British American Tobacco - Earnings Call - H2 2024

Transcript

Tadeu Marroco (CEO)

Good morning, everyone. I'm delighted to welcome you to our 2024 preliminary results presentation. With me this morning is Soraya Benchikh, CFO, and Victoria Buxton, Group Head of Investor Relations. I will begin with our transformation highlights and the progress we have made during our investment year. Soraya will then take you through our financial results in more detail before I return to talk more about our performance outlook ahead of Q&A. With that, I would like to draw your attention to the disclaimers on slide two and three. Let's begin by looking at the positive transformation momentum we are driving, starting with some highlights. 2024 was a key moment in our transformation journey as we sharpened our execution, enabling us to navigate near-term market challenges and deliver an improved performance in the second half.

We have delivered group results in line with expectations, which Soraya will talk about in more detail. Smokeless accounts for 17.5% of group revenue, up one percentage point versus last year. We added 3.6 million smokeless consumers, reaching 29.1 million, mainly driven by our continued success in modern oral. Our focus on quality growth, balancing top and bottom line delivery, has driven a further improvement in new category contribution, up to GBP 151 million, and a seven percentage point increase in our category contribution margin on an organic, constant rates basis. We are committed to rewarding shareholders with strong cash returns, and I'm pleased with our progress, improving financial flexibility, enabling the initiation of sustainable share buyback, continued progress on the leverage to within our target range at 2.4x, alongside our progressive dividend with 2% growth announced today.

Our foundations are solid, and I'm confident that the choices we have made and the actions we have taken through our investment year are the right way forward for BAT. I have been clear that we needed to invest to strengthen our U.S. business, accelerate innovation momentum, and enhance capabilities that support our strategic delivery. While there is more to do, we are making clear progress. Our previously announced commercial plans in the U.S. are completed, and I'm encouraged that our performance accelerated in the second half. Through our improved innovation ecosystem, our new category growth accelerated in the second half, driven by glo Hyper Pro and our refreshed Velo mix in the U.S. Furthermore, we are excited about the Q4 launchings of our latest innovations, including VELO Plus. As previously highlighted, we do not expect the journey ahead to be linear.

We will share more detail on the key drivers and assumptions behind our 2025 guidance later in the presentation. We remain committed to returning to 3%-5% revenue and 4%-6% APFO growth, adjusted for Canada at constant rates in 2026, and with that, I will hand over to Soraya to take you through our results in more detail.

Soraya Benchikh (CFO)

Thank you, Tadeu, and good morning, everyone. Before diving into the results and to set the context, I would like to remind you of my key focus areas. The first is to fuel our transformation by maximizing sustainable value from combustibles. The second is to drive quality growth in new categories by investing capital in a disciplined manner, targeting the largest profit pools and maintaining a laser focus on returns. The third is to strengthen our financial resilience, and even though we have reached our target debt corridor, including Canada in 2024, by 2026, we aim to be within this corridor, excluding Canada, while remaining committed to our balanced capital allocation. Now, with this in mind, I'd like to share our progress in 2024 as we move to the results.

I am pleased to share that we delivered organic, constant currency results in line with guidance, while our reported results reflect a number of adjusting items, including our exit from Russia and Belarus, a provision of GBP 6.2 billion for Canada's CCAA proposed plan, a charge in Romania in respect of an excise assessment, and the GBP 1.6 billion gain due to the partial sale of our ITC investment. To understand the underlying performance, we will focus on organic, adjusted, constant currency results. More details on adjusting items are in the appendices. In line with our guidance, group revenue grew by 1.3%, new category revenue grew by 8.9%, and adjusted operating profit rose 1.4%, and diluted EPS increased by 3.6%. Looking at some of the key drivers.

Combustibles price mix growth, with pricing up nearly 9%, partly offset by adjusted gross profit expanded by GBP 400 million, supported by revenue growth management and new category scale benefits. Excluding the U.S., we delivered 5.1% revenue growth and 7.5% operating profit growth. This highlights the strength of our multi-category portfolio and resilience of our global footprint. As expected, new category revenue growth accelerated in the second half. We achieved quality growth, with contribution margin rising to 7%. This reflects our targeted investment in high-value profit pools, focused ROI discipline, and scaling benefits across markets. I will now provide more details, and all share data is based on full year averages, unless otherwise stated, and further information is again available in the appendices. Let's start with vapor. Vapor is the largest new category globally, with consumer numbers accelerating.

While category fundamentals are strong, weak enforcement against illicit single-use vapes in the U.S. and Canada has distorted competition. Vapor revenue fell by 2.5%, and growth in Europe, led by Vuse Go Reload, was offset by illicit market challenges. Vuse remains the value share leader both globally and in the U.S., where we are demonstrating strong financial resilience. U.S. volumes declined by 4%, but they were outperforming the 9% industry decline in tracked channels. But without stronger enforcement, illicit vapor products will continue to impact the legal market. In AME, we retained value share leadership at 31.5%. Gains in France, Spain, and Germany lifted value share by 100 basis points, of course, excluding Canada's losses from Quebec's flavor ban. The U.K. and France, however, will likely face short-term disruption from single-use vapor bans in 2025, but we are well positioned for long-term growth.

In APMEA, revenue grew 24%, driven by strong momentum in South Korea and New Zealand. Moving on to heated products. In heated products, industry growth slowed, impacted by increased new category poly-usage in Europe. Glo revenue was up nearly 6%, with a stronger H2 performance as expected. Growth was fueled by the continued rollout of glo Hyper Pro and improved consumables, moving the brand towards premium positioning. Glo Pro helped improve volume share with a small decline of 40 basis points versus the 110 basis points in 2023. In Japan, Pro consumables gained 110 basis points in volume share, partly offsetting the decline of legacy Super Slims. In AME, category volume share stabilized with strong gains in Poland and the Czech Republic and continued improvement in Italy. Our tobacco-free range, Veo, continues to strongly outperform peers.

