Fitch: Downside Risks Remain for Imperial Tobacco

Source from:  Reuters 11/05/2014

Fitch Ratings says Imperial Tobacco Group PLC's preliminary results for financial year to 30 September 2014 showed that trading performance was in line with our expectations for a weak FY14 and demonstrated management's ability to stabilise profits amid a challenging environment. However, the results also showed that the company's credit metrics, despite a slight improvement, continue to be inconsistent with it"'BBB' rating.

A downgrade remains probable if management initiatives do not, during FY15, provide sufficient comfort that they would translate into an improvement in underlying performance and return credit metrics closer to levels consistent with its 'BBB' rating. These would be annualised funds from operations (FFO)-based net leverage below 3.5x, FFO fixed charge cover above 4.0x, the recovery of its standalone business with EBITDA margins trending towards 43%, and free cash flow (FCF) generation remaining above GBP600m in FY15. The timing of Imperial's improvement is particularly crucial, given an expected increase in leverage resulting from the acquisition of assets from Reynolds American Inc. and Lorillard, Inc. (BBB/RWN/Lorillard) in the spring of 2015. This acquisition, together with the FY14 results, has led Fitch to now project that leverage would peak at above 4.7x in FY15, before declining to 3.7x in FY17, a level that is still above our rating guideline of 3.5x. Based on preliminary results Fitch calculates that lease-adjusted net debt/FFO fell slightly to 3.8x in FY14, from 4.1x in FY13. Although we view positively the enlargement of Imperial's US operations, failure to enhance its core European business's (63% of operating profits in 2013) cash flow generation and profit growth capability would contribute to seriously impairing its credit metrics. The company's market share fell to 26.7% in FY14 from 27.3% in FY13 in its core "returns markets" (defined as countries where Imperial has large markets shares above 15%).

In addition, market conditions remain tough in many growth territories including Russia, Italy and Turkey, where we believe that management efforts to improve sales may be hampered. Although total adjusted operating profit in FY14 was unchanged on a constant currency basis compared with -1% in 1H FY14 and the decline of its underlying total volumes slowed in FY14, excluding stock optimisation effects, management has guided for still challenging conditions for FY15. Adjusted net debt was down GBP1bn at GBP8.1bn in FY14 due in part to GBP395m generated from the partial IPO of Imperial's non-core distribution arm, Logista, signalling the company's willingness in protecting its credit metrics. In addition, management has committed to suspending its share buybacks but not cutting back on its dividend pay-out. Enditem