Fitch Affirms Mondelez's IDR at 'BBB'; Outlook Revised to Stable
KEY RATING DRIVERS
Increased Confidence in 2018 EBIT Margin Target of 17%-18%:
The revision of the Outlook to Stable reflects Fitch's increased confidence in Mondelez's ability to improve EBIT margins to the targeted 17%-18% range in 2018 from 14.7% in 2015 on 2%-3% annual organic revenue growth. The improvement will primarily be driven by the large restructuring program the company put in place in 2014 to realize $1.5 billion in annualized savings by 2018 in the areas of supply chain, overhead costs, and other organizational efficiencies. Free cash flow (FCF; after dividends, cash restructuring charges, and pension contribution) is expected to improve from $200 million-$300 million in 2016 to over $1.5 billion in 2018, as the company cycles heavy restructuring-related cash payments and capex over the next 2-3 years. Debt/EBITDA is expected to trend toward 3.0x by 2018 from an expected 3.5x in 2016 on EBITDA growth.
Risks to the ratings include prolonged weakness in organic sales growth with Mondelez growing below industry-category sales growth and higher than expected investments needed to drive sales which would preclude the company from achieving the targeted EBIT margins. Debt financed share buybacks and M&A activity that keeps leverage elevated in the mid-to-high 3x are also rating concerns. Fitch expects M&A activity to continue in the packaged food sector as companies optimize product portfolio, geographic exposure, and seek cost reduction opportunities. Mondelez's attempted takeover of Hershey would have been a transformative event for the company. While Mondelez's rating does not factor a major M&A event, the company could be acquisitive or even the target of a larger multinational food company over the rating horizon.
Favorable Portfolio Mix
Fitch views Mondelez as having a favorable product mix relative to its packaged-food peers given that 80% of its sales are geared towards snacks, which Fitch expects should grow in the 2%-3% range going forward (versus 6% historically) against flat to 1% for overall packaged foods. The snacking category is well-aligned with consumer trends of eating more frequent, smaller meals, and convenience. In addition, 40% of its sales come from emerging markets which have near-term headwinds but strong growth prospects longer term. This supports long-term organic growth of 2%-3%, which Fitch expects will be driven equally from volume growth and pricing over the medium term.
Mondelez is one of the world's largest snack companies, with 2016 projected revenues of approximately $26 billion and an attractive portfolio of sweet snack brands. The company operates in approximately 165 countries and has #1 global market shares in biscuits and candy, as well as #2 global shares in chocolate and gum. Oreo, Cadbury, Nabisco, Dairy Milk, LU, Milka, and Trident each generate more than $1 billion in annual sales. Power Brands, which make up 68% of sales, are the company's fastest growing and highest-margin global and regional brands. These brands have grown at about twice the pace of overall sales during the past few years and have margins 100bps to 200bps higher than the company's other brands. Power Brands also receive about 80% of advertising and consumer (A&C) expenditures.
Restructuring Program to Yield Industry Level Margins
Management has been focused on improving efficiency as Mondelez was created through a series of acquisitions made by legacy Kraft that were never properly optimized or integrated. In 2014, the company announced a $3.5 billion restructuring program to be executed from 2014 through 2018 with $2.5 billion in cash costs. The purpose is to reduce supply chain and overhead costs by $1.5 billion by the end of 2018. This would be supported by an incremental $1.6 billion in capex to upgrade its manufacturing facilities and the company expects 70% of its Power Brand sales will move to upgraded facilities by 2018 versus 25% in 2015.
EBIT margin has improved steadily to 15% for the LTM period ending June 30, 2016 versus 12.1% in 2013 and Fitch views Mondelez's margin targets of 17%-18% in 2018 as achievable, and would bring Mondelez more in line with industry averages.
Fitch's assumptions in its base case projections are as follows:
--Organic growth of about 2% in 2016, with 2%-3% growth expected thereafter. Currency impact is assumed to be neutral beginning 2017.
--EBIT margin is expected to be 15.1% in 2016, versus 14.2% in 2015, and expand to 17%-18% in 2018.
--EBITDA margin is expected to be 18%-19% in 2016, versus 17.7% in 2015, and expand to the 21% range in 2018.
--Capex is expected to peak at $1.4 billion in 2016 and decline by $100 million thereafter to $1.2 billion by 2018 as restructuring-related capex declines over time.
--FCF (after dividends, cash restructuring charges, and pension contribution) of over $200 million in 2016, improving to over $1.5 billion in 2018.
--Total debt-to-EBITDA of around 3.5x in 2016, assuming $2 billion in additional debt (in the form of commercial paper [CP] borrowings) to fund around $2 billion in share buybacks. Leverage is expected to trend towards 3x in 2018, driven primarily by EBITDA growth.
Future developments that may, individually or collectively, lead to a negative rating action include:
--EBITDA tracks below expectation due to a shortfall in expected operating margin improvement or deceleration in organic top-line growth, aggressive financial policies or engaging in a large debt-financed acquisition, such that leverage is consistently above 3.5x.
Future developments that may, individually or collectively, lead to a positive rating action include:
--Organic growth in line with or better than category growth
--EBITDA margins in line with or better than industry average
--Leverage consistently below 3x.
Mondelez's liquidity at June 30, 2016 includes more than $1.8 billion in cash and equivalents and an undrawn $4.5 billion senior unsecured revolving credit facility expiring in October 2018. Mondelez had $2.4 billion in CP outstanding at June 30, 2016. Upcoming long-term debt maturities are significant with $1.5 billion due in 2017, which Fitch believes the company is likely to refinance. FCF (after dividends, cash restructuring charges, and pension contribution) is expected to improve from $200 million-$300 million in 2016 to over $1.5 billion in 2018, as the company cycles heavy restructuring-related cash payments and capex over the next 2-3 years. Debt/EBITDA is expected to trend towards 3.0x by 2018 from an expected 3.5x in 2016 on EBITDA growth.
FULL LIST OF RATING ACTIONS
Fitch has affirmed Mondelez's ratings as follows:
--Long-Term Issuer Default Rating (IDR) at 'BBB';
--Senior unsecured debt at 'BBB';
--Credit facility at 'BBB';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
The Rating Outlook is Stable.