We have driven a more balanced global performance with improved category contribution in 2024, driven by scale benefits and pricing. Last but not least, we move on to Modern Oral, which is the fastest growing new category. Usage and daily consumption are rising in both key and new markets, with non-traditional markets now making up 20% of industry volume. Our revenue grew 53% in Modern Oral in 2024, with strong growth across all regions, improving category contribution. Our category share increased, with volume share up 130 basis points. In AME, we led the Modern Oral category with 65% volume share, and Velo captured 70% of category revenue growth. This performance proves Velo is the leading brand and product in the category. In the U.S., our recovery was driven by a refreshed Velo expression and the launch of Grizzly Modern Oral.

We gained over 2 percentage points in volume share, reaching 6.6% and 18% in New York in December, where this mix was first introduced. We expanded our U.S. portfolio with VELO Plus at the end of the year, which Tadeu will discuss later. In combustibles, our volumes declined 5% organically, mainly due to the U.S. market exits and supply chain issues in Sudan, also affected performance. Excluding these, volume declined 3.5%. Our volume share grew by 20 basis points, with a strong performance in Brazil, Bangladesh, Mexico, and Pakistan. Value share declined 20 basis points, driven by the U.S. Our U.S. commercial investments in H1 helped recover volume and value share in the second half. Revenue was marginally higher, with growth in AME and APMEA, led by Brazil, and in APMEA, led by Brazil, Japan, and Turkey, offsetting the U.S. Now, turning to our regions, our U.S.

Revenue declined by 3.4%, mainly driven by the commercial actions implemented over the last 18 months. In addition to ongoing macroeconomic pressures impacting affordability and illicit vapor products affecting both combustibles and vapor, the combustibles industry declined by around 9% on a sales-to-retail basis. Excluding deep discount, where we are not present, the industry declined 11%, while our volume was down 10.1%. 4% of the industry decline was due to new category poly usage, with illicit vapor contributing 2.5% of this. Our U.S. financial performance improved throughout the year, driven by a strong performance in combustibles versus 2023. Adjusted operating profit fell 3.5% due to lower combustible volume and commercial spending. Tadeu will provide further U.S. updates later. Moving to AME, AME is a multi-category region, with smokeless revenue now making up 24% in markets where we are present in new categories.

11 of those markets now generate over 50% of their revenue from smokeless products. Revenue grew nearly 5%, driven by higher combustibles revenue supported by solid volume and strong pricing, and double-digit new category growth, with modern oral up 47%. Vapor revenue declined, mainly due to Canada, and adjusted operating profit rose 7.5%, as scale benefits in new categories and cost efficiencies offset inflation. In APMEA, growth improved in H2, and smokeless now represents 20% of revenue in markets where we are present with new categories. Total revenue grew by 5.4%, with combustibles up 3.5%, driven by pricing gains, partly offset by the declines in Australia and supply chain disruptions in Sudan. New category revenue grew nearly 9%, led by vapor and modern oral gains in emerging markets, and heated products benefiting from innovation and lapping Japan's prior year commercial plans.

Adjusted operating profit increased 7.5%, supported by pricing and improved performance in Japan, asset sales, and efficiency gains. Now, the group operating margin was flat, as we offset inflation and forex pressures with higher new category profitability and cost savings. BAT has a strong track record in delivering cost savings. Having achieved close to GBP 900 million in savings over the last two years, we are on track to deliver more than GBP 1.2 billion by year-end. These savings helped offset inflation and forex impacts while funding quality growth investments. In 2024, we absorbed GBP 390 million in inflationary costs and 1.1% transactional effects headwinds on adjusted operating profit. Inflationary pressures are expected to ease this year. Beyond 2025, we aim to simplify combustibles and drive scale benefits in new categories, targeting an additional GBP 2 billion in savings by 2030. EPS grew 3.6%.

Gains from lower net finance costs and share count were partly offset by our reduced share of ITC profits and tax. The underlying tax rate was 24.9%, and we expect around 25% in 2025 based on prevailing rates. Operating cash conversion exceeded 100% for the fifth year, reflecting our strong cash discipline. In 2025, we anticipate GBP 650 million of gross CapEx and GBP 1.8 billion net finance costs adjusted for Canada. Our debt profile is strong, with 87% of our net debt fixed, with average maturity of just under 10 years and close currency matching. We reduced leverage to 2.4x, which adjusted for Canada would be 2.75x. We expect to be back within our target leverage range of 2x-2.5x post-court approval and implementation of the proposed plans by the end of 2026.

We support the proposed CCAA settlement, which maximizes value for claimants while securing our continued operation in Canada. In accounting for the proposed settlement, we will continue to fully consolidate our Canadian business in accordance with IFRS. We have recognized a GBP 6.2 billion provision in our 2024 reported results, and this is treated as an adjusting item in line with our accounting policies. In order to ensure that the P&L reflects the economic delivery from Canada, from 2025, we will report APFO adjusted for Canada. Now, due to the uncertainty of the timing of the settlement in 2025, our non-GAAP reported numbers will remove 100% of our Canadian business, excluding new categories, with 2024 comparators provided on the same basis in the appendices. It is important to note that we will continue to fully consolidate our revenue in Canada. Subject to the settlement conclusion in 2025.

From 2026, we will adjust to remove 85% of our Canadian APFO in line with the charging schedule, excluding new categories, which we will reduce to 80% five years post-settlement and 75% ten years post-settlement. After six years in CCAA protection, we are pleased to have reached this stage, and our accounting treatment set out today is based on the current status of the proposed plan. We are hopeful for a swift resolution and remain committed to our capital allocation priorities. BAT is a highly cash-generative company, and we are expecting to deliver over GBP 50 billion of free cash flow between 2024 and 2030. We remain committed to our capital allocation priorities of, firstly, reinvesting in our transformation, whilst balancing deleveraging and progressive dividends and sustainable share buybacks and selective bolt-on M&A to accelerate our transformation. Looking ahead, we expect significant headwinds in Bangladesh and Australia.

In January, the interim government in Bangladesh increased VAT and supplementary duty on over 100 essential products, including tobacco. Excise has risen sharply, coupled with above-inflationary floor price increases across all categories, which is expected to accelerate illicit trade. In Australia, new tobacco regulations representing the biggest reform since plain packaging in 2012 will come into effect from April the 1st. In addition, recent ad hoc excise increases, most recently last September, are already accelerating industry volume decline. Last year, illicit trade was up 6 percentage points to 36% of industry volume, while smoking incidence have remained stable for the last five years. Combined with the vapor incidence, which are currently at 9%, this means that around 65% of nicotine usage in Australia is illicit.

