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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, and welcome to the Philip Morris International Fourth Quarter 2020 Year-End Earnings Conference Call. Today's call is scheduled to last about an hour, including remarks by Philip Morris International management and the question-and-answer session. [Operator Instructions].
I will now turn the call over to Mr. Nick Rolli, Vice President of Investor Relations and Financial Communications. Please go ahead, sir.
Welcome, and thank you for joining us. Earlier today, we issued a press release containing detailed information on our 2020 fourth quarter and full year results. You may access the release on www.pmi.com.
A glossary of terms, including the definition for reduced-risk products, or RRPs, as well as adjustments, other calculations and reconciliations to the most directly comparable U.S. GAAP measures and additional heated tobacco unit market data are at the end of today's webcast slides, which are also posted to the website. Unless otherwise stated, all references to IQOS are to our IQOS heat-not-burn products. Comparisons presented on a like-for-like basis reflect pro forma 2019 results, which have been adjusted for the deconsolidation of our Canadian subsidiary, Rothmans, Benson & Hedges, Inc., effective March 22, 2019.
Please also note that the growth rates presented on an organic basis reflect currency-neutral underlying results, and like-for-like comparisons where applicable.
Today's remarks contain forward-looking statements and projections of future results. I direct your attention to the forward-looking and cautionary statements disclosure in today's presentation and press release for a full review of the various factors that could cause actual results to differ materially from projections or forward-looking statements.
Please also note the additional forward-looking and cautionary statements related to COVID-19. In addition, please be aware that today's remarks and question-and-answer session will focus on the performance in 2020 and the outlook for 2021. We plan to address the outlook beyond 2021 at our Virtual Investor Day next week on February 10.
It's now my pleasure to introduce Emmanuel Babeau, our Chief Financial Officer; Andre Calantzopoulos, our Chief Executive Officer; and Jacek Olczak, our Chief Operating Officer, will join Emmanuel for the question-and-answer session. Emmanuel?
Thank you, Nick, and welcome, ladies and gentlemen. I hope everyone listening to the call is safe and well. Our business delivered a robust performance in 2020, despite the unprecedented challenges of the global pandemic. Most impressive was the continued strong growth of IQOS, which made up over 10% of our volumes and almost 1/4 of our net revenues for the year.
The daily consumption of HTUs by IQOS user saw minimal impact from social restriction, and despite significant constraint, we were able to continue acquiring new user in switching from cigarettes at a very good pace to reach a total of 17.6 million, of which 12.7 million have switched to IQOS and stopped smoking.
HTU shipment volumes grew 28% compared to the prior year, with record market shares in key IQOS geographies in Q4. Moreover, 10 markets exited 2020 with double-digit national share in December. Our rate of user acquisition was again strong in Q4, propelled by the increasing sophistication of our digital commercial model and the positive word-of-mouth effect from this increasing prominence, despite tighter restriction in a number of markets.
The most significant pandemic-related headwinds we faced were in the combustible business, with the highest impact in Duty Free and Southeast Asia, where we also faced additional challenges in Indonesia due to the excise tax structure. The least impacted region was the EU. While the timing and duration of the recovery remain uncertain, we expect a rebound in industry volumes over the next 1 to 2 years as the pandemic recedes.
Despite these challenges, our operating margins were again significantly ahead in the fourth quarter and the full year. This reflects the increasing weight and profitability of IQOS and the delivery of our 3-year cost efficiency target 1 year ahead of schedule, which also enables reinvestment in the business. This drove excellent EPS growth and cash generation where we also exceeded our prior targets.
From a product standpoint, we broadened our smoke-free portfolio with a wider range of consumables, such as heat dimension and HEETS, and the launch of IQOS VEEV in e-vapor and lil in heat-not-burn. We also continue to make good progress around the world on the recognition of the positive impact of switching smokers to scientifically substantiated RRPs.
The FDA's modified risk tobacco product authorization of a version of IQOS was a major milestone in this regard. This was also followed by the premarket authorization of the IQOS 3 device in December.
Turning now to the headline numbers. Our full year net revenue declined by 1.6% on an organic basis. This was an exceptionally resilient performance in the context of the pandemic. We estimate that Duty Free, net of partial volume recapture in local markets and Indonesia alone, were a mid-single-digit drag on our top line growth. Despite these factors, we saw strong organic growth of 6.9% in our net revenue per unit driven by the increasing weight of IQOS in our sales mix.
Combustible tobacco pricing was plus 3.7%, reflecting solid pricing in many markets, partially offset by headwinds in Indonesia. Excluding Indonesia, combustible pricing was around plus 6%. Despite the decline in organic net revenue and combustible volumes, our adjusted operating income margin increased by 240 basis points on an organic basis. This reflects the positive impact of IQOS on both our gross margin and the ratio of SG&A to net revenue, which I will come back to. The resulting 7% adjusted diluted organic EPS growth exceeds our previous guidance of around 6% and also reflect a strong end to the year in Japan.
This brings me on to the fourth quarter, which had very similar dynamic to the full year. Organic net revenue declined by 3.5%, while a significant improvement from the decline of almost 10% in Q2, continued weakness in Indonesia and Duty Free and the lower total market in the Philippines, including price increase effect, more than offset the strong performance from IQOS. Our net revenue per unit again increased solidly by 5.2% due to the same factors as the full year. Our adjusted operating income margin expanded by 200 basis points to deliver plus 7.4% adjusted diluted EPS growth, all on an organic basis.
Before we turn back to the full year, I will now expand on the strong underlying Q4 dynamic in a little more detail. Our HTU shipment volumes continued to show strong growth and reached a record 21.7 billion units driven by the EU region, Japan and Russia. In Japan, the industry was weak, as expected, as consumer and trade deloading following the October tax-driven price increase led to a 13% decline in the total tobacco market, including cigarillos. We outperformed this trend significantly as a strong finish for IQOS offtake and share gave rise to higher shipment for both in-quarter sellout and to provide appropriate inventory for a strong expected start to 2021.
