Fitch Rates Kellogg Company's $1.4B Senior Unsecured Notes 'BBB'; Outlook Stable

NEW YORK--()--Fitch Ratings has assigned a rating of 'BBB' to Kellogg Company's (Kellogg) $750 million due 2026 and $650 million due 2046. Proceeds from the notes will be used to tender $440 million of the $1.1 billion senior unsecured notes due in 2031 and to term out the outstanding $899 million U.S. commercial paper balance. A full list of ratings follows at the end of this release.

KEY RATING DRIVERS

The ratings reflect Fitch's expectations that core volume driven growth will be modestly positive at best through the medium term. Volumes have been negative in the -0.5% to -2.6% range on a consolidated basis in four of the past five years. Further, U.S. Morning Foods (mainly ready to eat cereal) and U.S. Snacks, which represent $6 billion in revenues and roughly 45% of the portfolio, have had negative organic growth over the past several years. Positive growth in some categories such as the high single digit levels for the Pringles brand with nearly $2 billion in revenues have been offset by negative organic growth trends in other brands.

The company should have some modest price driven growth going forward similar to historic performance over the last five years but there is uncertainty regarding if volume growth will be a long term driver of top line improvement. Revenues have been hampered by significant exposure to slow growing mature markets and this has been further challenged by recessions in key emerging markets. U.S Morning Foods, which is mainly cereal, and more than 20% of the company's portfolio had 10 quarters of negative organic growth before the +1.5% recorded in the fourth quarter of 2015.

Trends appear to be improving for the cereal category and for Kellogg. Per AC Nielsen, the cereal category was down -1.2% during 2015 but just -.1% in the last 12 weeks. More importantly, Kellogg took share in the category with just a -.5% decline and saw a 2.2% positive increase in consumer take-away in the last 12 weeks. Nonetheless, there is not enough track record to be confident these trends will be sustained.

Fitch expects leverage to remain in the low 3x range over the next two years, above the 2.75x average seen from 2011 through 2014. Fitch expects EBITDA to be roughly flat in the $2.5 billion to $2.6 billion range over the next two years, with near-term pressure on EBITDA due to negative currency translation in 2016. Debt is expected to remain essentially flat and Kellogg will continue to allocate $1.4 billion towards share repurchases and dividends annually.

Substantial Restructuring Costs: 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. Most of the savings are expected to be reinvested back into business for brand support.

The restructuring costs are expected to be in the range of $1.2 billion to $1.4 billion and will require about $300 million in incremental capital expenditures. Estimated cash costs are about $1 billion. The project's substantial cash cost to date, which is about halfway through, has been largely offset by working capital improvements. However, free cash flow (FCF) has declined from $603 million in 2013 to $438 million in 2015 due to the decline in EBITDA.

Fitch estimates that FCF will be modestly negative in the $120 million range in 2016, assuming $0.5 billion in remaining cash costs related to the restructuring program. However, annual FCF should improve meaningfully to the $450 million range as Project K cash costs subside in 2017.

KEY ASSUMPTIONS

--Revenues decline nearly 4% in 2016 impacted by negative F/X translation with organic growth expected to be in the 1%-2% range driven primarily by pricing. This is at the low end of management's public guidance of 1% to 3% organic growth for 2016 much of which will be driven by pricing to recover currencies particularly in Latin America. Thereafter, the top line should reflect 1.5% to 2% organic top line growth (with flat to modestly negative volume contribution) assuming neutral currency impact.

--Adjusted EBITDA margins improve modestly by 100 basis points (bps) to about 19.5% by 2017 as a small portion of Project K savings drops to the bottom line.

--FCF is negative in the $120 million range in 2016 but improves to more than $450 million thereafter with FCF margins reverting to the historical 3.5% range.

--Leverage (gross debt to EBITDA) remains in the low 3x range in 2016 and 2017.

RATING SENSITIVITIES

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

--A negative rating action could occur if Kellogg's organic growth rate is 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 sustained above 3.5x either as a result of poor performance or material debt financed share buybacks or acquisitions.

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. Additionally, Kellogg would have to maintain leverage in the mid to high 2x range.

LIQUIDITY

Kellogg's $2.4 billion liquidity included its undrawn $2 billion revolving bank facility plus $596 million cash and equivalents at Jan. 2, 2016. While there is pressure on FCF in 2016, Fitch expects this measure to improve substantially beginning 2017.

FULL LIST OF RATING ACTIONS

Fitch currently rates Kellogg as follows:

Kellogg

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

--Senior unsecured debt 'BBB';

--Bank credit facility 'BBB';

--Short-term IDR 'F2';

--Commercial paper (CP) 'F2'.

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.

Date of Relevant Committee: Feb. 18, 2016

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

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

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Contacts

Fitch Ratings
Primary Analyst
Grace Barnett
Director
+1-212-908-0718
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Monica Aggarwal, CFA
Managing Director
+1-212-908-0282
or
Committee Chairperson
David Silverman, CFA
Senior Director
+1-212-908-0840
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Grace Barnett
Director
+1-212-908-0718
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Monica Aggarwal, CFA
Managing Director
+1-212-908-0282
or
Committee Chairperson
David Silverman, CFA
Senior Director
+1-212-908-0840
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com