Looking forward, we expect this ineffective government policy to further accelerate legal industry volume decline, and coupled with the announced incremental impact of another excise increase in September to continue to significantly fuel illicit trade. Together, we expect these two headwinds, both in Australia and in Bangladesh, to impact our 2025 group revenue growth by 1% and group APFO growth by close to 2%, with the January budget in Bangladesh being the main driver of change since our December trading update. As a result, and including these impacts, in 2025, we expect to deliver revenue growth of around 1%, supporting APFO growth of 1.5%-2.5%, adjusted for Canada and including a 1.5% transactional effects headwind. The key drivers are an improving U.S. financial performance, returning to growth despite continued macro and illicit trade headwinds, another solid AME performance, and further strong growth from Velo globally.

Alongside the expected launch of exciting innovations for all three new categories throughout the year, we expect to grow APFO ahead of revenue, supported by continued strong new category growth contribution and a laser focus on ROI and further cost savings. We expect our group performance to be second-half weighted for both revenue and profit as we deploy our new category innovations throughout the year, with our first-half performance reflecting progress in the U.S., driven by combustibles and modern oral, offset by combustible headwinds as described in APMEA and the continued lack of enforcement in the U.S. and Canada, together with the Mexico vapor ban. As highlighted at our Capital Markets Day, we will continue to track key KPIs across all pillars to measure our transformation success. In summary, 2024 was an investment year, and I'm pleased to see our progress reflected in our key metrics.

We have deployed dashboards across business units to enhance decision-making. These dashboards focus on our transformation to deliver long-term growth, return on investment to ensure financial discipline, and cash flow and leverage to maintain financial strength. I am confident these metrics will help us create a sustainable shareholder value, and with that, I'll hand it back to Tadeu.

Tadeu Marroco (CEO)

So, thank you, Soraya. I would now like to spend a few moments outlining the pathway ahead. BAT is transforming. With our multi-category strategy and global footprint, we are well-positioned in a growing industry. I believe we have the right strategy, the right capabilities, and the right people to deliver a profitable transformation, while delivering strong returns to shareholders and making progress towards our vision of building a smokeless world.

At our Capital Markets Day in October, I shared these ten key reasons why I fundamentally believe in the future growth prospects of BAT. Many of the broader themes have been touched on by Soraya, and I would like now to share some additional color on our confidence in these six key areas highlighted in the slide. First, BAT is well-positioned within the value of the nicotine industry growing at an accelerated pace as consumers around the world increasingly switch to new categories. Second, we have transformed our entire innovation ecosystem. This has allowed us to step-change our product portfolio based on our consumer insights. We have developed an exciting innovation pipeline across our new categories that we will deploy in a target way through 2025.

As highlighted at our CMD, glo Hilo is a breakthrough system that we believe will reshape the way glo is positioned in the category, allowing us to compete effectively in the premium segment that represents over 80% of industry value. We launched our first two-piece premium device in Serbia in November. We are collecting insights and learnings, and we are encouraged by the results in the markets to date. Hilo and our new consumables, Veo and neo, are resonating well with the majority of acquired consumers new to the glo brand family. We will share further updates as we continue to roll out this exciting new platform from mid-2025. In vapor, Vuse Ultra will be our initial step in offering consumers premium vapor products, an untapped opportunity representing just 3% of vapor category value today.

Vuse Ultra is a new vapor solution delivering a responsible, high-quality, and satisfying experience for vapor consumers and positioned Vuse as a brand that consumers can trust. Our targeted rollout plans are commencing this quarter in Canada and will continue through the year. Modern Oral in the U.S. continues to grow strongly, and I'm pleased by the progress we are making with our existing portfolio, as highlighted by Soraya. Looking ahead, I'm excited about our portfolio expansion with VELO Plus, which we launched at the end of last year in seven flavors and two nicotine strengths. VELO Plus is a higher moisture product, and we are delivering very encouraging early results, including strong uptake driven by adult consumer demand and trial with our total volume share of modern oral above 10% in the latest reading.

We will continue the rollout through the first half with a full activation plan across retailer, media, and digital platforms. My next reason to believe is demonstrated by the growth and delivery of our business in Europe, where more than a third of total nicotine consumers are actively using new categories. Driven by our quality growth focus, our new categories have been game changers for our delivery in Europe, as illustrated in these charts. New category growth has both enabled our European business to exceed our group midterm revenue guidance and also enabled significant increases in absolute category contribution through scale and efficiencies. The next reason to believe is our U.S. business, which remains the cornerstone of our future. As we highlighted at our CMD, one-third of the global adult nicotine value pool is located here, with the industry continuing to grow at pace.

I'm encouraged that our investment approach, taken over the last 18 months to strengthening our business, is working. In combustibles, we have expanded our contracted distribution universe to 88% coverage, resulting in a 3.2 percentage point increase in volume share in these newly contracted outlets, with share gains across our brand. In addition, this has led to a 1.2 percentage point decline in the deep discount segment in these outlets. In premium, we have invested in Newport Soft Pack in key investment states, creating a layered portfolio. Alongside these, we have driven consistent value share gains in both the premium segment with Natural American Spirit and in the branded value segment with Lucky Strike, which remains the fastest-growing cigarette brand in the market. A key feature of our industry in recent years has been the strength of the deep discount segment, as consumers look to make their dollars stretch further.

In 2024, we have seen a slowdown in deep discount volume growth. At the same time, the branded value segment has grown volume share, with BAT increasing its segment share led by Lucky Strike. While the lower-end adult consumer clearly remains under pressure, we believe these segment dynamics, alongside improved consumer confidence levels, demonstrate some early indicators of progress towards recovery, which would provide a tailwind in the medium term. Moving forward, in order to have an even sharper view of market performance, we are switching to our retail sales data share read, with enhanced coverage, improving both decision quality and decision speed, which we expect will support us in sharpening our execution. We are beginning to see returns on our completed previously planned investments in the U.S. as we move towards value creation. Our total volume share stabilized in 2024.

