CHICAGO--(BUSINESS WIRE)--Fitch Ratings has assigned an 'A' rating to PepsiCo, Inc.'s (PepsiCo) $4.5 billion multi-tranche offering. The Rating Outlook is Stable. Proceeds will be used for general corporate purposes including the potential redemption of all or a portion of the 7.90% $1.5 billion senior notes due Nov. 1, 2018 issued by PepsiCo and the 5.125% $750 million senior notes due Jan. 15, 2019 issued by Bottling Group, LLC in accordance with the make-whole redemption provisions. PepsiCo had approximately $35.6 billion of total debt including $2.9 billion of commercial paper (CP) as of third quarter 2016 (ending Sept. 3, 2016).
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 of 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
PepsiCo's ratings reflect its considerable financial flexibility, substantial cash flow, significant scale, geographic reach, 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. Rating concerns include the increased leverage which has been driven by past debt funding for shareholder initiatives combined with foreign exchange headwinds. However, Fitch expects net supplemental leverage to remain within the mid-2.5x range going forward, which Fitch views as acceptable for current ratings.
Brand Strength and Scale Supports 3%-4% Organic Growth
More than half of PepsiCo's annual $62 billion in net revenue is derived from snacks with roughly 60% of revenue generated in the United States. PepsiCo's brand strength is demonstrated by its portfolio which consists 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 respective categories.
PepsiCo's challenges include global concern with health and wellness trends, increased excise taxes on its products in certain markets and the maturity of its categories in developed markets. In addition, negative sentiment toward artificial sweeteners have led to past U.S. diet carbonated soft drink (CSD) volume declines in the upper single digits although these trends have begun to moderate. Several of PepsiCo's developed markets have stagnant or declining per capita CSD consumption trends, weak economies and/or low population growth. Weak volume trends in developed markets places more dependence on emerging markets which have experienced volatility with growth and local cost inflation. 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 which enabled PepsiCo to generate core revenue growth of approximately 5% in 2015 and approximately 4% during the first three quarters of 2016.
PepsiCo maintains a good breadth of products across its beverage segment with strong positions in its non-carbonated soft drinks and optimization of price-pack architecture on both smaller pack size and premium/alternative packaging to drive a higher price per unit. Fitch expects PepsiCo will maintain rationality and discipline on price in order to balance declines within its CSD portfolio. CSDs have become a smaller portion of PepsiCo's overall revenues during the past several years, comprising less than 25% in 2015.
Operationally, PepsiCo is focused on increasing brand support to grow value share, expand its emerging market presence, grow its nutrition business, reduce overhead, and leverage technology and processes across its organization. Thus Fitch believes PepsiCo's diversified portfolio with strong brands and good innovation pipeline (approximately 9% of sales) should enable core revenue growth of at least 3% to 4% over the next couple of years supported by volume growth in the 2% range and price/mix growth in the approximate 2% range.
Productivity Underpins Stable Cash Generation
PepsiCo's five-year $5 billion productivity cost savings program to be completed by 2019, if fully achieved, should provide the company with significant financial flexibility to either reinvest into the business and/or increase cash generation. PepsiCo is using a portion of these savings to bolster brand strength by increasing media, innovation and R&D spending combined with cost reductions that should 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 effects of foreign exchange translation from the strong dollar that has negatively affected EBITDA, benefits of past productivity efforts and working capital gains have resulted in stable cash generation. Cash flow from operations (CFFO) and free cash flow (FCF) have averaged $10.3 billion and $3.7 billion, respectively, for the past three years. Fitch expects PepsiCo's CFFO and FCF will be within a similar range for 2016.
Overseas Cash Expected to Grow
PepsiCo generates substantial overseas cash flow due to its international operations. PepsiCo, like other multi-national 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.
In 2014, PepsiCo pursued a return-on-basis distribution which had negligible tax consequences and remitted $6 billion of international cash to the U.S. to repay CP. Absent a further return-on-basis distribution or a commitment to repatriate cash, Fitch anticipates foreign cash levels could grow to the range of $18 billion to $19 billion by 2017 compared to $11.1 billion at the end of 2015.
