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Fitch Affirms The Kraft Heinz Company's IDR at 'BBB-'; Outlook Stable
August 22, 2017 / 3:38 PM / 3 months ago

Fitch Affirms The Kraft Heinz Company's IDR at 'BBB-'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, August 22 (Fitch) Fitch Ratings has affirmed The Kraft Heinz Company's (Kraft Heinz, or KHC) Long-Term Issuer Default Rating (IDR) at 'BBB-' and Short-Term IDR at 'F3'. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release. KEY RATING DRIVERS Mature Markets Limit Organic Business Growth: Kraft Heinz generated $26 billion annual revenue in 2016. Its portfolio includes eight $1 billion-plus brands and many other large and well-known household brands. Kraft Heinz is heavily exposed to the mature, highly competitive North American market which makes up about 80% of sales and EBITDA. In addition, another 9% of its revenue comes from Europe, which is facing significant macro headwinds. Organic growth trends remain challenging for large packaged foods companies across most developed economies, due to brand maturity and changing consumer preferences. For the first half of 2017 (1H17), Kraft Heinz's organic sales were down by 1.8%, after reporting 0.3% growth in 2016. Fitch expects full-year 2017 top-line growth to be mildly negative. Beyond 2017, Fitch forecasts that the overall organic growth rate will be flat to modestly positive, assuming the North American and European businesses stabilize. Significant Margin Improvement Achieved: The ratings incorporate significant qualitative benefits from the company's 51% owners, 3G Capital (3G; 24.2% ownership) and Berkshire Hathaway (Berkshire; 26.8%), who were previous owners of H.J. Heinz Company. 3G has substantially increased operating profitability and delevered acquired firms including H.J. Heinz Company (Heinz) and Restaurant Brands International, Inc. (formerly Burger King, which is now integrating the Canadian Tim Hortons chain purchased in December 2014). For example, 3G and Berkshire acquired Heinz in June 2013 and improved the company's leverage (total debt to EBITDA) to 6.2x in 2014 from 8.9x in 2013. The improvement was driven by a 35% EBITDA increase due to lower overhead and manufacturing costs and more than $1 billion in debt repayment. As of 2Q17, Kraft Heinz has achieved $1.45 billion in savings since the merger closed in July 2015, stronger than expected, and completed approximately 70% of footprint right-sizing. However, gross margin improvement in 2017 has been muted by increasing input prices. As a result, Fitch expects EBITDA to reach the low $8 billion range by 2018 versus prior expectations of around $9 billion. Progress Towards Deleveraging: The company has made strong progress to date and is on track to realize integration savings through fixed-cost and overhead reduction, rationalizing the manufacturing footprint, and realizing procurement savings from increased scale. Fitch estimates that leverage will trend towards the mid-3x range by 2019 from 5x in 2015 (on pro forma combined 2015 EBITDA of $6.7 billion), due to the combination of realizing a substantial portion of the targeted annual synergies and $2 billion of debt reduction (paydown of June 2017 maturities). Consolidating Retail Landscape: The price pressure on food companies from their distribution channels is reflective of the consolidation occurring within the retail world and the threat of the European hard-discount grocers expanding in and entering the U.S. market. KHC's retail customers, such as supermarkets, warehouse clubs and food distributors, are consolidating, resulting in fewer but larger customers with greater negotiating power who are demanding lower product pricing and/or more favorable terms. Wal-Mart, for example, KHC's largest customer, accounted for 22% and 20% of its net sales in 2016 and 2015, respectively. In addition, Fitch expects Amazon's potential acquisition of Whole Foods, Inc. to result in even further downward pressure on food prices given Amazon's history of driving down prices in other industries. Fitch expects Kraft Heinz to respond to these challenges by stepping up marketing investments and increasing innovation. Elevated M&A Event Risk: It has been two years since the Kraft / Heinz merger closed in July 2015. The combined company has been able to drive leverage down from a pro forma level of 5x in 2015 to 4.3x in 2016. In February 2017, Kraft Heinz approached Unilever with an acquisition proposal for a purchase price of $143 billion. The acquisition would have increased KHC's leverage; Unilever declined the proposal. This Unilever overture affirmed Kraft Heinz's interest in seeking greater scale, geographic expansion and cost-cutting opportunities that could offset the challenging organic top-line growth environment, but would have delayed Kraft Heinz's deleveraging timeframe. DERIVATION SUMMARY The packaged food industry is highly competitive. Kraft Heinz competes with both large national and international food and beverage companies and numerous local and regional companies. It competes with both branded products and private brands on the basis of product quality, innovation, consumer preference relevancy, brand recognition and the effectiveness of its marketing programs, distribution, shelf space, merchandising support, and price. Kraft Heinz' 'BBB-' rating reflects the company's large scale with $26 billion in annual sales, industry-leading EBITDA margins of approximately 29%, and elevated leverage after the Kraft/Heinz merger. Compared to other packaged foods