Fitch Rates PepsiCo's Benchmark Notes Issuance 'A'; Outlook Stable
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
Brand Strength and Scale
PepsiCo's ratings reflect its considerable financial flexibility, substantial cash flow, significant scale, product diversification including strong margins in its Frito-Lay North America segment, increasing exposure to emerging markets, and brand strength as the world's second largest food and beverage company. Approximately 53% of PepsiCo's \\$63 billion in net revenue is derived from snacks. Beverages generate the remainder of the revenue with carbonated soft drinks comprising less than 25% of 2015 total revenue. Approximately 56% of PepsiCo's revenue is generated in the United States and 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.
Annual cash flow from operations (CFFO) and free cash flow (FCF) have averaged \\$10.6 billion and \\$3.8 billion, respectively, for the past two years. PepsiCo's CFFO and FCF in 2015 slightly exceeded expectations by approximately \\$100 million and \\$300 million respectively due to its cost savings initiatives and lower than expected capital spending. PepsiCo's primary goals are investing in its business, returning cash to shareholders, and maintaining credit ratings that provide ready access to global capital and credit markets including tier 1 commercial paper (CP).
Aggressive Financial Strategy
PepsiCo's financial strategy, historically viewed as aggressive, is also factored into its ratings. The past two years, PepsiCo has increased aggregate dividends and share repurchases to \\$9 billion and \\$8.7 billion respectively. Fitch views the use of debt to fund these initiatives negatively from a credit perspective, as debt-funded share repurchases have pressured the balance sheet, leaving modest ratings headroom. Leverage at the end of the fourth quarter 2015 was approximately 2.6x.
For 2016, PepsiCo has reduced expected shareholder returns to approximately \\$7 billion including approximately \\$4 billion in dividends and \\$3 billion in share repurchases. Consequently, Fitch expects PepsiCo could increase debt by at least \\$1.5 billion to fund these domestic cash requirements. This does not consider any foreign cash that could be potentially used for domestic needs. Fitch projects PepsiCo's total leverage at approximately 2.6x - 2.7x in 2016. Negative rating triggers include a more aggressive share repurchase policy that leads to sustained leverage in excess of the mid 2x range.
2015 Core Operating Performance Meets Expectations
For the year ended 2015, revenue fell 5% to \\$63.1 billion and operating income decreased by 13% to \\$8.4 billion on a reported basis. Organic revenue growth, which excludes a 10% negative impact from currency, increased 5% due to 4% pricing and 1% volume growth. PepsiCo experienced good performance in both Frito-Lay and North American Beverages with each segment experiencing 3% and 7% organic revenue and constant currency operating profit growth respectively. Excluding the \\$1.4 billion impairment charge related to the deconsolidation of PepsiCo's wholly-owned subsidiary in Venezuela, operating income increased 1%. Core gross margin and operating margin improved by 140 basis points and 30 basis points, respectively reflecting revenue management strategies and productivity initiatives.
Operating Challenges
PepsiCo's challenges include global concern with health and wellness trends, increased excise taxes on its products in certain markets, the maturity of its categories in developed markets, and negative sentiment toward artificial sweeteners that have led to U.S. diet carbonated soft drink (CSD) volume declines in the upper single digits. 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 recently have experienced volatility with growth although pricing has remained mostly rational in key developed markets which has allowed PepsiCo to increase price.
New product innovation will also be key to stemming concerns around health and wellness and consumers' growing preference away from artificial ingredients. Good execution on innovation will also allow for increased price realization. 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 to balance the declines within its CSD portfolio.
Operationally, PepsiCo is focused on increasing brand support to grow market share, expanding its emerging market presence, growing its nutrition business, reducing overhead, and leveraging technology and processes across its organization. PepsiCo has made noticeable progress on this strategy. Furthermore, PepsiCo's five-year \\$5 billion productivity cost savings program, if achieved, should provide the company significant financial flexibility to either reinvest into the business and/or increase cash generation.
KEY ASSUMPTIONS
Additional key assumptions within the 2016 rating case for the issuer include:
--Total revenue is essentially flat with organic revenue growth in the mid-single digit range primarily offset by foreign exchange;
--PepsiCo retains at least \\$1 billion of readily accessible domestic cash throughout the forecast;
--In 2016, PepsiCo increases debt by approximately \\$1.5 billion to fund domestic cash requirements including \\$2.5 billion in net share repurchases, \\$4 billion in dividends and more than \\$1 billion in domestic capital investment. This does not consider any foreign cash that could be potentially used;
--FCF for 2016 is in the low \\$3 billion range reflecting total capital spending of \\$3 billion or less;
--Total leverage of approximately 2.6x - 2.7x in 2016.
RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to a positive rating action include:
--Total debt-to-operating EBITDA below 2x and Fitch's belief that PepsiCo would manage its balance sheet to sustain an 'A+' rating. Currently, Fitch does not view this as likely given the increase in cash returned to shareholders.
Future developments that may, individually or collectively, lead to a negative rating action include:
--A significant increase in debt due to M&A activity and/or share repurchases combined with deteriorating operating performance that causes total debt-to-operating EBITDA to be sustained above the mid-2x level;
--Substantial and sustained declines in cash flow would also likely prompt negative rating actions.
LIQUIDITY
Liquidity, Maturities and Guarantees
PepsiCo maintains good liquidity. PepsiCo's cash and short-term investments totalled \\$12.0 billion at the end of the fourth quarter 2015, of which \\$11.1 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. 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 \\$3.1 billion in 2016 and \\$4.4 billion in 2017.
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 (Parent)
--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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