Fitch Affirms Coca-Cola's IDRs at 'A+/F1'; Outlook Negative
KEY ASSUMPTIONS
Additional key assumptions within the rating case for the issuer include:
--Underlying organic sales growth of approximately 3.5% with volume growth of 1.5% and price/mix growth of almost 2%. Estimated foreign currency headwind of approximately 6%;
--Coca-Cola generates at least \$10 billion of CFFO with approximately 50% of Coca-Cola's CFFO available for domestic use;
--Coca-Cola continues to borrow debt to fund domestic cash requirements in 2015 such that total debt increases to \$46 billion;
--Net share repurchases of \$2 billion for 2015;
--Capital spending of \$2.75 billion for 2015;
KEY RATING DRIVERS
Debt Structure, Elevated Leverage
The Negative Outlook reflects Coca-Cola's elevated gross leverage that was 3.2x on a total debt-to-operating EBITDA basis for 2014, up from 2.8x at the end of 2013. Since 2010, total debt has increased to by approximately \$18 billion to \$41.7 billion at the end of 2014.
Coca-Cola does not generate sufficient domestic cash combined with dividend and royalties from international sources to fund domestic cash requirements for the dividend, U.S. capital investment, share repurchase program and strategic M&A activities. The company has also been reluctant to repatriate foreign earnings given the tax consequences. Consequently, the past growth in total debt including Coca-Cola's large commercial paper balances, is due to domestic borrowing as a large portion of the firm's cash flows are generated off-shore.
Sizeable Off-shore Cash Position
Coca-Cola maintains a sizeable off-shore cash position due to the company's substantial international cash generation. Of the \$21.7 billion in cash, short-term investments and marketable securities, \$19.5 billion was held by foreign subsidiaries.
For U.S. issuers, Fitch currently excludes foreign cash balances from its definition of readily available cash used to calculate net leverage metrics. Fitch recognizes that these cash balances are an asset that may be accessed and used to reduce debt in the event it is necessary.
For certain issuers with significant levels of foreign cash positions like Coca-Cola, supplemental adjusted net leverage ratios are used when gauging the level of tolerance/cushion within the assigned ratings. The foreign cash balances are reduced by applying a generic 35% tax haircut and a further adjustment capturing expectations for additional foreign cash balances that could be used for shareholder-friendly actions. The supplemental adjusted EBITDA net leverage for Coca-Cola at the end of 2014 was 2.3x compared to 2.0x at the end of 2013.
Deleveraging is Key
Fitch currently expects Coca-Cola's supplemental adjusted EBITDA net leverage to further increase to the mid 2x range driven by an estimated \$4 billion increase in borrowing to fund domestic requirements and \$2.2 billion in cash used to close the Monster Beverage Corp. investment. Fitch views the increase in net leverage as concerning since it has been due to Coca-Cola's aggressive financial policies.
Progress by Coca-Cola toward developing and implementing an appropriate longer-term plan during the next 12 months to reduce aggregate debt balances including CP that would lead to an improved financial structure is key. If Fitch believes the company cannot realize improvement within its credit profile that is comparable to Fitch's 2016 expectations, a downgrade is likely.
Strong Global Brands
Coca-Cola ratings are supported by its position as the world's largest global beverage company and the value of the Coca-Cola brand. Coca-Cola has 20 \$1 billion plus brands, including: Coca-Cola, Diet Coke, Sprite, Powerade, Minute Maid, Fanta Orange, Schweppes and Dasani. The strong brands, market position and diversification lend considerable support to Coca-Cola's business profile. Given the prominence of carbonated soft drinks (CSDs) in Coca-Cola's beverage portfolio, the ratings consider the multiyear decline in CSD volumes in the U.S., continued concern over artificial sweeteners affecting diet CSD demand in North America, and modest CSD growth in other developed countries.
However, this risk is mitigated by Coca-Cola's market strength in developing geographies with greater long-term growth characteristics driven by low per capita CSD consumption characteristics and expanding middle class that should provide an important longer-term offset.
Innovation Pivotal
Innovation and M&A will continue to play pivotal roles for nonalcoholic beverage companies including Coca-Cola to evolve their product portfolios beyond CSDs and adapt to changing consumer behavior. CSDs constitute approximately 74% of Coca-Cola's global portfolio. Diet CSD declines in the U.S. are in the mid- to high single-digit range as perceptions toward artificial sweeteners, fueled by social media attacks, remain highly negative. U.S. diet volume trends are also inherently more volatile given the relatively narrow drinker base.
As the shift in consumer attitude has become more centered on health and wellness, companies are targeting new beverages that are fresh, natural, minimally processed, and have a shorter ingredient list with flavorful taste profile. Fitch believes innovation to bring back lapsed consumers to the CSD category given the numerous alternative choices could prove challenging and places a greater importance on having a well-rounded beverage portfolio. Regular CSD retail trends should remain stable in North America in 2015, buoyed by positive price/pack mix, innovation, marketing investments and an improving U.S. economy.