Excluding the deep discount segment, where we are not present, we grew volume share by 40 basis points. It's important to note that 95% of the U.S. combustibles value pool sits outside of the deep discount segment, and we believe we have turned an important corner with the U.S. returning to growth and look forward to continued improved delivery to our group performance in 2025 and 2026. Turning to regulation, we are encouraged by the withdrawal of a possible menthol ban and freeze of previous rulemaking as the new administration reconsiders proposed regulations, including very low nicotine. In new categories, our success in Europe demonstrates our ability to effectively compete on a level regulatory playing field, and we continue to work hard to achieve this in the U.S. by advocating for more appropriate regulation enforcement, especially in vapor. During 2024, we saw an increase in enforcement action from the FDA.

However, the success of legal products is dependent on the FDA doing more to tackle illicit vapor. To support this, we continue to advocate for the publication of a PMTA list, which would provide clarity to all market participants. In addition, the U.S. International Trade Commission continues to investigate our patent infringement complaint regarding these illicit products. At the state level, vapor directory or enforcement legislation has now been passed in 14 states, meaning that around 30% of the tracked vapor industry volume will be covered by state directories by the end of this year. Louisiana, a powerful example of what can be achieved, shows that well-constructed regulation can work, and it's paired with proper enforcement. Since implementation, the legal vapor market in Louisiana has grown volume by 33%, with a 91% reduction of single-use illicit products in tracked channels.

Vuse Alto continues to capture the majority of the volume outflow back into the legal segment. In the meantime, nationally, illicit vapor products continue to impact the legal market. We have seen this trend accelerate legal industry declines towards the end of last year, and we expect this to continue in 2025. While we are optimistic that government engagement actions will drive a more level playing field over time, we do not expect these actions to have any meaningful impact on our near-term performance. Of course, effective regulation enforcement is not just our U.S. focus. We have significant experience and capabilities in this area built over decades to connect science, corporate, and regulatory affairs towards a sustainable future. We have created Omni, which brings together scientific evidence to shift broader stakeholder perception of tobacco harm reduction.

We strongly believe that regulators should embrace tobacco harm reduction led by science and backed by robust enforcement to accelerate the reduction in smoking prevalence. Regulators who do not engage in this area will not only slow the pace of transformation that society needs, but we also see rapid growth in illegal products. Leveraging science and Omni, we are pursuing a more proactive engagement approach with global regulators, with encouraging progress on regulatory change in some areas, and we will continue to amplify our message. Now, since becoming Chief Executive, I have been clear that building on our foundations of integrity, collaboration, and inclusivity, we will drive the culture we need to successfully transform BAT. Guided by our 2030 People Strategy, we are already making great progress. We have a highly engaged and committed workforce, and our refreshed values are resonating strongly.

Our employer value proposition is attracting talent, and we are also making progress in advancing our diversity and inclusion agenda, all working towards one goal: driving a cultural transformation that enables an exciting and winning company for a better tomorrow. Finally, before we conclude, I want to share our priorities for 2025. As you can see, our first priority is our quality growth focus to ensure we roll out new innovations in a targeted way, balancing top and bottom line delivery. We are committed to driving value from our combustible business. This is key to fund our transformation, and the U.S. will be an important driver of this. We will amplify our proactive approach to regulatory affairs powered by science and Omni. All of these will be executed with a returns focus in terms of both cash generation and continue to build a track record of delivery.

In 2025, I'm confident that we will build on our investment year foundations. As Soraya has highlighted, our 2025 guidance includes significant combustible headwinds in Bangladesh and Australia. Together, these represent a 1% impact on group revenue and close to 2% on group APFO, which is already embedded in our guidance. Looking into 2026, I'm confident that we will build on our underlying momentum through 2025 to deliver 3%-5% revenue growth and 4%-6% APFO growth adjusted for Canada on a constant currency basis. We expect key drivers to include further improvement in our U.S. financial performance, supported by a less negative backdrop from industry volume, the macro environment, and more meaningful enforcement against illicit vapor. Second, quality growth driven by our new category innovations. And third, lapping the 2025 combustibles headwinds in Bangladesh and investments in our innovation rollouts.

Fourth, a step up in efficiencies with our GBP 2 billion savings programs to 2030. While there is more to do, I'm confident that we have the right strategy, capabilities, and people to deliver profitable transformation. I'm excited about the future for BAT, and I believe we will deliver long-term sustainable growth and value for all our stakeholders. Thank you for listening. We'll now be joined on stage by Victoria for the question and answer session. Victoria, please.

Victoria Buxton (Head of Investor Relations)

Thank you, Tadeu and Soraya. Good morning, everyone. If you've joined us via the webcast, you can type your questions directly into the online question box. Or if you joined the call, you can press star one on your telephone keypad. Tadeu and Soraya will be very happy to take your questions, and I will now hand over to the conference call operator.

Operator (participant)

Thank you very much, Victoria.

Today's very first question is coming from Faham Baig of UBS. Please go ahead. Your line is open.

Faham Baig (Analyst)

Good morning, guys. Thank you for taking my questions. I may take the liberty of three, please. Two clarification ones. I want to start with the U.S., please. I think you mentioned twice in your remarks that you expect a recovery in the U.S. financial performance and a return to growth despite continuing to assume a challenging environment from a macro perspective and illicit vape enforcement. So could you maybe clarify some of the factors that will result in the U.S. growing? And I presume that means revenue growth and profit growth. I'd like to start there.

Tadeu Marroco (CEO)

Yeah, you're right, Faham. Our expectation is that the U.S. goes back to growth. We have three difficult years in combustibles since 2022, 2023, 2024.

The last two years are basically an investment year for us to get back where we should. We fixed and we invested in a number of areas that I described in my presentation. Obviously, we'll be lapping a lower base in 2024. This is one of the reasons why we will be having the comparator will be a lower base in 2024. And also, we will be building on the positions that I just showed in terms of where we stand in terms of market share. We have great momentum behind the Lucky Strike brand, but also Newport has stabilized and now with all the litigating that we have done.

