Fitch Rates Coca-Cola's Benchmark Issuance 'A+'; Outlook Negative
OREANDA-NEWS. Fitch Ratings has assigned an 'A+' rating to The Coca-Cola Company's (Coca-Cola) multi-tranche proposed benchmark issuance of senior notes including senior notes due 2019 and senior notes due 2026. The Rating Outlook is Negative. Coca-Cola had approximately $46.8 billion of debt as of April 1, 2016. A complete list of ratings follows at the end of this release.
The notes will be issued by Coca-Cola and will rank equally with the company's senior unsecured obligations. Coca-Cola will use the net proceeds for general corporate purposes, which may include working capital, capital expenditures, acquisitions of or investments in businesses or assets, redemption and repayment of short-term or long-term borrowings and common stock purchases.
KEY RATING DRIVERS
Persistently Elevated Leverage
The Negative Outlook reflects Coca-Cola's elevated leverage (on both a gross leverage and supplemental net leverage basis) as high for the current ratings. Moreover, Fitch needs to see progress related to refranchising and evidence that Coca-Cola will adhere to a more balanced capital allocation strategy related to share repurchases, dividends and debt reduction. The Outlook could be stabilized with a public commitment over the next 12 months toward a deleveraging policy. Fitch would need to see clear visibility and traction on gross leverage declining below 3x and supplemental net leverage below 2x as the company transitions to a franchising model, produces at least 3% organic top-line growth and sees EBITDA improvement through targeted productivity initiatives.
Long-term Business Model Strengthened
Fitch believes Coca-Cola's long-term business model will strengthen as a result of accelerated refranchising plans. While refranchising will cause some near-term EBITDA dilution, Coca-Cola will receive upfront cash proceeds that will be used for debt reduction and an annuity stream related to bottling assets to offset this decline. Moreover, over time, the refranchising will substantially reduce SG&A costs, increase gross margins to the upper 60% range, result in operating margins that improve to the mid-30% range from approximately 24%, and significantly reduce capex intensity. Consequently, upon completion of refranchising in 2017, Coca-Cola's underlying cash flows are expected to be more stable providing greater support to its longer-term credit profile.
Coca-Cola's $3 billion productivity program to be completed by 2019 also provides additional benefits to operating profit and cash generation. While Coca-Cola is using a portion of these savings to support brand strength by increasing media and R&D spending, cost reductions should help drive future growth in operating profit. Consequently, Fitch views Coca-Cola's long-term mid-single-digit revenue and high-single-digit profit before tax financial targets as achievable.
More Balanced Capital Allocation Expected
Coca-Cola generates substantial overseas cash flows due to its position as the world's largest non-alcoholic beverage company and has been reluctant to repatriate foreign earnings given the tax consequences. Accordingly, foreign cash balances have grown along with debt including larger commercial paper (CP) balances to fund domestic cash requirements for the dividend, U.S. capital investment, share repurchase program and strategic M&A activities.
Coca-Cola is in the process of implementing a more appropriate longer-term capital allocation policy to improve the alignment of domestic cash generation versus domestic cash requirements that should benefit its longer-term financial structure. These steps include: a reduced reliance on CP usage to below $15 billion, a more balanced long-term share repurchase policy including reductions for material M&A activity, a more conservative pace of dividend growth, and using a portion of refranchising proceeds for debt reduction.
CP balances have declined to $14.9 billion at the end of the first quarter 2016 from a peak of approximately $19 billion as Coca-Cola has committed to reduce its reliance on this funding source, although overall debt increased by $2.2 billion in 2015. CP as a percent of total debt is currently approximately 32%, which compares to peak usage of approximately 50% of total debt. Fitch expects Coca-Cola will maintain CP balances below $15 billion over the long term compared to a past soft cap of $20 billion.
Supplemental Net Leverage Expected to Decline
For U.S. issuers, Fitch currently excludes foreign cash balances from its definition of readily available cash used to calculate net leverage metrics. Fitch recognizes that these cash balances are an asset that may be accessed and used to reduce debt in the event it is necessary. Therefore, for certain issuers with significant levels of foreign cash positions, like Coca-Cola, supplemental adjusted net leverage ratios are used when gauging the level of tolerance/cushion within the assigned ratings. Foreign cash balances are reduced by applying a generic 35% tax haircut and a further adjustment capturing expectations for additional foreign cash balances that could be used for shareholder-friendly actions. In its calculations, Fitch haircuts after-tax foreign cash balances by 25% to accommodate for share buybacks.
Fitch expects long-term gross debt, inclusive of CP, to decline during the next several years with a more balanced capital allocation policy. Supplemental adjusted EBITDA net leverage for Coca-Cola at the end of the first quarter 2016 was approximately 2.7x compared to 2.3x at the end of 2014. Over the longer term, Fitch expects supplemental net leverage will decrease to around 2x in 2018/2019 due to debt reduction and EBITDA growth.
Strong Global Brands
As the world's largest global beverage company, Coca-Cola's ratings are supported by its strong market shares, extensive geographic diversity, strong distribution platform and valuable brand equity. Coca-Cola has more than 20 $1 billion-plus brands, including: Coca-Cola, Diet Coke, Sprite, Powerade, Minute Maid, Fanta Orange, Schweppes and Dasani. The strong brands, geographic reach, market position and diversification afford considerable support to Coca-Cola's business profile that has led to stable, sustainable cash flows.
