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Fitch Rates PepsiCo's $4B Notes Issuance 'A'; Outlook Stable
October 6, 2017 / 10:08 PM / in 2 months

Fitch Rates PepsiCo's $4B Notes Issuance 'A'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, October 06 (Fitch) Fitch Ratings has assigned an 'A' rating to PepsiCo, Inc.'s $4 billion multi-tranche offering. The Rating Outlook is Stable. Proceeds will be used for general corporate purposes including the repayment of commercial paper. PepsiCo had approximately $3.8 billion of commercial paper at the end of the third quarter 2017. The notes will be issued by PepsiCo under the indenture dated May 21, 2007 and will rank equally with PepsiCo's senior unsecured obligations. Indentures include covenants for limitations on liens including a carve-out such that the aggregate amount of secured debt does not exceed 15% of consolidated net tangible assets, and conditions related to consolidation, mergers or sales of assets. PepsiCo is not bound by any financial covenants. The senior notes are callable by PepsiCo, subject to a make-whole provision. KEY RATING DRIVERS Brand Strength, Global Diversity: More than half of PepsiCo's annual $63 billion in net revenue is derived from snacks and more than 40% of operating profit is derived by its higher-margin Frito-Lay North America segment. PepsiCo has significant global geographical diversification, with approximately 42% of revenues generated outside of the U.S. PepsiCo's brand strength is demonstrated by its portfolio consisting of more than 20 brands, including Pepsi, Gatorade, Lay's, Doritos and Quaker, with more than $1 billion in annual retail sales, which are typically No. 1 or No. 2 in their categories. Diversification Supports Organic Growth: Operationally, PepsiCo is focused on increased brand support to grow volume share, expand its emerging market presence and grow its nutrition business. The company is also reducing overhead, and leveraging technology and processes across its organization. Fitch believes PepsiCo's diversified portfolio anchored by its food business, strong brands and good innovation pipeline should enable core revenue growth of at least 2%-3% during the next couple of years. PepsiCo has been able to use price/mix to offset a significant portion of foreign exchange headwinds, and pricing has remained rational in key developed markets. Fitch expects core revenue growth in 2017 of roughly 2%, driven by price/mix benefits that compares to 3.7% in 2016. Growing Overseas Cash: PepsiCo generates substantial overseas cash flows from its international operations. Fitch believes that PepsiCo, like other multinational companies, has been reluctant to repatriate foreign earnings, given the tax consequences. Accordingly, foreign cash balances have grown along with debt balances to fund domestic cash requirements for the dividend, U.S. capital investment, and share repurchase program. Absent material M&A and tax reform, Fitch anticipates foreign cash levels could grow to approximately $23 billion by 2018. As of Sept. 9, 2017, PepsiCo had cash, cash equivalents and short-term investments of $17.5 billion offshore. With potential tax reform on the horizon, multinationals including PepsiCo may be reluctant to pursue material repatriation until after a new tax plan is implemented. Fitch discounts PepsiCo's foreign cash balances by applying a generic 35% tax haircut and a further 50% adjustment capturing expectations for additional foreign cash balances that could be used for shareholder-friendly actions when determining supplemental net leverage. Mid-2x Supplemental Net Leverage: For U.S. issuers with significant foreign cash balances, Fitch uses a supplemental net leverage ratio as part of our analysis. PepsiCo's supplemental net leverage was approximately 2.5x at the end of third-quarter 2017 (3Q17). Supplemental net leverage is expected to be approximately 2.5x for 2017, compared with 2.4x at the end of 2016. Fitch expects gross debt leverage in 2017 of approximately 3.0x. Leverage at the end of 3Q17 was 3.1x, compared with around low 2x in 2010. For 2017, PepsiCo has reduced expected shareholder returns to approximately $6.5 billion from $9 billion in 2015, although Fitch anticipates it still will need to increase debt by about $3 billion-$3.5 billion to fund domestic cash requirements. This is based on Fitch's estimate that approximately 45% of cash flow from operations (CFFO) is available for domestic use and does not consider any foreign cash that could be used for domestic funding requirements. Debt increased $2.2 billion during the first three quarters of 2017. Productivity Underpins Earnings Expansion: PepsiCo's five-year, $5 billion productivity cost-savings program to be completed by 2019 remains on track and provides the company with significant flexibility to expand margins and drive increased earnings over the longer term. PepsiCo is using a portion of the savings to bolster brand strength by increasing media, innovation and R&D spending, combined with cost reductions that strongly support future growth in revenues and operating profit. Consequently, Fitch views PepsiCo's long-term mid-single-digit-profit before tax financial targets as achievable. Despite the past negative effects on EBITDA of foreign exchange translation due to the strong dollar,, benefits of productivity efforts and working capital gains have resulted in stable cash generation. CFFO and FCF averaged $10.5 billion and $3.6 billion, respectively, for the past three years. Fitch expects PepsiCo's CFFO to be approximately $10 billion with FCF less than $3 billion in 2017. Beverage Category Headwinds: PepsiCo's challenges include the global concern with health and wellness trends, increased excise taxes on its beverage products in certain markets, evolving consumer shopping habits and the maturity of its categories in developed markets. Several of PepsiCo's developed markets have stagnant or declining per capita carbonated soft drink (CSD) consumption trends and low population growth. Weak CSD volume trends in developed markets place more dependence on increases with price/mix. However, exposure to CSDs