And we believe that with the expansion in the trade coverage that I referred to, plus capabilities on the digital sides that we have been investing, we have more an expectation that we'll be back to the positive territory in 2025. On the new categories, obviously, Velo Plus is doing extremely well. And as I mentioned, this will be very supportive of the progress in the categories in the U.S. The concern we have, as I described it, we are not expecting major change in terms of the dynamic of the legal vapor market. This will be a headwind in 2025 that we hope that we can cover through the new categories in modern oral specifically. So overall, we expect the U.S. being back on growth from 2025 onwards.

Faham Baig (Analyst)

Thanks, Tadeu. And maybe I'd like to spend a bit of time on Velo Plus.

Could you clarify that volume share for Velo was 10% in the latest reading? And what would that number be for, I guess, just Velo? And maybe if you could share some insights into where are we on distribution for this product? Where do we expect it to go? Where are we on capacity? And I'd like to get your view on how you view moist and, I guess, wet pouches versus the existing dry offerings in the U.S. What type of consumers is it attracting? And do you think the U.S. consumer is willing to switch from dry to wet?

Tadeu Marroco (CEO)

Okay. So out of the above 10%, slightly above 10% that I was referring from the latest reading, Velo Plus accounts for something close to 7%, 7% of this number.

The Velo Trifecta, that is the internal project that we call the refreshed Velo launch last year, accounts for 3%-3.5%. What we have been seeing in terms of the Velo growth is that no more than 30%-35% is coming from our previous Velo. The majority is coming outside the previous Velo, which in New York we are getting close now to 20% reading when you consider both the Velo Plus and the previous one. Obviously, the biggest feature of Velo Plus is the moisture. We see that this resonates with all types of consumers because we are using higher moistures outside the U.S. in markets where we have traditional oral, i.e., consumers coming from snus and some other oral products and consumers that are coming from cigarettes or vapers. Moisture is a key feature and is the main driver behind that.

We have now established our presence around 75,000 outlets in the U.S., and we plan to get to 110 outlets from April, actually, which is the second quarter of the year.

Faham Baig (Analyst)

Brilliant. That's super clear. And then one question, I guess, probably a clarification. I do want to go back to Bangladesh and this sort of one percentage point profit impact that you're facing from Bangladesh. I guess I want to take you back to two years, and I want to take you to Pakistan where you had, I guess, an even larger excise tax increase, an even larger price increase. Volumes were down 33% in 2023, but your profits, if I'm not mistaken, in local currencies actually grew 33%. So why is Bangladesh different? Why are you anticipating profits to decline in that market with this price increase?

Tadeu Marroco (CEO)

Yeah, let me tell you about Bangladesh.

Normally, you'll see an excise policy every mid of the year, June, so what happened is that the government, in the pressure to raise tax collection, they decided to do an ad hoc increase, not just in cigarettes, but they increased VAT and duties over 100 products, including cigarettes, and then a specific excise increase in all tier points, including the above inflation, the floor price, so it's a question of really affordability because consumers were already struggling, as many other consumers in the world, with the cost of living, food price increase, inflation of food price, and then on top of that, had to face a 100 products increase in price, and we had to increase across the board the price of cigarettes to cope with those excise increases. Now, this is most of the 1% impact. There is also the Australia case that we highlighted.

But what we saw, and Pakistan is a good example, when geographies go too far in terms of excise shocks, they will reflect that this is counterintuitive in terms of their desire to increase tax collection because what happened is exactly the opposite in the second year. After the establishment of a legal market, government tried to mitigate and take some actions to avoid this from happening. This is our working assumption for 2026 that we'll be lapping 2025 and not getting even further the impact in 2026 related to that because the government in Bangladesh, 10% of overall tax collection is coming from tobacco, which means that they are very reliant on that. They cannot afford to see the spread of illegal markets across different years. That's where we talk about the lapping in 2025.

Faham Baig (Analyst)

Thanks, Tadeu. Appreciate that. Okay.

Operator (participant)

Thank you very much for your questions, Mr. Baig. We'll now move to Rashad Kawan of Morgan Stanley. Please go ahead. Your line is open, sir.

Rashad Kawan (Analyst)

Hey, good morning, guys. Thank you for taking my questions. Two for me, please. So first one, I know it's still relatively early, but you reiterated your getting to your midterm guide by 2026. I guess what gives you confidence in being able to achieve that? How much of an improvement does that assume in U.S. combustibles volumes and enforcement and illicit vapes? And then second question, talked about sustainable buybacks again today. And again, as you think about 2026, should we assume buybacks will continue irrespective of the Canadian settlement? I know you obviously have some flex from the ITC Hotels stake, but potentially, could you also look to monetize more of the ITC stake there to fund future buybacks?

I guess just any thoughts around how that fits within your capital allocation priorities would be helpful. Thank you.

Tadeu Marroco (CEO)

Okay. Thank you for the question. I'm going to leave Soraya to talk about the capital allocation question. On the 2026, well, we just spoke about Bangladesh, which accounts for most of the 1%. The underlying revenue growth of 2025 would have been around 2%, which is pretty much in line with what we have in mind in this journey towards our midterm algorithm in 2026. So like I just explained with Faham's question, we believe that we'll be lapping that in 2025. And the other point is obviously we have invested into a completely reshuffle of our innovation ecosystem during 2024. And the reason why we call 2025 a deployment year is that throughout the year, we'll be launching these new initiatives.

glo Hilo, for example, is a very different product than the one that we have currently. So we will increase substantially our competitiveness in tobacco heating products. Velo Plus in the U.S. now complements already a very successful and winning product that we have outside the U.S. in the fastest growing new category in the world today, which is modern oral. It's growing incidence and growing everyday consumption everywhere that we launch this product. And we are clearly a leader in that space. And also vapor, we will be working in terms of establishing a premium, creating actually a premium subcategory within vapor with our new product. So when you come to 2026, you'll have all these products already in the market. So we'll have a full year benefit of those products that will come throughout 2025. So that's another reason.