Supplemental Net Leverage Expected to Be Mid-2x
Fitch expects long-term gross debt leverage in 2016 could increase to approximately 2.8x. Leverage at the end of 3Q16 was 2.7x, which compares to the low-2x range in 2010. The rise in leverage is due to the increase in debt balances to fund domestic cash requirements resulting from increased shareholder returns and translational effects from foreign exchange headwinds.
For 2016, while PepsiCo has reduced expected shareholder returns to approximately $7 billion from $9 billion in 2015, Fitch believes PepsiCo could increase debt by at least $3 billion to fund their domestic cash requirements. This is based on Fitch's estimate that approximately 45% of CFFO is available for domestic use, and does not consider any foreign cash that could be used for domestic funding requirements. Debt increased $2.3 billion during the first three quarters of 2016.
For U.S. issuers with significant foreign cash balances, Fitch uses a supplemental adjusted net leverage ratio as part of our analysis. PepsiCo's supplemental adjusted EBITDA net leverage is expected to increase to approximately 2.4x for 2016 compared to approximately 2.3x at the end of 2015 (this figure was 2.4x at the end of 3Q16).
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for 2016 for PepsiCo include:
-- Underlying revenue growth (excluding the additional week and structural changes) of approximately 3.6% with volume growth in the 2% range and price/mix growth in the 1.5% range offset by foreign currency pressure of 3.5% in 2016. In 2017, underlying revenue growth of 3.8%;
-- $10.4 billion of CFFO with free cash flow (FCF) in excess of $3 billion in 2016. Fitch estimates approximately 45% of CFFO is available for domestic use. In 2017, Fitch expects CFFO and FCF to rise modestly;
-- Absent a further return-on-basis distribution or a commitment to repatriate cash, Fitch anticipates foreign cash levels could grow to the range of $18 billion to $19 billion by 2017;
-- Total debt increases by at least $3 billion to fund share repurchases in 2016/2017. This does not consider any foreign cash being used for domestic funding requirements;
-- Capital spending in the $3 billion range in 2016/2017;
-- Gross leverage of 2.8x and net supplemental leverage of approximately 2.4x. In 2017, gross leverage of approximately 2.9x-3.0x and net supplemental leverage of approximately 2.4x-2.5x.
RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to a negative action include:
--A significant increase in debt due to M&A activity and/or share repurchases combined with deteriorating operating performance that leads to supplemental adjusted net leverage sustained above the mid-2.5x range;
--Gross leverage sustained in excess of 3.0x;
--Over-reliance on CP to fund domestic cash flow deficits that causes long-term CP balances to rise materially.
-- Future developments that may, individually or collectively, lead to a positive rating action include:
--A public commitment by Pepsi to maintain gross leverage in the 2.5x range or less and supplemental adjusted net leverage as calculated by Fitch below 2x, while maintaining strong organic growth and operating metrics. Fitch does not view this as likely given the increased focus on returning cash to shareholders.
LIQUIDITY
Liquidity, Maturities and Guarantees: PepsiCo maintains good liquidity. PepsiCo's cash and short-term investments totalled $14.8 billion at the end of 3Q16, of which $14.0 billion was offshore. This compares to $11.1 billion at the end of 2015. PepsiCo has a combined capacity of $7.445 billion under its 364-day and five-year revolving credit facilities maturing in 2017 and 2021, respectively, that remain undrawn. Upcoming maturities of long-term debt include approximately $4 billion each in 2017 and 2018.
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.
FULL LIST OF RATING ACTIONS
Fitch rates PepsiCo and its subsidiaries as follows:
PepsiCo
--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'.
The Rating Outlook is Stable.
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.
Date of Relevant Committee: April 21, 2016.
Additional information is available on www.fitchratings.com
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage - Effective from 17 August 2015 to 27 September 2016 (pub. 17 Aug 2015)
https://www.fitchratings.com/site/re/869362
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