companies that are in Fitch's public rating coverage universe, Kraft Heinz has the largest scale, highest EBITDA margin, and a total Debt/EBITDA leverage ratio of 4.3x as of December 2016, reflecting merger-related debt. General Mills ('BBB+'/ Negative Outlook) had annual revenue of $15.6 billion and was levered at 2.8x total Debt/EBITDA as of December 2016. Kellogg ('BBB'/Stable Outlook) had annual revenue of $13 billion and was levered at 3.3x total Debt/EBITDA as of December 2016. Mondelez ('BBB'/Stable Outlook) had annual revenue of $25.9 billion and was levered at 3.7x total Debt/EBITDA as of December 2016. Conagra ('BBB-'/Positive Outlook) had annual revenue of $7.8 billion and was levered at 1.9x total Debt/EBITDA as of May 2017. Fitch expects Kraft Heinz to benefit from its scale, continue to generate strong cash flow, and steadily pay down debt associated with the merger. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: -- 2017 revenue of approximately $26 billion, reflecting flat organic top-line growth and minor FX headwinds. Revenue is expected to grow with a flat to modestly positive organic growth rate thereafter, assuming neutral currency. -- Fitch expects EBITDA margin to exceed 30% and reach $8 billion by 2018 as the company realizes full run-rate of $1.7 billion in targeted cost synergies. -- FCF (after dividends) is expected to be modestly negative in 2017 primarily due to significant integration cash charges and capex. Fitch expects FCF to turn positive and could increase significantly from 2018 onwards as cash charges decline. -- No share repurchases assumed in the forecast period. -- Fitch estimates that leverage will trend towards a mid-3x range by 2019 due to a combination of moderate EBITDA growth and $2 billion of debt reduction (repayment of 2017 maturities). Fitch assumed the latest refinancing of term loan and commercial paper (CP) to be leverage-neutral. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action -- Over the long term, a positive rating action could be supported by flat to modestly positive organic growth, substantial and growing EBITDA and FCF generation, along with meaningful debt reduction that takes leverage below 3.5x. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -- Sustained top-line weakness and potential market share loss in major categories; -- Inability to achieve targeted cost synergies, leading to insufficient FCF or cash on hand to pay down debt, which results in total debt/EBITDA sustaining above 4x over the medium term; -- A sizeable debt-financed acquisition that limits the company's ability to return leverage to under 4x 24-36 months post-transaction. LIQUIDITY Adequate Liquidity: Kraft Heinz's key sources of liquidity are its $4 billion revolving credit facility (RCF) maturing in 2021, and cash on hand. As of July 1, 2017, the company had cash and cash equivalents of $1.4 billion ($0.9 billion based outside of the U.S.) in addition to its $4 billion undrawn senior unsecured RCF. Capital Structure: As of July 1, 2017, Kraft Heinz had total debt outstanding of $30.8 billion, including $1.1 billion CP outstanding, $1.4 billion senior secured debt, and $28.3 billion senior unsecured debt. During 2Q17, the company paid down $2 billion of senior unsecured bonds that matured in June 2017. On Aug. 7, 2017, Kraft Heinz issued $1.5 billion of senior unsecured floating notes, and used the proceeds to repay all amounts outstanding under the $600 million term loan facility which matures in July 2022, refinance a portion of the CP outstanding, and for other general corporate purposes. FULL LIST OF RATING ACTIONS Fitch as affirmed Kraft Heinz's ratings as follows: The Kraft Heinz Company (Parent) --Long-term Issuer Default Rating (IDR) at 'BBB-'. Kraft Heinz Foods Company --Long-term IDR at 'BBB-'; --Short-term IDR at 'F3'; --Commercial paper at 'F3' --$4 billion unsecured revolving credit facility at 'BBB-'; --Senior unsecured notes at 'BBB-' --$1.2 billion second-lien secured notes due February 2025 at 'BBB' (legacy Heinz). Kraft Canada (operating subsidiary) --Long-term IDR at 'BBB-'; --CAD Senior Unsecured notes at 'BBB-'. H.J. Heinz Finance UK Plc. --$125 million GBP 6.25% second-lien secured notes due February 2030 at 'BBB' (legacy Heinz). Fitch also withdrew the 'BBB-' rating for the $600 million term loan at Kraft Heinz Foods Company which was refinanced by the recently issued senior unsecured notes. The Rating Outlook is Stable. Contact: Primary Analyst Ellen Itskovitz, CFA Senior Director +1-312-368-3118 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Monica Aggarwal Managing Director +1- 212-908-0282 Committee Chairperson Carla Norfleet Taylor Senior Director +1-312-368-3195 Date of Relevant Rating Committee: Aug. 21, 2017 Summary of Financial Statement Adjustments Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation, restructuring/acquisition related costs, and other one-time costs. For example, Fitch added back $46 million in non-cash stock-based compensation and approximately $1 billion restructuring/merger related costs in 2016. Fitch also adjusted for off-balance-sheet A/R securitization. As of July 1, 2017, Kraft Heinz had $624 million outstanding in its accounts receivable securitization and factoring program. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) here Non-Financial Corporates Notching and Recovery Ratings Criteria (pub. 16 Jun 2017) here Parent and Subsidiary Rating Linkage (pub. 31 Aug 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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