And the U.S., we expect to see a more supportive macroeconomic environment that will resonate better in terms of low-income consumers that has been impacted heavily over the last few years with very high levels of inflation, interest rates. So we expect throughout 2025 to see those macroeconomics being more supportive for the low-income. And we really believe that the new administration will try to address a massive problem that we have today in the U.S., which is the proliferation of illegal vapor products that today accounts for more than 7% of the total vapor market in the U.S. because this is not really benefiting anyone. It's not benefiting the U.S. consumers that are not having access to latest innovative smokeless products. It's not benefiting states that could have been collecting tax.

It's not benefiting consumers that don't have access to high-quality products that nobody knows exactly what is in those products. And the legal players because we don't have a level playing field. So I do believe that. Now, obviously, how much of those improvements is that's why we put the range between 3%-5% revenue, 4%-6% operating profit is exactly to cope with those ranges. If it's going beyond our expectation, we'll be more in the high end of the range. If it's less of our expectation, we'll be in the lower end of the range. But we'll know more of that as we go along in 2025.

Victoria Buxton (Head of Investor Relations)

Can I just make an addition? Today, we referred to the revenue impact on 2025. So 1% from Bangladesh and Australia, whereas on APFO, there is a 2% impact.

So if you think about that in terms of our 1.5%-2% guidance, then on an underlying basis, it will be 3.5%-4.5%. Okay. Just taking your question on sustainable buybacks in 2026, as Tadeu mentioned, we will be back to our 3%-5%, 4%-6% growth algorithm in 2026. And as I mentioned earlier in the presentation, excluding Canada takes us to a leverage of 2.75x. So looking in terms of capital allocation in 2026, we will aim to get back into our leverage corridor of 2%-2.5%. And we will continue to balance cash returns between basically our progressive dividend policy. We announced 2% this year, and we will continue with this policy because having met a lot of our shareholders, I know how much they value the dividends. But we will also look at we will be generating enough cash.

I think I mentioned in the CMD, once we reach our midterm algorithm, we'll be generating around GBP 8 billion of cash per annum. So we will have sufficient to be able to balance the progressive dividend policy with a sustainable buyback, share buyback. So in answer to your question, yes, we will be looking to maintain. I'll remind you that we've just completed a GBP 700 million share buyback, and we are committed to doing the share buyback of GBP 900 million this year.

Rashad Kawan (Analyst)

Thank you very much. Very clear.

Soraya Benchikh (CFO)

Thank you, sir.

Operator (participant)

We will now move to Gaurav Jain, please. Please go ahead.

Gaurav Jain (Analyst)

Hi, good morning. Tadeu, good morning, Soraya. Three questions from me as well. So one is, you know, on the ITC Hotels stake, you own directly 15%, I think, of that company. What would be your plans for that? Okay.

Tadeu Marroco (CEO)

As I have referred to in the past, Gaurav, BAT has no interest to become a long-term shareholder of a hotel chain in India. And as a consequence, in the right moment that will be decided where is the best moment to maximize shareholder value, we will be divesting and we will be using proceeds to making sure that we get to the leverage corridor of 2.5% by 2026. Sure.

Gaurav Jain (Analyst)

Thank you. The second is, you know, just on heated tobacco, and I hear the comments that, you know, there's a new platform getting launched this year. But, you know, I mean, and I know there was a divestiture of Russia and Ukraine, which has impacted reported numbers the way we see it.

But if we just look at, you know, the APMEA numbers, which largely is Japan and Korea, you know, it is like flat when competitors have clearly grown much, much, you know, higher. So do you believe that you will be able to accelerate this growth to, you know, in line with market growth? Yeah.

Soraya Benchikh (CFO)

Is HP?

Tadeu Marroco (CEO)

Yes. Yeah. What happened in Japan across 2024, we used to have a legacy system there, which is a Super Slims product. And this system got completely replaced by glo Hyper, basically. And we actually increased price in order to accelerate this migration from the Super Slims to the Demi Slim, which is the whole glo Hyper. So as a consequence, you haven't seen much difference in terms of the volumes, the revenue increase.

But at the end, we know that glo Hyper Pro is a much more attractive platform than the previous Super Slims that we used to have. They have a higher retention. They have an average daily consumption, which is higher and resonates in terms of brand attributes with consumers in a much better way than the previous one. So that's basically the story in Japan in 2024 in Hyper. And this impacts the whole region performance because most of the HP in the regions coming from Japan. And obviously, with the glo Hilo, as we said, this is not happening until the middle of the year.

But in the second half of the year, we expect to complement the offer that we have today with a much more improved and our expectation is that we're going to be in a much better position to make more better inroads in terms of category share of the tobacco heating products.

Gaurav Jain (Analyst)

Sure. And the last question is on the U.S. So, you know, this year, you know, after 2024, your revenue has declined 3.5%. And, you know, your cigarette volume is down 10%. Your revenue is down 4%. So your price has clearly lagged, you know, what the industry leader there was taking. So when you are saying that FY 2025 U.S. revenues will be flat, it's more or less that now the pricing on combustibles will start aligning with the industry leader. Is that how I should think about it?

Tadeu Marroco (CEO)

Well, we cannot talk about pricing, Gaurav, in the.

But like I said before, we'll be lapping a weaker comparator because we had to do the investments that we referred to. And we had to ladder brands to make it more adapted to the reality of the U.S. consumer. And this all has an implication in terms of the top line of the company. But the important thing is that all these initiatives now have been concluded. And then we start in 2025 with a different dynamic.

Gaurav Jain (Analyst)

Thank you so much.

Operator (participant)

Thank you, Mr. Jain. We will now move to Rey Wium of Anchor Stockbrokers. Please go ahead.

Rey Wium (Analyst)

Good day, Tadeu and Soraya. I just want to maybe quickly focus on the Canadian situation. First question, I just want to know whether the annual settlements that will come through, and I appreciate it's a bit early, but will those be tax deductible for BAT Canada?

Victoria Buxton (Head of Investor Relations)

Sure.

Currently, I mean, it's only a proposed plan. I'm sure you can appreciate the scale and complexity of the settlement. But our current early interpretation is that they will be tax deductible. But obviously, we'll get further clarification once the settlement is done.

