Philip Morris International, Inc. (PM)
2013 Consumer Analyst Group of Europe Conference Call
March 18, 2013 6:15 AM ET
Jacek Olczak – CFO
Nick Rolli – VP, IR and Financial Communications
Erik Bloomquist – Berenberg Bank
Chris Wickham – Oriel Securities
Henry Davies – Bank of America Merrill Lynch
Unidentified Company Representative
Kicking off this year, as we had last year as well its Philip Morris International, the world’s largest tobacco company, outside of the Chinese government [ph]. So fortunately for me, I actually I didn’t have to do much paperwork for today as introduction. I just copied and pasted some of the impressive statistics from the press release that went along with the Louis Camilleri’s recent retirement, so maybe read some of those back to you.
Since its spin-off in 2008, PMI has delivered total shareholder return of 103.5% versus the S&P 500 of minus 20.6%; returned over $50 billion to shareholders through dividends and share repurchases; met, or exceeded, the high end of its adjusted diluted EPS annual growth target of 10% to 12%; increased its dividend each year with a cumulative increase of 84.8%; and repurchased 489 million shares, or 23.2% of the shares outstanding at an average price of $56.96 per share. So Jacek, pretty ordinary results there?
But representing the company this morning is Jacek Olczak, CFO since August last year. Whilst he is fairly new to his role, he is certainly not new to the company and celebrates 20 years with PMI today. Interestingly, prior to becoming CFO, he was actually Head of the European Union region for three years. I’m sure there will be a question or two about that in today’s presentation, particularly how much cash you have sitting in Cyprus [ph] at the moment.
So without further adieu, let me hand it out to Jacek and he can tell us about PMI.
Thank very much. It’s a great pleasure for me to have the opportunity to be on a CAGE Conference in London for the first time. Let me also extend my warm welcome to those joining us on the webcast. My remarks contain forward-looking statements and accordingly, I direct your attention to the forward-looking and cautionary statements sections of today’s presentation, and our SEC filings. Reconciliations of non-GAAP measures, included in this presentation to the most comparable GAAP measures, along with a glossary of terms are available on our website.
Today, I will briefly review our strong 2012 performance; explain the reasons why we believe that the tobacco industry remains attractive, and why we should continue to outperform the sector. I’ll also reiterate our strong emphasis on returning cash to our shareholders, and remind you of our track record in consistently delivering results that meet or exceed our superior growth targets.
In 2012, we outperformed our international competitors, achieving an organic cigarette volume increase of 1.3% to a level of 927 billion units. We ended the year on a strong note with fourth quarter cigarette volume up 2.9% on an organic basis. This performance was partially flattered by some favorable inventory movements driven by the timing of tax and the price changes which we estimated, added some 60 basis points to our quarterly growth rate and which we expect to be reversed in the first quarter of this year.
I would also like to remind you that our results last year were helping the first quarter by the positive impact of the leap year. Last year, we grew our market share excluding China and the USA by half a point to a record 28.8%. Our results across the Asia, EEMA, and Latin America & Canada regions were very strong with gains of almost one share point in each.
We achieved solid financial results with net revenues and adjusted OCI up by 5.6% and 8.1% respectively, excluding currency and acquisitions, while our adjusted diluted earnings per share increased by 11.7% excluding currency.
Let me now turn to the tobacco sector as a whole, and why we believe that it remains attractive. We see five compelling reasons. Firstly, the regulatory environment while challenging, is manageable. Secondly, the excise tax environment is predominantly rational. Thirdly, the pricing environment is favorable driven by our strong brand and a relatively low elasticity of demand. Cost pressures are limited and finally, the ability to convert a higher portion of net revenues into free cash flow that can then be returned to shareholders.
Let me begin with the regulatory environment. As currently proposed by the European Commission, the updated Tobacco Product Directive contains a number of measures that we believe has no credible scientific basis and are counterproductive. These relate both to products and their packaging. The proposal calls today – calls notably for a ban on menthol and slimmer diameter cigarettes and the introduction of 75% graphical health warnings.
