OREANDA-NEWS. Fitch Ratings has downgraded Nestle SA's (Nestle) Long-Term Issuer Default Ratings (IDR) and senior unsecured ratings to 'AA' from 'AA+', and affirmed the company's Short-Term IDR at 'F1+'. The Outlook on the Long-Term IDR is Stable. A full list of rating actions is available at the end of this commentary.

The downgrade reflects slower deleveraging than previously expected and credit metrics that are more consistent with a 'AA' rating. The ratings continue to reflect the stability and strength of Nestle's business. Fitch expects Nestle to maintain a prudent financial policy balancing a leverage profile that is more commensurate with a 'AA' rating to accommodate for any slowdown in its key markets or for further expansion including, but not limited to, additional M&A or shareholder distributions.


Slower than Expected Deleveraging

At 1.4x in 2015, Nestle's funds from operations (FFO)-adjusted net leverage has remained above the maximum 1.2x compatible with a 'AA+' rating. On the assumption of debt-funded acquisitions of around CHF2bn in 2016 and CHF1.5bn in 2017, conservatively growing dividends and no further share buyback programmes over 2016 and 2017, Fitch estimates that FFO adjusted net leverage will still be above 1.2x in 2016 and is unlikely to return below that level until 2018.

While our prior 'AA+' rating was predicated on limited M&A and no further share buyback following the completion of the programme in 2015, Nestle has pursued additional external growth totalling CHF1.7bn in H116. This includes CHF572m spent in Proactive - a skin care brand - and CHF1.1bn spent on acquiring non-controlling interests. This amount has exacerbated the already weak credit metrics for the 'AA+' rating and Fitch's expectations for 2016.

Softening Sales Growth

Volume and pricing have consistently contributed to revenue growth, underlining Nestle's ability to drive both revenue components while delivering profit margin improvements. However, in a weakening global economy characterised by slow growth, increased competition as well as changing and increasing fragmentation in consumer tastes, Nestle reported organic sales growth of 4.2% in 2015, below its long-term target range of 5%-6%. 1H16 organic sales growth was 3.5%, impacted by lower-than - historical pricing owing to deflationary environments across a number of developed markets and low commodity prices.

Stable Business Profile

Although weaker than historically, Nestle's organic growth performance remains at the top end of major fast-moving consumer goods peer group and the company continues to achieve market share gains in several categories and countries.

Nestle's business profile remains strong due to the reliance of revenue growth on some of the company's fast-growing and higher-margin categories such as pet care, infant nutrition, coffee; Nestle Skin Health and Nestle Health Science; fast-growing emerging markets; and a more diverse channel or format exposure (e. g. Nepresso boutiques) than traditional store-based retail stores. Such a strong business profile is reflected in the 'AA' rating. Fitch expects Nestle to continue its consistent performance and to deliver organic growth of around 4% for 2016. Growth will be driven by both volume and pricing, which are in turn supported by Nestle's ability to innovate and achieve efficiencies.

Scope for Growing Profit Margins

Nestle's reported trading operating margin (continuing operations) was 15.1% in 2015, down 20bp versus last year but up 10bps in constant currencies. Fitch expects further margin improvement, driven by cost-saving initiatives, higher-margin categories/emerging markets, and premium product offerings. This follows the 30bp improvement in 1H16 trading operating margin, both on a reported basis and in constant currencies.

Management aims to achieve structural cost savings and improve Nestle's operating profit margin by at least 200bps by 2019/2020. However, a major part of these savings will likely be reinvested in the business. Therefore, the future margin trend is subject to the pace of growing consumer-facing marketing and promotions in both developed markets and emerging markets.

Resilient Free Cash Flow

Nestle is maintaining strict discipline on capex and working capital, with the latter having supported cash flow over 2015 and 1H16. Pre-dividend free cash flow (FCF) margin remains healthy at just over 10%. However, dividends have absorbed an increased portion of post-capex cash flow from operations over the last years. We therefore expect FCF margin post-dividends to remain around 3% by 2017; this is weak relative to other credits rated in the 'AA' category.

Diversification Complements Resilient Business

Nestle's 'AA' rating reflects operations in a sector characterised by high business stability and low capex and R&D spending requirements, despite operating in highly competitive segments, compared with other highly rated corporations. Furthermore, within its industry Nestle benefits from a portfolio of several high profit margin categories, from ownership of some of the strongest brands as well as from consistent and successful innovation. Balanced geographical diversity between developed and emerging markets further supports the ratings.

Foreign Exchange Volatility

Although Nestle enjoys balanced geographical diversity between developed and emerging markets, profits are exposed to emerging market currency devaluation. A portion of operating costs are denominated in domestic currencies but translation risks can still erode reported profits as seen in 2015.

Moreover, while Nestle maintains local currency-denominated debt at many of its emerging markets subsidiaries, the majority of the company's debt is in hard currencies, thus limiting the benefits of these natural hedges. Mitigating this risk is the company's track record of gradually increasing prices, albeit with a time lag, in countries suffering from currency devaluation.


Fitch's key assumptions within our rating case for the issuer include:

- Organic annual revenue growth of 4%-4.5%;

- Operating margins above 15%;

- Annual pre-dividend FCF around 10%;

- Capex of 4.7% of revenue per year in 2016-2017;

- Moderate growth of dividend per share;

- No share buybacks for 2016 - 2019;

- Approximately CHF2bn of net acquisitions in 2016 and CHF1.5bn of net acquisitions from 2017 onwards.


Positive: We do not anticipate an upgrade in the immediate term but future developments that may, individually or collectively, lead to positive rating action include:


- FFO adjusted net leverage below 1.0x (2015: 1.4x) as a result of asset sale proceeds, or improvement in operations

- Renewed commitment to a higher rating

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- FFO adjusted net leverage above 2.0x

- Deterioration in FCF generation after dividends, taking FCF margin below 3% (2015: 3.1%)

- Significant or prolonged downturn in emerging markets, or in main developed markets, causing a slowdown in organic growth (below 3%) and reduction in profits (EBIT margin below 14%)

- FFO fixed charge coverage (including rents) below 10x (2015:14.3x)


As of 30 June 2016 Nestle had liquidity of CHF18.4bn, comprising CHF5.1bn of cash and cash equivalents and committed undrawn back-up bank facilities of CHF13.3bn. This is sufficient to cover 100% of Nestle's short-term debt obligations (CHF14.6bn) consisting of bonds and bank loans due in the coming 12 months as well as outstanding commercial papers (CHF9.6bn).


Nestle SA

Long-term IDR downgraded to 'AA' from 'AA+'; Outlook Stable

Short-term IDR affirmed at 'F1+'

Senior unsecured debt downgraded to 'AA' from 'AA+'

Nestle Holdings, Inc. (USA)

Senior unsecured debt downgraded to 'AA' from 'AA+'

Nestle Finance International Ltd.

Guaranteed commercial paper affirmed at 'F1+'

Guaranteed bonds downgraded to 'AA' from 'AA+'

Nestle Holdings (UK) PLC

Senior unsecured rating downgraded to 'AA' from 'AA+' and withdrawn as this company is no longer issuing debt for the group

Guaranteed commercial paper affirmed at 'F1+'

Nestle Capital Corporation (USA)

Guaranteed commercial paper affirmed at 'F1+'

Nestle Australia Ltd

Guaranteed commercial paper, affirmed at 'F1+'