With social restriction starting to tighten towards the end of the quarter in a number of markets in response to a second wave of the pandemic, combustible volumes and revenue saw some impact from reduced mobility and social occasion, albeit to a significantly lesser degree than the second quarter. Nonetheless, the strength of the IQOS business enabled the EU, Eastern Europe and East Asia and Australia region to deliver mid-single-digit top line growth.
Elsewhere, the continued challenges in Indonesia and Duty Free against a tough comparison and a lower total market in the Philippines in the immediate aftermath of a price increase weighed on revenue growth. Despite the ongoing restriction in many markets in the first quarter of 2021 and a tough prior year comparison, we expect better top line performance, which I'll come back to later.
Let me now go into the drivers of our 2020 margin expansion, starting with gross margin, which expanded by 200 basis points on an organic basis. This is driven by multiple levers.
First, our ongoing transformation is delivering an increasing mix of IQOS consumable in our business. Second is pricing on combustible. Third is our focus on overall manufacturing and supply chain productivity, which compensated for lower combustible volume, exacerbated by impact of the pandemic, in addition to inflation, investment and extraordinary COVID-related cost in our supply chain.
Gross margin expansion was augmented by our focus on SG&A efficiency, with our adjusted marketing, administration and research cost 40 basis points lower as a percentage of net revenue on an organic basis. This reflects the ongoing digitalization and simplification of our business processes, including our IQOS commercial engine and more efficient ways of working.
Clear focus on cost efficiency allows us to improve profitability, while continuing to invest in the growth of IQOS. I am very pleased to report that we have already achieved our 2019, 2021 target of over $1 billion in annualized gross savings in only 2 years, with $1.1 billion thereof delivered by the end of 2020. Over 2/3 of these savings came from manufacturing and supply chain productivity and device costs, where our focus on efficiency, quality and footprint more than offset inflation, supply chain investment, extraordinary COVID-related costs and the effect of lower combustible volumes. The remainder came from commercial efficiency and G&A cost.
Importantly, these savings do not include those resulting from the pandemic, such as reduced travel and the necessary shift of consumer to digital channels. Between higher manufacturing costs and SG&A savings such as these, we estimate a net efficiency of around $150 million due to COVID effect. We plan to elaborate further on our cost initiative and the fueling of IQOS growth at next week's Investor Day.
The strong uplift in our profitability and excellent earning growth allowed us to deliver nearly $10 billion in operating cash flow for the year, well above our expectation of at least $9 billion. This represents 3.5% like-for-like ex currency growth and also reflects ongoing working capital initiatives, an impressive performance in a year with significant disruption to global supply chain.
Our capital expenditures amounted to $0.6 billion, below our historic run rate. Significant improvement in manufacturing performance have translated into lower ongoing requirements. However, we also benefited from the timing of certain investments and expect CapEx of around $0.8 billion in 2021.
Aside from reinvesting in the business, the primary use of cash is on return to shareholders, and we raised the quarterly dividend this year to an annualized rate of $4.80 per share. Capital allocation is another topic we will cover at Investor Day.
I turn now to industry volumes, which declined by around 6% in 2020, excluding U.S. and China. This compares to the historic average of a 2% to 3% decline. We estimate the 3% to 4% difference is almost entirely attributable to the effect of the COVID pandemic on the combustible category. As is evident in our results, the smoke-free category has displayed remarkable resilience, reflecting its convenience and suitability for different use occasions.
As we have covered in prior quarters, lower daily consumption in combustible has been driven by 2 main factors. First, the reduction in usage occasion during confinement, especially in markets with a large amount of daily wage workers. And second, the reduced amount of social occasion due to closure of hospitality settings and restriction on social gatherings. Duty Free also remains depressed, in line with global travel.
We have seen a partial recovery in daily consumption since the most severe period of reduced mobility in Q2, and we expect a gradual improvement as the pandemic recedes. As we all know, there remain considerable uncertainty on the speed, shape and timing of exiting the pandemic. And at present, many countries are experiencing a serious resurgence in infections. However, based on our recent experience with renewed lockdown situation, we do not expect to see a repeat of the severe drop in consumption of Q2 2020. However, it is uncertain if any rebound will occur this year, so we assume the historic average decline of 2% to 3% to be the floor for industry trends in 2021. I'll come back to this when discussing guidance assumptions.
Turning now to our volume performance. Weak combustible industry volumes were compounded by our exposure to Indonesia and Duty Free and the over-indexing of our premium portfolio to social consumption occasions. It follows that as pandemic recedes, we should see a better dynamic in our market share, and I'll come to this point shortly. As expected, quarterly fluctuation in inventory level were even out over the year, with no significant difference between our IMS and shipments.
The clear highlight in our volume performance was the shipment of 76.1 billion HTUs in 2020. This was just above the upper end of our previously communicated 75 billion to 76 billion range and represent 28% growth over the prior year. HTU net revenues increased by plus 33% on an organic basis, partly reflecting positive mix. We remain well on track to deliver on our target of 90 billion to 100 billion units this year, and we will have more to say on the outlook beyond 2021 next week.
This strong performance from IQOS means that heated tobacco units made up over 10% of our total shipment volume in 2020 at over 12% in the fourth quarter as compared to approximately 8% in the year of 2019 and 5% in 2018. We continue to expect this proportion to grow over time as the positive momentum on IQOS continues, providing a powerful driver of revenue and margin growth.
Our sales mix is changing rapidly. Smoke-free products made up 26% of our total net revenue in the fourth quarter. IQOS devices accounted for approximately 7% of the $6.8 billion of RRP net revenue for the full year mainly due to a naturally lower ratio of new users to existing users, longer replacement cycle and geographic mix. In some geographies, we still sell a substantial amount of the lower-priced original IQOS 2.4+ device, and we have now introduced lil Solid in Eastern Europe. Focusing now on our total international market share. Our volume share increased by 0.2 points before the impact of Duty Free cigarettes and Indonesia. This was driven by higher share for heated tobacco units, which increased by 0.8 points to reach 3%, only partly offset by lower share for cigarettes.
