Japan Tobacco Earnings: Solid Growth Lifted by Pricing, Volume, and Weak Yen but Slow Down From Q2

Wide-moat Japan Tobacco 2914, or JT, was off to a good start with the first-quarter results exceeding our expectations and the company’s internal targets thanks to solid volume growth and strong pricing in addition to yen weakness. Currency-neutral core revenue grew 6.3% (reported +15.3%) while adjusted operating profits rose 4.6% (reported +14.1%). Pricing remained the key profit driver during the quarter, echoing our investment thesis that JT’s ability to take pricing will bolster its midterm profit growth. Despite better-than-expected first-quarter earnings, with currency likely turning into a headwind and investment on the rollout of heated tobacco sticks, or HTS, rising from the second quarter, we have made no change in our forecasts of which our 2023 profit estimates are a touch below the guidance. After the recent rally possibly prompted by investors’ increasing appetite for defensive names, we view shares as modestly undervalued, indicating 9% upside to our fair value estimate of JPY 3,200.

There were several positive developments during the first quarter. First, global combustible volume grew 1.3% versus the guidance of a 1.5%-2.5% decline. While volume growth was fueled by EMA (travel retail and markets outside Asia and Western Europe), we were impressed by 2.6% growth in combustible volume in Japan, lifted by robust sales of the value Camel Craft and midpriced Mevius E series. Second, JT’s HTS share advanced in Japan, up 1.2 percentage points quarter on quarter to 9.3%. The reduced risk product market also expanded, representing 37% of the Japan’s tobacco market, up from 34% of the previous quarter. It looks that Philip Morris International and JT have gained share from British American Tobacco. The strategic cut on device prices combined with refined flavors of tobacco blends have helped JT acquire new users. Third, pricing strength continued in many core markets including Russia, U.K., and Philippines.