DBRS Confirms Rothmans, Benson & Hedges Inc. at BBB (high) and R-2 (high) with Negative Trend

DBRS has confirmed the ratings of Rothmans, Benson & Hedges Inc.’s (RBH or the Company) Senior Unsecured Debt at BBB (high) and its Commercial Paper at R-2 (high), with a Negative trend. The Negative trend continues to reflect RBH’s difficult operating environment and the uncertainty regarding ongoing legal proceedings.

The tobacco industry continues to see declining cigarette consumption (particularly in the premium category) and rising contraband tobacco activity. Going forward, DBRS expects industry volumes will continue to decline and pricing increases will become more difficult to implement. Although RBH generated flat operating earnings in F2007, DBRS expects this level of earnings will be difficult to maintain over the long term.

In terms of legal issues, there has been little development since our last rating report. The Province of British Columbia is slowly proceeding with its action against RBH and other tobacco manufacturers under the provincial Tobacco Damages and Health Care Recovery Act. Five other provinces have adopted similar legislation to allow for the recovery of health-care costs; however, no actions have commenced to date. Other significant actions/new developments include a consolidated class action suit filed in the Province of Québec seeking compensation for damages in excess of $23 billion, and a complaint from Imperial Tobacco Canada Limited (ITL) and one of its affiliates alleging that RBH’s Rooftop brand infringed on their rights in respect of the MARLBORO trademark registration in Canada. In addition, RBH is currently the subject of an ongoing investigation by the Royal Canadian Mounted Police (RCMP) relating to allegations that RBH tobacco products exported from Canada between 1989 and 1996 were illegally smuggled back into Canada without payment of taxes and duties. To date, no charges have been laid against RBH.

Given the fact that all legal actions are in the preliminary stages and RBH is expected to vigorously defend itself, the outcome of such proceedings remains uncertain and is likely years away. As well, since tobacco litigation remains relatively new in Canada, it is difficult to predict the outcome of such events or the overall impact of potential adverse judgments or future cases against the company or the industry. That said, DBRS believes the Negative trend is warranted given that over the long term, potential judgments against the company could severely affect the Company’s financial position and solvency. Any acceleration or progress regarding legal matters and/or deterioration in operating earnings could result in a ratings downgrade.

Note:
All figures are in Canadian dollars unless otherwise noted.