In key markets where IQOS has a meaningful presence, our share increased with very few exceptions. However, our total international market share was negatively impacted by Duty Free and Indonesia. Marlboro remains by far the world's leading brand with 9.5% share of cigarettes in 2020. However, in many markets, it over-indexes to social consumption occasions, which are naturally lower during COVID-related restriction. Indeed, we saw aggregate Marlboro share movement tracked pandemic development over the course of the year and expect its recovery to have a similar trend.
In terms of value share, i.e., our share of total industry net revenue, excluding the U.S. and China, which is more closely related to financial performance, we estimate to be significantly above our volume share given the premium positioning of Marlboro and IQOS. We expect our value share to grow strongly in 2021 driven by IQOS. I turn now to Indonesia. After a difficult 2020, we enter 2021 with a sequentially stable share trend, supported by our leadership of the hand-rolled kretek segment, which is growing again.
New excise duty rates will come into force on February 1, with weighted average increase of around 13% for our portfolio over 2021. This is broadly in line with the average annual increase prior to 2020 and for PMI is a lower average increase in the industry given our over-indexing to hand-rolled kreteks where excise rates are unchanged. Given these higher-margin segments, which support significant employment in Indonesia, is both lower priced and less tax than machine-made product, we expect a tailwind for our market share and financial performance over the coming year. Despite the negative consequences for government revenues, there has not yet been a significant move to level the playing field between the Tier 1 and below Tier 1 segments. We remain hopeful that the government will address this issue over time.
With respect to the minimum retail selling price, enforcement continued to progress slowly given mobility constraints. However, we expect the impact on the market is now likely to be more limited. The large majority of the industry is now above minimum level. And with no change in the minimum price in 2021, the pass on of new excise rate will move the remainder of the industry above compliance levels.
We also saw a flattening in the growth of the below Tier 1 segment in the fourth quarter and a gradual improvement in our shipment volume. As in many other markets, daily consumption improved since Q2, but is still below pre-pandemic level and remain sensitive to social restriction. Indonesia was a material drag on our 2020 financial results. While there remains much work to be done on the excise structure and ongoing uncertainty with the regard to the pandemic, for 2021, we expect a much less negative industry volume trend, a better market share outlook and a much smaller impact on our overall performance.
For the total international cigarette category, we assume a rebound over 2021, 2022 as the negative impact of COVID on daily consumption reverse. The fundamental of the category also remained intact, including price elasticity, which we estimate at around minus 0.4 on a global average basis. With regard to our combustible portfolio, investment levels remain adequate. However, incrementally more may be needed in the immediate aftermath of COVID. We will continue investing in the brand equity of Marlboro, which remain by far the world's leading brand. Given the economic environment, the management of price gaps and growing our share of the low-price segment will also be a focus.
Pricing in combustibles remain an important driver of performance. And while the carryover effect of COVID may impact our 2021 variance, the pricing power of our portfolio remains strong. Additionally, as HTU volumes grow, this pricing power increases due to the higher price productivity on HEETS and our other HTU brands. I would also highlight that pricing is no longer the sole driver of our top line growth, with the increasing weight of IQOS in our sales mix, generating significant growth in our average selling price.
I move now to IQOS performance. We estimate that there were 17.6 million legal-aged IQOS user as of December 31. This represents the addition of around 1.2 million adult users since the end of the third quarter and over 4 million in 2020. We have notably seen user acquisition accelerate through the second half of the year, despite renewed pandemic-linked restriction in the fourth quarter in a number of markets.
Our accelerated pivot to digital and remote engagement, combined with strong momentum for the IQOS brand, is paying off. We further estimate that 72% of this total or 12.7 million active smoker have switched to IQOS and stopped smoking, with the balance in various stages of conversion. This again reflects widespread user growth momentum across all IQOS geographies, including the EU region, Japan and Russia. As our user base expands in markets such as Japan and Russia, we are increasingly enriching our offer and segmenting the category with new products and more price points.
The addition of lil SOLID in Russia and Ukraine in the second half helped us to reach a broader range of legal-aged smokers in this market and bring them into the smoke-free category. Though at its early stage, the number of users acquired through the purchase of a lil device is immaterial in the context of our user base. As we have said previously, we plan to bring more exciting innovation from IQOS in the coming quarters, which we'll elaborate on further next week.
In the EU region, fourth quarter share for HEETS reached a record 5% of total cigarette and HTU industry volume. As shown on this slide, this reflects strong sequential and year-over-year growth in IMS volumes. I draw your attention to the contrast between the consistent sequential growth in IMS and the progression in sequential quarterly share, which can be distorted by the seasonality of the combustible market, in addition to other fluctuation linked to the pandemic, such as border closure and other social restriction.
It follows that 2021 and future years are also likely to see underlying share gain, accentuated in the winter months with a converged dynamic in Q2 and Q4. This excellent performance reflects strong growth in Italy, exiting the year with 10% share, with the large majority of user acquisition coming organically, as increasing awareness and prominence of the product build its own momentum.
Germany and Poland were also strong contributors. We added a further 0.6 million IQOS user in the fourth quarter to reach 5.2 million, a continuation of recent strong performance. In addition, we saw further progress in Spain and in the U.K., where both National and London HEETS offtake shares continued to grow, with the latter reaching almost 4% in the quarter. We show here select key cities, which demonstrate the strong traction of IQOS and the excellent potential for national shares across the region. I also refer you to the appendix, where we show shares for key EU market and globally key cities.
Strong performance continued in Russia, with our HTU share up by 2.2 points to reach a record 7.2% in Q4. As with the EU region, we highlight the effect of the seasonality in the combustible category on quarterly shares. The seasonal fluctuation in Russia can be significant, and we urge you to build this in mind when reading our quarterly results in the future.
