Fitch Rates Altria's Senior Notes Offering 'BBB+'; Outlook Stable
The ratings apply to approximately $13 billion of debt at June 30, 2016. A full list of current ratings follows at the end of this release.
KEY RATING DRIVERS
--The secular cigarette decline in the U. S., typically in the range of 3% to 4% per year, decelerated to less than 1% during 2015, but will likely return closer to historical levels by 2017.
--Altria should continue to generate strong EBITDA margins in the high 40%'s, even as volume declines resume and pricing improvement moderates due to fewer macroeconomic tailwinds.
--Altria's shareholder-friendly posture is expected to continue through the ratings horizon, including dividend payouts around 80% (of adjusted EPS) supplemented with active share repurchasing. Fitch sees the strategy as manageable at current cash flows and with leverage (total debt to EBITDA) consistently sustained below 2.0 times (x).
--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.
Fitch's key assumptions within our rating case for Altria include:
--Consolidated revenue increases by a compound annual growth rate (CAGR) of between 1%-2% from fiscal year (FY) 2015 to FY2018 as cigarette volume declines revert closer to historical levels of 3%-4% after moderating in 2015 and 2016.
--Consolidated EBITDA and EBITDA margin approximates $8.5 billion and 49.5%, respectively in 2016.
--Total debt to EBITDA increases from 1.4x in 2015 to around 1.5x in 2016, from a modestly higher debt load partially offset by incremental EBITDA growth.
--Modest free cash flow (FCF; operating cash flow, less CAPEX and dividends) in 2016 assuming that Altria makes voluntary pension contributions, followed by a return to levels between $700 million-$800 million (approximate 4% margin) annually over the remainder of the forecast period, reflecting annual increases to dividends and capital intensity maintained around 1%.
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, such as alternative smoking products including E-cigarettes;
--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 flexibility to accommodate a more aggressive shareholder-friendly stance or acquisition activity, but gross debt leverage exceeding 2.5x would warrant a one-notch downgrade;
--EBITDA pressures arising from greater-than-expected market contraction or a heightened competitive environment, such that gross debt leverage rises and stays above 2.5x;
--Regulatory decisions immediately banning sale of mentholated cigarettes or meaningfully increasing state or federal excise taxes on smoking products that significantly accelerates volume declines;
--Substantial changes in the litigation process, whereby legal cases may reach verdict quicker and/or material adverse judgments significantly increase in number and amount.
CIGARETTE VOLUMES IN DECLINE
The secular cigarette decline in the U. S., typically in the range of 3% to 4% per year, decelerated to less than 1% during 2015, benefitting from more disposable income remains in the hands of the smoking population, mainly driven by falling gas prices. As a result, cigarette consumers smoked more often and have up-trended to premium cigarettes. While there will be some benefit during 2016 as oil prices remain subdued, Fitch estimates a return to the historical annual rate of cigarette decline by 2017.
OPERATIONAL LEVERAGE/PRICING DRIVE EARNINGS
Operating leverage, pricing improvement, and moderating cigarette volume declines drove an increase of 6.2% in operating income in 2015 from a 5.1% increase in sales, net of excise taxes. This trend has reversed in the first six months of 2016, partially due to lower volume and higher promotional investments, offset by higher pricing. Fitch sees EBITDA margins of 49.5% in 2016, but then modestly easing annually as cigarette volume declines revert to historical levels.
HEAVY SHAREHOLDER RETURNS MANAGEABLE
Fitch expects Altria to maintain its shareholder-friendly posture through the ratings horizon, which includes dividend payouts around 80% (of adjusted EPS) supplemented with active share repurchasing. The company gains flexibility for heavy shareholder returns from limited acquisition opportunities and light capital spending Altria increases its dividend yearly by 8% to 9% (currently topping $4 billion) and spends around $1 billion for share repurchases that is determined annually. Fitch sees the strategy as manageable at current cash flows and with leverage (total debt to EBITDA) consistently sustained below 2.0x.
Capital Structure Well Managed: Altria has worked down $8.3 billion of high coupon notes (due in 2018, 2019, 2038, and 2039) issued for the U. S. Tobacco (UST) acquisition in 2009. Since 2012, the company re-financed and tendered for nearly $4.9 billion of the expensive debt, leaving a balance of approximately $3.4 billion as of June 30, 2016. This total could be reduced by $1 billion or more once the company's current tender offer is completed. As such, Altria's weighted average interest rate on its debt, all fixed rate, decreased to 5.5% in 2015 from 8.3% in 2011, and will likely decrease further once the company's current refinancing transactions are completed. The company also chose to pay off $1 billion maturing debt in 2015 as opposed to refinancing the notes, yielding total debt of $12.9 billion on June 30, 2016 (from $14.7 billion at the end of 2014) and gross debt leverage of 1.4x for the latest 12 months (LTM) ending June 30, 2016. Fitch expects that leverage will continue to approximate 1.5x over the next few years, as the company maintains financial discipline while benefiting from strong operational performance. Altria's next significant long-term debt maturity is the balance of 9.7% unsecured notes ($863.6 million) due in November 2018.
SABMiller Investment Change: Altria's liquidity has been supported by an approximately 27% ownership in SABMiller plc (SABMiller), valued around $23 billion, that provides annual dividends in the range of $400 million to $500 million. The proposed agreement whereby Anheuser-Busch InBev (AB InBev) will acquire SABMiller in a cash and stock transaction valued at $107 billion will effectively reduce Altria's ownership to approximately 10.5% of the economic and voting interest in the combined entity. In addition, Altria will receive $3 billion in cash before taxes from partial share alternative, with the final ownership stake and cash proceeds subject to proration.
Fitch sees Altria continuing to account for its investment in the merged entity through the equity method of accounting given board representation and continued ability to exercise significant influence in the combined company. Fitch sees a credit neutral impact from the transaction as cash dividends from the new entity are forecasted to remain relatively steady with present levels despite the likelihood that the AB InBev-SABMiller firm will reduce dividends to focus on debt reduction over the intermediate term.
INDUSTRY FACTORS LIMIT MOMENTUM
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. Reversal of positive price realization for tobacco products such that secular volume declines are not offset leading to compression in profitability and cash flow generation would have negative consequences for Altria's ratings.
Liquidity remains solid at June 30, 2016, with cash of $819 million (near the annual low point following Philip Morris USA Inc.'s (PM USA) yearly payment to the Master Settlement Agreement (MSA) of approximately $4 billion in April) and full availability under a $3 billion five-year revolver due August 2020. Internal liquidity is provided by strong operating cash flows that have historically increased annually and were $5.6 billion for the LTM period ending June 30, 2016, versus $5.8 billion in 2015 and $4.66 billion in 2014. Altria's liquidity is also supported by the company's approximate 27% share of SABMiller, worth around $23 billion, which provides annual dividends in the range of $400 million to $500 million. The current holding may convert to a 10.5% ownership in an AB InBev-SABMiller merged entity, potentially the world's largest brewer, in the near term. Excess liquidity is important given PM USA's annual payment to the MSA.
FULL LIST OF RATING ACTIONS
Fitch currently rates Altria as follows:
Altria Group Inc. (Parent)
--Long-Term Issuer Default Rating (IDR) 'BBB+';
--Guaranteed bank credit facility 'BBB+';
--Guaranteed senior unsecured debt 'BBB+';
--Short-Term IDR 'F2';
--Commercial paper (CP) 'F2.'
Philip Morris Capital Corp. (a wholly owned subsidiary of Altria)
--Long-Term IDR 'BBB+';
--Short-Term IDR 'F2';