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July 8 (The following statement was released by the rating agency)
Fitch Ratings has affirmed US-based tobacco group Philip Morris International, Inc's
(PMI) Long-term Issuer Default Rating (IDR) and senior unsecured rating at 'A' and its
Short-term IDR at 'F1'. The Outlook on the Long-term IDR is Stable.
The ratings reflect PMI's strong operating profile, supported by its leading
market shares and pricing power, which translates into a healthy operating
EBITDA margin in excess of 47%. The ratings also reflect stable and strong
underlying free cash flow (FCF) of USD4bn on average despite weak trading
conditions in the European Union and a few adverse one-offs in Asia in 1Q14.
This is, however, balanced by a lack of leverage headroom; Fitch expects PMI's
gross FFO leverage over 2014-2017 to be above the 2.5x-2.7x maximum threshold
compatible with the current 'A' rating. However, this is mitigated by PMI's
proven ability to sustain its profit margins and Fitch's expectations that it
will retain strong overall financial flexibility.
KEY RATING DRIVERS
No Leverage Headroom
The forecast increase in FFO leverage over 2014-2017 to above 2.5x-2.7x (FYE13:
2.7x) is a result of PMI's debt issuance to fund its share buyback programme.
However, Fitch views positively the announced reduction of share buyback to a
level equal to annual FCF (around USD2bn-USD3bn) from 2015, indicating PMI's
willingness to protect its credit metrics. As a consequence of this scale-back,
Fitch estimates that FCF will be able to cover all of PMI shareholder
distributions from 2015 onwards. PMI's long-term dividend payout ratio target of
65% is in line with other tobacco companies.
Undistributed Foreign Earnings (UFE)
There is a mismatch between earnings and debt given that PMI does not have any
sales in the US while debt is raised at the holding level (domiciled in the US).
While PMI repatriates its foreign earnings, repatriation of accumulated
remaining unremitted foreign earnings is unlikely to be immediate, but possible
in the future and could be costly under the current US tax regime. Also, PMI's
cash balances (mostly foreign) (USD2.2bn at FYE13) are small relative to other
US multi-nationals and to its total UFE (USD20bn at FYE13) figure. As a
consequence, Fitch considers only PMI's gross leverage ratios to reflect these
foreign cash balances.
Significant Shareholder Distributions
PMI has historically distributed more than its FCF generated to shareholders
through dividend (a high payout ratio of 70%) and share buyback programmes.
While PMI's cash flow continues to demonstrate considerable stability at
USD8bn-USD9bn (FCF before dividend) a year, the extent to which PMI allocates
cash flow to shareholders or M&A is the main driver of leverage, which is
currently outside the range compatible with its 'A' rating.
PMI is 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. It enjoys large market shares and pricing leadership in
many of the world's most profitable and growing tobacco markets, with superior
diversification across continents.
Solid Innovation Capability
Fitch is confident that PMI would be able to manage successfully a transition of
tobacco consumption towards e-cigarettes or other reduced-risk products, should
these trends accelerate. The products that PMI has available and under
development as well as its market clout should allow it to win against small
independent e-cigarette players.
Geographical Diversity Protects Volumes
In 2013, the EU market (30% of PMI's profits) suffered from a sharper
contraction than seen previously. However, PMI's strong presence in developing
markets remains key to its ability to protect volumes. Price increases in the EU
and other regions should continue to offset volume decline and support profit
growth, although probably at a slower pace. Additionally, 1Q14 results have
confirmed that the volume decline in the EU market was slowing due to overall
stabilisation in illicit trade during 2013, slower growth of e-vapor products in
many markets and reduced down-trading to fine-cut products.
Negative: Future developments that could lead to a negative rating action
-Spending on acquisitions or share buybacks, combined with slower-than-expected
growth of revenue and profit, leading to gross lease-adjusted debt/FFO above
2.5x-2.7x (FY14 forecast: 3.0x)
-FFO fixed charge coverage below 8x (FY14F: 8.5x)
-Unfavourable tobacco litigation outcome requiring PMI to pay a large
-EBITDA margin declining below 45% (FY14F: 47.1%)
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
-Maintaining the current level of profitability and enhanced FCF generation, in
the absence of shocks from far more stringent regulation, and a more
conservative financial policy