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Fitch Rates Coca-Cola's Issuance 'A+'; Outlook Negative
May 22, 2017 / 8:36 PM / in 7 months

Fitch Rates Coca-Cola's Issuance 'A+'; Outlook Negative

(The following statement was released by the rating agency) CHICAGO, May 22 (Fitch) Fitch Ratings has assigned an 'A+' rating to The Coca-Cola Company's (Coca-Cola) issuance of 5- and 10-year senior notes. The Rating Outlook is Negative. The notes will be issued by Coca-Cola and will rank equally with the company's senior unsecured obligations. Proceeds will be used to purchase any notes accepted in Coca-Cola's tender offer, pay any consent payments and general corporate purposes. Coca-Cola had approximately $47.4 billion of debt as of March 31, 2017. A complete list of ratings follows at the end of this release. KEY RATING DRIVERS Leverage Reduction Expected Fitch believes Coca-Cola will make substantial progress during the next 2+ years with reducing leverage and adhering to a more balanced capital allocation strategy that should yield material improvements to Coca-Cola's long-term capital structure as the company transitions to a franchising model. Fitch believes Coca-Cola would benefit materially from corporate tax reform that could provide significant flexibility for the company to repatriate overseas cash that could accelerate gross debt repayment. Coca-Cola's gross leverage was 3.9x on a total debt-to-operating EBITDA basis at the end of first quarter 2017, an increase from 3.6x at the end of 2016. Coca-Cola's supplemental net leverage was approximately 2.7x at the end of first quarter 2017, which was comparable to 2015. Fitch anticipates Coca-Cola will reduce debt in 2017 primarily through refranchising proceeds that would decrease expected supplemental net leverage to the mid-2.0x range. Over the longer term, Fitch expects supplemental net leverage will decrease to around 2x or less by 2019 due to debt reduction and EBITDA growth. Commercial paper (CP) balances were $13.7 billion at the end of first quarter 2017 from a peak of approximately $19 billion as Coca-Cola has reduced its reliance on this funding source. CP as a percent of total debt is approximately 27%, which compares to peak usage of approximately 50% of total debt. Long-Term Business Model Should Strengthen Fitch believes Coca-Cola's long-term business model will strengthen as a result of refranchising plans. While refranchising will cause some near-term EBITDA dilution through 2018, the company will receive upfront cash proceeds that will be used for debt reduction and an annuity stream related to bottling assets to offset this decline. Over time, the refranchising will substantially reduce SG&A costs, increase gross margins to the upper 60% range, lead to operating margins that will improve to the approximate mid-30% range from approximately 24%, and significantly reduce capex intensity. Consequently, with the expected completion of refranchising in late 2017 to early 2018, Coca-Cola's underlying cash flows should be more stable, providing greater support to its longer-term credit profile. Refranchising benefits are weighed against any challenges with the newly franchised bottlers maintaining a consistent and unified long-term vision particularly around future investment requirements. Productivity Benefits Coca-Cola's $3 billion productivity program to be completed by 2019 also provides additional benefits to operating profit and cash generation. Through 2016, the productivity program has resulted in approximately $1.7 billion in savings. 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. Thus, Fitch views Coca-Cola's longer-term mid-single-digit revenue and high-single-digit profit before tax financial targets as achievable once emerging and developing markets fully recover. 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 which has led to stable, sustainable cash flows. Current Headwinds Given the prominence of carbonated soft drinks (CSDs) in Coca-Cola's beverage portfolio, constituting in excess of 70% of the mix, the ratings consider the multiyear low-single digit 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 certain 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 an expanding middle class that should provide an important longer-term offset. Coca-Cola, along with the rest of the beverage industry, has 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 higher growth rates within this packaging combination mix. Coca-Cola has also focused on relaunching Coca-Cola Zero Sugar, scaling smaller brands like smartwater and honest tea globally and accelerating global reformulations on more than 500 products to reduce sugar levels. Fitch expects Coca-Cola will explore bolt-on M&A opportunities to broaden their beverage portfolio focusing on still beverages. CCR Ratings 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. