Aug. 21 (Bloomberg) -- Plans to outlaw branded cigarette packaging in Britain are hanging over Imperial Tobacco Group Plc as the company clings onto its investment-grade rating after announcing $7 billion of debt-financed acquisitions.
Forcing companies to sell cigarettes in plain packs could undermine profits by making it hard to raise prices at a time when global tobacco consumption is falling, according to Moody’s Investors Service and Fitch Ratings. Health Minister Jane Ellison said in April branded cigarettes could be banned as soon as next year.
“Tobacco manufacturers will find it increasingly difficult to maintain brand value over time,” Lola Cavanilles, Moody’s London-based tobacco analyst, said in an interview. “We expect sales volumes to decline.”
Imperial Tobacco, the No. 2 cigarette seller in the U.K. after Japan Tobacco Inc., was put on review for a possible downgrade at Moody’s and Fitch in July after it agreed to pay $7.1 billion for U.S. cigarette brands and assets cast off to assuage anti-trust concerns over the merger of Reynolds American Inc. and Lorillard Inc.
The Bristol, western England-based maker of Gauloises Blondes and Davidoff cigarettes, which has the lowest investment grade at Moody’s and the second lowest at Fitch, is financing the deal with debt. That’s stretching its balance sheet and “the threat of plain packaging adds to that,” Cavanilles said.
The U.K. would be the first major European country forcing all cigarettes to be sold in uniform olive green packages with graphic health warnings and the brand name confined to the bottom of the pack in small print. The Department of Health concluded its final consultation this month and will respond in “due course,” it said in a statement.
Imperial Tobacco pound bonds have returned 5.1 percent this year, compared with an average of 7 percent for the 50 largest similarly rated issuers, according to Bank of America Merrill Lynch index data. Investors demand an extra 155 basis points of yield to hold Imperial bonds maturing in 2022 instead of similar-maturity government debt, up from 139 basis points two months ago.
The company will see its debt rise to about 4.4 times earnings before interest, taxes, depreciation and amortization in 2016 from about 3.5 percent this year, according to Philip Gorham, an analyst at Morningstar Inc. in Amsterdam.
Imperial, which has 36 percent of the U.K. tobacco market, says it expects to retain its investment-grade status. “We’ve been engaging with all three credit rating agencies very recently related to the U.S. acquisition, and it’s clear they’ve factored potential plain-packaging developments into their thinking already,” spokesman Simon Evans said by e-mail.
Policy makers, tobacco executives and analysts are looking to Australia, where standardized packaging was introduced in December 2012.
A recent Australian packet of 20 Philip Morris International Inc.’s Marlboro Red is dominated by pictures of a 34-year-old man named Bryan on his deathbed, with a snap of a healthier version of him 10 weeks earlier. The photos appear under a banner that says “Smoking Causes Lung Cancer.”
A bold yellow sticker on the side warns that 10 drags on 20 cigarettes a day equal “73,000 toxic drags per year.” The back of the dark green pack has another picture of Bryan and text explaining that he started smoking as a teenager and died 47 days after being diagnosed with lung cancer.
Tobacco companies globally are struggling with falling smoking rates as consumers become more health-conscious and governments crack down on smoking by banning vending machines, tightening age restrictions and outlawing smoking in public places.
In 2013, cigarette consumption declined in all of the world’s 10 heaviest-smoking nations, except Indonesia and China, according to Tobacco Merchants Association data.
In the U.K., the smoking rate has dropped below 20 percent, probably the lowest in 80 years, scientists at University College London said in February.
After a year and a half of the Australian ban, both sides of the argument claim victory. The tobacco firms say the introduction has led to an increase in illicit tobacco sales. Anti-smoking group ASH says Australian government figures showing a drop in adult smoking rates are a direct result of plain packaging.
New Zealand and Ireland have also passed laws paving the way for standardized packs.
“The big question, though, is going to be what other countries are going to do, particularly Germany, France, Italy and Spain,” Giulio Lombardi at Fitch Ratings in Milan said in a phone interview. Imperial Tobacco generates about 65 percent of its operating profit in the European Union.
So far, there has been little appetite in those countries to incur the further ire of the big tobacco companies. In February, the European Parliament voted to require that cigarette packs feature a combined pictorial and text warning covering 65 percent of the front and back. It also banned cigarettes and roll-your-own tobacco with distinguishing flavors including menthol.
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