Bushnell, Vice President of Investor Relations and Financial Communications

These are our 2024 delivery and 2025 outlook, we are well positioned to meet or exceed all metrics of the 2024-2026 targets presented at our 2022 investor day. This is especially true at the level of operating income growth, as well as for EPS delivery, where our algorithm assumes instant. This level of top and bottom line growth reflects the best-in-class growth profile within the context of the consumer technology sector. Importantly, we're also well on track to deliver high single-digit adjusted diluted EPS growth in dollar terms across the 2024-2026 period. Indeed, we measure our cash flows in dollar and after a record delivery in 2024 we expect to deliver operating cash flow of around eleven to fourteen billion dollars. This is forty-nine with 2024. Once accounting costs in non-recurring payments with a total impact of around one billion dollars. While we continue to achieve the German target for such space, we have decided to make a zero point eight billion dollar payment this year. And we also anticipate the final transition tax payment related to the US tax code.

Emmanuel Babeau, Chief Financial Officer

We anticipate capital expenditure of around one point five billion dollars, this will be part of our ongoing investment in our most successful initiatives. Our 2024 cash flow and EBITDA growth combined with a favorable impact from our euro balance sheet allowed us to reduce our net debt to adjusted EBITDA ratio by 0.5 times, down to 0.66, ahead of our expectations and representing a dramatic improvement. We expect further progress in 2025 placing us on track for our target ratio of around two times by the end of 2026. I will now pass it back to Jacek for closing remarks.

Jacek Olczak, Chief Executive Officer

Thank you, Emmanuel. In summary, 2024 was a remarkable year for PMI. Our financial results reflect our strategy and the success of our transformation. The underlying momentum showed bolstered by our practice measures and pricing and cost efficiency. I remain confident in our position as the global smoke-free leader as we continue to identify opportunities with our multi-category strategy focusing on our premium brands.

Emmanuel Babeau, Chief Financial Officer

Our key strategic priorities for 2025 are clear. As we continue to support the function and development of our smoke-free business, we expect to maintain strong momentum in 2025. We remain confident in our ability to deliver against our twenty twenty-four, twenty twenty-six growth target as we progress towards our ambition of becoming the leading smoke-free company by twenty thirty. Finally, and importantly, our strong growth outlook and highly cash-generative business enable us to continuously reinvest in our transformation while returning cash to shareholders. In September, we increased our annual dividend for the seventeenth consecutive year in line with our long-term strategy.

Operator, Operator

Thank you. As a reminder, to ask a question, please press star one one. To withdraw your question, please press star one one again. Our first question today comes from Matt Smith of Stifel. Your line is open.

Matt Smith, Analyst

Yeah. Speaking to Manuel.

Emmanuel Babeau, Chief Financial Officer

Good morning. May I ask who's calling?

Matt Smith, Analyst

The 2025 outlook calls for HTU shipments in numbers or in-market sales growth fairly in line with what you saw in 2024. But could you talk about the composition of the growth? If it's overall in line, a different contribution by geography in your outlook and can you remind us on if there has been any progress in new markets contributing to growth in 2025 or if you've made any progress in those markets as you look out to your 2026 goals.

Jacek Olczak, Chief Executive Officer

In the guidance, our financials continue to show good growth in Japan and across several parts of Europe, I mean, especially in Italy, Czech Republic, and Poland, where the group is a bit below what we would expect at this stage, especially Italy and Czech following the flavor ban. But we also see some recovery coming, so I think hopefully in the second part of the year, we should bring Italy and other geographies back to what the rest of Europe is achieving. We have not, in the guidance, assumed any significant new market openings in terms of volume. As you know, we're dealing with a rational environment, fighting with irrational challenges. I hope that the most recent FDA authorizations will be a good incentive for other governments which to be very frank are opposing smoke-free products while allowing cigarettes. But in the guidance, we have not included any significant volumes coming from the new geography. So this is all organic growth, and as you've seen in the four quarters of this year, despite the fact even if you look at Japan where almost half the market is already on smoke-free products, the growth continues there.

Owen Bennett, Analyst

Thank you, Yaciek. I'll pass it on.

Operator, Operator

Thank you. Our next question comes from Monica of Goldman Sachs. Your line is open.

Bonnie Herzog, Analyst

Alright. Thank you. Hi, Emmanuel and Jacek. I had a question on your margins. You're guiding robust operating leverage on a currency neutral basis this year. So hoping you could highlight the key drivers behind this. Also, I wanted to verify if your guidance assumes a potential entry of a Lumina US or just possibly continued investments without any corresponding sales. How should we think about the margin contribution from ILUM in the US and how long it might take after your entries into the market for those margins to really be meaningful?