Menthol and slimmer cigarettes accounted for approximately 10% of the European Union cigarette industry volume in 2012, though in markets such as Poland they accounted for around one-third. We believe that such measures would further boost illicit trade which is already at a level of around 11% of EU cigarette consumption and negatively impact government revenues beyond the estimated EUR12 billion currently lost to illicit trade, all this with no meaningful benefit to public health.
The TPD has to be reviewed and adopted by both the Council of Ministers and the European Parliament. And the European Commission has indicated that this process will run through 2014. During this time, we will do our utmost to ensure that the numerous flaws that the TPD proposal has will be addressed. As the final outcome of the TPD process remains uncertain, we believe that reason should ultimately prevail providing a challenging, but manageable regulatory environment in the EU over the next ten years or so following this implementation which is currently foreseen in 2015 or 2016.
While the Australian High Court affirmed the constitutionality of the plain packaging legislation, six of the seven judges determined that the taking of property had indeed occurred. The ruling is important because it confirms the underlying problem of plain packaging legality in most other jurisdictions. It is a deprivation of property that should require substantial compensation if enacted.
We believe that this ruling provides us with a strong basis for our claims under the
Bilateral Investment Treaty between Hong Kong and Australia, and the issue of trademark deprivation is likely to play an important role in the debate before the World Trade Organization. Both, the BIT and WTO cases are expected to take two to three years to reach a conclusion. The importance of the pending legal challenges against Australia has been recognized by the government of New Zealand which has decided to defer its decision on the introduction of plain packaging until these are resolved. Contrary to certain media reports, the UK government has made it clear that it has not taken a final decision on this matter. Finally, it is very important to note that the proposed TPD does not mandate plain packaging.
Let me now turn to the fiscal environment. The excise tax environment remains by far the more critical element. It has become more rational over the past five years as governments increasingly make decisions that favor revenue predictability and consistency. From time to time there are exceptions, as with the Philippines this year. However outsize increases usually lead to an increase in illicit trade and a failure to reach targeted excise tax revenue levels.
Malaysia and Mexico are recent examples. Taxes have not been increased in these two countries, over the last couple of years as the governments have sought to stabilize the market, and reduce illicit trade that had boomed following disproportional excise price increases in the past. There are a number of different methods that the governments use to enhance the predictability of revenues generated from the tobacco industry.
They implement regular, reasonable increases in excise taxes and participate in retail price increases through ad valorem components in the tax structure. They increase the proportion of specific elements in excise tax structures, and implement significant levels of minimum excise taxes, in order to make themselves less dependent on the price decisions of the manufacturers.
Some countries such as Australia, Colombia, and the UK link excise taxes to inflation, while others such as Germany and Russia, legislates multiyear tax programs. Finally, in order to reduce revenue diluting down trading, a number of Southern European governments have been reducing the tax differential between other tobacco products such as fine cuts and cigarettes. We have witnessed a significant improvement in the excise tax structures in the EU since the revision of the EU Excise Tax Directive in January 2011.
This allows member states to increase the maximum proportion of specific taxes from 55% to 76.5% of the total tax yield and requires the minimum proportion to reach 7.5% by January of 2014. Since the directive was implemented, five countries have taken advantage of the higher maximum specific rule, and about three quarters of all the countries in the EU have increased the proportion of specific to total excise taxes.
By December of 2012, the average ratio reached a level of 35.1%, a very significant improvement over the 30.2% of January 2011. The third reason why we believe this is an attractive sector is pricing. Governments generally look to increase their excise tax revenues and lower tobacco consumption based on higher cigarette prices. Equally important, they seek to actively discourage reductions in price for fiscal and other measures. In addition, elasticity of demand is relatively low, generally in a range of minus 0.3 to minus 0.5. This means that the reasonable price increases only have a modest impact on volumes.
Our ability to increase prices is further enhanced by the strength of our brands and the breadth of our portfolio. We are not only an industry where the pricing environment is favorable. We are also a consumer products category that is subject to limited cost pressures. Our two most important cost components are tobacco leaf and direct materials. This represents 32% and 28% of our cost of goods sold respectively in 2012.
