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Fitch: No Rating Impact on Altria from Cronos Investment

DOW JONES & COMPANY, INC. 9:11 AM ET 12/11/2018
Symbol Last Price Change
MO 53.36down 0 (0%)
CRON 12.88up 0 (0%)
QUOTES AS OF 04:02:17 PM ET 12/10/2018

The following is a press release from Fitch Ratings:

Fitch Ratings-Chicago-11 December 2018: Fitch Ratings views the recent agreement by Altria Group Inc.(MO) (Altria(MO)) to acquire a 45% equity stake in Cronos Group Inc.(CRON) for USD1.8 billion as having no ratings impact to Altria's(MO) 'A-' Issuer Default Rating (IDR).

Altria (MO) maintains ratings headroom with current leverage (total debt to EBITDA) of 1.3x at the end of the third quarter 2018. Fitch expects Altria(MO) would fund the majority of the transaction using long-term debt with pro forma leverage estimated in the mid-1x range at transaction close which is well within rating expectations. However, further significant growth investments by Altria(MO) in other potential categories including e-vapor to diversify revenue streams could begin to pressure the ratings. Our downgrade rating sensitivities include leverage sustained above 2x.

Cronos is a geographically diversified and vertically integrated cannabis company located in Canada that operates a portfolio of brands for medicinal and recreational cannabis with multiple international production and distribution platforms across five continents. Cronos year-to-date revenues for the first three quarters of 2018 were approximately USD10 million with estimated annual production capacity of approximately 40,000 kg and ongoing capacity expansion plans of an additional 77,000 kg. The agreement also includes a warrant to acquire additional ownership interest in Cronos, exercisable over the next four years, which would increase Altria's(MO) ownership by 10% to 55%. The Cronos transaction is expected to close in the first half of 2019 and is subject to shareholder and regulatory approvals.

The investment provides Altria(MO) with an opportunity to participate in the growth of the emerging global cannabis category that could improve their long-term competitive position as global momentum continues to grow for medicinal, recreational and wellness-related cannabis products given an evolving regulatory and consumer perception that cannabis is a safer and healthier option compared with current medical and alcohol alternatives. The transaction allows Cronos to leverage Altria's(MO) existing consumer brand knowledge, regulatory experience, technology capabilities and manufacturing expertise to advance its operating strategy.

The investment also enables potential international diversification benefits as Cronus has no U.S. operations and better positions Altria(MO) if cannabis became federally permitted in the U.S. Passage at the U.S. federal level is not expected for at least a couple of years given likely resistance by key federal government leaders. Cronos recently struck a strategic partnership with U.S. based Ginkgo Bioworks, Inc. that is targeting necessary improvement with the scalability, efficiency and economics of cultured cannabinoid production. Research on cannabinoids has demonstrated the potential for a wide variety of medicinal uses.

Fitch believes tobacco and beverage companies will need to start contending with the increasing number of U.S. states and countries that are liberalizing medical and recreational cannabis. As such, we expect continued deal flow following other similar investments made by Constellation Brands, Inc. that increased its stake in Canopy Growth to 38% for USD4 billion and Molson Coors Brewing Company entering into a joint partnership with The Hydropothecary Corporation to pursue non-alcoholic cannabis infused beverages for the Canadian market. Over the longer-term, the potential global market for cannabis is very large, with notable growth opportunities across several sub-segments. For 2019, we expect cannabis- based products will remain a niche category in the U.S. with no material disruption anticipated to the non-alcoholic, alcohol or tobacco markets. Therefore, material structural changes that would cause business model disruption is likely beyond 2019.

Given the nascent nature of the cannabis industry and uncertainties around how markets will develop, Fitch believes execution risks are also high for Altria(MO) or any company making large investment bets, without providing the certainty of generating sufficient returns on invested capital as companies will need to focus on building scale, distribution and brands. Challenges include highly fragmented markets, developing differentiated branded products, differing regulatory environments, potential legal/reputation risk, and low barriers to entry that will likely create significant operating and profitability challenges for at least the next 3-5 years.

Altria's (MO) recent announcement to discontinue production of e-vapor products leaves a gap in their portfolio offering for reduced-risk products. Cigarette volumes have experienced further pressure in 2018 due to adult smokers shifting to other tobacco categories including e-vapor, higher gas prices and increasing state excise taxes. The U.S. Food and Drug Administration (FDA) has been slow to approve Philip Morris International, Inc.'s (PMI) pending premarket tobacco product application for iQOS that would allow Altria(MO) to commercially launch the reduced-risk product in the U.S. market.

Regulatory headwinds have also increased during the past 18 months as the FDA has stepped up scrutiny of the approvals and age restrictions on the sale of e-vapor and other electronic products, nicotine levels in tobacco products as well as on all flavored products, including menthol cigarettes that increases risk of long-term earnings erosion. As such, Altria's(MO) business profile is constrained by limited geographic diversification given its reliance on the U.S. market, which heightens the company's exposure to potential changes in regulatory, legal, and excise taxes particularly at the federal level.

Fitch currently rates Altria(MO) as follows:

Altria Group Inc. (MO)

--Long-Term Issuer Default Rating (IDR) 'A-';

--Guaranteed bank credit facility 'A-';

--Guaranteed senior unsecured debt 'A-';

--Short-Term IDR 'F2';

--Commercial paper (CP) 'F2'.

Philip Morris Capital Corp.

--Long-Term IDR 'A-';

--Short-Term IDR 'F2';

--CP 'F2'.

The Rating Outlook is Stable.

Contact:

Primary Analyst

Bill Densmore

Senior Director

[phone]

Fitch Ratings, Inc.

70 W. Madison Street

Chicago, IL 60602

Secondary Analyst

John Witt, CFA

Senior Director

[phone]

Media Relations: Elizabeth Fogerty, New York, Tel: [phone], Email: [e-mail].

Additional information is available on www.fitchratings.com

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(END) Dow Jones Newswires
12-11-180911ET