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Rating Action:

Moody's affirms British American Tobacco's Baa2 ratings; outlook stable

18 Feb 2020

London, 18 February 2020 -- Moody's Investors Service, ("Moody's") has today affirmed the Baa2 long-term issuer rating of British American Tobacco p.l.c. and of its guaranteed subsidiaries (together "BAT" or "the company"). Moody's also affirmed the P-2 short term ratings assigned to B.A.T. International Finance p.l.c., B.A.T Capital Corporation and the (P)Baa2 rating assigned to BAT's senior unsecured MTN programme. The outlook, where applicable, remains stable.

"Today's rating action reflects our expectation that BAT's leverage, measured in terms of Moody's adjusted gross debt to EBITDA, will improve over the next 12-18 months, driven by moderate EBITDA growth and strong free cash flow generation, which we expect to be used to reduce the company's gross debt." says Roberto Pozzi, a Moody's Senior Vice President and lead analyst for BAT. "Any rating upside is currently constrained by the company's limited progress in developing its potentially reduced-risk products portfolio."

A full list of affected ratings can be found at the end of this press release.

RATINGS RATIONALE

BAT's Baa2 rating reflects i) the company's very large scale and broad geographical diversification, ii) its solid brand portfolio, with strong market positions in both developed and emerging markets and iii) its strong pricing power, through which it has historically been able to more than offsets the so far moderate volume decline in its combustible business. These strengths notwithstanding, BAT faces challenges including the need to develop a still-small reduced-risk product portfolio, relatively higher exposure to litigation risks compared with peers and a still-high leverage for the assigned rating.

BAT is the world's largest listed international tobacco group, with net revenue of GBP25.4 billion in the 12 months ended 30 June 2019 and a market capitalisation of GBP78.8 billion as at 10 February 2020. BAT operates and sells its products in more than 200 countries worldwide, with GBP10.4 billion net revenue generated in the US, or 41% of total, GBP2.7 billion in Europe and North Africa (24%), GBP2.4 billion in Asia Pacific and the Middle East (19%), and GBP2.0 billion in the Americas (excluding the US) and Sub-Saharan Africa (16%). The company owns five of the 10 best-selling global cigarette brands — Pall Mall, Rothmans, Kent, Dunhill and Lucky Strike — and three leading cigarette brands in the US — Camel, Natural American Spirit and Newport. The tobacco industry remains challenged by regulatory pressure and declining sales volume of traditional cigarettes. However, BAT, as well as other tobacco companies, continues to display strong pricing power, thereby more than offsetting the lower shipments.

BAT's leverage remained relatively high at 4.4x as of 30 June 2019 (Moody's-adjusted) but we expect it to improve to 4.0x in 2019, and then to 3.7x and 3.3x in 2020 and 2021, respectively, driven by low to mid single-digit EBITDA growth and strong free cash flow (after dividends), which we expect to be mostly used to reduce gross debt to GBP42.1 billion by the end of 2021 from GBP49.9 billion (Moody's adjusted) as at 30 June 2019. Whilst currently still weakly positioned at Baa2, Moody's expects BAT to strengthen its positioning at the current rating level over the next 12-18 months, barring major regulatory changes or unexpected developments in terms of litigation.

Any rating upside is currently constrained by the company's limited progress in developing its potentially reduced-risk products portfolio, comprising heat-not-burn, e-vapour and modern oral tobacco products. This business represented a modest 4.5% of BAT's group net revenues in 2018 but is well diversified and, therefore, should be well placed to meet still evolving consumer demand and regulatory requirements.

Moody's believes the company's governance culture is good and recognises that it has stated that it intends to maintain credit metrics in line with current levels. In 2016, the Institute of Directors' 2016 Good Governance Report named BAT as the best among UK-listed FTSE 100 companies in terms of corporate governance performance.

The global tobacco sector is subject to high social risks related to the association of the use of its traditional combustible products to health issues such as cancer. Claims by tobacco manufacturing companies that a new generation of tobacco products, including heated tobacco and e-vapour, have reduced risk effects in human health are yet to be recognised by regulators.

Although litigation remains a latent risk, there has been only one major litigation case that has resulted in substantial cash settlements, namely the Master Settlement Agreement and the related state settlement agreements with the US states of Mississippi, Florida, Texas and Minnesota, signed in 1998. As a group, BAT is subject to substantial annual payment obligations under these agreements and paid a total $3.7 billion in 2018.

