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S&P revises Japan Tobacco outlook over deteriorating financial health

S&P Global Ratings revised to negative from stable its outlook on Japan Tobacco Inc.'s long-term corporate credit rating, citing the tobacco products manufacturer's deteriorating financial health.

Japan Tobacco's series of M&A transactions over the past two years has caused the debt-to-EBITDA ratio of the company to worsen to 1.2x by the end of December 2017 from 0.1x two years earlier. The company's about ¥190 billion planned acquisition of Russia's JSC Donskoy Tabak and its group companies, announced in March, is expected to further deteriorate the company's key cash flow ratio to about 1.4x, S&P said.

In addition, earnings from the Japanese firm's domestic tobacco business are falling more steeply than expected, due to a shift to e-cigarettes and tobacco vapor products. Japan Tobacco's plans to expand its market share of these products over the next two years, but the move is likely to be met with hurdles such as taxes and pricing regulations, S&P noted.

The rating agency, however, said the profitability of Japan Tobacco's overall tobacco business is unlikely to fall significantly from 2017 as the company's acquisitions will likely contribute to earnings. S&P Global Ratings said the company aims to continue aggressive M&A, particularly overseas, as its growth strategy.

Meanwhile, S&P Global Ratings' affirmed the company's AA- long-term and A-1+ short-term corporate credit ratings. The rating agency also affirmed the issue ratings on the company and an overseas subsidiary.

The rating agency sees more than a one-in-three chance of downward pressure mounting on the strong financial standing of the company if its earnings from the domestic tobacco business are slow to recover or the company carries out larger-than-assumed M&A.

S&P said it might downgrade the company if the debt-to-EBITDA ratio is likely to worsen to 1.5x or more and is expected to stay at such levels. It could, however, change the outlook back to stable if the company maintains positive discretionary cash flow and the ratio recovers to below 1.0x.

As of March 23, US$1 was equivalent to ¥104.94.

This S&P Global Market Intelligence news article may contain information about credit ratings issued by S&P Global Ratings, a separately managed division of S&P Global. Descriptions in this news article were not prepared by S&P Global Ratings. The original S&P Global Ratings documents referred to in this news brief can be found here.