Lorillard Inc. (LO), Reynolds American, Inc. (RAI): Can Tobacco Companies Sustain Their Growing Debt?

On a net debt to EBITDA basis, all four of the companies have a ratio of less than 1.6, which indicates that they could all pay off their net debt with slightly more than one-and-a-half years of earnings.

In addition, while the previous section presented a picture of rising debt for the four companies, this chart shows that on a debt to EBITDA basis, debt has actually remained relatively constant, or in some cases actually fallen.

Philip Morris, which as accumulated the biggest debt pile of the four in dollar terms, has actually seen its net debt to EBITDA ratio fall over the past three years, signaling that earnings are rising faster than the company is issuing debt.

Altria’s ratio has remained in a range of 1.4-1.6 times EDITDA, whilst Reynolds remains in the 0.3-0.5 net debt to EBITDA range, indicating that while the companies are actually increasing their debt piles, earnings are rising in-line, which makes the debt look much more sustainable.

Lastly, Lorillard has been the worst performer. Lorillard’s debt has risen to 0.6 times EBITDA over the last two years alone. This is not an earth-shattering movement, but over the same period the same ratio at PM, MO and RAI only changed about 0.2, which means Lorillards debt is growing three times faster than that of its peers.

Finance Costs

The financing costs faced by each company remain low. Every company but Altria has debt financing costs that are less than 10% of income before tax and interest costs.

I believe that the interest rates on the debt of each company is sustainable, even Altira, with its relatively high financing rates.

Conclusion

So, in conclusion, while debt is growing at these companies, currently it does not appear to be a significant problem.

Reynolds American and Lorillard have levels of debt lower than their yearly EBITDA, indicating they could pay off debt over the course of one year alone. In addition, Philip Morris’ net debt to EBITDA ratio is falling, and it will soon be under 1.

Altria, on the other hand, lags behind the rest of the group. Altria has the highest level of debt to EBITDA, highest debt financing rates, and has been forced to increase its debt over recent years.

It appears that all four of these companies are able to sustain their debt at the moment. That said, if Altria’s earnings start to fall and Lorillard continues to issue debt at its current pace, then these two companies could run into trouble ahead.

Data Source: Saxo Capital Markets, Marketwatch

The article Can Tobacco Companies Sustain Their Growing Debt? originally appeared on Fool.com and is written by Rupert Hargreaves.

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