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Fitch Rates Kellogg Co's $600MM Sr. Unsecured Notes 'BBB'; Outlook Stable
November 7, 2017 / 2:23 PM / 15 days ago

Fitch Rates Kellogg Co's $600MM Sr. Unsecured Notes 'BBB'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, November 07 (Fitch) Fitch Ratings has assigned a 'BBB' rating to Kellogg Company's (Kellogg) $600 million senior unsecured notes due November 2027. Proceeds from the notes will be used to repay most of the commercial paper borrowings that were used to finance Kellogg's $600 million acquisition of Chicago Bar Co LLC and to pay related fees and expenses. Chicago Bar Co LLC is the maker of RXBAR, a line of clean-label protein bars made with whole food ingredients and one of the fastest growing nutrition bar brands in the United States. The transaction closed on Oct. 27, 2017 and was initially funded through short-term borrowing. The Rating Outlook is Stable. A complete list of ratings follows at the end of this release. KEY RATING DRIVERS Revenue Pressure Amidst Changing Consumer Preferences Kellogg's ratings reflect Fitch's expectations that organic volume will remain modestly negative over the medium term given the Kellogg portfolio's exposure to mature developed markets that account for about 87% of total sales and a nascent natural/organic offering. Revenue declined an average of 4% over the past three years. Currency translation was responsible for most of the decline, followed by volume, which declined approximately 1% per year. Offsetting this weakness, price/mix has been positive for each of the past three years. These positive price/mix results were driven by a mix shift towards higher-growth categories and by Kellogg's efforts to expand its gross margin. Changing consumer preferences have had a negative impact on Kellogg's performance. The cereal category has seen steady declines in sales since peaking in 2011. Kellogg's cereal sales have declined at a CAGR of 3.5% since 2011 to $5.4 billion as of 2016. Cereal had accounted for 51% of company net sales in 2011 but fell to 42% of sales by 2016, a function of sales declines and portfolio restructuring moves, such as the 2012 purchase of Pringles. In comparison, snacks grew to account for 51% of sales in 2016 vs. 37% in 2011. Sales in the U.S. Snacks business, although trending right, have been slightly negative over the past three years, with growth ranging from -1.1% to -2.9%. Positive growth in some brands, such as Pringles with nearly $2 billion in revenues and approximately 14% of sales, has been offset by negative organic growth trends in other brands. While Kellogg's exposure to developing markets remains low, at just under 15%, the company is investing in the emerging economies. Fitch views these investments as a long-term positive despite the near-term weakness seen in China, Russia and Latin America that has been exacerbated by the strong U.S. dollar. In the fourth quarter of 2016, Kellogg closed an acquisition of a Brazilian snack company, Parati Group. And most recently, it acquired RXBAR, a Chicago based fast growing, clean-label nutrition bar brand, for a purchase price of $600 million. At the February 2017 Consumer Analyst Group of New York (CAGNY) conference, Kellogg reiterated its portfolio strategy as 1) stabilizing its core developed markets breakfast strategy, 2) growing its emerging markets business and 3) investing for growth in its snack business. Fitch expects Kellogg's cereal business growth to continue to be slightly negative, tracking industry growth, but sees opportunity in the snack business as investments in crackers and wholesome snacks take hold. Restructuring Efforts In November 2013, Kellogg announced Project K, a global restructuring program with savings expected to reach an annual run rate of $425 million to $475 million by 2018. The program was expanded in early 2017 to include exiting direct store delivery (DSD) for all of Kellogg's U.S. Snacks business in favour of a warehouse delivery system. As a result, estimated annual savings from Project K increased to $600 million to $700 million and the program was extended to 2019. In addition to Project K, Kellogg implemented zero-based budgeting (ZBB) in 2015 in North America and internationally in 2016. Cumulative savings from ZBB is expected to total $450 million to $500 million by the end of 2018, and is focused on selling, general and administrative expenses. Kellogg's restructuring programs are one of the more aggressive in the industry when evaluated based on savings as a percent of EBITDA at approximately 25% of 2016 EBITDA versus an average of 17% to 20% among the major U.S. packaged food companies excluding Kraft Heinz. The cash restructuring costs from the programs are expected to approximate $1.1 billion after-tax ($1.5 billion to $1.6 billion pre-tax). As of 2016, $725 million had been spent. Initial costs were largely offset by working capital improvements. At this stage, realized costs savings outweigh the current expenses. Kellogg is targeting an EBIT margin of 18% by 2018. Due to lingering costs of the DSD switchover, as well as revenue pressure, Fitch is projecting EBIT margins slightly below 18% in 2018 vs. 15.9% in 2016 (adding back non-cash stock-based compensation expense), gradually improving throughout the forecast period. DSD to Warehouse Delivery Changeover In February 2017, Kellogg announced that it would be transitioning from a direct store delivery (DSD) for all of Kellogg's U.S. Snacks business to a warehouse delivery system. A DSD system is fixed-cost and volume-dependent. Given that Kellogg was shipping only approximately 25% of U.S. sales through its DSD network, the Kellogg system was generally acknowledged to be relatively expensive. The change is expected to save nearly $300 million a year, some of which Kellogg envisions investing back in brand-building and marketing support. Kellogg will be taking resources away from delivery and in-store personnel, and putting resources into price reduction for retail, reflecting the transfer of in-store activity, and into brand building and marketing. Fitch finds the rationale behind this change reasonable. As of September 2017, DSD transition is on track. Leverage Expected to Trend