A notable success in the latter part of the year was the expansion of our product portfolio with lil SOLID and Fiit consumable to cater to a broader range of adult smokers across the socioeconomic spectrum. In both Russia and Ukraine, the majority of consumer purchasing a lil device are new user, with the incrementality contributing to an acceleration in user acquisition with high level of conversion in line with IQOS.
The volume of Fiit consumable sold is broadly commensurate with lil device ownership. And at this early stage of commercialization, both are small in the context of the IQOS business in this market. However, while we have successfully upgraded many legal-aged smoker in the medium price segment to IQOS, this bodes well for our ability to reach consumer in certain markets in the medium and below price segment for whom purchasing power may be a barrier to entering the category.
The IQOS brand also resonates strongly across the Eastern Europe region. Rapid growth and excellent market share are testament to our agile commercial model and the consumer appetite for smoke-free alternative, even in market with lower purchasing power and, again, serve as very encouraging indicators for the continued progression of our national market share.
In Japan, our total reported share for heated tobacco units reached 22.1% in the fourth quarter, supported by line extension for both Marlboro HeatSticks and HEETS, such as the recent launch of Marlboro Black Menthol. On a more representative total tobacco basis, including cigarillos and adjusted for trade inventory movement, the share for our HTU brands increased by 2.9 points versus the prior year quarter and by 1.2 points sequentially to 20%.
Both HEETS and Marlboro HeatSticks grew market share following the October price increase, highlighting the strength of our price tier portfolio. We are especially pleased by our Q4 offtake share in Tokyo, which reached the milestone of 25% in December.
Q4 2020 adjusted in-market sales volume for our HTU brands grew 0.6% sequentially, which we regard as a strong performance given the pull forward of consumer offtake into Q3 before the price increase. The overall heated tobacco category made up over 27% of the total tobacco market in Q4, with IQOS maintaining its high share of segment.
We are especially pleased by our Q4 offtake share in Tokyo, which reached the milestone of 25% in December. A very similar picture is seen in key cities across Japan, including Sendai.
The Korean market has specific challenges around consumer misperception of the category. And while we continue working to address this issue, it's notable that Kuala Lumpur in Malaysia has already overtaken Seoul in market share terms, crossing double digit in the third quarter.
In addition to strong growth in existing markets, the geographic expansion of IQOS continue. We leverage our digital capability to launch in three new markets: Estonia, Kuwait and the Maldives. This takes the total number of markets where IQOS is available for sale to 64, of which over half are outside the OECD. We continue the commercialization of IQOS VEEV, our new e-vapor product, with the first EU market launch in the Czech Republic in December. This follows lead market New Zealand in August 2020, and we will continue to enter new market over 2021, including Italy and Finland in the coming weeks.
As we have said previously, the commercial infrastructure of IQOS allows us to deploy efficiently and at scale. Both the VEEV device and the consumable will be premium position. We also place great importance on efforts to guard against youth access for all our products. As we roll out IQOS VEEV, we will be testing age verification technology in select markets.
Switching now to sustainability, I want to again emphasize that our corporate strategy and our sustainability strategy are deeply aligned. ESG issues are business issues that serve as input to our long-term strategy and sit at the core of our mission. Despite the unprecedented challenges of the global pandemic, we have not deviated from our efforts to be a more sustainable company, and we achieved a number of key milestones in 2020.
By replacing cigarettes with less harmful alternative, we can significantly reduce the negative impact of our product have on the health of our consumer. That's why the core of our strategy focuses on addressing the impact of P, product, the first and most critical pillar of our approach to sustainability. This is what differentiates our company and highlights our unique value proposition as the final piece of our ESG+P framework.
Phasing out cigarettes remain our focus. And in 2020, we estimate a further 4.1 million legal-aged smoker enter the smoke-free category with IQOS, with a total of 12.7 million now switched and stopped smoking.
We also show here some recent notable achievement across ESG, which we'll come back to in more detail at Investor Day. While there remains much work to do, we believe our transparency and detailed approach to sustainability, materiality and disclosure make PMI an excellent example of impact, which we are achieving through carefully embedding sustainability into business and understanding it as an opportunity for innovation and growth, including our pioneering role in tobacco and reduction. In other words, our transformation is a unique sustainability story, another topic we will return to next week.
I will now turn to guidance for 2021, where we expect a significant recovery. The main unknown is the speed and shape of the global exit from the pandemic. While COVID was clearly disruptive to our performance in 2020, it is not yet over, and we must factor this uncertainty into our outlook for the coming year. With the rollout of vaccine just starting and lockdown measures currently in place across many markets, we do not assume any meaningful change in the first quarter where we also faced an unfavorable pre-COVID prior year comparison.
Looking beyond this, there are clearly a range of outcome, and we are reflecting this by providing a range for our assumed organic growth in net revenue and EPS. These ranges assume that even in the event of prolonged restriction, we will not see a return to the depressed consumption level of Q2 2020, which is consistent with our observation of a less severe impact in the second wave.
For Duty Free, a rebound in global travel is likely to lag the improvement of in-country mobility. Our guidance assumes no meaningful recovery in Duty Free this year. Despite this assumption, we expect organic net revenue growth in the range of 4% to 7% and organic adjusted diluted EPS growth of plus 9% to plus 11%, or plus 14% to plus 16% in dollar terms.
This tighter range for EPS reflect the likely higher level of growth investment in the event of a faster recovery. And thus, our assumption is for at least 150 basis points of margin expansion in all scenarios within the range. This reflects the ongoing positive mix effect of IQOS in our business and the accretion of cost efficiency, net of continued growth investment.
This projected organic EPS growth, including an estimated favorable currency impact of approximately $0.25 at prevailing rates, translates into an adjusted diluted EPS range of $5.90 to $6. This guidance does not assume share repurchases. This guidance also assumes the achievement of our 3-year HTU shipment volume target of 90 billion to 100 billion units.
