American credit market outlook

Altria Group Inc's credit spreads have narrowed sharply since a key legal victory for the tobacco industry on Thursday, yet there may be more upside in store for credit investors, several analysts say.
Clearing a major litigation risk for Big Tobacco, the Florida Supreme Court refused to reinstate a $145 billion damage award against cigarette manufacturers in the 12-year-old case known as Engle v. Liggett.
Thursday's decision was especially positive for Altria, whose Philip Morris USA unit was a defendant in the case, because it clears the way for Altria's spinoff of its Kraft Foods Inc business, analysts said.
"There's a good chance that Altria will redeem or tender some of the Philip Morris debt as part of the Kraft spinoff process, which would provide an upside event for bondholders," said James Goldstein, analyst for fixed-income research service CreditSights. CreditSights has an overweight recommendation on both Altria's bonds and credit default swaps.
Spreads on Altria's 7 percent notes due in 2013 tightened by 5 basis points after Thursday's court decision to 83 basis points over Treasuries, according to MarketAxess. A basis point is 0.01 percentage point. The cost of protecting Altria's debt for five years fell by about 10 basis points to about 43 basis points, or $43,000 for every $10 million protected.
Still, Altria's default swap spreads remain about 10 to 20 basis points wider than comparably rated food and beverage companies and thus could decline more, to about the mid-30s, said an analyst who asked not to be named. Though Altria still faces potential damages in a Department of Justice racketeering case against the tobacco industry, the claim in the case has been significantly downsized, the analyst said.
In the DOJ case now awaiting a ruling, the government's initial $280 billion claim against the industry has been reduced to $14 billion.
"Our belief is that they will probably end up negotiating something significantly less than the $14 billion," said CreditSights' Goldstein. Though Philip Morris faces challenges as smoking bans reduce the number of cigarette smokers in North America, the business is still highly profitable, and Philip Morris commands a strong market share lead, Goldstein said.
"They also have growth opportunities in the international markets, especially Asian markets," Goldstein said. Philip Morris has about 62 percent of US market share for premium cigarettes and 50 percent of the total cigarette market, according to CreditSights. Some analysts said that the best of the spread tightening on Altria is likely in the past, but the risk of spread widening has also declined.
"Engle has been ongoing for over a decade, and as the first class action of injured smokers to go to trial, it has been a thorn in the industry's side," Craig Hutson, analyst for fixed-income research service Gimme Credit, said in a report on Friday.