Looking back on 2023 results

Throughout 2023, we saw continued challenges for business globally due to increasing geopolitical risks, higher supply chain costs due to inflation worldwide, and exchange rates broadly in flux. Despite all this, the Group was able to realize profit growth, bring in revenues and profits above the targets set at the beginning of the year, and achieve new records^* for both for the second consecutive year.

Adjusted operating profit at constant currency, the Group’s key performance indicator, grew by 5.2% year on year, which we attribute mainly to the positive pricing contribution of the tobacco business throughout the year, offsetting the negative effects of higher supply chain costs and accelerated investment in HTS (heated tobacco sticks).

Our growth rate of adjusted operating profit at constant currency has been rising year on year for four years, even as our RRP (Reduced-Risk Products) business is still in the investment phase.

Our revenue on a reported basis was 2,841.1 billion yen, up 6.9% year on year due to sustained momentum for the tobacco business and revenue growth in the pharmaceutical business. Adjusted operating profit on a reported basis was 728.0 billion yen, at about the same level as in 2023, affected mainly by the negative exchange effect of the Russian ruble.

Operating profit was 672.4 billion yen, up 2.9% year on year with reduced amortization of trademark rights, increasing real estate sales, and an adjusted item. On top of improved financial costs and lower corporation taxes paid, these two factors helped boost our profit for the year by 8.9% year on year, to 482.3 billion yen.

Free cash flow was 443.7 billion yen, up 60.8 billion yen year on year due to the end of expenditures related to initiatives to reinforce our tobacco business operations in Japan, recorded in fiscal 2022, and lower corporation taxes paid, more than offsetting the impact of the increased working capital.

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Revenues, adjusted operating profit, operating profit from ongoing businesses, and profit from ongoing businesses attributable to owners of the parent company

Operating environment outlook for 2024-2026

We project that conditions through the period of the current business plan (2024-’26) will remain challenging due to erosion of industry volume as well as downtrading, mainly in our key markets, rising geopolitical risk, tougher operational environment for RRP due to tightening regulations, higher taxes and stronger competition, and forex risks.

With these challenges in mind, we are committed to sustainable profit growth over the medium and long terms, specifically mid- to high-single-digit annual growth on average for adjusted operating profit at constant currency on a consolidated basis. In combustibles, we aim to improve ROI through marketing investments and consistent pricing execution for top-line growth, as well as cost efficiency initiatives through continuous supply chain improvements. In RRP, we will prioritize reinvestment of profits generated from combustibles towards HTS, which is expected to be the fastest growing RRP segment.

During the period of the current business plan (2024-’26), we project consolidated adjusted operating profit at constant currency on a par with that for 2023 in 2024 due to enhanced RRP investment, moving to the growth path for 2025 and onward. As a result, we project average mid-single-digit growth over three years, near the low limit of our mid- to long-term targets of mid- to high-single-digit growth.

• For details see Business Plan 2024 of this report.

Financial policy

The Group formulates and executes its financial plans in line with our two core values of resilience and flexibility. Resilience means the ability to maintain business despite significant or unexpected risk, such as economic crisis. Flexibility mainly means promptly responding to attractive investment opportunities.

As a new initiative, the Group set up its first green loan facility in 2023. This is for ESG-related funding approach, demonstrating our commitment to ESGs and sustainability efforts. It will also help diversify our funding options and expand our investor base. We will carry on with this keeping funding needs in mind.

Cash and cash equivalents on our balance sheet are increasing, but include some trapped cash related to international sanctions on Iran as well as retained funds related to our litigation in Canada. We will continue to work on flexible financing, watching the global situation from all angles, in addition to the outlook for funding needs, the money market environment and funding costs.

Cash flow management

In our cash flow management, we put highest priority on stable cash generation from top-line business growth. We are also undertaking initiatives to reduce foreign exchange impact and optimize working capital.

