Fitch Publishes Ratings on Lorillard IDR at 'BBB'; Outlook Stable

Fitch Ratings has published the following ratings on Lorillard, Inc. (Lorillard) and its subsidiaries as follows:

Lorillard (Parent)

--Long-term Issuer Default Rating (IDR) at 'BBB';

--Short-term IDR at 'F2';

Lorillard Tobacco Co. (Wholly owned subsidiary)

--Long-term IDR at 'BBB';

--Senior Unsecured Credit Facility at 'BBB';

--Senior Unsecured Notes at 'BBB';

--Short-term IDR at 'F2'.

The Rating Outlook is Stable. Lorillard had $2.6 billion of debt at March 31, 2012.

RATING RATIONALE

Lorillard's ratings are supported by the company's consistent and substantial operating earnings and cash flow generation resulting from industry-leading EBITDA and free cash flow margins, which exceed those of its much larger competitors. Ratings also incorporate Lorillard's competitive position in the domestic cigarette market, and its ownership of the Newport brand, which has a strong market share in menthol cigarettes, a growing segment within the shrinking U.S. cigarette industry. The ratings are further support by the company's U.S. geographic expansion strategy and the highly successful introduction of Newport Red, its non-mentholated cigarette entrant which has garnered just under a 1% market share in 18 months.

--Substantial Cash Flow and Shareholders Prioritized

Lorillard's cash flows from operations are sizeable, amounting to $1.2 billion for the latest 12 months ended March 31, 2012. From 2009-2011, free cash flow (FCF), defined as cash flow from operations less capital expenditures and dividends, averaged approximately $400 million annually. Fitch recognizes Lorillard's goal to return excess cash to shareholders in its ratings. The company's target dividend payout ratio of 70%-75% is high, but typical for U.S. tobacco firms. Although Fitch believes a high dividend payout ratio reduces financial flexibility, because management teams are reluctant to reduce dividends in periods of operational weakness, this risk is offset by the magnitude of Lorillard's excess FCF.

--Company and Industry Risk Factors

Lorillard's ratings are lower than those of companies with similar credit metrics, largely due to its dependence upon cigarettes and specifically the Newport brand for a substantial portion of its revenue and operating earnings, its concentration within the menthol cigarette sector which represented approximately 84.2% of the company's total volume at March 31, 2012, litigation risk, albeit reduced, and the possibility of increasing regulatory risk. Nonetheless, Fitch believes that with Newport's strong brand preference and brand equity, Lorillard's management team can adapt to a heightened regulatory environment.

RATING DRIVERS

--Upgrade Not Likely

Credit ratings for Lorillard are limited to the 'BBB' level. Upside to credit protection measures is limited by the reliance on the mature and declining cigarette sector, which inhibits growth potential. However, a deceleration of cigarette volume declines, industry growth, or material diversification outside of the tobacco industry would be positive for the company's ratings. Lorillard's focus on returning cash to shareholders indicates stable to rising debt levels and slightly higher leverage in the future. While not anticipated, an increase in leverage above 2.0x without the expectation of a return to lower levels within a reasonable time period would result in a negative rating action.

CREDIT MEASURES, DEBT STRUCTURE AND LIQUIDITY

--Credit Measures and Liquidity

Lorillard's credit metrics as of March 31, 2012 were strong for the rating level. The company's total debt-to-operating EBITDA was 1.4x; its operating EBITDA-to-gross interest expense was 14.0x; and its funds flow from operations (FFO) adjusted leverage was 2.0x. The company has a stated long-term leverage target of 1.5x total debt-to-EBITDA. Fitch's ratings reflect expectations that total debt-to-EBITDA will range between 1.5x- 2.0x, as excess free cash flow along with incremental borrowings will be used for share repurchases.

With over $1.9 billion of cash on March 31, 2012, Lorillard has excess liquidity. Tobacco companies typically reserve much of their cash for their annual MSA payments. However, Lorillard's settlement accrual to date was approximately $1.5 billion, $400 million less than its cash balance. Additional liquidity is derived from the company's undrawn $185 million revolving credit facility that expires in March 2013. Lorillard has no near-term maturities. The company's earliest maturity is $500 million in August 2016.

All of Lorillard's debt was issued by its wholly-owned operating subsidiary - Lorillard Tobacco Co. - and is unconditionally guaranteed on a senior unsecured basis by the parent company. In additional to covenants that restrict liens and sale and leaseback transactions, among other things, upon the occurrence of a change of control and a downgrade below investment grade, Lorillard Tobacco Co. will be required to make an offer to repurchase notes. The company's 2019 notes also include a coupon step-up provision in the event the company is downgraded below investment grade by the rating agencies.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and related research:

--'Corporate Rating Methodology' (Aug. 12, 2011);

--'2012 Outlook: U.S. Tobacco' (Dec. 9, 2011).

Applicable Criteria and Related Research:

Corporate Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229

2012 Outlook: U.S. Tobacco

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=658212

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Fitch Ratings
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