British American Tobacco p.l.c. Q2 FY2022 earnings call

• The company is transforming from cigarettes to lower-risk alternatives for smokers, with noncombustible products having over 20 million consumers. - New product launches include glo hyper X2 in Japan, Vuse Go in the UK, ePod 2+ in Canada, and recyclable cans for Velo. - On ESG, there are 18 certified carbon-neutral facilities with two added in the first half, and a target to achieve carbon-neutral operations for Scope 1 and 2 by 2030. - Financial results: group revenue up 3.7%, operating margin improved by 90 basis points, adjusted EPS up 5.7% at constant rate. Through Quantum, £1.5 billion annualized cost savings were achieved six months earlier and expect over £1.5 billion by year-end.

In the first half of 2022, New Category revenues grew by 25% in constant currency. New Category investment reached a total of £1.1 billion in the first half alone. We have now reached a milestone of over 20 million consumers of our noncombustible products. Noncombustible now represents 14.6% of group revenue, which is more than 2 percentage points higher than in 2021. For the combustible business, combustible volume was down 4.2%, impacted by factors such as the sale of the business in Iran and lower year-on-year industry volume in the US. However, the combustible business delivered a resilient operational performance with strong price mix, as cigarette pricing was up nearly 9%.

We are confident in delivering on our full year guidance. We expect 2% to 4% revenue growth and mid-single figure EPS growth for the full year. Through Quantum, we expect to achieve in excess of £1.5 billion of cost savings by the year-end. We are confident in our 2030 targets of 50 million consumers of non-combustible products and are well on track to deliver on our GBP5 billion target revenue for 2025.

• The transformation of the local Russian business is an extremely complex undertaking with uncertainties. - There are challenges in the increasingly challenging macro environment, including inflationary pressure. - The new category business faces competition risks such as price discounting from competitors.

Q: Good morning. Thank you for taking my question. I think -- see US volume down 13.4%. So obviously, you've highlighted the impact of inventory phasing. Are you able to quantify what the net impact of those various inventory phasing movements were for H1? Then, if we think about the 10% industry volume declines, you're lapping a tough comp base, gas prices are rising, that's obviously, weighed on your performance this year. But as you think about industry volumes for combustibles in the US over the next few years, are there any reasons why you don't think it should return to the 3% to 4% volume declines that we're used to seeing historically? That's my first question, and I've got a follow-up on New Categories after.

A: Okay. So, I'll take the second part. Tadeu will take the first part. I mean, the industry volume in the US, as I always said in the previous calls, you always have to consider a three-year average in order to see what's happening in the US. Of course, there has been some stock movements at the end of last year due to potential taxation and a lot of things that happened in the end of last year. But if you look at the overall trend, in terms of the US market on a three-year basis, you see that, of course, there is the post-COVID impact where the market was much stronger in the -- especially, in the two years that has passed. And now we are seeing a softer market in the first half of the year. You see a bit of recovery in the July results. But I think that what you have to consider is, one, we have a very strong portfolio. Two, we are growing premium share. Three, our brands are extremely robust in all price points and we don't see down trading currently in our portfolio or acceleration of down trading in the industry. So, we have to go step-by-step. We have generated a profit increase of 5% in the US. The New Categories, especially e-cigarettes is taking more consumers and that's good because we're making money in e-cigarettes. So, I think that the comparator is softer in the second half of the year, but we have to be prudent. We have to consider the numbers as they come. And as we know, we have a very strong position in the US market. We'll continue to grow on that both on combustible. Value share is growing by 30 bps, which is an extremely good number. And at the same time, we are very strong in terms of New Categories in the US. Tadeu?

Q: Great. Thank you. And my second question is on your New Category business and thank you for giving us a bit more disclosure on the contribution. It looks like you're making quick progress towards our breakeven target but my question is on gross margins for vapour. Now if I cast my mind back to your CMD at the start of 2020, you said that you were making about 40% gross margin on vapour, which at that stage is quite a long way below THP or your Modern Oral business. Now since then you've made good progress on trade margins, you're talking about COGS efficiency, you're taking pricing. Is it possible to give us an update on where those gross margins for vapour are today? Is it in line with your other new category businesses yet? Thank you.

A: Yes, yes. I mean first before Tadeu will give you more details. I think what is important is three years ago people thought that we would not be able to get a strong position in terms of new categories. We have demonstrated that multi-category, new categories was the way to go. And we are demonstrating last year with a growth of 50% in -- 51% in revenue and 45% in the first half of the year with a total number now of consumers of 20 million with a growth of more than 2 million in the first half of the year, which is even better than last year, that we are absolutely capable of driving our growth and that we have very strong brands. And at the same time we've reduced the losses by 50% in the first half of the year £281 million. So I think that this demonstrates that not only we are very effective in terms of our COGS, we are very effective in terms of our consumer acquisition costs and we are very well able now to take pricing across the board in the three categories, making sure that we deliver profitability at pace and that we meet all our targets for 2025. Tadeu?

A: Richard, we are really pleased with the progress in the new categories as a whole. In terms of our holistic view on that well for the first time like we highlighted in the presentation, we have been seeing revenue ahead of volume growth in all of the three categories. We have a 45% revenue growth at the back of 51% when we closed the 2021. So the growth continued at a very accelerated pace. In terms of vapour we have been doing a strong progress at the back of revenue growth management. We are taking price. We are reducing discounts on device. We are working hard on the COGS, the automation that we highlighted in the presentation, the trade margins that we quoted. So we -- in terms of vapour we have been doing a strong progress at the back of revenue growth management. We are taking price. We are reducing discounts on device. We are working hard on the COGS, the automation that we highlighted in the presentation, the trade margins that we quoted. So we -- if you the 40% that you are quoting you strip out the discounts on device on the consumable side. Today we are more on the 50%. So we have progress against this 40%. And overall, we have been progressing in all three categories and we are now with a business that has already passed these levels of investment creating the foundations. And we are now in terms of operating leverage and trying to get to a level of scale that will allow us to keep on track on those margin improvements not just in vapour but across the categories.