Tobacco leaf prices have remained fairly stable since 2008 and are expected to increase at a moderate rate. Volume requirements are relatively predictable year-on-year, geographic origin is quite diverse, and the tobacco cultivation is partially vertically integrated. And tobacco is not traded on any commodity exchange and is therefore not subject to speculative pressures. Direct material costs have been increasing broadly in line with inflation.
We believe we can continue to outperform our main competitors for four principal reasons. Our overall share leadership and broad global footprint with leadership in key emerging markets balanced with a strong position in very profitable developed markets. Our superior brand portfolio led by the only truly global cigarette brand, Marlboro, whose strong brand equity justifies premium prices and thus superior margins.
Favorable market trends and in particular, consumer up-trade in emerging markets to the premium category where we are over-indexed, and finally, our ability to convert a higher share of net revenues into free cash flow along with our strong capital structure, this enables us to return a greater proportion of cash to our shareholders.
In addition, we have business development opportunities in terms of new geographies such as India and Vietnam, the optimization of existing business structures, the commercialization of next generation products and our comprehensive approach to tackling illicit trade. Our superior global footprint manifests itself in the excellent balance between our businesses across the four regions with Asia now our largest one.
Emerging markets are playing an ever more prominent role in our success. In 2012, 61% of our cigarette volume and 39% of our adjusted OCI came from non-OECD markets. Asia has been our most important growth engine over the last five years. The compound annual average volume growth rate over this period has been 9.1% with 2012 volume reaching 327 billion units. This remarkable performance has been achieved organically and through our business combination with Fortune Tobacco Corporation in the Philippines.
Three markets; Indonesia, the Philippines, and Japan accounted for 78% of regional volume last year. Despite the expected significant volume impact in 2013, from the disruptive excise tax increase in the Philippines, we are convinced that the Asia region will continue to be a major contributor to both our volume and OCI growth. The cigarette industry volume in Indonesia grew by 8.2% in 2012, driven by demographic trends and increasing consumer purchasing power. This year, we expect growth to slow slightly to around 5% to 6%.
Our volume in Indonesia grew by 17.5% last year. Our market share growth accelerated with a gain of 2.8 points to 35.6% helped by attractive price points for key brands. We own the leading premium brands in all three cigarette categories namely in hand-rolled kreteks, Dji Sam Soe; in machine-made kreteks, Sampoerna A; and in white-cigarettes Marlboro.
In addition, we have a bright broad portfolio that includes strong mid-price brands such as U Mild, a superior national distribution system and the best field-force in the industry. The government of the Philippines introduced a large disruptive excise tax increase in January 2013. The tax on the two leading brands namely premium Marlboro and low-price Fortune increased from 12 pesos to 25 pesos and from 2.72 pesos to 12 pesos
per pack respectively. Though on a positive note, the legislation provides predictability with two-tiers merging into one by 2017.
In response, we raised the recommended retail price per pack of Marlboro from 32 pesos to 51 pesos, and that of Fortune from 15 pesos to 25.5 pesos. It is still difficult to judge the precise impact of these price changes due notably to a slow rollout of new prices at the bottom end of the market. However, there are preliminary indications that volume is down in line with our expectations of a 20% to 25% annual decline.
Despite this considerable volume impact, we expect the OCI impact to be marginal giving the prices actions that we have taken and in the longer term, we believe that the Philippines continues to have strong potential due to its demographic trends and robust economy.
Japan is an excellent market for PMI. Total industry volume was up by 0.7% in 2012 to reach the level of 197 billion units. For the full-year of 2012, our market share was 27.7%. This is well above our 2010 share but below the target we had set ourselves. Marlboro performed strongly while Lark remained under pressure as some adult smokers reverted to JT brands.
Going forward, we believe that our strong new product pipeline and the vigor of Marlboro whose young adult smoker share is significantly higher than its overall smoker share should enable us to further reinforce our market position in Japan. We are encouraged by our year-to-date February market share of 27.8%.
In contrast to Asia, where economic developments are generally favorable, we face a challenging operating environment in the EU region. Our cigarette volume declined in 2012 by 6.4% to 198 billion units. This was only partially offset by a three billion unit equivalent or 19.5% increase in our fine cut volume.
