Fitch Affirms Kellogg's IDRs at 'BBB+/F2'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed the following ratings for Kellogg Company (Kellogg) and its subsidiaries:

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'. Kellogg Canada, Inc.

--Long-term IDR at 'BBB+';

--Senior unsecured debt at 'BBB+'.

The Rating Outlook is Stable.

KEY RATING DRIVERS:

Strong Brands, but Predominantly in Developed Markets: Kellogg's ratings incorporate its leading market shares, strong brand equities in breakfast foods and snacks, as well as ample liquidity. The company has good geographic diversification, with nearly 40% of its sales generated outside the United States. However, with 85% of the company's sales in North America and Europe, Kellogg's growth has been hampered by significant exposure to slow growing mature markets and modest exposure to faster growing emerging markets. U.S. Morning Foods and U.S. Snacks were particularly weak in 2013, generating low single digit top line declines. Improving these businesses, including Kellogg master brand category building programs, is a key near-term priority.

Pringles Integration Largely Complete: The company's primarily debt financed $2.7 billion Pringles potato crisps and sticks acquisition in May 2012 provided it with a stronger snacks platform for product and geographic expansion, but brought lower margins. Leverage (total debt to EBITDA) is down from its peak over 3.0x; the integration has gone smoothly and is on track and largely complete. Pringles provided high single digit internal net sales growth in 2013, but Fitch believes longer-term growth from Pringles may not be enough to prevent the need for additional growth acquisitions.

Project K's Substantial Cost: In November 2013, Kellogg announced Project K, a global four-year efficiency and effectiveness program, to improve its long term growth prospects and cost structure. Kellogg expects total pretax program charges of $1.2 billion to $1.4 billion plus about $300 million incremental capital expenditures. The company estimates total cash costs for the program at $1.2 billion to $1.4 billion. The project's substantial cash cost will negatively impact FCF as discussed below. Kellogg has estimated Project K pretax savings of $425 million to $475 million annually by 2018, with more than half of the cost savings coming from the supply chain. Kellogg expects Project K costs of $300 million to $350 million in 2014, along with modest cost savings of $50 million to $60 million which the company intends to invest back in the business.

FCF Constrained in Near Term: Kellogg generated significant FCF (cash flow from operations less capital expenditures and dividends), which averaged approximately $500 million annually during the past three years. The company provided cash flow guidance for cash flow from operations less capital expenditures of $1 billion to $1.1 billion in 2014. Fitch estimates that this will translate into approximately $400 million of FCF including Project K cash cost and heightened capital expenditures at 4% to 5% of sales. FCF will also be constrained by these factors in 2015.

Leverage to Remain Approximately Flat: Given lower than historical FCF related to Project K's cash cost, Kellogg will need to borrow for a portion of its planned share repurchases. The company expects debt to increase $200 million to $300 million through 2015, factoring in the positive working capital impact from a new accounts payable initiative. However, Fitch expects EBITDA improvement, which should allow leverage (total debt to EBITDA) to remain approximately flat at 2.7x achieved in 2013. This places leverage at the higher end of the mid 2x level previously anticipated and does not allow room in the rating for leveraging transactions or significant operating underperformance beyond current guidance. For 2013, FFO adjusted leverage was 4.1x and operating EBITDA to gross interest expense was 11.5x. Both of these measures showed modest improvement from 2012.

Sizeable Liquidity and Manageable Maturities: Kellogg's $2.3 billion liquidity included its undrawn $2 billion revolving bank facility plus $273 million cash and equivalents at Dec. 28, 2013. In February 2014 Kellogg entered into a new $2 billion revolver expiring in February 2019, which replaced the previous facility. The company had $686 million of CP at Dec. 28, 2013. Kellogg is likely to refinance upcoming debt maturities, which include CAD$300 million notes issued by Kellogg Canada Inc. (under a full parent guarantee) due in May 2014, $600 million notes due in 2015, and $1.3 billion notes due in 2016. In March 2014, Kellogg completed a cash tender for $680.7 million of its notes due in 2020 through 2023 funded with CP.

RATING SENSITIVITIES: Future developments that may, individually or collectively, lead to a positive rating action include:

--A positive rating action is not anticipated in the near to intermediate term. However, it could occur with a commitment to maintain leverage in the low 2.0x range or lower, strong free cash flow, operating margin improvement and top line growth due to successful expansion into emerging markets.

Future developments that may, individually or collectively, lead to a negative rating action include:

--A negative rating action could occur if Kellogg's operating performance does not support cash outflows from Project K and share repurchases, resulting in leverage that is likely to be sustained at or above the 3.0x range.

--Material debt financed acquisitions or other leveraging transactions, continued or accelerating negative volume trends or inability to achieve targeted Project K cost savings would also support a negative rating action.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (August 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=827329

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Contacts

Fitch Ratings, Inc.
Primary Analyst
Judi M. Rossetti, CPA/CFA
Senior Director
+1-312-368-2077
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Grace Barnett
Director
+1-212-908-0718
or
Committee Chairperson
Wesley E. Moultrie II, CPA
Managing Director
+1-312-368-3186
or
Media Relations:
Brian Bertsch, New York, +1 212-908-0549
brian.bertsch@fitchratings.com

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Contacts

Fitch Ratings, Inc.
Primary Analyst
Judi M. Rossetti, CPA/CFA
Senior Director
+1-312-368-2077
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Grace Barnett
Director
+1-212-908-0718
or
Committee Chairperson
Wesley E. Moultrie II, CPA
Managing Director
+1-312-368-3186
or
Media Relations:
Brian Bertsch, New York, +1 212-908-0549
brian.bertsch@fitchratings.com