Credit Ratings: Imperial Brands

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Fitch: April 2024

Fitch affirms Imperial Brands’ credit rating (long-term issuer and senior unsecured debt) at BBB and keeps the outlook at Stable1. The BBB rating reflects Imperial’s focus on cash-generative (profitable) but structurally-declining combustible tobacco markets, supplemented by a selective Next Generation Product (NGP) offering, as well as a conservative financial structure (leverage target). Disciplined capital allocation and financial policy remain key to maintaining the BBB rating as the mature market focus results in moderate business growth assumptions.

Rationale for the Rating

– Strategy implementation on track: Focus on achieving a stable overall share in core (mature & highly regulated) markets that can be characterized by stiff competition and structural volume declines (weighing on growth and profitability). Targeted NGP approach resulting in less investment needs. Presence in selective emerging markets offering growth and margin expansion potential while balancing against the developed markets’ demand predictability.

– Moderated but steady growth assumed: Cigarette revenue as the key growth driver. Limited contribution from NGPs (3% of Imperial’s net revenue in FY23). Average sales CAGR of 1.4% to FY26. Slightly improving (Fitch-defined) EBITDA margin to 44% in FY24-FY27 (vs. 43% in FY23) as a result of strong pricing and smaller NGP losses. Free cash flow (FCF) generation to remain resilient at 5%-6% of sales, supporting liquidity and enabling multi-year share buybacks.

– Capital allocation focus & financial policy: Adherence to the lower end of 2.0x-2.5x net debt / EBITDA target (Fitch-calculated 2x net leverage in FY24). No large-scale acquisitions or significant capex increases. Multi-year share buyback program (£1.1Bn in FY24).

– Regulatory risk lower than peers: Lower exposure to NGPs, which are less regulated and attracting increased scrutiny with greater scope for regulators to act and disrupt. Focus on five established developed markets with strong and stable regulation.

– Benefit from down-trading: Well-placed to gain market share in the US given its larger focus on the mid-to-low price segments.

Comparison

Imperial’s rating is lower than PMI (A/Negative) and BAT (BBB+/Stable) due to its limited geographical diversification and muted progress in NGPs – partially offset by the lower regulatory risk profile. Imperial’s rating is at the same level as Altria (BBB/Stable).

Key Assumptions

– Constant-currency net revenue growth: 1.4% p.a. to FY27

– EBITDA margin: around 44% in FY24-FY27

– Capex: 2.5% of revenue in FY24-FY27

– Annual dividend per share: growing at mid-single digits to FY26

– Share buybacks: £1.1Bn in FY24, increasing by 10% per year in FY25-FY27

Catalysts for future rating action

– Positive: Tighter financial policy; More favorable trading environment in core markets; EBITDA margin above 48% (effective cost rationalization); Net EBITDA leverage below 2x; EBITDA interest cover above 10x

– Negative: Heightened business risk profile (shares losses, reducing diversification or a weakening brand portfolio); Net EBITDA leverage above 2.5x; Annual FCF margins to below 3% on a sustained basis; EBITDA interest cover below 8x

Moody’s: December 2023

Moody’s affirms Imperial Brands’ Baa3 (long-term issuer and senior unsecured debt) ratings while changing its outlook from stable to positive2. Moody’s notes that the outlook upgrade is based on Imperial’s steady earnings growth, strong free cash flow (supported by the high margins in combustible tobacco business) and reduction of (company-defined) net leverage towards the lower end of the 2.0x-2.5x target range.

Rationale for positive outlook: At the end of Imperial’s FY23 (Sept 20, 2023), company-defined net leverage of 1.9x translates to Moody’s-adjusted gross leverage of 2.7x. Multi-year deleveraging trend coupled with the leverage below the 3.0x threshold warrants the positive outlook.

In terms of risk factors, Moody’s underlines elevated social & regulatory risks (associated with the tobacco industry) as well as the limited progress (vis-à-vis peers) made in transformation to more sustainable, potentially reduced-risk tobacco products (i.e. only 3.3% of total tobacco net revenue and loss making).

Each of the following factors should be be achieved for an upgrade:

– Sustained organic revenue and earnings growth, with price increases more than offsetting declining volumes in combustibles and expectations of sustained positive momentum from NGP

– Debt/EBITDA remaining sustainably comfortably below 3x

– Tobacco operating margins maintained above 40%

– RCF/net debt of at least 15%

– Prospects of preserving strong liquidity.

One or a combination of the following factors could lead to a downgrade:

– Weakening in business profile either from an acceleration of the pace of declines of combustible volumes, diminished pricing power, significantly weaker operating margins if not more than offset by NGP growth

– RCF/net debt below 10%

– Debt/EBITDA sustained above 3.5x

– Negative free cash flow over an extended period

– Weaker liquidity.

Fitch: September 2023

Fitch Ratings issued a Credit Analysis report for the Global Tobacco companies3: PMI (A/Stable), BAT (BBB/Positive), Altria (BBB/Stable) and Imperial Brands (BBB/Stable). The ratings remain underpinned by strong operational cash flow generation across the industry.

Fitch states that US/UK tobacco companies show solid performance supported by continued good pricing power, along with resilient demand with only moderate volume pressure from weakening consumer purchasing power in some markets. In the medium term. Fitch believes most global tobacco companies to maintain their ability to implement price increases and develop product mixes that compensate for continuous volume declines in the core combustible segment.

Fitch expects smoke-free products – an increasingly material share of revenue for many – to gradually support sector revenue and profit. However, Fitch views the business risk profiles for rated tobacco companies as increasingly differentiated by the development of smoke-free products and notes that the smoke-free products require careful strategic execution to reflect differing and developing consumer tastes and preferences, as well as growing regulatory pressure on non-combustible products in many markets.

Fitch notes that credit rating headroom has improved for PMI with deleveraging on track after its significant Swedish Match acquisition in 2022 and BAT’s deleveraging supports the Positive outlook on the rating.

References:

  1. Fitch Affirms Imperial Brands at ‘BBB’; Outlook Stable (fitchratings.com) ↩︎
  2. https://ratings.moodys.com/ratings-news/412916 ↩︎
  3. https://www.fitchratings.com/research/corporate-finance/global-tobacco-ratings-gain-headroom-on-solid-profits-capital-allocation-19-09-2023 ↩︎

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