In the tobacco business, particularly in emerging markets, we are working to optimize our businesses for local levels of economic growth and build the value of our businesses in local currency over the medium and long terms. We pursue cash creation via top-line growth, made possible both by, on the one hand, pricing that takes into consideration tax hikes and inflation, and on the other, share gains building on the strength of our brand portfolio, enhanced with a long-term strategic investment view. Pricing is a profit-growth driver for our tobacco business, but it’s done with consideration for various factors and from all angles, including brand equity, competition, consumer^* behavior and acceptance, and the economic environment. In some markets, temporarily or for short periods, our retail prices may fall behind inflation growth, but we have been generally successful in raising prices to meet inflation rates over the medium and long terms.

Because the JT Group operates worldwide, we live with constant risk of exchange effects on our cash flow. To reduce forex impact in this environment, we use natural hedging, by which we mean matching incoming and outgoing currencies, as well as hedging using exchange forwards and other derivatives, taking costs into consideration. In principle, foreign currency credits and debts are fully hedged. We also hedge 25-90% of future cash flow, and in some cases apply hedge accounting to reduce forex risk, taking into account possible impact on the profit and loss statement.

To optimize working capital, we continuously enhance our cash-conversion cycle, reviewing terms for receivables and payables and applying methods such as liquidation of receivables and supplier financing while optimizing inventory levels.

As a result of these initiatives, we have been reliably generating free cash flow of about 400 billion yen per year over 10 years, leaving aside the transient effects of M&A initiatives and so forth.

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Adult consumers: The minimum legal age for smoking varies with legislation in each country; in Japan smoking is not permitted for those under 20 years of age

Investment distribution

There has been no change in our two key policies for management resource allocation: give top priority to investment and balance profit growth resulting from investment with shareholder returns. Based on the 4S model, our management principle, and the JT Group Purpose, we will put top priority on investments leading to sustainable profit growth, especially in the tobacco business. We continue to designate the pharmaceutical and the processed food businesses as complementary to our core business, assisting profit growth for the entire Group.

Based on the resource allocation policy I’ve just described, our benchmark payout ratio has been 75%^* since February 2021. In monitoring trends in shareholder returns among global FMCG firms, we have confirmed this as a competitive level in terms of capital markets in Japan and abroad. Through the term of the current business plan, we will invest substantially in HTS. However, we are working to increase shareholder returns by continuing to build adjusted operating profit at constant currency, which is our foundation for profit growth over the medium and long terms, while maintaining a target payout ratio based on the policy I’ve outlined.

In discussing whether to buyback our own shares and in what quantities, in addition to financial prospects for the current fiscal year, we carefully consider the medium- and long-term prospects of our environment; our FCF, balance sheet and the like; and levels of profit and progress with investments and initiatives.

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To be in the range of approximately ±5%

Profitability of capital and market evaluation

In drawing up a business plan, we calculate and examine our capital costs and report them to the Board of Directors. We check and confirm that our return on equity is well above capital costs. We set up a hurdle rate, taking into consideration risks associated with each country in which we operate, as well as inflation and other external risks, and use that as our baseline for profitability. By maintaining that discipline, we make sure our ROE is always above capital costs. The Group uses adjusted operating profit at constant currency as a key performance indicator^*, which excludes the effects of exchange rate fluctuations that can be substantial due to temporary factors, as well as amortization costs related to M&A activities for the previous year. We work to grow profit by achieving mid- to high-single-digit growth in this KPI over the medium and long terms. We also believe it leads to improved ROE.

Comparing our total shareholder returns (TSR), including dividends, with the Tokyo stock price index (TOPIX) shows that ours have been below the TOPIX over the long term, matching the trend in our share price, but outperformed the TOPIX in comparison between the end of 2019 (pre-pandemic), and the end of 2023, thanks to profit growth during the period and a higher 2022 dividend. We believe continuous profit growth is important to the medium- and long-term stability of our equity value. We also believe that building quantitative corporate value through profit growth, while cultivating a better understanding of the Group through enhanced information disclosure from a qualitative standpoint, will lead to rising TSR.

