Nov 09 -
-- We consider that U.K.-based tobacco manufacturer British American
Tobacco PLC (BAT) is sufficiently cash flow generative to be able to maintain
its credit metrics at levels we view as commensurate with an 'A-' rating.
-- Furthermore, BAT has expressed its commitment to maintain its credit
metrics at these levels.
-- We are therefore raising our long-term corporate credit rating on BAT
to 'A-' from 'BBB+' and affirming our 'A-2' short-term corporate credit rating
on the company.
-- The stable outlook reflects our view that BAT is sufficiently
profitable and cash flow generative to maintain metrics that are compatible
with an 'A-' rating.
On Nov. 9, 2012, Standard & Poor's Ratings Services raised its long-term
corporate credit rating on U.K.-based tobacco manufacturer British American
Tobacco PLC (BAT) to 'A-' from 'BBB+'. At the same time, we affirmed our 'A-2'
short-term corporate credit rating on BAT. The outlook is stable.
The upgrade reflects our view that BAT is sufficiently cash flow generative to
be able to maintain its credit metrics at levels we view as commensurate with
an 'A-' rating. In addition, the group has stated that it manages its
financial profile in line with an unadjusted net-debt-to-EBITDA ratio of
1.5x-2.5x. This is compatible with an 'A-' rating in the context of BAT's
"strong" business risk profile.
Further support for the upgrade derives from the relatively consolidated
nature of the tobacco industry. The four largest players (including BAT)
comprise about 80% of the global market, excluding China. This means that
there are not as many acquisition targets as in some other consumer goods
sectors. In addition, BAT has significant financial flexibility. Its adjusted
leverage was 1.7x at the end of June 2012, and adjusted funds from operations
(FFO) to debt was 42%, both of which are comfortably compatible with an 'A-'
rating. Moreover, BAT has maintained adjusted leverage of comfortably less
than 3x for the past five years.
Under our base-case operating scenario, we believe that BAT's revenues will
grow by low single digits over the next few years, driven by product
innovation, selective price increases, and sales mix improvements. This growth
is despite continued pressure on volumes resulting from long-term declines in
some of the group's mature markets, and decreasing disposable incomes in some
European countries. Regulatory changes, such as the plain packaging law in
Australia, and unexpected excise tax increases can put additional pressure on
We believe that BAT will be able to increase its EBITDA margin modestly and
gradually over the next few years as a result of both price increases and
efficiency gains. Our view is consistent with BAT's annual margin expansion
target of 50-100 basis points. Based on these assumptions, we estimate that
the group will generate FFO of GBP4.5 billion-GBP5.0 billion and discretionary
cash of about GBP1 billion annually over the next few years. Taking into account
our assumptions of spending on bolt-on acquisitions and a gradual increase in
the amount of share buybacks, we project that BAT will be able to maintain
metrics that at their minimum are compatible with an 'A-' rating. We consider
adjusted debt to EBITDA of less than 2.5x and adjusted FFO to debt of more
than 35% as compatible with an 'A-' rating.
The 'A-2' short-term rating reflects our opinion that over the short term, BAT
should have ample internal liquidity, good cash flow characteristics, and
significant access to the capital markets. We view BAT's liquidity as
"adequate" under our criteria. This means that we estimate that sources of
cash will cover uses of cash by at least 1.2x over the next 12 months.
We estimate that liquidity sources comprise:
-- Cash and cash equivalents of GBP1.7 billion on June 30, 2012;
-- An undrawn GBP2.0 billion revolving credit facility due 2015; and
-- FFO of about GBP4.5 billion.
We estimate that BAT's liquidity uses over the next 12 months comprise:
-- Short-term debt of GBP1.8 billion as of June 30, 2012.
-- Capital expenditure of about GBP700 million;
-- Dividend payments of about GBP2.5 billion; and
-- Share buybacks of GBP1.3 billion.
In addition, we consider the following factors to support of BAT's "adequate"
-- Widespread bond maturities. On June 30, 2012, the group's average
centrally managed debt maturity was seven years. This is unchanged from
year-end 2011, and is within BAT's five-year target. Less than 20% of the
group's debt matures in any one year. The group manages a residual portion its
debt locally rather than centrally.
-- Significant headroom under BAT's 4.5x interest coverage financial
covenant, which most of its bank facilities include. There was about 50%
EBITDA headroom under this covenant as of June 30, 2012.
-- Absence of downward rating triggers that would accelerate the maturity
of a material amount of debt.