Credit Ratings: BAT

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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

Fitch: March 2024

Fitch upgrades British American Tobacco (BAT)’s credit rating (long-term issuer and senior unsecured debt) from BBB to BBB+ (perpetual subordinated notes rating: from BB+ to BBB-) while keeping the outlook as Stable and short-term debt rating as F22. Fitch notes that the upgrade reflects BAT’s lowered leverage ratio and drive for further deleveraging as well as the improved profitability and strong free cash flow (FCF) generation.

Rationale for the upgrade

– Financial Policy: BAT’s narrowed target net leverage range of 2x-2.5x (based on BAT’s metrics) allows comfortable headroom at BBB+ (Fitch’s own leverage estimation & expectation: 2.8x at the end of 2023; at / below 2.5x in 2025 and beyond)

– Strong Cash Generation: Fitch estimates annual post-dividends FCF of £1.7-2Bn over the next four years, supported by low single digit organic revenue growth and EBITDA margin improvement towards 49% from 47% in 2023 (- supported by double-digit new category growth and further efficiency savings). Fitch expects share buybacks of up to £3.5Bn over 2026-2027 in addition to announced £1.6Bn buybacks in 2024-2025

– NGP Profitability: Positive operating contribution achieved in 2023, two years earlier than originally anticipated (BAT’s target: 50Mn NGP users by 2030, up from 24Mn in 2023)

– Expectation of (eventual) improvements in the US market: Despite the persistent lower consumer confidence in the US, Fitch expects BAT’s US combustible volume decline to decelerate to high-single digit rates in 2025 (from 11% in 2023). However, especially in 2024, price increases will not be able to fully make up for the volume decline in the US. Nevertheless, Fitch believes that robust performance in other segments (i.e. NGPs) and regions together with further cost efficiencies will more than compensate the profitability pressure from the US combustible segment

– Delayed US regulatory risks: Final approval of the US Menthol ban was delayed and timing in the context of the US election year is uncertain (although it is scheduled for 2024)

– Decent execution capabilities

– Litigation impact well-managed (“limited downside risk”): Fitch assumes no value remaining in ITCAN (Canadian operations) as a result of the litigation and eliminates all cash uncertainties associated with the legal proceedings (resulting in +0.2x leverage increase). This de-consolidation removes a profit contribution of £600Mn (~5% of operating profits) and restricts around £1.9Bn of cash.

Key Assumptions

– Organic annual revenue and profit growth: +2.2% to 2027 (on average)

– EBITDA margin: just above 48% in 2024 and trending toward 49% by 2027

– CAPEX: stable at 2.6% of sales to 2027

– M&A Spending: Bolt-on acquisitions and partnerships at £100Mn a year over 2024-2027

– Dividend growth: 3%-5% a year

– Share buybacks: £1.6Bn over 2024-2025, £1.5Bn in 2026 and £2Bn in 2027.

Catalysts for future rating action

Each or a collection of the following factors could lead to a positive rating action:

– Good progress towards NGP category target (increased revenue contribution leading to sustained organic revenue and EBITDA growth)

– Net debt/EBITDA towards 2.0x on a sustained basis

– Maintaining FCF margin at around mid-single digit

– Operating EBITDA/interest coverage above 8x.

Each or a collection of the following factors could lead to a negative rating action:

– A material impact from the menthol ban in the US

– Lower profits leading to FCF margin declining under 4% of sales (loss of global market share or an inability to maintain NGP profitability as the combustible volumes decline and competition for NGP intensifies)

– Net debt/EBITDA above 3.0x on a sustained basis

– Operating EBITDA/interest coverage below 6.5x.

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://www.fitchratings.com/research/corporate-finance/fitch-upgrades-british-american-tobacco-to-bbb-outlook-stable-26-03-2024 ↩︎
  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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