MOODY'S CHANGES PHILIP MORRIS' RATING OUTLOOK TO STABLE FOLLOWING ACCEPTANCE OF MEDICAID REIMBURSEMENT SETTLEMENT; SR. DEBT IS RATED A2.
Moody's Investors Service confirmed the A2 long-term and Prime-1 short-term ratings of Philip Morris Companies, Inc. and changed the rating outlook to stable from negative. This change in outlook reflects Moody's expectation that the Medicaid Reimbursement Settlement Agreement which has been signed by Philip Morris and other U.S. cigarette companies, and accepted by 46 states attorneys general, will ultimately be approved by the courts in each of those states. This agreement will eliminate the most challenging form of litigation facing Philip Morris and the tobacco industry. Moreover, we believe Philip Morris' highly competitive position in its principal markets, in combination with its considerable financial flexibility, will enable the company to maintain strong debt protection measures despite: 1) the economic and non-economic provisions contained in the agreement, and 2) the possibility of a resumption in its share repurchase program.
Ratings confirmed are:
Philip Morris Companies, Inc.: Senior debt rated A2 and Prime-1 short-term rating.
Philip Morris Capital Corporation: Senior debt rated A2 and Prime-1 short-term rating based on a Philip Morris Companies, Inc. support agreement.
Philip Morris Finance Europe B.V.: Prime-1 short-term rating based on Philip Morris Companies, Inc. guarantee.
Philip Morris Incorporated: Debentures rated A1.
Dart & Kraft Inc.: Senior debt rated A1.
Dart & Kraft Finance N.V.: Subordinated euronotes rated A2 based on Dart & Kraft guarantee.
The following are the essential elements of the proposed settlements. The cigarette companies that are party to the agreement will pay a total of $206 billion over 25 years. An initial payment of $2.4 billion is due from these companies now that the agreement has been signed. Philip Morris' share of this initial payment is based on its market capitalization relative to the other cigarette company signatories and is approximately $1.6 billion. Subsequent payments will be based on its share of the U.S. cigarette market. Philip Morris and the other cigarette company signatories have also agreed to various marketing and promotional restrictions. In return, the states which are party to the agreement will settle Medicaid reimbursement suits which are pending or which might have been brought in the future. We expect that the costs associated with this settlement will precipitate an increase of about 40 cents in the price of a pack of cigarettes during the first year of the agreement, with an additional increase of about 10 cents per pack by 2002.
There are some important differences between the current settlement and the June 20, 1997 proposal. The most important is that the tobacco industry will be afforded no protection from class action suits and there will be no caps on amounts that can be paid in individual suits. Mitigating the lack of these protections is the fact that the total 25-year cost of the current proposal will be about $160 billion less than the $368 billion required in the earlier proposal. In addition, only $2.4 billion in payments are due immediately following acceptance of the proposal, rather than the original $10 billion. Finally, marketing restrictions are not as broad; there are no penalties for failing to reduce under age smoking; and, the FDA is not awarded regulatory jurisdiction over the industry.
We believe that Philip Morris has considerable capacity to sustain its current ratings under the terms of this agreement. The company has the most formidable brand franchise and competitive business position in both the U.S. and international cigarette markets. It also enjoys a strong and globally diverse food business. Moreover, about 70% of the company's $14 billion in annual operating income is generated by operations other than it U.S. tobacco business. Philip Morris is currently generating fixed charge coverage in excess of 10 times, its annual rate of free cash flow (after working capital, capital expenditures and dividends) is running about $2.5 billion, and its cash balances stand at $5.5 billion compared with about $15 billion in debt. Should Philip Morris resume its share repurchase program, we expect that it will manage the pace of these repurchases so that debt protection measures remain strong.
Philip Morris Companies, Inc., headquartered in New York, is the world's leading cigarette manufacturer and is a major global food company.
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