We view BAT's liquidity as adequate, reflecting robust and reliable free cash flow generation and available cash balances, but also significant debt maturities and the need to extend available credit facilities. Annual free cash flow generation is over GBP2 billion based on our estimates, whilst the company's cash balance of GBP3.3 billion as at 30 June 2019 were unusually high (GBP2.4 billion as of 31 December 2018) excluding GBP115 million of restricted cash. BAT has a GBP6.0 billion revolving credit facility, split between a GBP3.0 billion 364-day facility with a one-year extension (recently extended to 2020) and a one-year term-out option, and a GBP3 billion facility maturing in May 2021. These facilities were undrawn as of 30 June 2019 but have relatively short dated maturities, and we expect the company to extend these over the next few months.

In H2 2019, BAT made two early redemptions repaying two bonds maturing in 2020 -- the $2.25 billion and $1.25 billion bonds notes- thus reducing the amount of debt maturing in 2020 to the $1.9 billion term loans due in July this year. Additional maturities of GBP2.9 billion will be due in 2021 and GBP5.2 billion in 2022, including another term loan of GBP1.9 billion. Moody's expects the company to only partly refinance the upcoming maturities and to use most of its free cash flows to pay down debt. The average debt maturity was 8.6 years as of 30 June 2019.

RATIONALE FOR THE STABLE OUTLOOK

The stable outlook reflects Moody's expectations that BAT's leverage, measured in terms of Moody's adjusted gross debt to EBITDA, will improve to at least 4.0x in 2019, and that the contribution of reduced-risk products to group revenues will gradually increase over the next two years. The stable outlook does not factor in any regulatory change such as a ban of menthol cigarettes in the US nor any meaningful payment related to litigations.

WHAT COULD CHANGE THE RATING UP/DOWN

Positive rating pressure could result from improving credit metrics and, in particular, leverage falling below 3.5x on a sustained basis, combined with a substantially greater contribution of the reduced-risk portfolio to group revenues, broadly unchanged profitability, and reduced regulatory and litigation risk.

Negative pressure could result from a combination of leverage not improving below 4x over the next 12-18 months, a fundamental erosion of the company's market position resulting in a decline in operating profit or a significant deterioration in the regulatory or litigation environment. Failure to meaningfully expand the reduced-risk portfolio could also exert negative rating pressure.

PRINCIPAL METHODOLOGY

The principal methodology used in these ratings was Consumer Packaged Goods Methodology, published in February 2020. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

LIST OF AFFECTED RATINGS

Affirmations:

..Issuer: British American Tobacco p.l.c.

.... LT Issuer Rating, Affirmed Baa2

..Issuer: B.A.T Capital Corporation

....Backed LT Issuer Rating, Affirmed Baa2

....Backed Commercial Paper, Affirmed P-2

....Backed Senior Unsecured Medium-Term Note Program, Affirmed (P)Baa2

....Backed Senior Unsecured Regular Bond/Debenture, Affirmed Baa2

..Issuer: B.A.T. International Finance p.l.c.

....Backed LT Issuer Rating, Affirmed Baa2

....Backed Commercial Paper, Affirmed P-2

....Backed Senior Unsecured Medium-Term Note Program, Affirmed (P)Baa2

....Backed Senior Unsecured Regular Bond/Debenture, Affirmed Baa2

..Issuer: B.A.T. Netherlands Finance B.V.

....Backed Senior Unsecured Medium-Term Note Program, Affirmed (P)Baa2

..Issuer: British American Tobacco Hldgs (Netherlands)

....Backed Senior Unsecured Medium-Term Note Program, Affirmed (P)Baa2

..Issuer: R.J. Reynolds Tobacco Company

....Backed Senior Unsecured Regular Bond/Debenture, Affirmed Baa2

..Issuer: Reynolds American Inc.

....Senior Unsecured Regular Bond/Debenture, Affirmed Baa2

Outlook Actions:

..Issuer: British American Tobacco p.l.c.

....Outlook, Remains Stable

..Issuer: B.A.T Capital Corporation

....Outlook, Remains Stable

..Issuer: B.A.T. International Finance p.l.c.

....Outlook, Remains Stable

..Issuer: B.A.T. Netherlands Finance B.V.

....Outlook, Remains Stable

..Issuer: British American Tobacco Hldgs (Netherlands)

....Outlook, Remains Stable

PROFILE

BAT is the world's largest tobacco company in terms of revenue, with strong market positions in multiple countries and a brand portfolio that includes five of the 10 best-selling cigarette brands globally.

REGULATORY DISCLOSURES

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Roberto Pozzi
Senior Vice President
Corporate Finance Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Richard Etheridge
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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