Tobacco Companies: Credit Ratings

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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 F21. 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.

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: November 2023

Fitch revises the Outlook on Philip Morris International (PMI) to Negative (from Stable) while affirming senior unsecured long-term debt rating at A3. The Negative outlook reflects

– deleveraging taking longer than previously expected: dividend policy limiting deleveraging from 3.1x in 2023 to 2.5x by end-2025 (vs. 2.0x in Fitch’s previous estimates) as PMI’s debt is set to remain above $46Bn in 2024

– uncertainty around the timing and contribution of the launch of IQOS ILUMA in the US (Recall: “IQOS: The US launch“)

– a temporary reduction in free cash flow (FCF) in 2023-2024 following inflationary pressures, currency headwinds, increased interest payment (relating in part to debt-funded acquisition of Swedish Match) and the uncertain outcome of the German tax surcharge ruling on heated tobacco sticks

– no headroom for operating under-performance (such as, the execution risks in increasing the contribution from RRPs, recovering profitability margins and delivering the announced $2Bn cost-efficiency plan for 2024-2026) as PMI aims to return to around 2x leverage in 2026.

PMI is the highest Fitch-rated issuer in the tobacco sector, supported by an industry-leading business risk profile that reflects its global scale, diversified brand portfolio, and leading position in RRPs, in addition to its substantial geographical reach. However, the absence of clear deleveraging toward 2.5x in the next 12-18 months will lead to a downgrade.

Fitch’s ratings for the other tobacco companies are: British American Tobacco (BBB/Positive), Imperial Brands (BBB/Stable) and Altria (BBB/Stable).

Moody’s: November 2023

Moody’s affirms Philip Morris International’s A2 long-term issuer and senior unsecured debt ratings4. The outlook remains Stable.

Moody’s notes that

– PMI is making good strategic progress in smoke-free products (now more than 35% of revenues)

– Strong pricing power is more than offsetting the long-term systemic volume decline in combustibles

– Growth is particularly strong for ZYN nicotine pouches (providing a strong platform for IQOS ILUMA launch in the US)

– Top- & bottom-line growth momentum is to be maintained in 2024/25 (on FX-neutral basis).

Due the notable strength of the US$, PMI’s EBITDA will be lower and debt will be somewhat higher than the expectations set a year ago. Moody’s now expects the adjusted gross leverage to return to around 2.5x at the end of 2025 – a year later than previously expected. High dividend pay-out leaves limited scope for debt reduction (i.e. slower deleveraging) and means that PMI is weakly positioned in the A2 rating category.

In light of the relatively elevated leverage arising from the Swedish Match acquisition, an upgrade is unlikely in the foreseeable future:

– Debt/EBITDA below 1.5x, FFO/Net Debt above 30% (or RCF/Net Debt in the mid-teens) and EBITDA margins above 40% are the prerequisites for an upgrade

– Lack of improvements in credit metrics over the course of the next two years (Debt/EBITDA to around 2.5x and RCF/Net Debt to around 10%) could lead to a downgrade.

Fitch: November 2023

Fitch Ratings assigns “BBB” rating to Altria’s senior unsecured notes5. Other comparable peers include Philip Morris International (PMI; A/Stable), British American Tobacco (BAT; BBB/Positive) and Imperial Brands (IMB; BBB/Stable).

Altria’s rating reflect its position as the industry leader in the US cigarette category, anchored by its Marlboro franchise (58% Premium segment share, 42% overall market share), and in the US moist smokeless tobacco (MST) category with strong profitability and cash flow that benefits from good pricing power. Altria’s business profile is constrained by limited geographic diversification, given its reliance on the US market and associated regulatory risks, secular combustible cigarette declines and uncertainties around the long-term portfolio shift to smoke-free products.

Altria will continue to focus on maximizing profitability in its core tobacco operations while reallocating resources to fund increased investments in smoke-free products. Fitch believes the robustness of Altria’s innovation pipeline materially increased given recent announcements (e.g. partnership with Japan Tobacco and NJOY acquisition). The key long-term risk centers on whether Altria’s product mix will evolve into a strong portfolio of non-combustible tobacco brands that maintains long-term nicotine share, particularly in light of the burdensome regulatory process, heightened competitive environment and uncertain consumer product acceptance. Altria will need to scale the smoke-free businesses, which are loss-making today, to generate contribution margins that are at least on par with existing mature tobacco brands, to support stable to growing cash flows. 

Fitch: September 2023

Fitch Ratings issued a Credit Analysis report for the Global Tobacco companies6: 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.


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