Our four key international cigarette brands in the EU region are performing well. Marlboro gained share in 2012 to reach 18.3%, driven by progress in Belgium, Greece, Italy and Poland. We also have a strong position in the lower price segments with L&M, Chesterfield, and the Philip Morris brand. L&M, which is the second best selling cigarette brand in the region gained share notably in Germany and Poland, though on a regional basis its share was unchanged as it declined in Southern European markets. These markets generally returned stronger results for Chesterfield, whose regional share was up by 0.4 points to 3.7%.
Our business in the EU remains resilient. The key issue we face is the macroeconomic environment, and in particular the continued rise in unemployment in all the largest economies except for Germany. This was the key driver behind the cigarette industry volume decline of 6.3% across the region in 2012. There is a clear correlation between unemployment and cigarette industry volume trends with the sharpest cigarette volume declines occurring where unemployment worsened the most.
Given the continued rise in unemployment at the start of this year, we do not expect any meaningful improvement in cigarette industry volume trends. Our current expectations for the full-year 2013 is that the rate of decline in the EU region will broadly be in line with that prevalent in 2012, provided that the decline in disposable income starts to moderate and that there is no substantial surge in illicit trade.
Let me focus on two of our key markets in the EU region starting with Italy. While cigarette industry volume declined by 7.9% last year to 78.7 billion units, the estimated total tobacco consumption decreased by just 1%, once the global fine cut and illicit trade is taken into account. Our business fundamentals in Italy are strong. Marlboro grew share in this difficult economic environment with an increase of 0.6 points to 23.1% on an annual basis, and an even more impressive 1.3 share points to 23.5% during the fourth quarter of last year.
We successfully launched Philip Morris Selection in the growing international low-price segment. In the fourth quarter of 2012, it registered a market share of 0.8%. Finally, we have gained leadership in the fine cut category with the 27.9% share in 2012, behind the successful growth of Chesterfield fine cut.
In Germany, cigarette industry volume declined by 1.2% and fine cut industry volume grew by 2.2% in 2012. While these volumes were flattered by an increase in competitors’ trade inventories in December and the reduction in illicit trade in the first half of the year, we estimate that the underlying trend in cigarettes remains a relatively moderate decline of around 2%. Our business is in good shape in Germany. The new Be Marlboro campaign is resonating with adult smokers and our disciplined investment in support of the brand have started to yield results as underscored by the brand’s share performance.
L&M continued to gain share in 2012 and remains the leading brand among legal age to 24 year old smokers, with a 20% smoker share nearly doubled its current overall market share. Last year, we achieved strong volume growth of 4.7% in the EEMA region to reach a volume of 304 billion units. Though, it should be noted that this growth was somewhat flattered by an increase in trade inventories in the fourth quarter. Russia and Turkey accounted for 47% of our cigarette volume in the region and the Middle East and North Africa for a further 20%.
Let me review on our progress and the potential that these markets offer going forward. Following significant excise tax and price increases in the recent past, cigarette industry volume in Russia decreased by 1.3% last year and a further moderate decline is expected this year. We increased our volume by 3.8% last year and our market share by 0.5 point to 26.3% as we continued to invest behind our broad brand portfolio, our field-force and our infrastructure.
The growth was driven by Parliament, L&M, Bond Street and Next. In November last year, the Duma confirmed its planned excise tax rates for 2013 and extended the law through 2015. We consequently registered retail price increases of six to seven rubles per pack in December. Though the new prices have only been in the market since February. The price increases ranged from 9% on the above-premium Parliament to 22% on the super-low Optima.
Cigarette industry volume in Turkey grew by 8.8% last year to reach a level of 99 billion units. We estimate that about one-third of the increase in volume was attributable to higher year-end trade inventories. In addition, the growth reflects the decline in illicit trade from 20% in 2011 to 13% in 2012. We again outperformed the industry increasing our market share by 0.9 points to a record level of 45.7%. At the same time, our product mix improved with gains coming from our premium Parliament and the mid-price Muratti brands.
