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Rating Action:

MOODY'S DOWNGRADES LONG TERM RATING OF ALTRIA (SENIOR UNSECURED TO Baa2); CONFIRMS ITS SHORT TERM RATING AT PRIME-2; CONFIRMS KRAFT'S LONG AND SHORT TERM RATINGS; ALTRIA'S OUTLOOK IS NEGATIVE; KRAFT'S OUTLOOK IS STABLE

22 Apr 2003
MOODY'S DOWNGRADES LONG TERM RATING OF ALTRIA (SENIOR UNSECURED TO Baa2); CONFIRMS ITS SHORT TERM RATING AT PRIME-2; CONFIRMS KRAFT'S LONG AND SHORT TERM RATINGS; ALTRIA'S OUTLOOK IS NEGATIVE; KRAFT'S OUTLOOK IS STABLE

Approximately $20 Billion Of Debt Securities Affected

New York, April 22, 2003 -- Moody's Investors Service downgraded the long-term ratings and confirmed the short-term ratings of Altria Group Inc. ("Altria") and Philip Morris Capital Corp. ("PMCC"). Moody's also confirmed the long and short term ratings of Kraft Foods Inc. ("Kraft"). Altria's rating outlook is negative, reflecting diminished expectations for free cash flow and diminished financial flexibility. Kraft's rating outlook is stable. This concludes the review of Altria's and Kraft's ratings initiated on March 24, 2003.

Ratings downgraded are as follows:

Altria:

Senior unsecured rating, to Baa2 from Baa1

PMCC:

Senior unsecured rating, to Baa2 from Baa1

Ratings confirmed are as follows:

Altria:

Prime-2 for commercial paper rating

PMCC:

Prime-2 for commercial paper rating

Kraft Foods Inc.:

A3 for senior unsecured rating

Prime-2 for commercial paper rating

Kraft Foods North America:

A3 for senior unsecured rating

The downgrade of Altria's long term rating reflect:

(1) The reduced free cash flow available for Altria debt service due to the terms of the bonding requirements set in the Price/Miles case.

(2) The continuing pressure on Altria's profitability and free cash flow brought about by difficult U.S. tobacco market conditions

(3) The risk of periodic future adverse rulings and/or bonding requirements, similar to Price/Miles in the mass of litigation faced by Altria

(4) Philip Morris USA's reduced financial flexibility caused by the Price/Miles bonding requirement, in the event it is required to post bond as a result of another significantly adverse verdict.

The downgrade of Altria's long-term rating to Baa2 reflects the constraints on cash flow available for Altria due to the bonding requirement imposed by the presiding judge pursuant to a stay of execution in the Price/Miles Illinois consumer fraud class-action case. These requirements exacerbate pressure on Altria's cash flow from a difficult US tobacco market. Because Philip Morris USA has put into escrow a $6 billion note due from Altria to satisfy the bond, and the interest payable on that note of $420 million per year is not available to be dividended back to Altria. Also to satisfy the bonding requirements, Philip Morris USA must place into escrow four quarterly payments of $200 million each, starting on September 30, 2003. As such, the bonding requirements will reduce annual free cash flow by a minimum of $420 million and (for the 12-month period ending September 30, 2004) a maximum of $1,220 million, until the case is concluded, after all appeals. This reduction is significant in regards to free cash flow available for Altria's dividend payment and other uses. In 2002, combined free cash flow generated by Philip Morris USA and Philip Morris International, and available for Altria (after deduction of Altria interest expenses and Altria corporate expenses, and before Altria debt repayment, dividend payment and share repurchases ) was $5.3 billion. Moody's notes that the company has currently suspended its purchases under its share buyback program.

Moody's notes that although the time required for the appeal process is uncertain, it could last for years and is, to some extent, outside the control of Philip Morris USA. The bonding requirement exacerbates pressure on Altria's cash flow otherwise driven by a difficult US tobacco market. Moody's also notes that the bonding requirement could be appealed by the trial attorney representing the class, and that he has indicated willingness to do so. While Moody's believes that the chances of success of such an appeal are low, Moody's could adjust Altria's ratings downwards if the appeal resulted in bonding requirements more unfavorable to Philip Morris USA than the current ones.