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer over the 2017 to 2019 timeframe include: --Underlying organic sales growth of approximately 3-4%; --Coca-Cola generates approximately $10 billion of cash flow from operations (CFFO) with roughly 50% of Coca-Cola's CFFO available for domestic use. --FCF in the range of $1.6 billion +/- 10% for 2017 with moderate growth through 2019; --Gross debt reduction of at least $2 billion in 2017, which is dependent on timing of refranchising proceeds and South African bottling transaction; --Supplemental net leverage to the mid-2.0x range; --Net share repurchases of $2 billion for 2017; --Capital spending of $2.25 billion for 2017, declining to approximately $1.3 billion. Over the forecast period once refranchising is complete, assumptions include: --Gross Margin increasing to at least 67%; --Operating margins increasing to the mid 30% range; --Supplemental leverage net reducing to around 2x or less by 2019. RATING SENSITIVITIES The Negative Outlook reflects Coca-Cola's elevated leverage (on both a gross and supplemental net leverage basis), which is high for the current ratings. To stabilize the Outlook, Fitch would need to see a public commitment that Coca-Cola will adhere to a more balanced capital allocation strategy including a reduction in share repurchases resulting in gross debt reduction. The Outlook stabilization would be contingent upon demonstration of a public commitment toward a deleveraging policy including: 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 with EBITDA improvement through targeted productivity initiatives. This commitment would be reflective of achieving a more balanced capital allocation policy. Negative: Future developments that may, individually or collectively, lead to a negative rating action include: --A lack of progress deleveraging such that gross leverage is expect6ed to be sustained above 3x and supplemental net leverage is sustained above 2x beyond 2019; --Proceeds from refranchising materially less than expected; --Productivity program does not fully deliver expected cost benefits; --A more aggressive financial strategy related to dividend, M&A and share repurchases; --Consecutive years of materially less than expected FCF. LIQUIDITY Coca-Cola's ratings reflect the company's ability to generate considerable CFFO and free cash flow (FCF). For 2017, Coca-Cola generated LTM CFFO and FCF of $8.6 billion and $2.2 billion (adjusting for dividend payment), respectively. The pension plan funding was 89% at the end of 2016. Coca-Cola anticipates making pension contributions of $106 million in 2017. Coca-Cola generates substantial overseas cash flows due to its position as the world's largest non-alcoholic beverage company and has been reluctant in the past to repatriate foreign earnings given the tax consequences. Accordingly, foreign cash balances have grown along with debt including larger CP balances to fund domestic cash requirements for the dividend, U.S. capital investment, share repurchase program and strategic M&A activities. As of March 31, 2017, Coca-Cola's approximate $33.5 billion liquidity position consisted of $25.2 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 2022. Coca-Cola maintains a sizeable offshore cash position as a result of the company's substantial international cash generation. Of the $25.2 billion in cash, short-term investments and marketable securities, the majority was held by foreign subsidiaries. Coca-Cola's long-term debt maturing in the next 12 months pro forma for the debt issuance in early 2017 is approximately $1 billion. FULL LIST OF RATING ACTIONS Fitch currently rates The Coca-Cola Company (Coca-Cola) and its subsidiaries as follows: The Coca-Cola Company --Long-Term 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. Contact: Primary Analyst William Densmore Senior Director +1-312-368-3125 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst Carla Norfleet Taylor, CFA Senior Director +1-312-368-3195 Committee Chairperson Monica Aggarwal Managing Director, CFA +1-212-908-0282 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: --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 then haircuts after-tax foreign cash balances by 25% to accommodate share buybacks and determine supplemental net leverage. --Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation expense and restructuring as reported in financials. --Bottler dividends ($386 million in 2016) added back to EBITDA. Date of Relevant Committee: March 23, 2017 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: Additional information is available on Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 10 Mar 2017) here Additional Disclosures Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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