At the beginning of the year, the government increased excise taxes and introduced a specific element. Subsequently, we increased retail prices by TRL1.00 per pack across our portfolio with an additional TRL0.25 per pack for Parliament. North Africa has been a key focus area for us over the last five years. Total cigarette industry volume in the area is currently estimated at 138 billion units, with potential for further growth driven by demographic trends and future improvements in living standards.
The business environment has generally normalized after the disruptions of the Arab Spring, though the situation in Egypt, Libya, and Tunisia remains tense. Our business in these markets relies on local partners, both in terms of manufacturing and sales and distribution. We produce locally for example, with Eastern Tobacco in Egypt and STAEM in Algeria.
The growth of our business has been driven by Marlboro which currently accounts for nearly 60% of our volume. L&M accounts for a further third and we have a leading 52% share of the international segment across the North Africa.
I will complete my regional review with the Latin America & Canada region, where Argentina and Mexico accounted for 58% of our 2012 cigarette volume. In Argentina, we further increased our market share by 0.9 points to 74.9% in 2012. In Mexico, underpinned by Marlboro campaign, Marlboro reached a record market share of 53.6% in 2012 and helped drive our overall share gain of 1.2 points to 73.5%.
Marlboro has been the key driver of our strong performance not only in Mexico, but also in other markets such as Brazil and Colombia where our company share increased by 1.0 and by 1.8 share points respectively. Arguably our greatest achievement in 2012 was the sustained growth of Marlboro worldwide. Its architecture is firmly in place and has been complemented by a new global campaign and the rollout of an array of consumer relevant line extensions across the Flavor, Gold and Fresh lines.
In 2012, Marlboro further expanded its share on a global basis to reach 9.3%, excluding China and the USA. For the first time since 2002, Marlboro grew its share in all the four regions underscoring its enhanced brand equity, continued relevance, and renewed vitality.
Such a strong performance from a premium brand in a challenging economic environment augurs well for the future. Marlboro will continue to benefit from the growth of the premium segment in emerging markets. In non-OECD markets as a whole, the estimated share of premium has increased steadily from 17% in 2009 to 19% last year. Marlboro, shown in red is the foundation of our leadership in the premium segment in emerging markets and is complemented in several of them by Parliament, shown on the chart in blue.
Parliament has the refined luxury image and accordingly is priced above premium. In 2012, Parliament volume increased by 10.1% to 43.4 billion units. This strong performance was driven by growth in Turkey and across Eastern Europe. L&M is our second largest and our best selling non-premium brand. In 2012, L&M volume increased by 4% to 93.7 billion units. In addition to a solid share performance in the EU region, L&M volume grew by 8.6% in the EEMA region last year, thanks to better availability in Egypt, the long awaited turnaround in Russia, and strong sales in Turkey.
Overall, our broad superior brand portfolio performed well at last year. Eight of our top ten largest brands by volume grew in 2012, led by Marlboro. Driven by the strength and vitality of our industry leading brands, our pricing power remains strong. We achieved a $1.8 billion positive pricing variance in 2012, which was slightly above the average for the years 2008 to 2011. We also remained focused on further improving margins through productivity and cost savings programs. We are targeting a further $300 million this year in pre-tax productivity and cost savings. We have successfully increased our adjusted OCI margin on a continuous basis since the spin, reaching 45.4% in 2012, four points above the 2008 level despite our long-term focus on our investments building our business and marketing infrastructure.
We intend to continue to invest behind our brands, our field-forces, our business infrastructure and our efforts to successfully develop and commercialize next generation products. We are able to transform a greater share of our net revenues into free cash flow than our peers, which we have complemented with additional debt financing at increasingly attractive terms. This was all whilst with maintaining our single-A credit ratings. The weighted average coupon of our total bond portfolio declined from 5.4% in 2010 to 4.8% in 2011 and to 4.2% last year. At the same time, we increased the weighted average time to maturity of our total long-term debt from seven years in 2010 to 10.1 years in 2012.
We have increased our dividend rate by a cumulative 84.8% since the spin. This represents one of the highest dividend growth rates amongst our peers over this period.
Our dividend yield was an attractive 3.7% at the end of last month. By the end of 2012, we had spent $27.9 billion to repurchase 489 million of our own shares or 23.2% of the shares outstanding at the time of the spin. The average price was $56.96 per share.
