OREANDA-NEWS. August 31, 2015.  Fitch Ratings has affirmed Nestle SA's (Nestle) Long-term Issuer Default Ratings (IDR) and senior unsecured ratings at 'AA+', including debt issued by Nestle Holdings, Inc. (USA), and its Short-term IDRs at 'F1+'. The Outlook on the Long-term IDRs is Stable. A full list of rating actions is available at the end of this commentary.

Today's affirmation reflects our expectation that despite a CHF8bn share buyback programme and currency headwinds affecting emerging markets operations and a persistently weak consumer environment in Europe, Nestle should maintain a strong business profile consistent with its 'AA+' IDR.

The ratings also reflect a lack of leverage headroom. Fitch expects Nestle's funds from operations (FFO) net leverage over 2015-2016 to remain above the 1.2x maximum threshold compatible with the current 'AA+' rating. However, this is mitigated by Nestle's proven ability to sustain its profit margins and cash flows and Fitch's expectations that it will retain strong overall financial flexibility. Nestle has stable and strong underlying free cash flow (FCF) on average of CHF3bn despite weak trading conditions in some of its key markets and product categories.

In our projections we have assumed limited M&A and no further share buyback following the completion of the programme in 2015.

KEY RATING DRIVERS

No Leverage Headroom
The forecast increase in FFO net leverage over 2015-2016 to above 1.2x (2014: 1.1x) is a result of Nestle's CHF8bn share buyback programme, which was only partly funded with the proceeds of the sale of L'Oreal shares, and FX transactional costs impacting profits. In July 2014, Nestle sold part of its L'Oreal shares back to L'Oreal for CHF7.3bn in exchange for 50% of skin health business-Galderma that it did not already own (equity value CHF3.2bn) and cash of CHF4.1bn.

On the assumption of no major debt-funded acquisitions and no further share buyback programmes following the completion in 2015, Fitch estimates that FFO net leverage will be able to fall back below 1.2x on a sustained basis by 2017. We expect Nestle to continue to balance the pace of future acquisitions and, occasionally share buybacks, relative to FCF and divestments.

Diversification Complements Resilient Business
Nestle's 'AA+' ratings reflect operations in a sector characterised by high business stability and low capex and R&D spending requirements compared with other highly rated corporations. Furthermore, within its industry Nestle benefits from a portfolio of several high profit margin categories, from ownership of some of the strongest brands as well as from consistent and successful innovation. Well-balanced geographical diversity between developed and emerging markets further supports the ratings.

Foreign Exchange Volatility
Nestle enjoys well-balanced geographical diversity between developed and emerging markets, which further supports the ratings. However, profits are currently exposed to emerging market currency devaluation. Also, most of the company's debt is raised in hard currencies thus precluding any benefits from natural currency hedges. Mitigating this risk is the company's track record of gradually increasing prices in countries suffering from currency devaluation to compensate this negative effect.

Superior Sales Growth
Over the years, volume and pricing have consistently contributed to revenue growth, underlining Nestle's ability to drive both components while delivering profit margin improvements. It maintained healthy organic sales growth of 4.5% in 2014, making it one of the best-performing global fast-moving goods players during that period compared with the average 2%-3% of organic sales growth among peers in a challenging global trading environment. It maintained the momentum for 1H15 with organic sales growth of 4.5%.

The strength of its revenue growth rests on some of Nestle's fast-growing categories with higher margins such as pet care, infant nutrition, coffee; Nestle Skin Health and Nestle Health Science; a fast-growing emerging market platform; and a more diverse channel or format exposure than traditional store-based retail stores (e.g. Nepresso boutiques). Fitch expects Nestle to continue its strong performance and to deliver organic growth of around 5% for 2015. Growth will be driven by both volume and pricing, which are in turn supported by Nestle's ability to innovate and achieve efficiencies.

Growing Profit Margins
Reported trading operating margin (continuing operations) increased to 15.3% in 2014, up 10bp versus last year and 30bps in constant currencies. The trend continued in 1H15 with trading operating margin up 20bps on a constant currency basis. Fitch expects further margin improvement, driven by stronger growth and/or higher-margin categories/emerging markets; its premium product offerings and acceleration of cost and savings efficiencies. Fitch expects Nestle's profit margin to continue to improve slightly, subject to the pace of growing consumer-facing marketing and promotions in both developed markets and emerging markets.

KEY ASSUMPTIONS
- Organic annual revenue growth of 5%;
- Operating margins above 15%;
- Annual pre-dividend FCF sustained at or above CHF9bn from 2015;
- Capex of 4.6% of revenue;
- Moderate dividend per share growth;
- Share buybacks of CHF6.4bn in 2015;
- Approximately CHF500m of net acquisitions in 2015 and CHF1bn of net acquisitions from 2016 onwards.

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Adjusted FFO net leverage below 0.8x (2013: 1.35x) as a result of asset sale proceeds, or improvement in operations
- Renewed commitment to a 'AAA' rating

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Adjusted FFO net leverage above 1.2x beyond 2017
- Deterioration in FCF generation before dividends, taking pre-dividend FCF margin below 7% (2014: 11%)
- Significant or prolonged downturn in emerging markets, or in its main developed markets, causing a slowdown in organic growth (below 5%) and reduction in profits (EBIT margin below 15%)
- FFO fixed charge coverage (inc. rents) below 12.5x (2014:14.8x)

LIQUIDITY
As of 30 June 2015 Nestle had liquidity of CHF17.4bn, comprising CHF4.7bn of cash and cash equivalents and committed undrawn back-up bank facilities of CHF12.7bn. This is sufficient to cover 100% of Nestle's short-term debt obligations (CHF3.3bn) consisting of bonds and bank loans due in the coming 12 months as well as outstanding commercial papers (CHF8.7bn).

FULL LIST OF RATING ACTIONS

Nestle SA
Long-term IDR affirmed at 'AA+'; Outlook is Stable
Short-term IDR affirmed at 'F1+'
Senior unsecured debt affirmed at 'AA+'

Nestle Holdings, Inc. (USA)
Senior unsecured debt affirmed at 'AA+'

Nestle Finance International Ltd.
Guaranteed commercial paper and bonds affirmed at 'F1+'/'AA+' respectively

Nestle Holdings (UK) PLC
Guaranteed commercial paper and bonds affirmed at 'F1+'/'AA+' respectively

Nestle Capital Corporation (USA)
Guaranteed commercial paper affirmed at 'F1+'

Nestle Australia Ltd
Guaranteed commercial paper, affirmed at 'F1+'