Fitch Rates PepsiCo's $500MM Sr. Note Issuance 'A'; Outlook Stable

CHICAGO--()--Fitch Ratings has assigned an 'A' rating to PepsiCo, Inc.'s (PepsiCo) newly issued $500 million 30-year senior note offering. Fitch also assigns an 'A' rating to PepsiCo's $3.7725 billion five-year credit agreement maturing in June 2019 and an 'A' rating to PepsiCo's $3.7725 billion 364-day revolving credit agreement. PepsiCo will use the net proceeds for general corporate purposes. The Rating Outlook is Stable. PepsiCo had approximately $32.7 billion of debt at the end of the third quarter 2014 (3Q'14).

The notes will be issued by PepsiCo, Inc. and will rank equally with PepsiCo's senior unsecured obligations. Significant covenants include limitations on secured debt and conditions related to consolidation, mergers or the sale of assets. PepsiCo is not bound by any financial covenants. The notes are callable by PepsiCo subject to a make-whole provision.

KEY RATING DRIVERS

PepsiCo's ratings reflect its considerable financial flexibility, substantial cash flow, significant scale, product diversification, increasing exposure to faster growing emerging markets, and position as the world's second largest food and beverage company. Of PepsiCo's $66.9 billion of net revenue during the last 12 months (LTM) approximately half of its revenues are generated outside of the United States with emerging or developing markets representing a little over one-third of the total revenues.

PepsiCo's brand strength is demonstrated by its wide-ranging and diverse portfolio which includes 22 brands; including Pepsi, Gatorade, Lay's, Doritos, and Quaker, with more than $1 billion in annual retail sales that are typically No. 1 or No. 2 in their respective categories. PepsiCo's financial profile is supported by the strong cash generation derived from its brand strength. Annual cash flow from operations (CFO) and free cash flow (FCF) have averaged $8.9 billion and $2.6 billion, respectively, for the past four years.

Fitch expects PepsiCo to generate in the range of $10 billion in CFO and at least $3 billion in FCF for 2014 driven by its cost savings initiatives. PepsiCo's LTM CFO was $9.7 billion as of Sept. 6, 2014. PepsiCo's primary goals are investing in its business, returning cash to shareholders, and maintaining credit ratings that provide ready access to global capital and credit markets including tier 1 commercial paper.

PepsiCo's financial strategy, historically viewed as aggressive, is also factored into its ratings. The company has experienced pressure from an activist investor, and has indicated plans to increase shareholder-friendly initiatives for 2014 by more than $2 billion or approximately 35%. PepsiCo increased share repurchase expectations to $5 billion for 2014 from $3 billion in 2013. Share buybacks had averaged $2.3 billion per year, net of stock options and tax benefit, since 2010. During the first three quarters of 2014, PepsiCo repurchased $2.6 billion shares of common stock net of stock options and tax benefit.

During 2014, PepsiCo increased the dividend per share by 15% to $2.62 per share for an approximate annual dividend of $3.7 billion. The company's dividend per share has typically grown annually by 6% or more over the past several years, with a total dividend of $3.4 billion for 2013. Consequently, Fitch views these plans negatively from a credit perspective as PepsiCo will further leverage its balance sheet to fund increased shareholder return, leaving modest ratings headroom. However, PepsiCo's current anticipated leverage for 2014 is still within Fitch's rating expectations albeit at the high end.

PepsiCo's challenges include global concerns with health and wellness trends, increased excise taxes on its products in certain markets, mature developed markets, and continued negative sentiment toward artificial sweeteners that has resulted in U.S. diet carbonated soft drinks (CSD) volume declines in the upper single digits. Several of PepsiCo's developed markets are more mature with stagnant or declining per capita consumption trends, weak economies and/or low population growth. This places more dependence on growth in emerging markets and on new product innovation, thus likely increasing the firm's longer-term operating risk.

Notably, PepsiCo maintains a good breadth of products across its beverage segment with strong positions in its non-carbonated soft drinks to balance the declines within its CSD portfolio. However, PepsiCo and the rest of the industry must develop new beverage products that are healthier, natural-sweetener-based with lower calorie options to successfully evolve their portfolios. Fitch anticipates that innovation will not fully ameliorate the continued CSD declines in some developed markets due to changing habits, which are driving some consumers to leave the carbonated soft drink category for healthier options.