A steadfast commitment to shareholder value is a part of our DNA and we have delivered superior total shareholder returns since becoming an independent company in 2008. We compete in a sector with attractive business fundamentals that we believe can endure for many years to come. We have consistently surpassed and expect to continue to be able to outperform our international competitors, thanks to our strong volume and excellent share momentum, our world-class portfolio of brands led by Marlboro, our truly global footprint with a leading position in both OECD and non-OECD markets, our continuous investments behind our brands, our field-forces and our infrastructure.
Our pipeline of consumer relevant innovations, that places us in an ideal position to take full advantage of growing adult smokers preferences such as premium brands in emerging markets. Our ability to convert net revenues into free cash flow, which is unparalleled in our industry, and our strong capital structure and credit rating which has allowed us to increase our debt maturity while reducing the relative cost of borrowings.
Our success has enabled us to return over $50 billion to our shareholders since 2008 through a balanced program of higher dividends and substantial share repurchases. We have consistently delivered on our currency neutral annual adjusted diluted earnings per share growth target, and remain optimistic that we should be able to provide superior returns to our shareholders going forward.
Thank you for the interest in our company. Me and Nick, will be happy to take your questions.
Unidentified Company Representative
All right, Nick (inaudible), so if you could raise your hand and please just wait for the microphone to get to you because obviously being a webcast we want those questions recorded on the web. So we’ve got just under 11 minutes, we’ll finish off maybe 11:00 and then go to the break after mock room [ph]. Nick?
I think that’s clear. You have a mike right down here. Back there and then we’ll come upfront here. While we’re waiting for that, if you did not get a copy of the slides, we have a printout of the slides in the back of the room on the table, so please take a copy for yourself.
Erik Bloomquist – Berenberg Bank
Hello, thank you.
There you go.
Erik Bloomquist – Berenberg Bank
Erik Bloomquist, Berenberg Bank. Two questions please, one with respect to the Japanese market. How do you see the underlying volume trend evolving? So far it looks to be doing recently well, down only modestly. So I was just curious as to Phillip Morris’s view on that market. Secondly, with respect to NGPs, I was curious if there – how close you are to make any decision on citing the plant and then related to that, what the relevance to Phillip Morris is the UK’s MHRA decision on nicotine containing products. Does that have some meaning in terms of the regulatory environment in the evolution of the NGP regulatory structure? Thanks.
With regard to Japan, last year the industry volumes were down by I think 1%, we estimated that the underlying decline trend in the Japan is 1%. This year I think we’re estimate like for 1% to 2% decline which is still a very modest decline if you compare it to the historical trend in Japan, if you go back before the pricing and then the destructions following the earthquake – tsunami and earthquake.
On the NGP, we are very close to make a decision where we will place our manufacturing facilities, but I would not like to go further than that, but we’re very close. As you know the plan is that we should be ready with the commercialization on the 2016-17, so this year we said we will start investing behind the manufacturing centers. We also have said, I think on a few occasions that this will increase our CapEx by about EUR500 million to EUR600 million.
We’re working in parallel on all platforms which we have. So it’s not just the platform one which are more on the – reduce the temperature of changing the process from combustion into the fitting [ph] of the tobacco, as you know we have also other platform on which we are working and they all were part of us entering at various market with a different composition of a portfolio.
Just on that CapEx, that spending over three years, Erik, just to be clear on that. And we could stay down here and they will go the other side, I think Chris Wickham is here, if we can have a mike right here.
Chris Wickham – Oriel Securities
Yes, thanks. It’s Chris Wickham from Oriel Securities. Just a couple of points on Europe, I was just wondering where you sense we are with regard to illicit trade and something meaningful being done to reduce the amounts of illicit trade in Europe. And I suppose on the back of that, I mean what sort of pricing trends, pricing capability we should really be thinking about in the sort of mid to medium term are available in Southern Europe?
