S&P: The Hershey Co. 'A' Rating Affirmed, Outlook Stable
"The affirmation reflects our view that the company will continue to maintain its leading U. S. market share in chocolate, while slowly growing through tempered organic growth and possible future acquisitions," said credit analyst Chris Johnson. "We believe Hershey can achieve growth while also modestly reducing debt leverage, as we expect it to reduce shareholder returns from recent elevated levels and as it applies cash flows toward modest debt reduction. As a result, we forecast debt to EBITDA to strengthen to about 1.5x over the next 18 to 24 months, compared with about 1.9x for the 12 months ended July 2, 2016."
The stable rating outlook reflects S&P Global Ratings' expectations that Hershey will modestly improve EBITDA margins, reduce share repurchases, and apply cash flows to modest debt reduction over the next two years and restore credit measures closer to historical levels. We believe the company will generate low-single-digit topline growth given its heavy exposure to slower growing North American markets, which, together with cost cutting, should permit it to expand its EBITDA margins by more than 100 basis points (bps) and generate more than $700 million in annual FOCF over the next two years. This should permit the company to fund its ongoing dividends of more than $450 million, modestly increase capital expenditures to fun additional growth can capture more cost synergies, while reducing debt and improving debt to EBITDA closer to 1.5x.
We could lower the rating if the company sustains debt to EBITDA above 2x. Given the company's stable cash flow generation and stated leverage target of about 1.5x, with the flexibility to weaken periodically closer to 2x for bolt-on acquisitions, we believe the company would have to make a large debt-financed acquisition or significantly increase its share repurchases to trigger these metrics. Assuming the company performs in line with our base-case projections, we estimate the company would need to make an acquisition of well over $2 billion and not reduce leverage thereafter, or more than double its recent annual share repurchases by a similar amount while sales growth modesty declines, in order to lower the rating.
We could also lower the rating if any negative developments regarding Hershey's governance materialize, possibly from any undue influence by the Hershey Trust to benefit its interests over those of Hershey's other stakeholders.
Currently the company generates more than 80% of revenues and earnings in North America, primarily from confections and chocolates. Therefore, absent a change in financial policy whereby the company targeted and sustained leverage closer to 1x, an upgrade would require significant diversification of the company's business into other non-chocolate and confectionery products and into geographies outside of the U. S. If the company materially improves diversification in this scenario, Hershey would also have to maintain debt to EBITDA below 2x.