Strong Cash Generation, Liquidity
Coca-Cola's ratings reflect the company's ability to consistently generate considerable cash flow from operations (CFFO) and free cash flow (FCF). For 2014, Coca-Cola generated \$10.6 billion and \$2.9 billion (adjusting for dividend payment) of CFFO and FCF, respectively, after generating \$10.5 billion and \$2.9 billion for the year ended Dec. 31, 2013. For 2015, Fitch expects CFFO of at least \$10 billion, a moderate decrease from 2014 due to foreign exchange headwinds and increased interest expense. Coca-Cola's long-term debt maturing in the next twelve months totals \$2 billion following the February Euro issuance of 8.5 billion.
As of Dec. 31, 2014, Coca-Cola's \$28.0 billion liquidity position consisted of \$18.0 billion of cash and short-term investments, \$3.7 billion of marketable securities, and \$7.7 billion of availability under its committed credit lines and revolving credit facility with rolling maturities through February 2019.
Operating Performance
Coca-Cola has demonstrated relatively good resiliency in the past with underlying top-line and cash flow growth driven by increasing volume, price/mix and improved operating expense leverage. Persistent global macroeconomic pressure, foreign exchange movements, higher taxes, negative perceptions of artificial sweeteners in certain markets and weather related issues at times has made past volume growth and operating performance more challenging.
During 2014, consolidated net operating revenue excluding the negative effects of currency and structural changes grew 3% with concentrate volumes rising 1% and price/mix contributing 1%. Operating income increased 6% excluding the impacts of currency and structural changes. With the macro-environment headwinds, Coca-Cola's operating performance was slightly lower than Fitch's expectations. In 2015, Fitch forecasts organic sales growth of approximately 3.5% reflecting volume growth of 1.5% and pricing of almost 2%. Underlying operating income growth is estimated to increase by almost 5%.
Coca-Cola's expanded productivity savings program should enable additional financial flexibility over the next several years to cover incremental investments and costs that will be primarily redirected for increased media investments and brand support development in 2015.
M&A Investments
The ratings also consider the potential for future acquisitions given the company's transaction history. Fitch views KO's investments in minority positions of Monster Beverage and Keurig Green Mountain, Inc. as relatively low risk and having key strategic benefits of improving product diversification and distribution. The shifting secular trends within the soft drink industry make these investments essential to create an additional avenue for growth.
Coca-Cola Refreshments USA, Inc. (CCR) Ratings
Fitch does not make a rating distinction between The Coca-Cola
Company and CCR issued obligations, since default risk is very low at this level on the rating scale. CCR's notes are structurally superior to the notes issued by Coca-Cola.
RATINGS SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
Fitch currently does not anticipate a positive rating action given Coca-Cola's high financial leverage.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
A lack of progress toward developing and implementing an appropriate longer-term plan during the next 12 months to reduce aggregate debt balances including CP that would lead to an improved financial structure. Parameters of a deleveraging plan could include the following:
--Meaningful debt reduction from 2015 debt levels of at least 10%. Longer-term rating expectations are for Coca-Cola to maintain supplemental adjusted EBITDA net leverage of approximately 2x or less;
--Long-term gross leverage of approximately 3x or less;
--An improved long-term alignment of domestic cash availability versus domestic cash requirements such that Coca-Cola does not need to meaningfully increase total debt on an annual basis to fund domestic cash needs;
--A less aggressive financial strategy related to dividend and share repurchases;
--A reduction in commercial paper reliance. At the end of 2014 commercial paper balances totaled approximately \$19 billion or 46% of the firm's capital structure;
If Coca-Cola successfully executes a deleveraging plan, Fitch could affirm the ratings with a Stable Outlook.
Other factors that could individually or collectively, lead to negative rating action include:
-- Large debt-financed acquisition;
-- Coca-Cola materially underperforms Fitch's expectations for organic growth including volume and price/mix;
-- Further slowing growth in emerging and developing market regions;
-- Margin erosion from channel mix shifts, competition, increased spending that result in reduced profitability;
-- Lack of progress with executing on productivity based initiatives;
Fitch affirms the ratings for The Coca-Cola Company (Coca-Cola) and its subsidiaries as follows:
The Coca-Cola Company
--Long-term Issuer Default Rating (IDR) at 'A+';
--Bank credit facilities at 'A+';
--Senior unsecured debt at 'A+';
--Short-term IDR at 'F1';
--Commercial paper (CP) at 'F1'.
Coca-Cola Refreshments USA, Inc. and Coca-Cola Refreshments
Canada, Ltd. (CCR)
--Long-term IDR at 'A+';
--Senior unsecured debt at 'A+'.
Fitch has withdrawn the following ratings:
Coca-Cola Refreshments USA, Inc. (CCR)
--Senior shelf 'A+'.
The Rating Outlook is Negative.
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