Coming to some of the other key assumptions underpinning this guidance, we expect a total industry volume progression of flat to minus 3%, depending on the speed and shape of recovery from the pandemic. We expect to outperform the industry trend driven by the share gains of IQOS, with the resulting PMI volume forecast of plus 1% to minus 2%. This also incorporates a manageable excise outlook, including a positive structural change in Turkey and above average increase in Russia and the increase in Indonesia, in line with historic averages.
As I mentioned earlier, our combustible pricing power remains strong. However, given 2020 carryover effect, notably in Indonesia, and the immediate aftermath of the COVID crisis, we assume combustible pricing of 2% to 3% in 2021, or around plus 4%, excluding Indonesia. As in 2020, the biggest driver for our top line growth is likely to be the higher weight of the IQOS business, which has significantly higher average net revenue per unit.
As laid out in this morning's press release, we assume that our full year effective tax rate will be around 22% and assume that operating cash flow will grow strongly to around $11 billion at prevailing exchange rate and subject to capital -- to working capital requirement. As I already mentioned, we assume capital expenditure of around $0.8 billion.
Let me now spend a moment on the expectation for the first quarter. Our organic net revenue are likely to be around stable to slightly down as we lap a strong Q1 2020, which benefited from inventory buildup in March as the pandemic began to spread in many markets, in addition to being a largely COVID-free quarter. This incorporates continued strong year-on-year growth in the shipment and IMS volumes of HTUs.
Due to normal seasonal patterns and the lower number of selling days in Q1, we expect this volume to be sequentially stable to slightly below Q4 2020. We also expect strong sequential HTU share gains on both an underlying and reported basis compared to Q4, noting the seasonal factor in the combustible market I already mentioned.
We expect strong margin progression in Q1 primarily due to the positive mix effect of IQOS and the effect of the cost efficiency realized in 2020. We believe this should result in an organic adjusted diluted EPS growth of around 8%, which equates to around $1.40, including an estimated $0.09 favorable currency impact at prevailing rates. Looking beyond the first quarter, it will come as no surprise that the easier comparison in Q2 should enable higher-than-average year-over-year growth in volumes and net revenues.
To conclude, our results were stronger than expected, with plus 7% organic EPS growth delivered in the tumult of 2020. We are building a business through IQOS to deliver superior and sustainable growth over the coming years. Continued momentum of IQOS through the challenges of the pandemic demonstrate this structural growth characteristic. We are also committed to maintaining the strong leadership and competitiveness of our combustible business.
We have a number of levers for growth in our top and bottom line. First, the powerful mix effect of IQOS. Second, pricing which remains important for combustible and, where appropriate, for RRPs. Additionally, efficiency in our manufacturing, supply chain and SG&A costs are further lever as we continue to hone our business model.
Moreover, with the launches of the IQOS VEEV and lil product, we are broadening and stepping up our product offer and innovation in 2021. You can also expect us to bring further exciting innovation to our IQOS heat-not-burn platform.
As I mentioned, sustainability is at the heart of our smoke-free strategy, and we continue to work tirelessly to further our mission. Our organization demonstrated extraordinary resilience in 2020, coping and growing admirably through one of the most challenging period in recent history. At the same time, our business continued to transform, incorporating and leveraging new skills and capabilities.
In short, we look forward with confidence, and we will expand on this topic further at our Virtual Investor Day on February 10. We look forward to seeing you there.
Thank you. Andre, Jacek and I are now more than happy to answer your questions.
[Operator Instructions]. Our first question will come from the line of Bonnie Herzog with Goldman Sachs.
And congratulations, Andre and Jacek. I guess my first question today would be on margins. And I guess, Emmanuel, I was hoping you could talk a little bit more about your expectations around margins, I guess, in terms of any favorable fixed cost absorption you expect as you amortize the investment behind IQOS over this increasingly larger accelerating volume base.
And then as I'm thinking about that, in the context of your variable costs going lower as you touched upon thinking about the progress you've made with digital, so could you just talk about that and how big of an impact this could be or big of an opportunity this could be in the future?
Sure, Bonnie. Happy to do that. It's going to be only a teaser versus what we're going to see next week. So bear with us, and we'll elaborate with much more detail. But I can certainly anticipate a few headlines on what we'll share next week.
I think what is obvious in our number for 2020 is the fact that, beyond the great performance of IQOS, we have also used efficiency on cost as a powerful lever to generate performance. That's really showing up very clearly in our numbers. So we are delivering in 2 years, instead of 3 years, the overall at least $1 billion savings. And what is good is that we are working on cost efficiency on several levels, and many of them, of course, are related to IQOS, but not exclusively to IQOS for some of them.
If you look at the gross margin level, it's quite obvious that we are being very successful in generating manufacturing productivity, and that's a great driver for further margin improvement. And here, we are working globally across the portfolio, I would say, on margin improvement. So it's not just on IQOS, even if probably on IQOS, because that's a business that doesn't have the same maturity, we have more runway, if you want, to improve the productivity. And we are certainly making extremely good inroad in that respect, but we are also generating manufacturing productivity on CC.
And then on our SG&A, I think you could identify 2 drivers on cost efficiency. One, I would say it's probably something you're going to find in many companies today. We are working to be a more efficient and agile company. So we work on being more digitized, we work on simplifying the way we work, we automate, we standardize, and that is allowing us not to be cost cutter, but just to take cost to be a better company and deliver overall higher performance.
And then you have elements that are indeed connected with our commercial performance and not only to IQOS, but certainly mainly to IQOS, and you have 2 elements. One is all the investment that we made in the past, and that is a great platform on IQOS. And I'm not saying that the investment is over. We're going to keep investing. But of course, we have now an investment that we amortize over a fast-growing base. And we are not growing the level of investment at the speed of the growth of the IQOS business.
And then there is this great work that we are doing. Thanks to digital and thanks, of course, to all the learnings that we are making on the IQOS business, where we very nicely reduced all the variable per user cost. But I will stop there because we will elaborate on that next week.
Okay. That was really helpful. I appreciate that. And then my second question is all the progress you've made with IQOS in growing the base, and it's so large. But as you look out, could you talk about further segmentation of markets with your different platforms or possibly different price points as you continue to convert more smokers? I mean you touched on that. My guess is you're going to touch on that more next week.