Rey Wium (Analyst)

Good. Now, the other interesting question that I have is the total settlement amount of it is CAD 32 billion. Obviously, it needs to be, you know, paid over the years through profits. Is there a minimum liability that you face? Let's say, for instance, you know, the cigarette industry, you know, declines at such a rapid rate that Canada goes smoke-free, let's say, after 10 years, and the total payments, let's say, have amassed to about CAD 20 billion. Is there a top-up that you will need to do, let's say, for industry-wise for the other CAD 12 billion, for instance?

Victoria Buxton (Head of Investor Relations)

No, there is no minimum liability. The provision that we've made in the accounts this year of GBP 6.2 billion is basically split into two amounts. The GBP 3.7 billion is obviously our estimate of the liability, and GBP 2.5 billion is the current cash that we hold. But obviously, depending on the evolution of the industry, that's what will be paid out. But this is our best estimate is the GBP 3.7 billion, obviously on a discounted basis.

Rey Wium (Analyst)

Excellent. And have you sort of finalized what your share will be of these payments, you know, between the main industry players?

Victoria Buxton (Head of Investor Relations)

As I said, it's our current estimate. It's our current estimate of what the liability would be. And the next milestones in the case is by the 3rd of March, the judge needs to either approve the plan or we're back into negotiation.

And then we have a 21-day window for appeal where the judge needs to approve the basis for the appeal. That's basically the next steps. But under IFRS, we'll do that. Sorry, go ahead.

Rey Wium (Analyst)

Yeah. I just want to quickly touch on the situation in Australia. You know, the market has declined at a material rate in recent years. I mean, I think, you know, based on what your competitors said, the market was like basically five billion sticks in 2024. I just want to know up to what, I mean, is Australia still profitable for you? And, you know, how long can you continue to operate in such a diminishing market until you, you know, maybe decide also to exit that market?

Tadeu Marroco (CEO)

Yeah. Look, it's clearly the youth tobacco policy, you know, that we are seeing in real life.

And unfortunately, in this case, I think that Australia has become one of these outliers in the world. Like we said today, 65% of nicotine consumption is already legal in Australia. You can count on a handful of your fingers what are the countries that you can find this type of very, very extreme case. And we hope that this will be at a certain point recognized by the authorities and they can make something about that. Because at the end of the day, it's not just about tax collection that's reduced dramatically, but also we know that these illegal activities always come together with other criminal activities.

And on top of that, for example, what's happening in vapor, where basically 100% is illegal, you lose completely control in terms of access to youth, in terms of what consumers are consuming because these products are completely with a very doubtful type of quality standards. So we hope that the government will wake up for that and take some action related to that. And that's the reason why we are still supportive of the country, of our people there. Obviously, it's still profitable. Otherwise, we wouldn't have had this impact in our numbers in 2025. But the reality is that we are in the hope that these things can change as soon as they can understand what the reality is.

Rey Wium (Analyst)

Okay. Thank you very much.

Operator (participant)

Thank you. Great question, sir. We'll now move to Damian McNeela of Deutsche Numis. Please go ahead.

Damian McNeela (Analyst)

Hi. Morning, Tadeu. Morning, Soraya.

I know we've had a couple of questions already on the U.S., but I just wanted to clarify because I think some of the things that need to go better for you in the U.S. are a function of things that are outside of your control, like U.S. consumer and the illicit trade. I just wanted to clarify in your FY 2026 sort of return to the sort of the growth algo at the bottom end of the range, that's being driven by everything that you can control in the U.S. But at the top end of the range, that would benefit from things that are outside of your control is the first question. Second question is on, can you provide any quantitative or qualitative data around what drove the improvement in new category profit contribution in the period by sort of subcategory, please? And they're my two questions.

Tadeu Marroco (CEO)

Yeah.

Thank you, Damian. Look, the first question doesn't work precisely like that, but I was trying to articulate in line with what you are just describing. And our numbers in 2026 will be, you know, easily within the range or at the top of the range if we see a proper meaningful enforcement on the vapor business, for example, an improvement in the macroeconomics. But like I said, we are already expecting 2025 to be for the U.S. to be turning to the corner into a more supportive business for the rest of BAT. So we believe that we can deliver the range of 3-5, 4-6 in 2026. And we expect that if we are surprised for better enforcement, better macroeconomics than we have in our plans, that we actually could be more in the upper side of the range. You want to take it there.

Victoria Buxton (Head of Investor Relations)

In terms of the improvement on the new category profitability, if we look at the main drivers, firstly, we've supported the top line with RGM going forward. And also, we've been able to optimize our cost of sales by driving scale. And as a result, you'll see in the results that we've actually accreted our gross margin in new categories by 500 basis points. Further down, getting to contribution, we've also been able to work on our return on investment by focusing on the largest profit pools, so reallocation of resources on the largest profit pools. But also, we've been driving throughout the business, across all the business unit dashboards with data analytics to support decision-making and a marketing spend effectiveness program, which we've begun to roll out and hopefully throughout this year will roll out throughout the group. And that's really been supporting the delivery and contribution.

As you will have seen, we've delivered over GBP 250 million in category contribution. We're up to 7%. And there's a lot more to come. We'll continue on this trajectory enhancing contribution. If I had to highlight some of the categories, I think in HP and heated tobacco products, we drove particularly a better contribution there through RGM, as I said, supporting the top line and taking some pricing, but also reducing losses on devices and benefiting from scale. Modern Oral, as you know, is a highly profitable category. And vaping, we continue to work on the profitability by focusing on the premium side of vaping while we roll out our innovations going forward.

Damian McNeela (Analyst)

Very clear. Thank you very much.

Operator (participant)

Thank you, Damian. Ladies and gentlemen, today's last audio question, or people who have dialed in from their phone, will be coming from Richard Felton of Goldman Sachs. Please go ahead.

Richard Felton (Analyst)

Thank you very much. Good morning. Three questions from me, please. The first one is on the illicit vapor category outside of the U.S. I'd be interested to know any thoughts or observations on what you're seeing across your markets in terms of the growth of illicit vape. I know there's a lot of attention on the U.S., but are there any other markets which are following a similar pattern? And does that have any implications for your appetite to invest in that category? Second question, is there anything on your guidance in terms of phasing that you can call out? I know in the statement you say second half weighted, but is there any quantification that you can provide around that? And then the third one, apologies if I've missed it, but could you just remind us what the new tobacco regulation actually is in Australia? Thank you.