Toward Low-to-Mid 3x Fitch expects leverage (adjusted debt to EBITDA) to trend toward the low-to-mid-3x range over the next three years, with EBITDA expected to remain in the range of $2.6 billion to $2.8 billion annually over the next 24-36 months and debt essentially flat. Fitch estimates that FCF (after dividends and cash restructuring costs) will gradually increase from negative in 2016 to approximately $600 million in the forecast period as cash costs related to the restructuring program abate. Fitch expects FCF to be used for either tuck-in acquisitions or share buybacks. Fitch adjusts for the Accounts Receivable Securitization program's impact on debt count and cash flow. DERIVATION SUMMARY The packaged food industry is highly competitive. Kellogg competes with both large national and international food and beverage companies and with 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. Kellogg (BBB/Stable) had annual revenue of $13 billion and was levered at 3.3x total Debt/EBITDA as of December 2016. General Mills (BBB+/ Negative) had annual revenue of $15.6 billion and was levered at 2.8x total Debt/EBITDA as of May 2017. Kraft Heinz (BBB-/Stable) had annual revenue of $26 billion, industry-leading EBITDA margin of approximately 29%, and was levered at 4.3x total Debt/EBITDA as of December 2016. Mondelez (BBB/Stable) had annual revenue of $25.9 billion and was levered at 3.7x total Debt/EBITDA as of December 2016. Conagra (BBB/Stable) had annual revenue of $7.8 billion and was levered at 1.9x total Debt/EBITDA as of May 2017. KEY ASSUMPTIONS Fitch's assumptions in its base case projections are as follows: --Revenues decline by low single-digits in 2017 due to weak organic growth and volume disruption as the company exits its Direct Store Delivery (DSD) business model for its snack business in the U.S. Beyond 2017, top line is expected to be essentially flat with volume declines in the low-single-digit range being offset by modest price increases. --Fitch is projecting EBIT margins slightly below 18% in 2018 vs. 15.9% in 2016 (adding back non-cash stock-based compensation expense), gradually improving throughout the forecast period. --EBITDA is expected to be in the range of $2.6 billion to $2.8 billion over the next 24 to 36 months. --FCF (after dividends and cash restructuring costs) gradually increases from approximately negative $449 million in 2016 (Fitch adjusted for A/R securitization) to approximately $600 million in the forecast period as cash costs related to the restructuring program abate. Fitch assumes working capital is neutral and expects FCF to be used for either tuck-in acquisitions or share buybacks. --Leverage (gross debt to EBITDA) remains in the low- to-mid-3x range. RATING SENSITIVITIES Future developments that may, individually or collectively, lead to a positive rating action include: --A positive rating action could occur with sustained low- to mid-single-digit organic growth with volume trends turning positive and with overall market shares stable or improving. In addition, Kellogg would have to maintain leverage consistently below 3x. Future developments that may, individually or collectively, lead to a negative rating action include: --Kellogg's organic growth rate continues to be negative in the low single-digit range. Consistently negative trends would signal that the company's renovation and brand support efforts are not effective and/or that emerging markets performance is worse than expected. --Leverage moving toward mid-3.0x as a result of either poor performance or material debt-financed share buybacks or acquisitions. LIQUIDITY As of Sept. 30, 2017, Kellogg reported $267 million of cash. The company maintains an unsecured $2 billion revolving bank facility maturing in 2019 that was undrawn as of September 2017. This facility backs up the company's commercial paper (CP) borrowings, which stood at $486 million at the end of the third quarter of 2017, including $285 million U.S. CP borrowings and $201 million Europe CP borrowings. On Jan. 30, 2017, Kellogg entered into an unsecured 364-day facility for $800 million. This facility backs Kellogg's account receivable sale program (program executed in 2016 that allows for certain account receivables to be sold to third party financial institutions). There was no borrowing under this facility as of September 2017. Debt Maturities: As of September 2017, Kellogg had total debt of approximately $9 billion, including $486 million CP outstanding, $7.5 billion senior unsecured debt, and approximately $1 billion of A/R Securitization that Fitch counts as debt. Subsequent to the quarter, Kellogg issued $600 million senior unsecured notes, and will deploy the proceeds to repay most of the commercial paper borrowings which were used to finance the purchase of Chicago Bar Co, LLC, the maker of RXBARs, and pay related fees and expenses. FULL LIST OF RATING ACTIONS Fitch currently rates Kellogg as follows: Kellogg Company --Long-Term Issuer Default Rating (IDR) 'BBB'; --Short-Term IDR 'F2'; --Commercial paper (CP) 'F2'. --Senior unsecured debt 'BBB'; --Bank credit facility 'BBB'; Kellogg Europe Company Limited --Long-Term IDR 'BBB'; --Short-Term IDR 'F2'; --CP 'F2'. Kellogg Holding Company Limited --Long-Term IDR 'BBB'; --Short-Term IDR 'F2'; --CP 'F2'. Kellogg Canada, Inc. --Long-Term IDR 'BBB'; --Senior unsecured debt 'BBB'. 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 Crystal Yuan Associate Director +1-646-582-4890 Committee Chairperson Phil Zahn Senior Director +1-312-606-3226 Date of Relevant Rating Committee: April 6, 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 and restructuring / acquisition related costs. For example, Fitch added back $63 million in non-cash stock-based compensation and $608 million restructuring related costs in 2016. Fitch also adjusted for A/R securitization. For example, Fitch adjusted for $854 million Account Receivables factoring in 2016. 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 Criteria for Rating Non-Financial Corporates - Effective from 10 March 2017 to 7 August 2017 (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. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. 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