Fitch Affirms British American Tobacco p.l.c. at 'A-'; Outlook Stable

Tue Mar 11, 2014 1:11pm EDT

(The following statement was released by the rating agency) MILAN/LONDON, March 11 (Fitch) Fitch Ratings has affirmed British American Tobacco p.l.c.'s (BAT) Long-term Issuer Default Rating (IDR) and senior unsecured rating at 'A-'. The Short-term IDR has also been affirmed at 'F2'. The Outlook is Stable. In addition, the senior unsecured long-term rating of debt issued by BAT's subsidiaries, British American Tobacco Holdings (The Netherlands) B.V., B.A.T. International Finance p.l.c. and B.A.T. Capital Corporation, has been affirmed at 'A-'. The Short-term rating has been affirmed at 'F2'. The affirmation reflects BAT's stable cash generative profile, capable of successfully coping with the industry's contracting volumes through price increases and cost rationalisations. These elements support steady and consistent revenue and profit growth. At the same time, generous shareholder distributions keep leverage at the top end compatible with BAT's 'A-' IDR. The affirmation is premised on Fitch's expectation that BAT should remain capable of defending its profits even amidst product innovation or stronger regulation in the industry and that management would consider scaling down share buybacks to protect credit metrics should it be necessary. KEY RATING DRIVERS Stable Business Profile The ratings reflect BAT's position as a leading international tobacco company, supported by the diversity of its portfolio of brands and the countries in which it operates. BAT's superior geographical diversity, which includes close to 60% of profits coming from high-growth emerging markets, is key to its ability to protect revenues in an industry characterised by the accelerating decline of consumption in the developed world. Regulatory Pressures The ratings also factor in the increasing regulation of tobacco companies. This includes the gradual extension, sponsored by the World Health Organization, of smoking and advertising restrictions, as well as higher excise duty, to the less regulated, developing markets of eastern Europe, Asia and Latin America. In addition, several governments are watching the effects of Australia's plain packaging legislation introduced in December 2012. Fitch does not expect widespread replication. However, if this was the case, it could have adverse effects on the industry's pricing power. Demand Pressures and Profits Unemployment and sharp increases in excise duties in selected countries are causing some down-trading by consumers and a shift of purchases towards illicit trade. However, thanks to price increases, cost rationalisation and wide geographic diversification, BAT maintained healthy revenue and profit momentum over 2008 to 2013, despite a consistent, low single digit contraction of volumes. Substantial Cash Flow The ratings are also supported by the group's stable and substantial cash flow from operations (2013: GBP4.1bn) and by Fitch's view that the operating profit margin should continue to improve, aided by price increases and cost rationalisation. Generous Shareholder Distributions The above positive factors are partly offset by BAT's generous dividend policy (at least 65% of earnings) and share buybacks, which more than absorb free cash flow (FCF). BAT has increased its annual share buyback programme to GBP1.5bn for 2013 and 2014. Excluding working capital movements Fitch forecasts growing FCF over 2014-2015 from 2013's GBP0.8bn. Such strong cash flow generation should enable net FFO-based lease adjusted leverage to remain stable at 2012-2013's level of 2.0x. RATING SENSITIVITIES Negative: Future developments that may, individually or collectively, lead to a negative rating action include: - FFO based net leverage above 2.0x on a sustained basis. - FCF (adjusted by working capital swings) falling below GBP500m as a result of litigation or dividend distributions. - FFO Fixed charge cover under 6.0x. - A deteriorating operating profile, as evidenced by impaired organic profit growth capability, resulting from more adverse regulation or declining demand for BAT's products. Positive: Provided that litigation and regulation risks remain manageable, upward rating pressure could materialise in the event of: - FFO based net leverage lower than 1.0x - 1.2x. - FFO Fixed charge cover above 10.0x. - FCF above GBP1.5bn and FCF margin at least in the high single digits. - Further improvement in operating EBIT margin above 38%. Contact: Principal Analyst Ching Mei Chia Director +44 20 3530 1068 Supervisory Analyst Giulio Lombardi Senior Director +39 02 8790 87214 Fitch Italia S.p.A. Via Morigi, 6 Ingresso Via Privata Maria Teresa, 8 20123 Milan Committee Chair Pablo Mazzini Senior Director +44 20 3530 1021 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: Additional information is available on 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 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. 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