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Vector Group Ltd. -- Moody's rates Vector's senior secured notes Ba3, affirms CFR of B2; outlook is stable

·17 min read

Rating Action: Moody's rates Vector's senior secured notes Ba3, affirms CFR of B2; outlook is stable

Global Credit Research - 11 Jan 2021

New York, January 11, 2021 -- Moody's Investors Service, ("Moody's") assigned a Ba3 rating to Vector Group Ltd's ("Vector") new $850 million senior secured 8-year notes. At the same time Moody's affirmed Vector's existing ratings, including its B2 Corporate Family Rating (CFR), its B2-PD Probability of Default Rating and the Caa1 rating on the company's senior unsecured notes due 2026. Proceeds from the new senior secured notes will be used to refinance the existing $850 million senior secured notes due in 2025. The Ba3 rating on the existing $850 million senior secured notes will be withdrawn at closing. Moody's also upgraded the speculative grade liquidity rating to SGL-1 from SGL-2. The rating outlook is stable.

The rating affirmation reflects Moody's expectation that Vector's performance will remain stable over the next 12-18 months as its tobacco business will benefit from modest market share gains. During the current recession, Moody's expects consumers will continue to trade down to less expensive brands thus supporting growth in Vector's market share despite longer-term industry headwinds leading to declining cigarette smoking. The company's focus on permanent cost savings initiatives will further support EBITDA in the $330 million to $340 million range over the next 12 to 18 months. Moody's further expects the company's free cash flow will range between $25 million to $30 million per year assuming an annual dividend payout of approximately $130 million. Debt to EBITDA will also remain high at around 5.0x and the company has very good liquidity. The refinancing is modestly credit positive because it extends the maturity profile with a limited effect on cash interest expense and leverage.

The upgrade to SGL-1 reflects sizable cash and equivalents of $451 million as of September 30, 2020 accumulated through free cash flow. Vector also has approximately $124 million of liquid investments, an undrawn $60 million revolver expiring in January 2025, and no meaningful debt maturities for the next 5 years. The company has very good cushion within the $100 million minimum EBITDA covenant and should remain comfortably below the $20 million maximum capital expenditure covenant. The covenants are triggered when revolver availability is less than $20 million, which Moody's views as unlikely.

Ratings assigned: Vector Group Ltd.:

- Senior Secured Notes due 2029 at Ba3 (LGD2)

Ratings affirmed:

Vector Group Ltd.:

- Corporate Family Rating at B2

- Probability of Default Rating at B2-PD

- Senior Unsecured Notes due 2026 at Caa1 (LGD5)

Ratings upgraded:

Vector Group Ltd.:

- Speculative Grade Liquidity Rating, Upgraded to SGL-1 from SGL-2

Outlook Actions: Outlook, Remains Stable RATINGS RATIONALE

Vector's B2 CFR reflects its relatively small scale compared to larger U.S. tobacco companies and limited pricing flexibility. The company participates in the deep discount cigarette segment that is highly regulated. Vector's credit profile also reflects its aggressive financial policy, modest free cash flow and the ongoing threat of adverse tobacco litigation and regulation. Partially offsetting these risks is Vector's good track record of increasing EBITDA operating performance and improving share in the US cigarette market. Additionally, the company holds a cost advantage based on the beneficial terms provided under the Master Settlement Agreement ("MSA"). Vector also has very good liquidity with large cash balances and real estate investments that are conservatively managed and a realtor business (Douglas Elliman) that provides an additional, albeit volatile, source of earnings diversification.

The coronavirus outbreak, the government measures put in place to contain it, and the weak global economic outlook continue to disrupt economies and credit markets across sectors and regions. Moody's analysis has considered the effect on the company's performance from the current weak US economic activity and a gradual recovery for the coming months. Although an economic recovery is underway, it is tenuous, and its continuation will be closely tied to containment of the virus. As a result, the degree of uncertainty around Moody's forecasts is unusually high leading to wide potential variations in demand for tobacco products. Moody's regards the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety.

Vector is exposed to increasing social risks in the cigarette business related to life-style changes, regulation and litigation. Over the past three decades, volume decline in traditional cigarettes is a direct consequence of a social shift away from cigarette smoking. Vector could be negatively impacted if US regulators decide to implement a ban of flavored cigarettes as another means to discourage smoking.

Vector also has an aggressive financial policy including the use of high leverage. Additionally, as recently as 2019, the company historically paid high dividends in excess of cash flows ($239 million paid in 2019 versus cash from operations of $143 million) using debt to primarily fund these large excess payments. Over the past year, Vector has since reduced dividends by approximately half to about $130 million annually, a level that it can now support with internally generated cash flow. Although the company has curtailed its dividends it continues to have limited ability to reduce debt.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

The stable outlook reflects Moody's expectation that Vector's sales and EBITDA will grow modestly by 1% to 2% over the next 12 to 18 months due to some cigarette volume improvement as the company will benefit from some trade-down from branded cigarettes in a period of elevated unemployment. The outlook also reflects Moody's expectation for continued high debt-to-EBITDA leverage of around 5.0x. The real estate brokerage business will have top line improvement, though add little lift to overall operating profits. Moody's outlook also reflects expected annual dividends at the current run-rate of about $130 million per year.

Ratings could be upgraded if litigation risk diminishes and the company's profitability and credit metrics improve with no adverse impact on volume growth and/or market share. An upgrade would also require debt to EBITDA to remain below 4.5x with sustained positive free cash flow after dividends.

Ratings could be downgraded if pricing flexibility trends or growth prospects for the discount cigarette industry deteriorate, or if there is an unexpected material increase in litigation or regulation risk. A decline in liquidity, including diminished cash and marketable securities could also lead to a downgrade. Vector's ratings could also be downgraded if debt to EBITDA is sustained above 6.0x.

The principal methodology used in these ratings was Consumer Packaged Goods Methodology published in February 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1202237. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

Vector Group Ltd. is a publicly traded holding company with subsidiaries engaged in U.S. domestic cigarettes manufacturing, real estate brokerage through Douglas Elliman and real estate development. Vector generates roughly $1.5 billion in annual revenue (net of federal excise taxes) as of last-twelve-months ending September 30, 2020.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

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Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1243406.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Maria Iarriccio Vice President - Senior Analyst Corporate Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 John E. Puchalla, CFA Associate Managing Director Corporate Finance Group JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653

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