The downgrade also reflects pressure on operating income due to difficult US tobacco market conditions. In the first quarter of 2003, the operating income of Philip Morris USA decreased year on year 41% to $742 million. This decrease was only partially offset by an 8% improvement in the operating income of Philip Morris International to $1,690 million in the first quarter of 2003. The decrease in the operating income of the domestic tobacco subsidiary reflects lower volumes, higher promotional expenses and an expansion of the sales force. Over recent months, original participants (such as Philip Morris USA) to the 1998 Master Settlement Agreement (MSA) with the states have consistently lost market share to companies that do not participate to the MSA or have signed on to it at a later date (subsequent participating manufacturers). Moody's believes this market share erosion is caused by the cost gap between original participating manufacturers on the one hand, nonparticipating and subsequent participating manufacturers on the other hand. This cost gap has led to a consumer retail price gap, which Philip Morris USA has tried to narrow through heavier promotional expenses. While the first quarter data seems to indicate that market share erosion might have slowed down for Philip Morris USA, such stabilization has come at a significant cost for the U.S. tobacco subsidiary of Altria. Based on the terms of the MSA and of the model statute legislation passed by the states, a difference in settlement-related costs is likely to remain for at least several years, and Moody's believes that Philip Morris USA is unlikely to regain its pricing flexibility during this period.

Finally, the downgrade reflects increased litigation risk in the industry and its concomitant threat of liquidity shocks. Faced with an ongoing mass of litigation driven in part by the release of internal industry documents, Philip Morris USA runs the risk of more unbondable verdicts, such as Price/Miles could have been if the presiding judge had not reduced the bonding requirement. By requiring Philip Morris USA to place a substantial asset into escrow, Price/Miles has diminished the ability of Philip Morris USA to offer assets for bonding purposes in the case of a future significantly adverse lower court decision.

Bonding risk is distinct from the ultimate outcome of each case after all appeals. Philip Morris USA's track record in court demonstrates success in winning cases and moderating awards granted, and recent legal developments may support that record in the future. Nonetheless, juries and judges in state and federal lower courts will retain substantial discretion in their decisions affecting Philip Morris USA. Especially in difficult jurisdictions, their verdicts could still lead from time to time to substantial bonding requirements that might prove difficult for the company to meet, and plaintiffs may be expected to seek out such jurisdictions.

The downgrade of PMCC's long term rating is tied to the support agreement provided by Altria to PMCC, which is the basis for PMCC's ratings. Under this support agreement, Altria commits to make contributions to PMCC in order to maintain a minimum fixed charge coverage ratio.

The negative outlook for Altria reflects the potential for reduced liquidity resources brought about by the verdict and bonding requirement in Price/Miles, and ongoing profitability pressure occurring in the U.S. tobacco market. A substantial portion of the company's liquidity is provided by a $3 billion 364-day revolving credit maturing on July 14, 2003 and by a $5 billion five-year revolving credit revolving July 23, 2006. Non-renewal of the 364-day facility would significantly reduce the company's liquidity, given the ongoing substantial use of cash represented by Altria's $5 billion annual common stock dividend. Reduction in liquidity resources or continuation of downwards profitability trends in the US tobacco market could place pressure on the ratings.

The confirmation of Kraft's ratings reflect Kraft's fundamental strength as the largest US packaged food company, its very strong market share and impressive portfolio of branded food products, as well as its large and stable cash flows. The ratings also take into consideration risks Kraft faces resulting from its significant 84% ownership and 98% voting control by Altria. Moody's recognizes that Altria could seek to extract cash from Kraft in order to deal with tobacco-related litigation issues, but its rating reflects that this risk is mitigated by the fiduciary responsibility of Kraft's board and management to look out for the well-being of its minority shareholders. This risk is also mitigated by certain corporate governance procedures. Of particular importance is a requirement whereby Kraft's Auditing Committee -- comprised entirely of four outside directors -- must approve of any material intecompany transactions between Kraft and Altria. This procedure limits Altria's ability to unilaterally step in and redirect Kraft's cash flows to assist Altria. Moody's notes that Kraft's ratings assume that Kraft continues its progress in improving its debt protection measures. It also assumes that there is no change in its present corporate governance structure, policies, or procedures, as well as no change to financial policies with respect to dividends or intercompany loans between itself and Altria. Any such change in financial or corporate governance policies could have a negative impact upon Kraft's outlook and ultimately its rating.

Based in New York, N.Y., Altria is a holding company, controlling 100% of Philip Morris USA, a domestic tobacco manufacturer; 100% of Philip Morris International, an international tobacco manufacturer; 100% of Philip Morris Capital Corp., a subsidiary engaged in leasing activities; and 84% of Kraft Food Inc., a package food manufacturer.

New York
Julia Turner
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Christophe Razaire
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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