Fitch Affirms Philip Morris International at 'A'; Outlook Stable

Tue Aug 13, 2013 10:24am EDT

(The following statement was released by the rating agency) LONDON, August 13 (Fitch) Fitch Ratings has affirmed Philip Morris International, Inc's (PMI) Long-term Issuer Default Rating (IDR) and senior unsecured rating at 'A' and Short-term IDR at 'F1'. The Outlook on the Long-term IDR is Stable. The affirmation and Stable Outlook reflects PMI's strong operating profile - which translates into a healthy operating EBITDA margin in excess of 47%, a stable and large underlying free cash flow (FCF) of on average USD4bn despite weak trading conditions in the European Union and a few adverse one-offs in Asia in H113. This is however contrasted by the scope for higher gross leverage as PMI is issuing more short term debt to fund an offshore cash build-up while aiming to maintain its current tax rate. KEY RATING DRIVERS Growing Leverage The buyout of a 20% stake in Philip Morris Mexico for approximately USD700m during 2013 will not affect Fitch's leverage calculation as the agency had already included this in its lease and put option adjusted leverage ratio. However, PMI's gross funds from operations (FFO) leverage could - over 2013-2015 - move close to the 2.5x-2.7x maximum threshold compatible with the current 'A' rating as a result of the issuance of short term debt. We believe PMI is seeking to maintain its current 29% tax rate against a US corporation rate of 35% and, in the absence of US tax reform, is likely to maintain part of its overseas profits offshore. Moderate Net Leverage An increase of debt could represent an increase in PMI's financial risk. However, Fitch takes comfort from the fact that, should PMI decide to apply its cash to repaying this additional debt, the effects on net leverage of the associated tax burden would be limited to between 0.1x and 0.2x. By incorporating these adverse scenarios, Fitch projects that PMI's net lease adjusted debt to EBITDAR should remain between 1.6x and 1.9x over 2013-2015. This remains aligned with other stable and highly cash generative 'A' category issuers. International Leader The ratings reflect PMI's position as the leading company in the global tobacco industry (excluding the US and China), supported by the diversity of its portfolio of brands and the countries in which it operates. PMI enjoys large market shares and pricing leadership in many of the world's most profitable and growing tobacco markets, with superior diversification across continents. The company also enjoys solid innovation capability. Fitch is confident that PMI would be able to manage successfully any transition of tobacco consumption towards e-cigarettes, should these pick up more significantly. The product that PMI has under development, as well as its market clout should allow it to win against the small independent players once e-cigarettes are subjected to more regulation. Geographical Diversity Protects Volumes During 2012 and H113, the EU market (30% of PMI's profits) has suffered from a sharper than historical volume contraction of over 6%, causing a 0.6% and 5.4% organic contraction, respectively, in PMI's regional profits. Still, PMI's presence in developing markets, where population is growing and the incidence of smoking is high, remains key to its ability to protect volumes. Price Increases Support Profit The weakness of the EU will continue to weigh on consolidated profits but Fitch believes that PMI should continue to enjoy scope for profit growth because of the likely reversal of some cost issues that further affected H113 performance. Therefore, the 0.2% contraction of profits excluding currency suffered in H113 should be seen as a one-off. Fitch believes price increases in the EU and other regions should continue to offset volume decline and support profit growth, although likely at a slower pace than the close to 10% a year delivered on average over 2008-2012 in organic terms. Significant Shareholder Distributions Fitch expects dividends and share buyback spending to remain high, with the latter at USD6bn pa for 2013-2014. While PMI's cash flow continues to demonstrate considerable stability at USD8bn-USD9bn (FCF before dividend payments and excluding working-capital movements) a year, the extent to which PMI allocates cash flow to shareholders or M&A is the main driver of leverage. During 2008-2012 dividends grew by over 10% a year and annual share buyback disbursements increased to USD6.5bn in 2012 from USD5bn-USD5.5bn. Mitigating these concerns is the fact that there is limited scope for M&A in the tobacco industry. RATING SENSITIVITIES Positive: Although Fitch does not currently expect management to pursue financial policies that would be commensurate with an upgrade, future developments that could lead to a positive rating action include: - Maintaining gross lease-adjusted debt/FFO sustainably below 1.8x or gross lease-adjusted debt/EBITDAR below 1.3x-1.4x - Maintaining the current level of profitability and FCF generation in the absence of shocks derived from far more stringent regulation Negative: Future developments that could lead to a negative rating action include: - Spending on acquisitions or share buybacks, combined with an impaired rate of growth for revenue and profit leading to gross lease-adjusted debt/EBITDAR above 2.3x-2.5x or gross lease-adjusted debt/FFO above 2.5x-2.7x - FFO fixed charge coverage below 8x - A materially adverse judgment by a court after all appeals processes requiring PMI to pay a large amount of money as compensation following tobacco litigation - Pressure on EBITDA margin dropping below 40% Future developments that could result in the Outlook being revised to Negative: - Lack of clarity in the US over the resolution of the high tax being charged on foreign profits and, at the same time, insufficient action (including reducing its share repurchases) by PMI to prevent a permanent increase in gross leverage above levels prescribed for a downgrade. Contact: Principal Analyst Ching Mei Chia Director +44 20 3530 1068 Supervisory Analyst Giulio Lombardi Senior Director +39 02 8790 872 14 Fitch Italia SpA 1, Vicolo Santa Maria alla Porta 20123 Milan Committee Chair Pablo Mazzini Senior Director +44 20 3530 1021 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Applicable criteria, 'Corporate Rating Methodology', dated 5 August 2013, are available at www.fitchratings.com. Applicable Criteria and Related Research: Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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