DEBT POLICY AT

UST Inc.
B.B.Chakrabarti
IIMC
 THE ISSUE
UST planning a major change in capital
structure via a debt-financed stock
repurchase program

Dec 98
UST Board approved a plan to borrow $1
billion over 5 years
 UST - BACKGROUND
 175 year old company
 Dominant producer of moist smokeless tobacco
 Uninterrupted cash dividends since 1912
 One of the most profitable American companies
 5-year ROCE of 92.1%
 Increasing EPS and Share price
 P/E ratio = 13.8
 SMOKELESS TOBACCO
MARKET (1998)
 $2 bn in retail revenue
 5 mn consumers of moist smokeless
tobacco
 7 mn consumers of chewing tobacco
 Moist smokeless tobacco fastest growing
segment at 3.7% annual growth over past
17 years against 2% annual decline in
cigarettes
 UST and COMPETITION
UST Ph. Morris Median-ex UST
GPM 80.1 41.7 28.0
NPM 32.9 10.3 2.7
ROE 103.4 49.3 22.5
ROA 53.8 13.2 3.1
Debt/ Mkt Eq. 1.5 10.1 49.8
EBITDA Int. Cov. 105.6 12.7 4.1
Debt Rating A
 LITIGATION and LEGISLATIVE
ENVIRONMENT
 Litigation and legislation are everyday
occurrences
 7 pending health related lawsuits (98)
 UST to pay $100 - $200 mn over 10 years
as part of Smokeless Tobacco Master
Settlement Agreement to settle Medicaid
disputes (Nov 98)
 Lawmakers to continue to push new laws
against tobacco use
 UST – FINANCIAL RESULTS
5-Yr CAGR 10-Yr CAGR
Net Sales 5% 9%
EBIT 6% 11%
EPS 9% 13%
GPM 79.7% 77.3%
NPM 32.7% 31.3%
ROE 122.8% 89.1%
Div Payout 61.6% 51.4%
 WALL STREET OUTLOOK
In late 98, analysts maintain neutral rating on UST.

Reasons
- Continued threat of price-value competitors
- Softening smokeless tobacco market
- No international expansion
- Lackluster performance of non-core operations
- Public and political sentiment against tobacco
UST – ATTRIBUTES and RISKS
VIEWPOINT OF BONDHOLDER
Brand Name and Market Position
- Dominant Producer with 77% market share
- Largely insulated from competition due to
advertising restrictions

Cash Flow Generation

- Cash cow
- Expected to continue generating strong cash
flows for a long time
UST – ATTRIBUTES and RISKS
VIEWPOINT OF BONDHOLDER
Cyclicality
- Small $ purchases
- Relatively inelastic demand
- UST able to raise prices in excess of
inflation
Geographical Diversification
- Minimal sales outside of US
UST – ATTRIBUTES and RISKS
VIEWPOINT OF BONDHOLDER
Product Diversification
- Very high single product risk (smokeless
tobacco)
Asset Tangibility
- Few tangible assets
Litigation
- Moderate
- Low relative to cigarette manufacturers
 KEY FINANCIAL RATIOS FOR
DEBT RATINGS
AAA AA BBB
EBIT Interest Coverage 12.9 9.2 4.1

Return on Capital 30.6 25.1 15.4

Long-term Debt/Capital 21.4 29.3

40.8
S & P Industrial Senior Debt
Ratings Distribution - 1999
AAA 1%
AA 4%
A 13%
BBB 20%
BB 24%
B 32%
CCC 4%
D 2%
 UST – INCOME STATEMENT
PROJECTION
Actual 98 Pro-forma 99
Sales 1423.2 1494.2 5% growth
EBIT 753.3 791.9 53% of sales
Interest -2.2 0.0
PBT 755.5 791.9
Taxes 287.6 300.9 38%
Net Income 467.9 491.0
Net debt 0.0 0.0
Int. Rate
Int. Cover
Debt rating
 UST – INCOME STATEMENT
PROJECTION
Pro-for. 99 Pro-for. 99 Pro-for. 99
Sales 1494.2 1494.2 1494.2
EBIT 791.9 791.9 791.9
Interest 64.7 67.6 78.2
PBT 727.2 724.3 713.7
Taxes 276.3 275.2 271.2
Net Income 450.9 449.1 442.5
Net debt 1000.0 1000.0 1000.0
Int. Rate 6.47% 6.76% 7.82%
Int. Cover 12.2 11.7 10.1
Debt rating AAA AA BBB
 UST - VALUATION
Status Quo $1 bn Recap
PV Tax Shields 380
Value of UST 6,469 6,849
Net Debt 0 1,000
Stock Price 34.875 36.924
Shares Repurchased 27.08
Shares 185.5 158.4
Market Equity 6469 5849
Debt/Market Equity 0.00 0.17
IMPACT OF RECAPITALIZATION
ON DIVIDENDS
Actual 98 Pro-for. 99 Pro-for. 99
Net Income 467.9 491.0 442.5
Shares 185.5 185.5 158.4
EPS 2.52 2.65 2.79
Div Payout 301.1 314.2 283.2
Div per Share 1.62 1.69 1.79

Net debt 0.0 1000.0

Int. Rate 7.82%
Debt rating BBB
Assumed: UST continues to pay 64% of earnings as
dividends
UST – REPURCHASE PROGRAM
OVERVIEW
1999
- Raised $240 mn in 10-yr debt (rated A+)
- Repurchased 16.1 mn Shares for $466 mn at
avg. price of $28.94
- Dividend - $1.76 per share
2000
- Raised $300 mn in 5-yr debt (rated A+)
- Repurchased 4.7 mn Shares for $97 mn
- Repurchase program suspended due to $1.05
bn award against UST for violation of antitrust
laws