But just as I look at your business, it implies that your user base is probably going to need to double in the next maybe 3-plus years based on our analysis for you to hit your aspirational target of that 250 billion units by 2025. So love to hear any strategy there, insights because if I think about it, I assume more of the conversion is going to come from other reduced-risk technologies. And how do you anticipate your mix evolving over time?
Yes. I'll give you the first shot. I still believe, over the next 3 years, Bonnie, as I said many times, that heated tobacco technology will be the prevailing technology because it has the highest ability in terms of taste and satisfaction to convert people.
Now in terms of segmentation, I believe, in most markets, we will need 1 or 2 heat-not-burn technologies, if I stay with this segment, and probably 2 to 3, over time, consumable price segment, so we can cover mostly the vast majority of the market. There will be exclusions where you need to cover 4 price segments with probably 2 technologies. And we'll talk next week about the next step in technology for aerosolization in heat-not-burn, which will address many of the pain points consumers have today.
Now clearly, the heated tobacco product is one category. I think that's the fastest growth, both in terms of revenue and bottom line and volume. The second is obviously e-vapor. We are entering this market because I believe there is consumers there that want to switch trade to these products. There is a lot of dual users, and we see also dual users between heat-not burn and e-vapor that, obviously, we would like to capture. I think we can also capture consumers for every e-vapor products.
The key there is clearly to leverage the infrastructure and the brand name of IQOS. I think the product is very good, and that's the first reactions we get, but we need to build equity because that's a problem for the category, as you know, and also consumer loyalty because for the economics to be at best for e-vapor, you don't only need to be premium positioned, but you also need to have loyal consumers because if you discount just products and you sell them, and then a consumer has 10 different products from 10 different competitors and consumes half a cartridge of your product per week, it's very difficult to make the turn and, more importantly, it's very difficult to maintain an infrastructure.
Now we have the advantage of having a lot of infrastructure with IQOS that we can leverage. The equity of IQOS is undeniably the best in the RRP, so I think that's helpful. Technology is good. We are premium, so I think we can make inroads in this category.
And then obviously, we were also going to expand in the pure nicotine products like nicotine pouches or the P3 over time, although I think this is more occasional use products or non-predominant use products. So that's a little bit -- and again, sorry to cut this here, but we're going to elaborate this more -- in more -- extensively next week, okay?
The next question will come from the line of Michael Lavery with Piper Sandler.
Just wanted to touch on IQOS again. And the Philippines, you have a 20 basis points share, which, of course, is small, but it's very early there. And if I understand it right, you launched there without any stores initially. You also touched on the call about some digital launches in Estonia and Kuwait and the Maldives.
And so just would love a little more sense of how some of those digital efforts work. And it's certainly seen in the Philippines, they're ready to be pretty quickly effective. Can you just bring to life a little bit of how you're going to market there?
Yes. It's Jacek here. So yes, we started this year in Philippines, to be very precise, in the Manila, not even greater Manila. And the product as expected actually responded pretty well. This was one of the first fully digital, if I may, launch, also driven by the fact that we had to change the strategy last moment due to the COVID restrictions and the whole COVID impact.
And the product starts getting good tractions. I think we'll still stay for a while in Manila, which is, frankly speaking, not the major secret because we're following the same path of the same strategy for the rollout in every geographies, right, especially if you go to the sizable geography like Philippines.
But product is well received. I think the taste characteristics, et cetera, fits very well. We're also testing the different route-to-consumer models, as we're entering the countries when you have a stick purchase. There is a lot of consumption on trade rather than just off trade. So we need to come up with very good solutions there. But I'm very positive on that part of Asia, which is still unchartered for IQOS.
Okay. That's helpful. And just a second one on buybacks. Helpful clarity that there's no consideration on that in the guidance. But with some currency tailwinds now and the balance sheet where it is, it certainly seems like that could be -- it could come into play. Can you give a sense of what you would need to have in place or see before you might trigger resuming with buybacks?
Look, if you bear with us until next week, we'll have a global review of our capital allocation strategy, and we'll address all components at that stage.
Okay. That's no problem. If I could just maybe swap that question then. Could you give any sense of where you stand on Platform 2 with TEEPS? Any update on that?
On TEEPS on the Platform 2, I mean, we will be further conducting that this time the market commercial test this year in 2021.
The next question will come from the line of Vivien Azer with Cowen.
I wanted to also drill down on IQOS. I was wondering if you could give us some color on what the mix looks like for the consumables from traditional tobacco flavors and some of the novel flavors that you have in the market.
That's Jacek here, Vivien. It varies market by market, okay? Obviously, as you know, we have flavors of menthol. We have some other flavors. But still, IQOS, frankly speaking, in most of the places is very much attractiveness is coming from tobacco flavors.
I mean, at the end of the day, most of the segments which we are targeting at this stage, and we are operating at scale, I mean most of the segments are the flavor -- tobacco flavor type of segment, right? So IQOS really has a very winning proposition. There also has a great proposition in menthol and our flavors.
So that varies by the country, and you can't really -- I think if I give you the international share of the flavors, it will be just misleading. The average doesn't make that. But it follows, typically, if you have a predominant menthol market like Japan, the dominance of menthol if you are predominantly full -- I mean, cigarette markets without menthol, then you are predominantly there. A bit sometimes over indexed in menthol in general because it has a bit more impact for people, so it's easier to switch.
Understood. And my follow-up also on IQOS, please. In terms of the market share progression that you saw in Japan, either in the quarter over the course of the year, can you contextualize the contribution from the Marlboro brand versus the HEETS brand?
The Marlboro brand is still the major contributor of the overall volumes and the growth, so we're very pleased that on the course of the last year, we continue growing Marlboro.
