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Moody's places Japan Tobacco's ratings on review for possible downgrade

Moody's Japan K.K. on March 19 placed Japan Tobacco Inc.'s Aa3 issuer and senior secured ratings under review for a possible downgrade, citing weakening trend in the company's free cash flow.

The review comes after JTI-Macdonald Corp., a subsidiary of the tobacco giant, lost an appeal in a class-action lawsuit in Canada that also involves subsidiaries of British American Tobacco PLC and Philip Morris International Inc.

JTI-Macdonald could be forced to pay C$1.77 billion to settle the case.

Moody's said the exact financial impact and the timing of JTI-Macdonald's protection under the Companies' Creditors Arrangement Act are unclear, "but they reflect the rising business risk for the tobacco company."

Tokyo-based Japan Tobacco previously said its other subsidiaries are not affected in the Canadian proceedings. Analysts earlier said that JTI-Macdonald, BAT's Imperial Tobacco Canada Ltd. and Philip Morris' Rothmans Bensons & Hedges Inc. could face bankruptcy as a result of the C$15.6 billion court judgment.

Meanwhile, the review by Moody's also covers the aa3 baseline credit assessment, the (P)Aa3 senior secured rating on the company's medium term note program, the Aa3 backed senior unsecured ratings and the (P)Aa3 backed senior unsecured rating on Japan Tobacco's Netherlands-based financial arm Jt International Financial Services B.V.

Moody's said Japan Tobacco's free cash flow declined to ¥41.2 billion in 2018 from ¥245.0 billion in 2014. The agency noted that the tobacco company's free cash flow sees a weakening trend while operating cash flow stagnates and dividends increase.

Moody's said its review will focus on Japan Tobacco's financial policies and its plan to achieve its profit growth targets amid an increasingly challenging operating environment.

According to the agency, it could proceed with the downgrade if the company's debt/EBITDA remains around 2.0x or retained cash flow/net debt remains below 50%. However, it could upgrade the ratings if the company's cash flow and profit increase sufficiently, albeit noting that this is "unlikely in the foreseeable future."