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Fitch Affirms Reynolds American's IDR at 'BBB-'; Outlook Stable

^{Published on 2010-06-30 12:35:30 - Market Wire}
 

CHICAGO--([ BUSINESS WIRE ])--Fitch Ratings has affirmed the ratings of Reynolds American Inc. (NYSE: RAI) and R. J. Reynolds Tobacco Holdings, Inc., a wholly owned subsidiary of 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.

--IDR at 'BBB-';

--Senior unsecured notes at 'BBB-';

--Guaranteed unsecured notes at 'BBB-'.

The Rating Outlook is Stable. This rating action affects approximately $4.4 billion of debt outstanding on March 31, 2010.

The affirmation reflects RAI's continued ability to generate substantial cash flow from operations due to its high operating margins, its significant levels of liquidity and its prominent industry position as the second largest U.S. tobacco company. The ratings further consider RAI's shareholder-friendly high target dividend payout ratio - currently 75%. RAI's significant losses in cigarette market share for its non-growth brands, which comprise roughly half of the company's cigarette volume, are balanced by the continued growth of its Pall Mall brand and the company's operational diversification provided by its growing smokeless tobacco subsidiary, American Snuff Co. (formerly Conwood). American Snuff Co. only represents approximately 15% 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 profiles, largely due to industry factors, including continued, and potentially accelerating, cigarette volume declines and ongoing, albeit reduced, litigation risk.

RAI's credit metrics for the latest 12 month (LTM) period ending March 31, 2010 were within Fitch's expectations and remained strong for the rating category. The company's total debt-to-operating EBITDA was 1.7 times (x) compared to 1.7x at Dec. 31, 2009 and 1.8x at Dec. 31, 2008. RAI's FFO adjusted leverage was 2.7x up from 2.6x at Dec. 31, 2009 but down from 3.0x at Dec. 31, 2008. The company's operating EBITDA-to-gross interest edged up to 10.4x from 10.1x at Dec. 31, 2009 and 9.5x at Dec. 31, 2008 due to the company effectively using swaps to achieve lower interest payments and lower total debt.

RAI's liquidity remained substantial with a cash balance of $3.3 billion at March 31, 2010, of which, a large portion was held for its annual MSA payment, which was $2 billion for the April 2010 payment. The company's liquidity position is bolstered by $488 million of availability under its $498 million revolving credit facility, which expires June 2012. In July, $300 million in notes mature, which Fitch expects RAI to repay with cash on hand. RAI's next maturity is not until June 2011 when $400 million of floating-rate notes come due.

With the U.S. Supreme Court declining to hear the Department of Justice's arguments for disgorgement in the government's case against tobacco companies for civil RICO violations, the U.S. tobacco companies have cleared another legal hurdle. While the tobacco companies still face legal challenges in various jurisdictions from Engle progeny cases in Florida to 'lights' consumer fraud cases, litigation risk has been reduced substantially since the height of potentially existential claims in the early to mid-2000s.

In contrast, tobacco companies face higher regulatory risk with the Food and Drug Administration's (FDA) oversight of the industry. The Family Smoking Prevention and Tobacco Control Act, signed by the President on June 22, 2009, provides a framework for FDA regulation of the industry. While the changes to date have had little effect on the industry, future rule making by the FDA could have far reaching consequences. Most immediately, the FDA is tasked with developing a report on the risks of menthol flavoring and issuing a recommendation based on its findings. For a more in-depth analysis of the potential effects of the FDA's menthol review, see the special report, 'The Great Flavor Debate: Assessing the Risk of a Menthol Ban,' available on the Fitch Ratings website at '[ www.fitchratings.com ]'.

Fitch expects flat to low single-digit growth in RAI's net revenue in 2010. Operating income is anticipated to improve in the mid-single digits as cost savings from rationalizing production are realized. RAI's 2010 results are likely to face headwinds in the form of state excise tax increases. States are grappling with substantial budget deficits, and tobacco excise tax increases face less political resistance than other revenue raising options state governments have.

Applicable criteria are available on Fitch's website at '[ www.fitchratings.com ]' and specifically include:

--'Corporate Rating Methodology', dated Nov. 24, 2009;

--'Liquidity Considerations for Corporate Issuers', dated June 12, 2007.

Additional information is available at '[ www.fitchratings.com ]'.

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