Fitch Rates Coca-Cola's Issuance 'A+'; Outlook Negative
The notes will be issued by Coca-Cola and will rank equally with the company's senior unsecured obligations. Coca-Cola will use the net proceeds for general corporate purposes, which may include working capital, capital expenditures, acquisitions of or investments in businesses or assets, redemption and repayment of short-term or long-term borrowings and common stock purchases.
KEY RATING DRIVERS
Debt Structure, Elevated Leverage
The Negative Outlook reflects Coca-Cola's elevated gross leverage of 3.4x on a total debt-to-operating EBITDA basis for the first half of 2015, up from 2.8x at the end of 2013. Since 2010, total debt has increased by approximately $21 billion to $44 billion at the end of the second quarter 2015. At July 3, 2015, commercial paper balances totalled approximately $16 billion or 36% of the firm's total debt.
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. As a result, 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 offshore.
Sizeable Offshore Cash Position
Coca-Cola maintains a sizeable offshore cash position due to the company's substantial international cash generation. Of the $20.9 billion in cash, short-term investments and marketable securities, $18.2 billion was held by foreign subsidiaries excluding accounts held in Venezuela and Argentina.
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 the first half 2015 was 2.5x compared to 2.0x at the end of 2013.
Deleveraging is Key
Fitch had expected Coca-Cola's supplemental adjusted EBITDA net leverage to increase to the mid 2x range driven by an estimated $4 billion of borrowing to fund domestic requirements. Fitch views the increase in net leverage as concerning since it has been due to Coca-Cola's aggressive financial policies.
Continued progress by Coca-Cola toward developing and implementing an appropriate longer-term plan during the next 12 months to reduce aggregate debt balances including sustaining lower commercial paper (CP) balances that would lead to an improved financial structure is key. Past CP levels were roughly half of the total debt compared to 36% for the most recent quarter. 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.
CCEP Bottling Combination A Positive
Fitch views the new bottling combination of Coca-Cola European Partners (CCEP) that will have pro forma 2015 revenue and EBITDA of $12.6 billion and $2.1 billion respectively, as a positive step toward improving the sustainability of cash generation for the Coca-Cola System's underlying business operations in Western Europe. As such, Coca-Cola's segment results should benefit longer-term as its largest independent bottler improves its strategic operating profile.
Coca-Cola's European bottling business has faced persistent headwinds caused by a macro environment characterized by reduced consumer spending, higher unemployment and the negative effects of austerity programs in Western Europe. In addition, structural challenges due to health and wellness trends are affecting the demand for carbonated soft drinks in developed markets. The challenging environment thus places more importance on the need for Western European consolidation.
The merger increases operational scale, creates synergy opportunities, better leverages best practices and improves operational strategy across 13 contiguous countries. This should improve efficiencies, thus increasing CCEP's ability to invest behind the brands. Fitch believes The Coca-Cola Company's 18% ownership position, which includes two board seats, should also enhance the strategic alignment within the Coca-Cola system between the two companies. The transaction is expected to close in the second quarter of 2016.
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 taste or preferences. 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.
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 cash flow from operations (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.
RATING 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 meaningful 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;
--Sustained reduction in commercial paper reliance.
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.
LIQUIDITY
Strong Cash Generation, Liquidity
Coca-Cola's ratings reflect the company's ability to generate considerable CFFO and free cash flow (FCF). For the LTM period, Coca-Cola generated $11.3 billion and $3.2 billion (adjusting for dividend payment) of CFFO and FCF, respectively, after generating $10.6 billion and $2.9 billion for the year ended Dec. 31, 2014. For 2015, Fitch expects CFFO of at least $10.5 billion. Coca-Cola's long-term debt maturing in the next 12 months totalled $1 billion following the September 2015 maturity of $1 billion in senior notes.
As of July 3, 2015, Coca-Cola's $29 billion liquidity position consisted of more than $17 billion of cash and short-term investments, approximately $3.4 billion of marketable securities, and $8.1 billion of availability under its committed credit lines and revolving credit facility with rolling maturities through 2019.
FULL LIST OF RATING ACTIONS
Fitch currently rates Coca-Cola and its subsidiary as follows:
The Coca-Cola Company
--Issuer Default Rating (IDR) 'A+';
--Bank credit facilities 'A+';
--Senior unsecured debt 'A+';
--Short-term IDR 'F1';
--Commercial paper 'F1'.
Coca-Cola Refreshments USA, Inc. and Coca-Cola Refreshments
Canada, Ltd. (CCR)
--Long-term IDR 'A+';
--Senior unsecured debt 'A+'.
The Rating Outlook is Negative.
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