November 24, 2023 (MLN): Fitch Ratings has revised the outlook on US-based tobacco group Philip Morris International, Inc.'s (PMI) Long-Term Issuer Default Rating (IDR) to Negative from Stable and affirmed the IDR and senior unsecured long-term rating at 'A', as per its latest post.

The negative outlook reflects that deleveraging will take longer than we previously expected following PMI's acquisition of Swedish Match (SM), plus uncertainty around the timing and contribution of the launch of IQOS ILUMA in the US, pending FDA approval.

Moreover, a temporary reduction in free cash flow (FCF) in 2023-2024 while maintaining a progressive dividend payment policy limits deleveraging to 2.5x by end-2025 compared with our previous estimate of under 2.0x.

The rating actions also reflect PMI's commitment to its publicly stated financial policy, which leaves no headroom for operating underperformance as the company is aiming to return to around 2x leverage in 2026.

PMI's 'A' IDR remains underpinned by its leading size in the sector, as well as product, brand and geographical diversification.

The key rating drivers for the credit rating agency include;

Heightened Leverage Until 2026

PMI's Fitch-calculated 2023 net EBITDA leverage is projected to remain high at 3.1x after its over USD16 billion debt-funded acquisition of SM.

This is outside the 'A' rating category, and Fitch projects PMI's net leverage will only fall to the pre-acquisition level of below 2.0x after 2026.

In the entity’s view, PMI's ability to reduce its debt by 2025 as originally anticipated will be hampered by likely weak FCF generation in 2023 and 2024 following inflation pressure, currency headwinds, increased interest payment relating in part to SM's debt-funded acquisition and the uncertain outcome of the German tax surcharge ruling on heated tobacco units.

Financial Policy Key to Deleveraging

PMI's commitment to its stated financial policy is key to reducing leverage under 2x.

The entity sees certain operational headwinds to deleveraging, such as moderate execution risks in increasing the contribution from reduced risk products (RRP), and recovering profitability margins aided by the announced $2 billion cost-efficiency plan for 2024-2026.

However, we note PMI's focus on large progressive dividend distributions, which materially limit the cash flow available to reduce debt.

The absence of clear deleveraging toward 2.5x in the next 12-18 months will lead to a downgrade.

Weak FCF in 2023-2024

Fitch Ratings estimate neutral to negative FCF generation in 2023-2024, which will significantly constrain the deleveraging prospects compared to our previous projections.

The combination of large progressive dividend distributions, FX volatility and expected negative working capital will in our view limit PMI's ability to significantly reduce its debt in 2024, which we estimate will remain above $46 billion.

We only expect a meaningful deleveraging from 2025, with Fitch-calculated FCF margins projected to return to healthy 5%-7% levels.

The inability to restore FCF to the projected levels, which in turn will impact the deleveraging pace, will lead to a downgrade.

US IQOS ILUMA Launch Uncertain

The company is planning a limited launch of IQOS Blade products in the US in 2024, awaiting FDA approval of the new generation IQOS ILUMA device for a potential larger-scale launch.

The premarket tobacco application (PMTA) for IQOS ILUMA was submitted in October 2023. Timing on the PMTA is uncertain, but PMI guides for a launch in mid-2025-2026.

"We have consequently not included this upside in our forecast, and view a significant contribution to profitability as unlikely before 2027," the report reads.

However, Fitch Rating sees limited risk in the approval process of the new device, given the older generation device is the only inhalable smoke-free nicotine product in the US to have been granted a Modified Risk Tobacco Product order from the FDA.

It also believes that PMI has significant capability for fast sales ramp-up in the US supported by SM's existing platform. PMI has a strong record of IQOS launches in other markets, with annual net revenue of over $9.9bn in 2022 and leading RRP market shares in most countries.

Strong Business Risk Profile

PMI's ratings are anchored in its market-and-price leadership in the global tobacco industry (excluding the US and China), supported by a diverse portfolio of leading tobacco brands in the countries in which it operates.

The company is also successfully implementing its RRP strategy and is the leading manufacturer in the heated tobacco segment.

Its SM (ZYN brand) acquisition and the IQOS launch in the US will help PMI to make progress towards its new target of reaching two-thirds of net revenue from smoke-free products by 2030.

Copyright Mettis Link News

Posted on: 2023-11-24T14:34:14+05:00