Fitch Ratings has affirmed Altria Group, Inc.'s (Altria) 'BBB+' Issuer Default Rating (IDR). The ratings apply to approximately $14.7 billion of total outstanding debt. The Rating Outlook is Stable. A complete list of ratings follows at the end of this release.
KEY RATING DRIVERS
Leading Market Positions
Altria remains the industry leader in the U.S. cigarette market with its Marlboro franchise, and leading positions in moist smokeless tobacco (MST) with its Copenhagen brand and tipped cigars with Black & Mild. PM USA, the company's smokeable tobacco subsidiary, captures slightly more than one-half of the U.S. marketplace given Marlboro's nearly 44% share. The company's MST offerings, Copenhagen and Skoal, also hold slightly more than one-half of the domestic MST market on a combined basis.
Diversification Eases Cigarette Pressures
Altria, holding around one-half of the U.S. cigarette marketplace, is most at risk in the industry by secular volume declines in the mid-single digits annually as consumption continues to decrease in the U.S. The number of cigarettes consumed in the U.S. fell to 273 billion in 2013 from a peak of 640 billion in 1981, representing a compound annual rate of decline of 2.6%. The compound annual decrease has accelerated to 4.6% per year in 2007 to 2013 (and 5.8% in 2013 alone) representing approximately 15 billion fewer cigarettes consumed annually.
Altria's product portfolio is somewhat diversified with leading MST brands, various smoking alternatives and premium wine offerings. However, the smokeable tobacco business still generates around 86% of revenues and operating income despite the broader offering. Within the smokeable segment, Altria achieves modest sales growth in most years through biannual price increases on key brands and innovation to brand architecture. Reversal of positive price realization for tobacco products in the absence of a viable source of profitability outside of the tobacco category would have negative consequences for Altria's ratings.
Steady Leverage, Improving Margins
Altria's long term operating strategy includes managing diverse revenues streams and a strong balance sheet. Reflecting the success in this strategy, gross debt leverage (total debt to EBITDA) has been maintained in the range of 1.8 times (x) to 2.1x since 2008, and is currently at 1.82x as of the latest 12-month (LTM) period ending Sept. 30, 2014. EBITDA margins have expanded almost annually since 2009 benefiting from Altria's ability to control operating costs through a $1.5 billion cost savings program finalized in 2012 and a $400 million initiative completed in 2013. As a result, EBITDA margins increased to 44.5% for the LTM ending Sept. 30, 2014 from 39.6% in 2011. Fitch sees leverage staying within the historical range through the long term, absent leveraging transactions, backstopped by a consistent debt load coupled with relatively stable EBITDA margins.
Superior Liquidity includes Investment
Altria has strengthened operating cash flow generation year-over-year since 2010 and neared $4.5 billion for the LTM period ending Sept. 30, 2014 compared to $2.7 billion in 2010. Excluding 2010, OCF has satisfied a growing heavy dividend and modest capital spending leading to free cash flow falling in the range of 1% to 4% of revenues. Liquidity is significantly supported by 26.8% ownership of SABMiller plc., valued at approximately $22.5 billion, which Fitch sees the company holding through the ratings horizon.
In addition, the company had cash of $2.2 billion and full availability under a $3 billion five-year revolver (due August 2019) on Sept. 30, 2014. Excess liquidity is necessary with the annual payment of more than $4 billion to the Master Settlement Agreement due every April. Beyond $1 billion in senior unsecured notes due this year, Altria has no other debt maturities until 2018.
Manageable Litigation Exposure
Significant litigation risk, which includes product liability, consumer fraud, and health recovery cases totaling in the thousands, will weigh on Altria and the industry for years to come. Altria as the leading cigarette producer is the most exposed to tobacco and health cases, with high risk stemming from the Engle progeny legal actions in Florida presently consisting of 4,000 state and federal cases. The company, like its competitors, has an experienced legal team that has stretched the period to resolution of litigation by effectively using the appellate process. Since 2006, only 64 Engle cases have reached a verdict as of Oct. 27, 2014 with total damages of $16.3 million (including interest). The damage awards at this rate can be easily satisfied with current cash flows.
Shareholders Rewarded
Fitch sees no change to Altria's shareholder-friendly posture bolstered by a long-term financial strategy that includes maintaining a dividend payout of 80% of adjusted diluted EPS. Moreover, the company supplements the sizable dividend with active share repurchasing that totaled $679 million in the first nine months of 2014. Fitch expects the remaining repurchase authorization of $778 million under $1 billion program authorized in July 2014 to be fully utilized by the end of 2015. Fitch sees the approach as manageable under current cash flow generation and with gross leverage remaining around 2.0x.
Industry Factors Limiting Ratings
Positive action to current credit ratings is restrained by key factors in the mature industry, specifically secular volume declines, high litigation exposure, rising regulatory risks and an accommodative shareholder stance.
RATING SENSITIVITIES
Future development that may individually or collectively, lead to a positive rating action:
-- Mitigation of negative industry factors with an emphasis on the slowing or reversal of secular volume declines;
-- Altria fully offsetting cigarette volume pressures with meaningful portfolio diversification;
-- Significantly reducing litigation risk, most notably the Engle progeny exposure;
-- A commitment to a conservative financial strategy demonstrated by lower dividend payouts and less-aggressive share repurchasing.
Future development that may individually or collectively, lead to a negative rating action:
-- Altria has some flexibility to accommodate a more aggressive shareholder-friendly stance or acquisition activity, but gross debt leverage approaching 2.5x would warrant a one-notch downgrade;
-- EBITDA pressures arising from greater-than-expected market contraction resulting from accelerated volume declines or a heightened competitive environment, such that gross debt leverage rises and stays around 2.5x;
-- Regulatory decisions immediately banning sale of mentholated cigarettes or meaningfully increasing excise taxes on smoking products that significantly further suppresses volume and demand;
-- Dramatic changes in the litigation process, whereby legal cases may reach verdict quicker and/or material adverse judgments significantly increase. This may include the reinstatement of compensatory and punitive damages in the Price case.
ALTRIA'S RATINGS
Fitch affirms Altria's rating as follows:
Altria Group Inc. (Parent)
--Long-term Issuer Default Rating (IDR) at 'BBB+';
--Guaranteed bank credit facility at 'BBB+';
--Guaranteed senior unsecured debt at 'BBB+';
--Short-term IDR at 'F2';
--Commercial paper (CP) at 'F2.'
Philip Morris Capital Corp. (a wholly owned subsidiary of Altria)
--Long-term IDR at 'BBB+';
--Short-term IDR at 'F2';
--CP at 'F2'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 2014).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=978614
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