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Supplemental note: Why we use adjusted operating profit at constant currency as a key performance indicator

• We use adjusted operating profit to show our business results for the current year in a way that’s easy to understand, excluding the effects of amortization costs related to any acquisitions in the previous year.
• Starting with our Business Plan 2014, to manage business investments and returns more appropriately, we changed our key performance indicator from adjusted EBITDA to adjusted operating profit, which does not require adding back depreciation or amortization costs, which fluctuate with investment scale for the year.
• We use figures at constant currency, believing we can show the true strength of our businesses much more clearly by disregarding exchange rates effects, which can fluctuate substantially over short periods due to geopolitical risks and other factors not directly related to our businesses.

IR activities

The Group appropriately discloses timely information, both financial, as with business results, and non-financial, such as management strategy, ESG factors and the status of each business segment, and engages in active dialogue with shareholders and institutional investors to ensure clear understanding. Our IR teams in Tokyo and Geneva, where JT and JTI are respectively headquartered, meet with securities analysts and institutional investors to discuss recently announced financial results and other disclosed information, as well as conduct individual meetings on ESG matters. Our plan for investor-focused events is in process.

In 2023, we held about 400 individual conferences, and in May an online Tobacco Investor Conference, as opportunities to explain our long-term prospects and strategies for the tobacco business. Our IR representatives participate in conferences hosted by securities houses and meet with domestic and overseas institutional investors. On some of these occasions, the CEO, Executive Vice President in charge of finance and myself are present.

In meetings specifically focused on ESG, we sometimes seek investor opinions, including assessments of our integrated reports. In 2023, we held the first meeting between our Outside Directors and investors. We will actively continue this kind of dialogue, making the most of the opportunities we’ve created.

We report the investor opinions we obtain through these meetings to our Board of Directors three times a year, and quarterly to all executive officers and related divisions, along with information related to market trends, including share prices. We consider investor viewpoints as we improve and review our ongoing initiatives, and continue working to reflect their views and expectations appropriately in our strategies and operations so they will better understand our results and initiatives.

Dialogues with investors in 2023

Communication with bond investors

The Group is also working to enhance communication with bond investors. In compliance with the Japan Tobacco Inc. Act, on which our Company was founded, the Japanese government is obliged to hold at least one-third of corporate equity at all times. Following this rule, the government must also accept one-third of any new shares issued for funds procurement. So debt finance is our primary funding method from the standpoint of fund maneuverability. Corporate bonds are a particularly important means for funding to help achieve sustainable growth. For reliable funding even in an unstable financial environment, we are endeavoring to broaden our scope of communications with domestic and overseas bond investors. To create more opportunities for dialogue with bond investors and promote better understanding of the Group, in addition to meetings when issuing new bonds, since 2018, we have been regularly organizing non-deal road shows with bond investors in Europe, North America, the Middle East, and Asia. We will be adding similar opportunities to communicate with more bond investors.

In addition to enhancing our dialogue with bond investors, we are working to increase our engagement with the organizations that conduct ESG assessments and to improve our ESG scores, which are widely referenced in the capital markets. We believe we can strengthen our relationship with bond investors and prepare for the next bond issue by helping them better understand and appreciate our ESG initiatives.

The response to the Sustainability Disclosure Standards

Reflecting the growing interest in sustainability, the range of information stakeholders demand that corporations disclose is widening to cover ESG areas. Talks are going on in many countries, including Japan, to legally require the disclosure of sustainability information based on standards set by the EU, the IFRS Foundation, and the like.

This trend aims to increase the transparency of corporate approaches and initiatives toward sustainability, allowing investors and stakeholders to more accurately assess corporations. The Group considers this as an excellent opportunity to align with international standards for disclosure of sustainability-related information. Providing more transparent and comparable information builds a stronger foundation for us in providing investors and other stakeholders with truly useful information.

We have been working to enhance our disclosure of sustainability-related information, including in integrated reports and on our website. Going forward, we will continue to do so in compliance with standards as a responsible corporation, and communicate it in ways that help us build corporate value.