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Fitch Rates PepsiCo's $3B Notes Issuance 'A'; Outlook Stable
April 28, 2017 / 6:19 PM / 7 months ago

Fitch Rates PepsiCo's $3B Notes Issuance 'A'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, April 28 (Fitch) Fitch Ratings has assigned an 'A' rating to PepsiCo, Inc.'s (PepsiCo) $3 billion multi-tranche offering. The Rating Outlook is Stable. Proceeds will be used for general corporate purposes including the repayment of commercial paper. PepsiCo had approximately $4.5 billion of commercial paper at the end of the first quarter 2017. 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 increased leverage driven by past domestic borrowing for shareholder initiatives combined with foreign exchange headwinds. Consequently, debt has increased to approximately $39 billion at the end of first quarter 2017 compared to $29 billion at the end of 2014. Fitch expects supplemental net leverage to remain within the mid 2x range going forward, which Fitch views as acceptable for the current ratings. Brand Strength and Scale Supports 3%-4% Organic Growth More than half of PepsiCo's annual $63 billion in net revenue is derived from snacks with roughly 60% of PepsiCo's 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 and 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, U.S. diet carbonated soft drink (CSD) volume declines and the maturity of its categories in developed markets. Several of PepsiCo's developed markets have stagnant or declining per capita CSD consumption trends and low population growth although PepsiCo's exposure to CSDs continue to decline at less than 25% of revenues. Weak volume trends in developed markets places more dependence on increases with price/mix. Developing and emerging markets have experienced more volatility and pressure in the past with growth and local cost inflation. However, growth in these markets improved during the first quarter of 2017 to the mid-single digits driven by Mexico and Russia although certain pockets remain weak including Brazil and Argentina. Operationally, PepsiCo is focused on increased 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 (high-single digits of sales) should enable core revenue growth of at least 3% to 4% over the next couple of years. 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. Consequently, PepsiCo generated core revenue growth of approximately 3.7% in 2016 and approximately 2.1% during the first quarter of 2017 that was affected by a few headwinds including timing of the New Year holiday and the delay in U.S income tax refunds. Productivity Underpins Stable Cash Generation PepsiCo's five-year $5 billion productivity cost savings program to be completed by 2019, if fully achieved, provides 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 due to 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 $3.6 billion respectively for the past four years. Fitch expects PepsiCo's CFFO will be in a similar range for 2017 with FCF less than $3 billion. Overseas Cash Continues 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. Absent material M&A, Fitch anticipates foreign cash levels could grow to approximately $19 billion by 2017. With potential tax reform on the horizon, multi-nationals including PepsiCo would be reluctant to pursue material repatriation until after a new tax plan is implemented. Fitch discounts PepsiCo's 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 when determining supplemental net leverage. Supplemental Net Leverage Expected To Be Mid-2x Fitch expects long-term gross debt leverage in 2017 of approximately 3.0x. Leverage at the end of the first quarter of 2017 was 3.0x which compares to the low 2x range in 2010. For 2017, while PepsiCo has reduced expected shareholder returns to approximately $6.5 billion from $9 billion in 2015, Fitch anticipates PepsiCo will still need to increase debt by approximately $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 $1.7 billion during the first quarter of 2017. For U.S. issuers with significant foreign cash balances, Fitch uses a supplemental net leverage ratio as part of our analysis. PepsiCo's supplemental net leverage was 2.6x at the end of the first quarter 2017. Supplemental net leverage is expected to be approximately 2.5x for 2017 compared to approximately 2.4x at the end of 2016. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for 2017 and 2018 for PepsiCo include: --Underlying revenue growth in the 3 to 4% range; --Modestly improving margins over the time period as commodity inflation moderates and productivity benefits accrue; --$10.3 billion of cash flow from operations (CFFO) in 2017; increasing to the mid-to-upper $10 billion range in 2018. Fitch estimates approximately 45% of CFFO is available for domestic use; --Free cash flow (FCF) slightly less than $3 billion in 2017 approaching the mid $3 billion range in 2018; --Absent cash repatriation, Fitch anticipates foreign cash levels could grow to approximately $19 billion and $23 billion in 2017 and 2018 respectively; --Total debt increases by roughly $3 billion annually to fund domestic cash requirements; --Capital spending in the $3 billion range; --Share repurchases in the $2 billion range; --Gross leverage of approximately 3x and net supplemental leverage of approximately 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 causes supplemental adjusted net leverage sustained above the mid 2.5x range; --Gross leverage sustained in excess of 3.0x; 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 focus on returning cash to shareholders. LIQUIDITY Liquidity, Maturities and Guarantees: PepsiCo maintains good liquidity with cash and short-term investments that totalled $16 billion at the end of the first quarter 2017, of which $15.5 billion was offshore. 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 are material and include $3.7 billion in 2017 and $2.5 billion in 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 currently 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'. The Rating Outlook is Stable. Contact: Primary Analyst Bill Densmore Senior Director +1-312-368-3125 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst Carla Norfleet Taylor, CFA Senior Director +1-312-368-3195 Committee Chairperson David Peterson Senior Director +1-312-368-3177 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. 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