Let me start with the second part of the question, I think it’s a higher correlation of the unemployment trend and the general macros in a given market, in the European Union region and the level of illicit trade. I mean very clearly we can see this in the Southern European countries, like Italy, Spain very much, Greece initially when the crisis started. There is a moment when the unemployment in a very fast manner across this double-digit number 10% or so, and then we start seeing the acceleration of the illicit trade. So I think this is more of the driver of that and obviously its unemployment plus all the austerity measures which are imposing these countries which significantly reduce the purchasing power of consumers.
Now you have – we have had enough mentioned it in our remarks, the success stories in a number of individual member states in the EU, I think the biggest challenge which we have today is behind making the member state, taking some more coordinated efforts in a fighting country [ph], all this effort taking on a country by country basis. They do year-over-year results in the shorter term, but we cannot serve – they are not sustainable in a mid to long-term, I mean I’ve mentioned Germany, they had a very successful – they focused very much on a contraband illicit – smuggling illicit illegal factors et cetera at the very beginning of the 2012. We indeed – almost immediately seen the improvement in the industrial legal volumes, as the illegal trade was moving for the legal part and then somehow towards the second part of 2012, various German authorities get a little bit of more relaxed, I mean help you with the initial success and the trend, I mean there was no further improvement seen.
I’ve mentioned Turkey which brought over one year contraband from a 20% in 2011 to 13% in 2012 and that’s the significant improvement. I mean I can mention Romania – the number of countries in EU or close to the EU which in which we have observed the reduction of illicit trade. The problem is that you reduce the illicit trade in one country it’s very easily on a growth in the other country. Therefore our cooperation agreement with European Commission with all that, we also signed last year the agreement with INTERPOL, these are all efforts to bring the fight with the illicit trade at the international level being more coordinated et cetera.
We also – lot of effort which we’re taking on the reducing or making it more difficult (inaudible) in a supply chain for those which are producing this illegal cigarette because the fastest growing category in a illicit trade today is actually what we call the illicit ways [ph], the trademarks owned by companies which are officially registered in one place. They were never intended to be commercialized in that country. The all intention is about the moving this product result obviously [ph] and the tax payments to another places. So we were to council with other members of the industry on putting some like obstacles in the supply chain by having a better control of the flow of the direct materials which are necessary to manufacture cigarettes.
So I think once you have a more cooperation on the international basis, that our two agreements which we’re having in place whilst we tighten up our supply chain on the material side, needed to manufacturer cigarette I think we can start there seeing – we should be in a position to see a more sustainable reduction in the illicit trade.
We have a question on this side. And hands here? Anyone else? We have one way back here on.
Unidentified Company Representative
We’ll make that the last question.
So it will be last one right there. Right there, there we go.
Henry Davies – Bank of America Merrill Lynch
Hi Jacek, Henry Davies from Merrill Lynch. Just sticking on illicit trade, couple of your competitors have said, that a lot of the recent declines in the EU have been driven by an upsurge in illicit trade. When you look at the minus 6% volume decline, can you give us some feel for how much of that is for substitution into illicit trade, I mean what overall consumption is during – including illicit?
Well especially if you – if we zoom in into the Southern European countries and you look into the daily consumption of the smoking incidents among the adult smokers, you won't really see a declines in the consumption, a very minor, something which is part of the trend in – underlying trend in the category. This substantially means that while the legal part of the market, I mean the cigarettes is on decline, the demand is being – consumer demand is being satisfied by either fine cut products or they go into trade with the illicit trade.
And we see the growth of the illicit trade which essentially provides the supply part that does satisfy the demand from the customers. And we see this is not only actually in Southern Europe. So the 6% decline on the industry, 6.3% decline of the industry volumes last year, I think at the end of the day you presumably have an underlying decline more in the range of 2%, 1% to 2% and the rest is at least temporarily being satisfied by the illicit sources and the fine cut. Fine cut, I mentioned in my remarks there are more and more markets which are closing to the gap between the taxation of the fine cut and a cigarette so I believe that one can get (inaudible) to make their future progress last quarter of last year.
I think on that one, we should see some improvement on the trends over the period of time, the contraband remains an issue.
Unidentified Company Representative
Good. Six seconds there, so good timing. We’re going to now go to the breakout room with the black floor further 15 or so minutes of Q&A but if you could just join me in thanking Jacek in making for PMI’s presentation.
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