Tadeu Marroco (CEO)

Okay.

Illicit vapor category, the biggest problems that we are facing nowadays in terms of, even though because of the size of the vapor market, is basically U.S. and Canada. Canada, remember that Quebec has announced the ban on all flavors other than tobacco, but without any enforcement. And then the following day is exactly the same situation that you see in the U.S., all these illegal products coming in with all the flavors back to the market and, you know, thousands of puffs and with a completely uncontrolled in terms of the quality of the products that are being sold. But these are, I would say, the biggest two. Obviously, we have situations where things are much more under control. Go to France, for example, vapor is sold under tobacco niche. This is a more controlled environment because you have retail license.

That's why in the discussions we are having, it's happening here in the U.K., we are a very strong advocate for retail license, and hopefully, the government will do something about that in the final act related to that. We have a case of New Zealand that has been very well managed, vapor, and has a very good impact in terms of reduction of incidence of cigarettes and towards a much more controlled increase of vapors, but we also have cases like Australia that I had just spoken about, which is 100% of illegal, 9% of consumption of the population, all basically illegal vapor, or the likes of Malaysia that also have opened up, but without enforcement.

The key thing here is not about giving up on the category, even though because the category is the, in terms of if you analyze the number of consumers using these smokeless products, vape is by far the largest category and has a lot of potential to convert smokers outside cigarettes and using those that want to carry on using nicotine to a much lesser risk of doing that. But this needs to be properly regulated and with proper enforcement. And that's why I put a lot of emphasis on Omni because we want to provoke this debate in the various jurisdictions that we operate. And some of them listen to what we say. We have just seen Chile now approving vapor in the marketplace starting in a few weeks.

We want to work as much as we can closer to policymakers in order to not lose this opportunity that could have a tremendous positive impact on public health. That's where we see the illicit vapor, obviously a challenge. Our strategy related to move and creating a more premium segment within vapor also has to do with this proliferation of products in some markets where the enforcement is still not present. In terms of your question of second-half weighted, we will see the benefits of all these new launches coming more towards the second half and a lot to do with that. I spoke about the glo Hilo. The glo Hilo is the first opportunity that BAT has actually to participate in the premium side of tobacco heating products category. This will be accretive, obviously, for the company.

But this is all coming in the second half of the year. And so the other innovations we spoke, you know, Velo Plus is doing extremely well. Obviously, when it comes to the second half, they will be more established in the market. So this also will be supportive. So these are the reasons why we expect because most of the revenue, and going back to the 3%-5%, 4%-6%, is being driven by new categories, has been the case now for some time in BAT. We have spoken about this before. Out of the revenue, combustible needs to give us between zero, flattish to 2%. All the balance will come from the new categories. And it's more or less the same when we talk about the APFO line and between 1%-3%. Most of the difference will come from new categories.

This is one feature that we'll be seeing more and more moving forward as new categories become more and more relevant in our business. The new legislation in Australia is the highest, it's the biggest change that happened since the plain packaging was introduced in 2012. It encompasses a number of things in terms of new health warnings through the stick, different pack formats that have been eliminated, for example. Obviously, together with the continuation of this ad hoc excise on top of the inflationary excise that happened in the first half of the year. This is obviously the legal/illegal market doesn't have any of that. That's one of the reasons why illegal is creeping up big time in Australia. Now, just to put, I would like to use this as an opportunity just to invite you all to have a more holistic view.

Now, because obviously there will always be some problems here and there, but there are a lot of opportunities as well. The fact that BAT has the strength of having a multi-geography and multi-category portfolio helps us to mitigate some of those pressures that happen in some locations. We saw this all the way back in the COVID where all the other two regions suffered a lot that were supported by the U.S. that did extremely well. More recently, with the U.S. going through an investment phase and the other two regions like we highlighted today in the 2024 results stepping up, the fact that combustible going through a hard time and being compensated by the new category. So this is a dynamic that a company like BAT has all the possibilities to navigate through it.

I'm very confident that with all the foundations we create in 2024 and being in transition in 2025, we'll be able to go back to 2026. The beauty, and we spoke about Canada, at a certain stage we would have to have a deconsolidation of Canada. We could never deconsolidate Canada due to our FRS. We have explained this before. This will be at a certain stage, this would be happening at a certain moment. We decide to do this right now in 2025 because we believe that hopefully we are close to a solution that could come in 2025. The clouds are dissipating. We used to have a U.S. menthol ban that looks more and more distant, U.S. low-nic cap that looks more and more distant.

If any time will come back or not, I have very doubtful on that because this is actually in effect is a tobacco ban, effectively a tobacco ban in the U.S., which this administration will never agree with that. We had a lot of doubts about our ability to make money out of new categories when we have more than GBP 1 billion of loss in the P&L. Today, we have a 7% operating margin in new categories. Just in four years, a swing between GBP 1.1 billion loss to GBP 0.3 million of positives. We have built a leader brand in Modern Oral, in the fastest growing new categories that we have. We have revamped completely our innovation portfolio, have a much more competitive product in heated tobacco product that we start to make a difference from 2025 onwards.

And we also have a very well-established vapor business that if we address the enforcement elements that we were speaking about, this will be putting us in a very leading position to benefit from that. And obviously, the leverage has been a concern and we have demonstrated that we can leverage the company to the targets that we need. So I would like to invite you to have this holistic view because I think that this is quite important.

Victoria Buxton (Head of Investor Relations)

Thank you, Tadeu. I'm afraid that's all we have time for today. If your question hasn't been answered, then please don't hesitate to contact the IR team and we will help you directly. But I'd like to hand back to Tadeu for some closing remarks.

Tadeu Marroco (CEO)

Thank you all for listening today and for your questions. To close, I'm pleased that we have delivered 2024 results in line with expectations.

While there is still more to do, I'm confident the investment actions we have taken are the right way forward for BAT as we build our momentum through 2025 to deliver our medium-term algorithm in 2026. We will continue to reward our shareholders through strong cash returns, including our progressive dividend and sustainable share buyback, and build on our foundations to deliver long-term growth and value creation. Thank you again for joining us, and I look forward to update you on our progress at our half-year results.