Obviously, HEETS, which is priced not below the Marlboro had a bit a better dynamics than Marlboro, but the above actually contributing to the growth. And it's very interesting, Vivien. You're asking because this is the first market which we try the dual -- or double -- dual positioning of the consumables, Marlboro and HEETS in Japan.
As you know very well, we also extended HEETS in a couple of Eastern European geographies, in Russia. When first, we brought the above premium propositions to HEETS, the HEETS Creations. And the HEETS Creations contributes. So we like premium rise further to HEETS in Russia. And HEETS Creations in Moscow constitute now about 10% of the overall HEETS volume. So that's very good.
And then we complemented on the notch below price segment by bringing the lil Fiit proposition. So with now in Russia, we're testing can IQOS operate on the free essentially price segments on the devices. And the spread is pretty phenomenal because IQOS devices will go from $60 on the premium device, and then we go down to the $20 on the lil device. And then we have a coverage on the consumables spreading from RUB 170 per pack to RUB 130.
So it gives you the hint how broadly we now -- why we can go with IQOS touching the segments above medium and below medium. And this is despite, as you know, that we have a competition in Russia. But frankly speaking, competition in terms of the devices is essentially close to 0.
So it's a little bit of a very aggressive promotions, but we continue delivering the strong growth on IQOS, both in terms of user acquisitions measured by the device sales and by the HEETS -- further expansions on the HEETS. And what is also good in places like in Russia that we continue growing in the top cities, which we started a few years ago. So we have a continuous growth in the cities, and the expansion doesn't need from that growth which we have in the Moscow, St. Petersburg and the other main cities.
The next question will come from the line of Gaurav Jain with Barclays.
So on the organic margin improvement, which you are guiding to for FY '21 of 150 basis points, that is on top of 240 basis point improvement in FY '20. And this saw benefits like production and travel expense, there was a cut in German VAT, et cetera.
So what I'm trying to ask is that is your underlying margin improvement closer to 200 basis points, not 150 basis points, and that is clearly happening because of high cost. So is that how we should be thinking about the next few years as well?
Well, so for the medium term, again, we'll elaborate next week on more outlook. For the year, Gaurav, I'll let you make your assumption. I think we are clear on the kind of one-off savings that we have seen because of the COVID, so you can factor that in your model. And then I think we are also clear on what are the driver for margin improvement. So it's about the positive impact of the growth of IQOS in terms of per stick revenue, in terms of margin and then everything that is happening on cost efficiency.
That is really what is driving -- that has been driving the margin improvement in 2020, and that will continue in 2021. As you can imagine, beyond 2021, but we'll elaborate on that next week.
Sure. My second question is on the European Beating Cancer Plan, which was released earlier this week, and they talk of things like flavor ban, plain packaging, increasing taxes on heated tobacco to -- equal to cigarettes. So how do you think of that? And how do you incorporate these sort of risks in your outlook?
Okay. First of all, this is a plan, and there are many positive aspects also in this plan in my view. First of all, we don't talk about taxes. I mean, this is subject to directives. The tobacco excise directive that governs the excise tax and the tobacco product directive, that is the regulation of the products, okay?
The first is the tobacco side directive today does not foresee reduced risk product category, so it has to be amended under all circumstances, okay? And we're not talking about increases. It's creating a framework under which member states can tax.
Our view is that absence of combustion, for example, is a key criteria on how to tax differently cigarettes to other products. And then within that major cliff of change in toxicity and exposure, member states can have different tax rates for these products. But this product should not be, by any means, higher than any combustible category available, okay, as a minimum criteria. But this has to happen.
Nobody said that taxes will increase or hit the tobacco products, frankly speaking, at this stage or in vapor product, okay? So all this has to be defined, and the discussions are going to start in the course of this year and continue in next year, in any case.
So that's for -- and then the tobacco product directive been served, I hope that there will be a bit more regulatory clarity in there regarding RRPs because -- and e-vapor product because just now, we left it up to the member state to regulate, which, frankly speaking, is not harmonizing a directive, one; and secondly is a pain for all the industry participants because every country has a different regulation. And we always advocated serious regulation on these products, provided that this is differentiated from cigarettes, okay?
Now there are voices that say that these products should be the same thing as cigarettes. But at the end of the day, it was very clear also in the cancer plan that all -- in the Q&A that only based on science and evidence, they will take decisions. So I wouldn't be particularly worried about this at this stage. And I think the outcome may be positive actually because it's an opportunity to discuss all these things.
Now in the longer term, we discussed very often, I believe tax differentials will be maintained because it makes sense for public health, it makes sense for the consumers. And as we also explained, we have room even to pass taxes if, by any chance, differentials close somehow because IQOS, also in order to pass part of the tax benefit to the consumers, it's mid-price position, essentially, if you take the weighted average of the countries, number one.
And number two, its price productivity is much, much higher than cigarettes, so passing on a tax is triggering less price increase than passing on tax on cigarettes. So that's in a nutshell the way we should look at it, but we have to assume that excise taxes will increase over time also for RRPs as governments need money, and that will apply to heated tobacco products that's already taxed substantially and, potentially, in some cases, to e-vapor products in the future. But that's all baked in, in the assumptions.
Sure. And if I can ask one last question. It's on a minority interest, which has been increasing at a higher rate than your EBIT, and that's driven by Philippines. So is there an opportunity to reduce your minority interest, considering your partner in Philippines, it trades on the exchanges at like some 6x PE?
No, we don't envisage this. Not in the -- I mean if our partner wants to sell one day, we can discuss. At the moment, they're very happy with us.
We're very happy with our partnership in Philippines.
The next question will come from the line of Adam Spielman with Citi.
So the first question, I think you said in your guidance that you're expecting to take less pricing variance on combustible cigarettes than usual. Now for years and years and years, it's been 6%, and I think you said it's something to do with COVID that you want to take less pricing. I'm really surprised by that.
You also said the pricing model has been broken. So I suppose the question is, if you take less pricing in combustibles this year, 2021, what would it take for you to have another low year in 2022? That will be my first question.
