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July 15 (The following statement was released by the rating agency)
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
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 debt rating has been affirmed at 'F2'.
The affirmation follows BAT's announcement that it will contribute USD4.7bn
(GBP2.7bn) capital to funding the acquisition by its associate Reynolds American
Inc (RAI) of rival US player Lorillard Inc. through a cash and equity offer. BAT
will in turn raise this from internal resources and borrowings, which Fitch
believes will keep leverage, through to at least end-2015, at a level well
beyond the maximum compatible with BAT's 'A-' rating. However, the impact of
higher leverage is, in Fitch's view, sufficiently mitigated by BAT's decision to
suspend its share buyback programme with effect from end July-2014 and by the
future benefits of a strengthened RAI, in which BAT has a 42% stake.
KEY RATING DRIVERS
Stronger US Associate
The transaction will transform the US tobacco market by consolidating the number
two and number three players in the industry into a more robust competitor to
the strong leader Altria, Inc (BBB+/Stable). The new RAI will, after adjusting
for the asset disposal envisaged, enjoy a stronger market share of above 30%,
and a highly focused and easier to manage brand portfolio. It will also enjoy
substantial cost synergies resulting from the back-to-back divestment of
Lorillard's manufacturing, sales force and head office. BAT will indirectly
benefit from RAI's enhanced profitability through the likely maintenance of a
high dividend pay-out of 75% by its US associate.
Share Buyback Suspension
The imminent suspension of BAT's share buyback - which we assume to last until
at least end-2015 - helps BAT build sufficient headroom ahead of the transaction
and minimise the adverse effect from the planned USD4.7bn (GBP2.7bn) capital
disbursement. Post completion in 2015, this should help contain funds from
operations (FFO)-based net leverage to no more than 2013's 2.3x. Despite scope
for organic profit growth in 2014 we expect pre-completion leverage to remain
around 2.0x as a result of foreign currency headwinds. We project net leverage
should return to around 2.0x from 2016, on the assumption that the share buyback
Tight Rating Headroom
The above mentioned leverage is beyond the level compatible with BAT's 'A-'.
This is mitigated by BAT's strong global market position in a consolidated and
highly cash-generative industry. The ratings are also supported by the group's
stable and substantial profits and cash flow from operations (2013: GBP4.1bn),
as reflected in our projection of a free cash flow margin of 5%-6% and a healthy
EBITDA margin of over 40% from 2014.
Stable Business Profile
The ratings continue to reflect BAT's position as a leading international
tobacco company, supported by the diversity of its portfolio of brands and of
the countries it operates in. BAT's superior geographical diversity, which Fitch
estimates to include over 50% of profits coming from high-growth emerging
markets, continues to enable it to protect profits through price increases and
cost rationalisation in an industry that is facing declining consumption and the
penetration of illicit trade. These dynamics have accelerated over the past 18
months, particularly in the European Union and Australia.
Negative: Future developments that may, individually or collectively, lead to a
negative rating action include:
- FFO-adjusted net leverage above 2.0x on a sustained basis (FYE13: 2.3x)
- FCF (adjusted for working capital swings) falling below GBP500m as a result of
litigation or dividend distributions (FY13: GBP660m)
- FFO fixed charge cover under 6.0x (FYE13: 7.0x)
- A deteriorating operating profile, as evidenced by impaired organic profit
growth capability,resulting from weak pricing power and lack of cost rationalisation to offset
Positive: Fitch does not currently expect BAT to pursue financial policies
consistent with an upgrade.