Given the prominence of carbonated soft drinks (CSDs) in Coca-Cola's beverage portfolio and constituting approximately 73% of the mix, the ratings consider the multiyear declines in CSD volumes in the U.S., continued concern over artificial sweeteners affecting diet CSD demand in North America, risks associated with excise tax increases and slowing growth in other developing countries. Fitch believes this risk is mitigated in part by Coca-Cola's market strength in developing and emerging geographies with greater long-term growth characteristics driven by low per-capita CSD consumption characteristics, urbanization, population growth, and expanding middle class that should provide an important longer-term offset.
Coca-Cola, along with the rest of the beverage industry, have also modified their price/mix strategy, primarily in developed markets, to focus on both smaller pack size and premium/alternative packaging to drive a higher price per unit versus its past volume focus. Consumers are increasingly seeking premium and smaller-sized offerings as evidenced by the low-double-digit growth rates within this packaging combination mix.
Underlying Growth Should Improve
Fitch expects underlying revenue growth in 2016 of approximately 3.6% with volume growth of 1.8%, price/mix growth of 1.8% and foreign currency pressure of 4%. Beyond 2016, Fitch believes Coca-Cola should be able to improve organic growth rates during the medium term to close to 5% on volume growth of 3% and product/mix of 2%. Fitch expects underlying operating income growth will increase in 2016 by almost 7% driven by productivity benefits and organic growth. Coca-Cola's productivity savings program enables additional financial flexibility over the next several years to cover incremental investments and costs that will be used in part for increased media investments and brand support development. Coca-Cola has already redirected $600 million in previous productivity savings toward increased media spending and expects to increase spending by up to $200 million-$400 million more during the next two years.
Fitch does not make a rating distinction between Coca-Cola Company and Coca-Cola Refreshments USA, Inc. (CCR) issued obligations, since default risk is very low at this level on the rating scale. CCR's notes are structurally superior to the notes issued by Coca-Cola.
Fitch's key assumptions within its 2016 rating case for Coca-Cola include:
--Underlying revenue growth of approximately 3.6% with volume growth approximately 1.8%, price/mix growth of approximately 1.8% and foreign currency pressure of 4% in 2016;
--Underlying operating income growth is estimated to increase by almost 7%;
--Coca-Cola generates approximately $10 billion of cash flow from operations (CFFO) with more than 50% of Coca-Cola's CFFO available for domestic use. Free cash flow (FCF) in excess of $1.5 billion in 2016;
--Total debt increases marginally as borrowings to fund domestic cash requirements are expected to moderate;
--Net share repurchases of $2.25 billion;
--Capital spending of $2.5 billion;
--Gross leverage of 3.7x and net supplemental leverage of 2.7x.
Over the forecast period through 2019 and once refranchising is complete, assumptions include:
--Gross margin increasing to the high 60% range;
--Operating margins increasing to the mid 30% range;
--Gross debt levels declining from a current level of $44.2 billion through proceeds from asset sales combined with a more balanced capital allocation policy;
--Gross leverage of 3x times and net supplemental leverage reducing to less than 2x.
Positive: Future developments that may, individually or collectively, lead to a stabilization of the Rating Outlook include:
--A public commitment toward a deleveraging policy over the next 12 months. This commitment would be reflective of achieving a more balanced capital allocation policy with a pullback in share repurchases and a commitment to reduce gross debt levels.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--A lack of deleveraging such that gross leverage is sustained above 3x and supplemental adjusted EBITDA net leverage is sustained above 2x over the long-term;
--A lack of public commitment to debt reduction;
--A lack of execution with refranchising plans;
--Productivity program does not fully deliver expected cost benefits;
--A more aggressive financial strategy related to dividend, M&A and share repurchases.
Strong Cash Generation, Sizeable Offshore Cash Position
Coca-Cola's ratings reflect the company's ability to generate considerable CFFO and FCF. For the LTM period, Coca-Cola generated $9.6 billion and $1.2 billion (adjusting for dividend payment) of CFFO and FCF, respectively. As of April 1, 2016, Coca-Cola's approximate $28 billion liquidity position consisted of $22.2 billion of cash, short-term investments and marketable securities, and $8.3 billion of availability under its committed credit lines and revolving credit facility with rolling maturities through 2019. Coca-Cola's long-term debt maturing in the next 12 months is substantial, totalling $5 billion.
Coca-Cola maintains a sizeable offshore cash position due to the company's substantial international cash generation. Of the $22.2 billion in cash, short-term investments and marketable securities, the majority was held by foreign subsidiaries. Foreign cash balances increased during the first quarter of 2016, when Coca-Cola received $2.4 billion for its ownership interest in Keurig Green Mountain, Inc. following its acquisition by JAB Holding Company.
FULL LIST OF RATING ACTIONS
Fitch currently rates Coca-Cola and its subsidiary as follows:
The Coca-Cola Company
--Issuer Default Rating (IDR) 'A+';
--Bank credit facilities 'A+';
--Senior unsecured debt 'A+';
--Short-term IDR 'F1';
--Commercial paper 'F1'.
Coca-Cola Refreshments USA, Inc. and Coca-Cola Refreshments
Canada, Ltd. (CCR)
--Long-term IDR 'A+';
--Senior unsecured debt 'A+'.
The Rating Outlook is Negative.