Fitch rates Reynolds American issuer default rating at 'BBB-'; outlook positive
November 16, 2011
– Fitch Ratings expects share repurchases made by Reynolds American Inc. (RAI) under its $2.5 billion, two and a half year share repurchase program announced yesterday to be executed prudently and in a manner in which leverage would only increase modestly. Should RAI experience unanticipated cash expenditures that reduce free cash flow (FCF) or if corporate credit markets tighten, Fitch anticipates RAI will pullback or halt share repurchases. RAI has demonstrated conservatism with its buyback programs in the past, most recently stopping share repurchases short of the full authorization during late 2008.
Fitch rates RAI's Issuer Default Rating (IDR) 'BBB-' with a Positive Outlook. The Positive Rating Outlook is driven primarily by an improved balance sheet. RAI has reduced debt over the past several years to $3.7 billion at Sept. 30, 2011 from $4.7 billion at Dec. 31, 2006. The company's pension funding position is much healthier after making contributions of $811 million and $295 million in 2010 and 2009 respectively. RAI's pension plan was 89% funded at Dec. 31, 2010, and the company has made $216 million in contributions to date in 2011. The share repurchase program signals a stop to the company's de-leveraging. The Positive Outlook is dependent upon the company maintaining leverage materially below 2.0 times (x) on a total debt-to-operating EBITDA basis.
Fitch forecasts the program will require incremental debt issuance since FCF (cash flow from operations less capital expenditures and dividends) is expected to range from $250 million to $500 million over the program's timeframe. The incremental debt incurred is not expected to move leverage above 2.0x. For the period ended Sept. 30, 2011, RAI's total debt-to-operating EBITDA was 1.4x, down from 1.6x at Dec. 31, 2010. The company's operating EBITDA-to-gross interest was 11.9x, up from 11.4x at Dec. 31, 2010. RAI's funds from operations (FFO) adjusted leverage was 3.2x, down from 3.8x at 2010 year end.
RAI's ratings are supported by the company's continued ability to generate substantial cash flow from operations. RAI's operating earnings have been stable due to its maintaining its position as the second-largest U.S. tobacco company with approximately 28% of cigarette share. Growth of the company's Pall Mall brand, now its largest by volume and share, has offset steep losses in cigarette market share for its non-growth brands, which now comprise slightly less than half of the company's cigarette volume.
RAI's growing smokeless tobacco subsidiary, American Snuff Co. (formerly Conwood), provides operational diversification beyond cigarettes. American Snuff Co. only represents approximately 13% of RAI's operating income, but its contribution is expected to grow as Fitch's forecast for the moist smokeless tobacco category's annual volume growth is in the mid-single-digit range.
RAI's ratings are lower than those of companies with similar credit metrics, largely due to industry factors of continued cigarette volume declines of 3% to 5%; ongoing, albeit reduced, litigation risk; and increasing regulatory risk.
An upgrade is possible if RAI is able to exercise its share repurchase program while sustaining leverage materially below 2.0x and preserving its current credit profile. An expanded debt-financed share repurchase program or material acquisition would likely result in a Stable Rating Outlook or possibly negative rating actions. A return to the litigation risks faced in the early 2000s could result in negative rating actions.
The company has significant liquidity. RAI maintains appreciable cash balances and generates meaningful FCF. The company had $2 billion of cash as of Sept. 30, 2011. Enhancing its liquidity, RAI entered into a new $750 million four-year revolving credit facility on July 29, 2011, an increase from its previous facility of $498 million.
Fitch currently rates RAI as follows:
Reynolds American Inc.
--Long-term Issuer Default Rating (IDR) at 'BBB-';
--Guaranteed bank credit facility at 'BBB-';
--Guaranteed unsecured notes at 'BBB-'.
R. J. Reynolds Tobacco Holdings, Inc. (a wholly owned subsidiary of RAI)
--IDR at 'BBB-';
--Senior unsecured notes at 'BBB-';
--Guaranteed unsecured notes at 'BBB-'.
The Rating Outlook is Positive.
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