Fitch: Kellogg´s Rating Outlook is Negative

Battle Creek / MG. (fr) Fitch Ratings has removed Kellogg Company and its subsidiaries´ ratings from Rating Watch Negative and affirmed the ratings as follows:

  • Kellogg: Long-term Issuer Default Rating (IDR) at BBB+; Senior unsecured debt at BBB+; Bank credit facility at BBB+; Short-term IDR at F2; Commercial paper (CP) at F2.
  • Kellogg Europe Company Limited: Long-term IDR at BBB+; Short-term IDR at F2; CP at F2.
  • Kellogg Holding Company Limited: Long-term IDR at BBB+; Short-term IDR at F2; CP at F2.

The Rating Outlook is Negative

The ratings affirmations resolve the Rating Watch Negative placed on Kellogg´s ratings on February 15, 2012, following Kellogg´s agreement to acquire Procter + Gamble´s Pringles business (Pringles) for approximately 2,7 billion USD. The acquisition is expected to close by mid-2012, pending regulatory approval. Kellogg plans to finance the transaction with new long and short-term debt issuance and a portion of Kellogg´s 404 million USD cash and cash equivalents at March 31, 2012. Pringles will significantly enhance Kellogg´s existing snacks business, which is primarily in North America and provide it with a stronger platform for product and geographic expansion.

The ratings affirmation also incorporates Fitch´s view that operating earnings growth beyond 2012, combined with significant debt reduction from free cash flow, could restore leverage near pre-acquisition levels within two years of the acquisition closing. Kellogg has committed to reduce debt by refraining from share repurchases beyond offsetting the dilution from stock option exercises, in order to focus on debt reduction.

The Negative Outlook reflects that near-term leverage (total debt to operating Ebitda) of slightly more than 3,0 times (x) will be high for the rating level. It also considers that Kellogg´s debt reduction plans may be impeded by current operational challenges, significant reinvestment in its supply chain and Pringles integration. These factors are compounded by persistently high commodity inflation, with seven percent inflation anticipated in 2012, macroeconomic uncertainty and some consumer resistance to recent food price increases.

A one notch downgrade could occur if Kellogg´s operating performance, which factors in the company´s recently lowered guidance, substantially deteriorates from current expectations or if debt reduction is slower than anticipated, resulting in leverage that is likely to be at or near 3,0 times in mid-2014. A downgrade could also occur if Kellogg becomes more aggressive with share repurchases or acquisitions. Conversely, Fitch could revise the Outlook to Stable if Kellogg´s operating earnings trends show sustainable improvement or if debt reduction occurs at a faster rate than anticipated so that leverage appears likely to be sustainable in the mid-two-times range by mid-2014.

Kellogg´s ratings incorporate its #1 and #2 market share positions, strong brand equities and ample liquidity. The company is diversified geographically, with nearly 40 percent of 2011 sales generated outside of the United States. However, Kellogg has significant exposure to slow-growing, mature markets and modest exposure to faster growing emerging markets. Although Pringles will provide Kellogg with a vehicle to expand Kellogg´s snacks business to emerging markets, Pringles also generates approximately 70 percent of its sales in mature markets in Western Europe and North America, where Kellogg´s is incurring operating earnings declines.

Kellogg recently revised its top line and earnings expectations downward for 2012, reflecting weakness in its core ready-to-eat cereal business in Europe and the U.S., primarily due to recently implemented price increases that are receiving a tepid response from consumers. Kellogg currently anticipates internal operating earnings (excluding currency and acquisitions/divestitures) to fall two percent to four percent in 2012, after a three percent decline in 2011 and flat results in 2010. Kellogg´s guidance also incorporates approximately 100 million USD permanently higher level of investment in its supply chain after it had cut back too far in previous years.

Pringles generated sales and Ebitda of 1,5 billion USD and 243 million USD, respectively, in 2011 across 140 countries. Fitch estimates that Pringles will add about six months of sales to Kellogg but little if any operating earnings in 2012 due to one-time costs to achieve synergies and Kellogg´s planned investment in this business for future growth. Kellogg estimates it will spend approximately 160 million USD to 180 million USD one-time costs to achieve annual synergies of 50 million USD to 75 million USD by 2014. Fitch believes these goals are achievable and that most of the costs will be incurred in 2012 and 2013.

The company´s ample free cash flow (FCF, cash flow from operations less capital expenditures and dividends) has averaged almost 400 million USD annually during the past five years. Excluding pension and post-retirement contributions, which have been substantial, FCF has averaged almost 700 million USD annually for the same period. Fitch anticipates that Kellogg can return to this level of FCF in 2014 or 2015, but in the near-to intermediate term heightened capital expenditures, earnings pressure, reinvestment in Pringles and cash costs to achieve synergies will reduce cash flow significantly.

Kellogg´s sizeable liquidity includes two billion USD available on its un-utilized revolving bank facility expiring in March 2015 and 404 million USD of cash and cash equivalents. Kellogg plans to utilize a substantial amount of its cash for the Pringles acquisition. On March 16, 2012, Kellogg also entered into an unsecured 364-day term loan agreement which will allow the company to borrow up to one billion USD to partially fund the acquisition and to pay related fees and expenses. Kellogg´s total debt at March 31, 2012 was 5,8 billion USD. Pro forma for the transaction Kellogg´s debt will be approximately eight billion USD.

Kellogg´s upcoming debt maturities include 750 million USD 5,125 percent notes due December 03, 2012 and 750 million USD 4,25 percent notes due March 06, 2013. Debt reduction over the next two years could include a portion of these maturities and debt that will be issued for the Pringles deal.