Jacek Olczak, Chief Executive Officer

Yeah. So maybe I start, Bonnie. Good morning. Yes, we are looking for robust margin expansion this year, maybe not precisely to the same level as we had last year, but still it's going to be robust, aiming for a hundred basis points of improvement. This is driven by a combination of a few factors; we are still looking at pricing contributions, which are pretty obvious. There’s obviously a positive mix of products as well, especially now that we have three smoke-free categories that are contributing positively to margin, including vape. Our strategy is focused and selective while ensuring quality when investing in needed geographies. We've had significant headwinds in COGS, but I think those are behind us. In terms of the initial period, we expect that to be a negative impact on margins, however, over a few years, it should contribute positively, similar to the past experiences with IQOS internationally.

Emmanuel Babeau, Chief Financial Officer

Look, on the consumables, we've already highlighted the fact that there was a ten percentage point gap, and it has been expanding in the last few years. So, indeed, we have the ambition to do better regarding the gross margin for combustibles, and we explained why. But as we continue to progress rapidly on smoke-free products, both ZYN and IQOS, we want to continue to grow, potentially leading to a gap that could expand between smoke-free products and combustibles in the coming years.

Bonnie Herzog, Analyst

Alright. Thank you. I'll pass it on.

Gaurav Jain, Analyst

Good morning, Emmanuel and Jacek. I have a couple of questions. One is on ZYN. If I look at the scanner data, the volumes have decelerated to mid-teens growth. And your guidance is for thirty-four percent to forty-one percent growth. Then you also mentioned that the supply normalization would only happen in Q2 2025. So, wanted to understand what gives us the confidence that we'll be accelerating to this almost forty percent growth rate again?

Jacek Olczak, Chief Executive Officer

If we look at the volumes evolving in Q4 of the last quarter, we've seen growing velocities behind ZYN. Actually, it was the only brand which was growing in velocity despite the rest of the brands experiencing deceleration, at least those larger ones. We need to take into account that we’re in a supply constraint environment. With the increased capacity in Owensboro, we had the first quarter with significant sequential growth. Even if you will take the run rate of what we see the last weeks, I think our guidance reflects what we see there. We believe we should meet the demand by about mid-year. But understanding demand is complex due to our knowledge of out-of-stock products. The recent FDA authorizations have provided visibility and stability to market participants, including trade and consumers. We believe that will translate into the volumes reflected in our guidance.

Gaurav Jain, Analyst

Sure. And a follow-up to that. Retailers have been putting their markups. I think you increased prices by thirty cents last year while retail has increased by one dollar or three dollars. How do you control retail price? And as supply normalizes, is there a way for you to reduce retail price so that would also have a positive effect on your volume?

Jacek Olczak, Chief Executive Officer

If you have a degree of out-of-stock as ZYN is experiencing, managing the price at the retail level is a bit more challenging. I believe with the growing supply of the product, I think pricing will more normally settle as out-of-stock conditions improve. Retailers are also challenged with managing their margins while confronted with supply issues. Once we achieve full supply normalization, we should start seeing improvements in pricing in the market.

Gaurav Jain, Analyst

Got it. Thank you so much.

Phillip Stein, Analyst

Hi. Good afternoon. Thanks very much for taking my questions. I just had one question, please. It was just on the HTU guidance. If I look at where the volumes landed at the end of twenty-four and then I look at the guidance range you've provided for twenty-five, just trying to get a sense of what gives you confidence in what my math suggests implies an acceleration in growth in twenty-six. What gives you that confidence that you will see that re-acceleration?

Jacek Olczak, Chief Executive Officer

Our guidance for 2025 emphasizes organic growth in a stable environment. Markets such as Russia and Ukraine still contribute around twenty percent of our potential growth, which could significantly enhance our volumes if restored. We see a strong outlook overall, and expect our multi-category strategy to provide a meaningful long-term boost to our growth. We plan to focus more on the total smoke-free category dynamics moving forward as consumption continues to shift.

Gaurav Jain, Analyst

Thank you. That was helpful.

James Bushnell, Vice President of Investor Relations and Financial Communications

Thank you. Before closing our call, I'd like to remind you that as Jacek mentioned, we will be presenting at the CAGNY conference on February 19th and we hope you'll be able to join us either in person or virtually. Thank you again for joining us today. If you have any follow-up questions, please contact the Investor Relations team. Have a great day.

Jacek Olczak, Chief Executive Officer

This concludes today's conference call. Thank you for participating.