Fitch Affirms PepsiCo's IDRs at 'A/F1'; Outlook Stable
The Rating Outlook is Stable. PepsiCo had approximately \\$35.1 billion of debt at Mar. 19, 2016.
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
Approximately 53% of PepsiCo's \\$63 billion in net revenue is derived from snacks, and approximately 56% of PepsiCo's revenue is generated in the United States with 69% of revenue within developed markets. 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 and the maturity of its categories in developed markets. Additionally 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 that enabled PepsiCo to generate core revenue growth of approximately 5% in 2015.
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 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 should enable core revenue growth of at least 3% to 4% over the next couple of years supported by volume growth in the 1% range and price/mix growth in the 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 organic revenue growth and high-single digit core constant-currency EPS growth as reasonable.
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 \\$3.7 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 United States 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. This compares to 2.6x at the end of 2015 and the low 2x range since 2010. The rise in leverage is due the increase in debt balances to fund domestic cash requirements 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.
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. Fitch also anticipates PepsiCo's long-term commercial paper (CP) balances could rise materially to support the higher debt borrowings given the reluctance to repatriate foreign cash. CP balances as of March 19, 2016 were approximately \\$1.2 billion.
KEY ASSUMPTIONS
Fitch's key assumptions within Fitch's rating case for 2016 for PepsiCo include:
--Underlying revenue growth (excluding the additional week)of approximately 3.6% with volume growth in the 1% range and price/mix growth in the 2% range offset by foreign currency pressure of 4.5% in 2016. In 2017, underlying revenue growth of 3.8%;
--\\$10.4 billion of cash flow from operations (CFFO) with free cash flow (FCF) in excess of \\$3 billion in 2016. Fitch estimates that 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.
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.
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;
--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 \\$12.1 billion at the end of the first quarter 2016, of which \\$11.3 billion was offshore. This compares to \\$7.4 billion at the end of 2014. During the third quarter 2015, PepsiCo deconsolidated the wholly-owned Venezuelan subsidiary due to the increasingly restrictive exchange control regulations and substantially reduced access to dollars through the official currency exchange markets that negatively affected the ability for the Venezuelan business to pay dividends. Consequently, PepsiCo recognized a \\$568 million reduction in cash due to the Venezuelan deconsolidation.
PepsiCo has a combined capacity of \\$7.445 billion under its 364-day and five-year revolving credit facilities maturing in 2016 and 2020 respectively that remain undrawn. Upcoming maturities of long-term debt include \\$1.8 billion remaining in 2016 and \\$4.4 billion in 2017. CP balances as of March 19, 2016 were approximately \\$1.2 billion.
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 affirms the ratings for PepsiCo and its subsidiaries as follows:
PepsiCo
--Long-term Issuer Default Rating (IDR) at 'A';
--Senior unsecured debt at 'A';
--Bank credit facilities at 'A';
--Short-term IDR at 'F1';
--Commercial paper program at 'F1'.
Pepsi-Cola Metropolitan Bottling Company, Inc. (Operating Company/Intermediate Holding Co.)
--Long-term IDR at 'A';
--Guaranteed senior notes at 'A'.
Bottling Group, LLC (Operating Company)
--Long-term IDR at 'A';
--Guaranteed senior notes at 'A'.
The Rating Outlook is Stable.
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