Fitch affirms Altria's issuer default rating at BBB+; outlook stable
January 27, 2012
– Fitch Ratings has affirmed the Issuer Default Ratings and debt ratings of Altria Group, Inc. (Altria) and its subsidiaries as follows:
Altria --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'.
UST LLC (a wholly owned subsidiary of Altria) --Senior unsecured debt at 'BBB+'.
The Rating Outlook is Stable. Altria had $13.7 billion of debt at Dec. 31, 2011.
RATING RATIONALE --Commanding Market Share Position Altria Group, Inc.'s (Altria) ratings are supported by the company's commanding market share of U.S. tobacco segments. Altria's Philip Morris USA, Inc. (PM USA) subsidiary's Marlboro brand has an estimated market share of 42% and total cigarette market share of 49%. PM USA has maintained U.S. market share of about 50% for several years. Altria's U.S. Smokeless Tobacco Company (USSTC) has roughly 55% U.S. market share, driven by the two large brands of Copenhagen and Skoal.
--Substantial Cash Flow The ratings reflect that Altria's operations consistently generate large cash flows. For the 2011, Altria generated $3.6 billion of cash flow from operations (CFFO) comparable to 2010 year end when adjusted for unusual items. The company's CFFO was negatively affected by a $200 million discretionary contribution to its pension plans but higher than 2010 year end CFFO of $2.8 billion which was weighed down by a one time payment of $945 million (see below for further discussion). Altria's 2012 CFFO will be affected by a $500 million discretionary payment to its pension plans. Altria's healthy operating margins drive the company's high operating cash flow to revenue ratio. Manufacturing optimization has helped improve margins. Operating margins are expected to grow further with Altria's cost reduction efforts announced October 2011 which aim to produce $400 million of annualized savings.
--Significant Liquidity Altria has ample liquidity which Fitch expects will be maintained given the company's CFFO. Altria maintains a significant cash position throughout the year to meet its annual Master Settlement Agreement payment. Bolstering Altria's liquidity is the company's 27% equity ownership of SABMiller plc, one of the world's largest brewers, valued at roughly $15.2 billion as of Dec. 30, 2011.
--Shareholders Prioritized Fitch recognizes Altria's goal to return cash to shareholders in its ratings. The company's target dividend payout ratio of 80% is high but typical for U.S. tobacco firms. Fitch believes Altria's dividend reduces its flexibility since management teams are reluctant to reduce dividends in periods of operational weakness. However, the company's dividend is sustainable given the consistency of CFFO. Altria also has repurchased 37.6 million shares under its recently completed $1 billion share repurchase program authorized in January 2011. In October 2011, the company's board authorized another $1 billion share repurchase program under which it repurchased 11.7 million shares at a cost of $327 million in the fourth quarter of 2011. Altria intends to complete its current share repurchase program by the end of 2012.
--Industry Risk Factors Altria'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. Cigarette consumers becoming more price sensitive to a point where Altria loses pricing power would result in Fitch contemplating a negative rating action. Altria has historically been able to offset declining volumes with price increases to continue to grow cigarette revenue.
RATING DRIVERS --Upgrade Not Likely Upside to credit protection measures is limited by Altria's reliance on the mature to declining cigarette sector, which inhibits growth potential. Altria's focus on returning cash to shareholders signals stable to rising debt levels. A deceleration of cigarette volume declines or industry growth, or material diversification outside of the tobacco industry, would be positive for the company's ratings.
--Shareholder-Friendly Actions A large debt-financed share buyback or acquisition would be credit-negative. An increase in leverage to the low 2.0 times (x) range without a reasonable expectation for lower leverage going forward would result in a negative rating action. Fitch would view that increase as Altria declining to maintain its credit profile through the use of its financial flexibility afforded by its cash flow generation and its SABMiller stake.
CREDIT MEASURES, DEBT STRUCTURE AND LIQUIDITY --Credit Measures Altria's 2011 total debt-to-operating EBITDA of 2.0x is in line with Fitch's expectations. This is an increase over year end 2010 leverage of 1.8x due to $1.5 billion of debt issued in 2011 to finance a modest share repurchase program given the company's cash flow generation. Gross interest coverage increased to 6.1x at the 2011 year end versus 5.8x for the 2010 year end due to growing operating EBITDA more than offsetting increased interest from a larger debt balance. FFO adjusted leverage decreased to 2.7x at the 2011 year end from 3.1x at the 2010 year end. The decrease was due largely to the cycling of a $945 million payment made relating to an IRS ruling in 2010 (see further discussion below related to the payment).
--Expected Performance Fitch expects continued cigarette volume declines in the low- to mid-single digits in 2012, since no substantial Federal Excise Tax increase or widespread large State Excise Tax increases are anticipated in the near term. As a result, revenues are expected to increase in the low- to mid-single digit range. With continued cost improvements expected from Altria, overall operating income is forecast to increase in the mid- to high single-digit range. Credit metrics will therefore be stable to improving depending on Altria's plans to address the maturity of $600 million of 6 5/8% of UST Inc. notes due July 15, 2012.
--Liquidity Position As stated previously, Altria has ample liquidity. On June 30, 2011, the company entered in to a new $3 billion, five-year revolving credit facility which was undrawn at Dec. 31, 2011. The company had no CP and $3.3 billion of cash at Dec. 31, 2011. Altria took a charge in the second quarter totaling $627 million based on the IRS disallowing certain tax positions taken by the company regarding Lease-In/Lease-Out and Sale-In/Lease-Out (LILO/SILO) transactions and the increased probability the IRS disallowances will withstand legal challenges. Altria is contesting the IRS disallowances. Altria has made cash payments in the past for the IRS disallowing tax treatments for LILO/SILO transactions relating to audits for the 1996 though 2003 tax years including a $945 million payment in 2010. The company has not made a cash payment to date for the 2004 - 2009 tax years since the IRS has yet to complete its audits for those years, but as early as this year the IRS could disallow the tax positions taken in those years. Altria may be required to make a payment for a disallowance by the IRS. Altria is expected to have adequate internally generated liquidity to meet a required cash outlay.
--Debt Structure The notes of UST Inc. are structurally superior to the notes and debentures issued by Altria Group, Inc. Fitch has chosen not to make a distinction in the ratings given the notes in total are a small portion of total debt, Altria has not issued notes from its UST subsidiary since acquiring UST Inc. in January 2009, and the low risk of default at the 'BBB+' rating level.
Additional information is available at www.fitchratings.com . The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research: --'Corporate Rating Methodology' (Aug. 12, 2011).
Applicable Criteria and Related Research: Corporate Rating Methodology http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229
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