continues to decline at less than 25% of revenues. Developing and emerging markets have experienced even more volatility and pressure in the past, with growth and local cost inflation. Even so, growth in these markets has improved driven by Mexico and Russia. DERIVATION SUMMARY PepsiCo's significant scale, geographic reach, distribution, product diversification including strong margins in its Frito-Lay North America segment, and brand strength as the world's second-largest food and beverage company strongly positions the company relative to its peers. Consequently, PepsiCo's ability to execute on innovation and price/mix strategies has leveraged consumer trends in the snack food segment, resulting in greater U.S. retail growth than other larger competitors. With less than 25% of its beverage portfolio carbonated soft drinks, PepsiCo has much less exposure than The Coca-Cola Company (A+/Negative Outlook) where it is in excess of 70% of its beverage portfolio. PepsiCo has a weaker presence in higher-growth developing/emerging markets than Coca-Cola, with lower brand equity, resulting in less pricing power across its international footprint. Consequently, PepsiCo's consolidated operating margins are also much lower, due to its lower-margin beverage segment in the mid-teens, when compared to Coca-Cola in the mid 20% area. However, PepsiCo's Frito-Lay NA segment generates industry-leading operating margins at approximately 30% versus Mondelez' (BBB/Stable) NA segment at approximately 20% and Kellogg's (BBB/Stable) U.S. Snacks segment at approximately 12%. PepsiCo's financial policies have been aggressive during the past several years with increased shareholder returns, similar to Coca-Cola, which has resulted in higher domestic borrowing given the reluctance to repatriate foreign earnings. Given the increases in leverage for both companies, Fitch expects moderating shareholder returns with PepsiCo's long-term supplemental net leverage in the mid-2x range compared with Coca-Cola's long-term supplemental net leverage that is expected to decline to less than 2x. Fitch does expect PepsiCo will return a higher level of cash to shareholders than Coca-Cola during the medium term, particular in the event of tax reform. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for 2017 and 2018 for PepsiCo include: --Underlying revenue growth of around 2%; FX impact of approximately 1% in 2017; --Modestly improving margins over the rating horizon as productivity benefits accrue; --$10 billion of CFFO in 2017; increasing to around mid-$10 billion range in 2018. Fitch estimates approximately 45% of CFFO is available for domestic use; --FCF in the $2.5 billion to $2.6 billion range, increasing to approximately $2.8 billion to $2.9 billion in 2018; --Absent cash repatriation, Fitch anticipates foreign cash levels could grow to approximately $19 billion and $23 billion in 2017 and 2018 respectively; --Total debt increases by roughly $3 billion annually to fund domestic cash requirements; --Capital spending of around $3 billion; --Share repurchases of around $2 billion; --Gross leverage of approximately 3x and net supplemental leverage of approximately 2.5x. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action --A public commitment by PepsiCo to maintain a more conservative financial strategy related to debt levels and cash returned to shareholders; --Supplemental net leverage as calculated by Fitch below 2x and/or gross leverage of 2.5x or less; --Better than expected organic growth and operating metrics. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -A significant increase in debt due to M&A activity and/or share repurchases; --Weaker than expected organic growth and operating metrics; --Supplemental net leverage sustained above mid-2.5x; and/or gross leverage sustained materially above 3.0x. LIQUIDITY Liquidity, Maturities and Guarantees: PepsiCo maintains good liquidity;. cash and short-term investments totaled $18.3 billion at the end of 3Q17, of which $17.5 billion was offshore, compared to $15.2 billion at the end of 2016. PepsiCo has a combined capacity of $7.5 billion under its 364-day and five-year revolving credit facilities maturing in 2018 and 2022, respectively, that remain undrawn. Upcoming maturities of long-term debt include $1.2 billion in 2017 and $2.5 billion in 2018. Commercial paper (CP) balances as of Sept. 9, 2017 were approximately $3.8 billion. During 2Q17, PepsiCo issued $3 billion of USD-denominated senior notes and $750 million of CAD-denominated senior notes, with net proceeds used for general corporate purposes, including the repayment of CP. PepsiCo guarantees all of the senior notes at its bottling subsidiary - Pepsi-Cola Metropolitan Bottling Company (PMBC), which is wholly owned by PepsiCo. While the notes of PMBC are structurally superior to the notes issued by PepsiCo, Inc., Fitch has chosen not to make a distinction in the ratings at the single 'A' level as default risk is very low. FULL LIST OF RATING ACTIONS Fitch currently rates PepsiCo and its subsidiaries as follows: PepsiCo --Long-term Issuer Default Rating (IDR) at 'A'; --Senior unsecured debt at 'A'; --Bank credit facilities at 'A'; --Short-term IDR at 'F1'; --Commercial paper program at 'F1'. Pepsi-Cola Metropolitan Bottling Company, Inc. (Operating Company/Intermediate Holding Co.) --Long-term IDR at 'A'; --Guaranteed senior notes at 'A'. Contact: Primary Analyst Bill 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 Bonar Senior Director +1-212-908-0579 Date of Relevant Committee: July 20, 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 expense and restructuring as reported in financials. --Supplemental adjusted net leverage ratio is determined by reducing foreign cash balances by applying a generic 35% tax haircut and a further 50% adjustment capturing expectations for additional foreign cash balances that could be used for shareholder-friendly actions to accommodate PepsiCo's relatively aggressive policy for share buybacks. Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. Additional information is available on www.fitchratings.com. 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