Okay. First of all, we didn't say we will take less pricing. We will also -- where the pricing opportunity, we'll take pricing, and I think the model still works very well. Elasticities are the same, everything.
We had to make some, in my view, reasonable, conservative, you may say, assumptions regarding what's going to happen in Indonesia and Russia because of the tax increase. And Indonesia has never got it carryover from last year, which makes the comparisons year-to-year problematic, okay? Plus, in Germany, we had a VAT, I would say, tax break, which we assume is not going to continue this year. So if you exclude all these elements, I think we're still back to a normal pricing in the other markets.
So clearly, in terms of post-COVID, I would say, assumptions, we have to watch more carefully the price gaps, that's clear, at the mid- to low end of the market, but that doesn't mean that we're going to take any severe pricing decisions at this stage anywhere. I just -- this is a watch out.
If there is down trading, which is happening between the mid-price typically and the low-price segment, also because we have absence of contraband and all these things, that's something to watch in certain markets. But overall, I think we're in good shape.
Also both on IQOS, on heat-not-burn products and combustible, the excise taxes are now in, if I'm not mistaken, everywhere. So we have pretty good visibility of where we are, okay? So I don't think it's super COVID related. What is COVID related in the guidance is the range we gave because if you look, Adam, at what happened last year, if we assume 2% to 3% underlying industry decline, even baking in Indonesia, we had a 6.7% industry decline.
So we're missing consumption for mathematically 3.7%to 4.7%. That's on average, $100 billion for the industry. So we don't -- that will rebound, in my view, one day, but once the restrictions finish.
Now we gave a guidance for this year of 0 to minus 3, which is at 0, you have some recovery. At minus 3, you have super underlying negativity, maybe exaggerated. I don't know at this stage, but that's plus/minus 20 billion units for us. So that's plus/minus 2.5 revenue points.
So that's where the volatility is, okay? And if pricing comes better in Russia and Indonesia, that much the better. We may end up at the high end of the range.
Okay. Well, I think that leads to my next question, which is, to be blunt, I don't really understand the EPS guidance, and there are many aspects to really understand about it.
So first of all, you're saying in Q1, where your comp is insanely hard, you're going to have flat organic sales, you're going to have margin expansion, you're going to have 8% like-for-like EPS growth. You then say because the comp is really easy in Q2, you're going to have a great quarter, or you imply that. And yet the full year is only 9% to 11%, and it seems to me that if you can do so well in Q1 and you don't do well in Q2, then the 9% to 11% is very conservative.
And another way of asking the same question. Every single time you've given guidance of any sort on EPS since 2018, you're being smooth. This is -- this quarter, you gave guidance. It wasn't a range. It was a point estimate.
You said you were going to do about $1.20 for the fourth quarter, and you said that in December, And yet you beat it very handsomely. Now that would suggest that the way you give guidance is systematically incredibly conservative.
You either you can't forecast, which I don't believe, or you're systematically incredibly conservative. To that point, the fact you've always been conservative with the price very well in Q1 against a really tough comp suggests to me that the guidance for the full year is also super conservative. Is that fair?
I wouldn't say conservative, but it's not bullish either, okay? I mean, I understand what you are saying, but we're at the beginning of the year, okay? Many things can happen regarding COVID because it's not finished.
So last year, as Emmanuel said, we had more than $150 million exceptional expenses because of COVID, okay? So you need to put some cushion in the bottom line regarding unexpected costs. And if we have a rebound, I would call, not a very gradual recovery, we may need to invest a bit more money towards the end of the year to accelerate acquisition. You can physically do that. If we physically can't, then clearly, the money will go to the bottom line.
So at this stage, we gave this range, okay, which, by the way, if the dollar stays where it is, it's not bad at all because it's 14% to 16%, and the revenue line would be 8% to 11%, which will be phenomenal, I would say. So I don't think this is conservative. It's just I don't have a crystal ball to foresee everything that's happening in every month of this year, okay? We're still not in normal situation. That's all. So I understand and -- but -- and it's just how I can further explain.
Just in the sequence, please factor in that -- I mean, as we say, we talk about a gradual recovery that we are expecting without being able to, of course, design exactly what is going to be the trajectory, but that would mean certainly more investment in H2.
Remember, we've been, of course, limited in commercial activity. As you know, we say H2 could be a better moment overall with a number of restrictions being eased. There will be also more investment skewed towards the second part of the year.
So you have to take that into account, and that explains as well why Q1 maybe is expected today better than one could have expected initially. But the investment will need to happen in the year.
Any case, I would love to be conservative and as the quarters unfold, we'll get more. But I think I gave the parameters. The pricing, that still can come more favorable. That goes straight to the bottom line. If we have bit more combustible, that's fine. It goes to the bottom line, but we have to assume that. So as the quarters pass, we will give you better outlook.
The final question will come from the line of Robert Rampton with UBS.
Hello? Hello?
Robert, your line is open.
How to come in the queue actually?
Operator, can you put Robert Rampton in queue from UBS, please?
His line is open.
Robert, can you join? Okay. We'll get back to Robert after the call, operator. If we can just go to the final remarks. Andre, I think you have some closing remarks.
Yes. I mean, thank you all for joining. I think we had a rather complicated 2020, but the results came out much better than I would have thought when we were talking for the first time in March.
I think we look at a very good recovery in relative terms in '21. IQOS continues to grow strongly. The momentum is excellent, in my view, and we will see some rebound, hopefully, in cigarette volumes in the next 1 to 2 years. I would love to see positive total market maybe in '22.
And we look forward to sharing with you more on the long-term growth and more on understanding the profitability of IQOS in -- next week, actually. So have a very good day, and thank you for listening to us.
I just wanted to add that, well, if you have any follow-up questions, you can contact the Investor Relations team and look on our website for the instructions on how to log on to the Investor Day event. It starts at 8:30 Eastern Time on February 10. You can register on our website. And again, thank you very much for joining the call. Have a nice day.
Bye.
This does conclude today's conference call. We thank you for your participation and ask that you please disconnect your lines.