Operationally, PepsiCo is focused on increasing brand support to grow market share, expanding its emerging market presence, growing its nutrition business, reducing overhead, and leveraging technology and processes across its organization. PepsiCo has made noticeable progress on this strategy; therefore, Fitch believes PepsiCo's strategic initiatives should help the company improve trends. Furthermore, PepsiCo announced an incremental five-year $5 billion productivity cost savings program that, if achieved, should allow the company significant financial flexibility to reinvest in the business.

Credit Statistics

For 2Q'14, total debt-to-operating EBITDA was 2.5x, operating EBITDA-to-gross interest expense was 14.6, and funds from operations (FFO) adjusted leverage was 3.5x. PepsiCo's leverage is modestly higher than similarly rated food and beverage companies but ratings are supported by, as mentioned previously, the company's substantial and stable FCF, significant scale, diversification, and brand leadership. Fitch believes downside ratings risk is present if PepsiCo further increases debt to fund higher shareholder returns.

Fitch's ratings reflect expectations that total debt-to-operating EBITDA leverage will rise to the 2.4x to 2.5x range for 2014, which further reduces flexibility at its current rating. PepsiCo's cash flow growth should benefit from its strategic initiatives around brand support and productivity as savings are realized. PepsiCo's 2014 operating cash flow will not be materially affected by pension and retirement medical plan contributions. PepsiCo's U.S. pension is well-funded at approximately 97% as the company expects to make global contributions of approximately $190 million in 2014 compared to payments of almost $1.5 billion in 2012.

Liquidity, Covenants, and Maturities:

PepsiCo maintains good liquidity. At the end of 3Q'14, the firm had $12.9 billion of cash and short-term investments, with $12 billion of it offshore. This compares to $6.6 billion of cash with $5.3 billion offshore in 2012. PepsiCo has combined capacity of $7.545 billion under its 364-day and five-year revolving credit facilities. PepsiCo's revolvers expire in June 2015 and June 2019, respectively, and are not bound by financial covenants. Fitch recognizes that repatriation of cash could result in incremental taxes but believes PepsiCo would more likely use the cash to grow in overseas markets. Upcoming maturities of long-term debt are $4.1 billion in 2015 and $3.1 billion in 2016. PepsiCo had issued $5 billion in commercial paper as of Sept. 6, 2014, an increase of approximately $2 billion from the end of 2013.

PepsiCo guarantees all of the senior notes of its bottling subsidiaries - Pepsi-Cola Metropolitan Bottling Company (PMBC) which is wholly owned by PepsiCo and Bottling Group, LLC (wholly owned by PMBC). While the notes of PMBC and Bottling Group, LLC 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.

RATING SENSITIVITIES

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

--Total debt-to-operating EBITDA below 2x and Fitch's belief that PepsiCo would manage its balance sheet to sustain an 'A+' rating. Currently, Fitch does not view this as likely given the increase in cash returned to shareholders.

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

--Significant debt-financed acquisitions and/or deteriorating operating performance that causes total debt-to-operating EBITDA to be sustained above the mid-2.5x level;

--Substantial and sustained declines in cash flow would also likely prompt negative rating actions;

--Financial policy changes including higher level of share repurchases or dividends that would increase financial leverage.

Fitch currently rates PepsiCo as follows:

PepsiCo (Parent)

--Long-term Issuer Default Rating (IDR) 'A';

--Senior unsecured debt 'A';

--Bank credit facilities 'A';

--Short-term IDR 'F1';

--Commercial paper program 'F1'.

Pepsi-Cola Metropolitan Bottling Company, Inc. (Operating Company/Intermediate Holding Co.)

--Long-term IDR 'A';

--Guaranteed senior notes 'A'.

Bottling Group, LLC (Operating Company)

--Long-term IDR 'A';

--Guaranteed senior notes 'A'.

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

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May, 2014).

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=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=903695

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Contacts

Fitch Ratings
Primary Analyst
William Densmore
Senior Director
+1 312-368-3125
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Carla Norfleet Taylor, CFA
Director
+1 312-368-3195
or
Committee Chairperson
Wesley Moultrie II, CPA
Managing Director
+1 312-368-3186
or
Media Relations
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
William Densmore
Senior Director
+1 312-368-3125
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Carla Norfleet Taylor, CFA
Director
+1 312-368-3195
or
Committee Chairperson
Wesley Moultrie II, CPA
Managing Director
+1 312-368-3186
or
Media Relations
Brian Bertsch, +1 212-908-0549
brian.bertsch@fitchratings.com