TEXT-S&P revises Dr Pepper Snapple Group outlook to positive
Overview -- We expect U.S.-based Dr Pepper Snapple Group Inc. (DPS) to continue to generate strong cash flow in the next one to two years despite lingering weak macroeconomic conditions in the U.S. -- We are affirming our ratings on DPS, including the 'BBB' long-term corporate credit rating. -- We are revising our outlook on DPS to positive from stable, reflecting our opinion that DPS will be able to sustain its current credit measures, including leverage below 2.5x and funds from operations to total debt near 30%, which could lead us to upgrade the company. Rating Action On Oct. 26, 2012, Standard & Poor's Ratings Services affirmed its ratings on Plano, Texas-based Dr Pepper Snapple Group Inc. (DPS), including the 'BBB' long-term corporate credit and 'A-2' short-term, corporate credit and commercial paper ratings. At the same time, we revised the outlook to positive from stable. Rationale The positive outlook reflects our opinion that DPS has the ability to sustain its credit measures, including leverage (as measured by total debt to EBITDA) less than 2.5x and funds from operations (FFO) to total debt near 30% or more. These ratios are within the indicative ratio ranges for an "intermediate" financial risk profile, including leverage in the range of 2x-3x and the low-end of the range for FFO to total debt ratio of 30%-45%. We believe the FFO to total debt ratio will remain on the low-end of the indicative ratio range because of the company's geographic concentration in the U.S., which has higher corporate tax rates than most other countries. The ratings on DPS reflect our assessment of the company's business risk profile as "satisfactory" and financial risk profile as "intermediate." Key credit factors in our assessment include DPS' position as the third-largest soft drink company in North America, good brand recognition, share position and cash flow generation, yet relatively narrow business and geographic focus, with the majority of its footprint in the mature and low-growth nonalcoholic beverage markets of North America. The company has a moderate financial policy, adequate liquidity, and key credit measures that we believe will remain consistent with indicative ratios for an intermediate financial risk profile. DPS is a leading integrated-brand owner, bottler, and distributor of nonalcoholic beverages in the U.S., Canada, Mexico, and the Caribbean. Although the company has a diverse portfolio of flavored (non-cola) carbonated soft drinks (CSD) and noncarbonated soft drinks (non-CSD; including ready-to-drink teas, juices, juice drinks, and mixers), we believe CSDs continue to account for a significant portion of DPS' volume. In 2011, U.S. sales represented 89% of total net sales. The brand portfolio includes well-known CSD brands such as Dr Pepper, 7UP, Sunkist soda, A&W, Canada Dry, Schweppes, Squirt, and Penafiel; non-CSD brands such as Snapple, Mott's, Hawaiian Punch, Clamato, Mr. & Mrs. T, Margaritaville, and Rose's; as well as regional and smaller niche brands. The company has limited CSD brand rights outside of North America, so international growth potential is limited, but DPS has strong shares for some of its brands, including Dr Pepper's leading U.S. market position in the flavored CSD category. However, DPS remains a distant No. 3 in the U.S., with about a 17% share in CSD (according to Beverage Digest), far behind financially stronger No. 1 Coca-Cola Co. (Coke; AA-/Stable/A-1+) with an approximate 42% share and No. 2 PepsiCo Inc. (A/Stable/A-1) with about 29% of the CSD market. Thus, we believe DPS lacks the marketing economies of scale that its key U.S. competitors enjoy. In 2011, DPS bottled and/or distributed about 46% of its product volume sold in the U.S. We believe long-term distribution agreements executed during 2010 with Coke and PepsiCo, as well as expanded presence in fountains at quick-serve restaurants, combined with expected continued investments in DPS' brands, should support modest volume growth during the next few years despite lingering weak macroeconomic conditions in North America, and volatile commodity costs. For the quarter ended Sept. 30, 2012, DPS' net sales were flat as favorable product mix and price increases were offset by lower volume and unfavorable foreign currency exchange rates compared with the same period in 2011. However, DPS' adjusted EBITDA margin strengthened about 300 basis points (bp) during this timeframe as the company realized cost savings from ongoing productivity initiatives and favorable mark-to-market gains, which more than offset higher commodity costs and selling, general, and administrative expenses, including increased marketing expenses. For the 12 months ended Sept. 30, 2012, we estimate the ratio of total debt to EBITDA was about 2.3x, which remained on the stronger end of the indicative ratio leverage range of 2x-3x for an intermediate financial risk profile. The ratio of FFO to total debt (adjusted for tax-related payments pertaining to the 2010 license fees and paid in 2012) was about 30%, which is at the low end of the 30%-45% indicative range for an intermediate financial profile. We expect DPS' credit ratios to remain near current levels by the end of 2012 into 2013. Our 2012 forecast assumptions that support this include: -- Net sales growth of about 2% driven by higher pricing and favorable mix, partially offset by continued somewhat lower volume; -- Adjusted EBITDA margin to be flat to down about 30 bps as compared with 2011 due to expected soft volume as higher commodity costs should be largely offset by cost savings from its productivity initiatives; -- Capital expenditures will be less than 4% of net sales; and -- We expect dividends and share repurchases will be funded out of discretionary cash flows or excess cash. Importantly, we believe management will continue to implement financial policies that will allow DPS to maintain its existing financial profile and credit ratios near current levels during the outlook period. Liquidity We believe DPS has "adequate" liquidity (as defined in our criteria) and sources of cash are likely to be in excess of uses for the next 12 months. Our view of the company's liquidity profile incorporates the following expectations: -- We expect liquidity sources (including cash, discretionary cash flow, and significant availability under its $500 million revolving credit facility) will exceed uses by 1.2x or more over the next 12 months. -- We expect liquidity sources will continue to exceed uses, even if EBITDA were to decline by 15%, and without breaching the company's financial covenant test, as it currently has more than sufficient cushion. -- We believe DPS has solid relationships with its banks and a generally satisfactory standing in the credit markets. -- It is our opinion that the company's relatively stable cash flow characteristics will continue, despite a very competitive operating environment. DPS has generated average normalized discretionary cash flow (after dividends and capital expenditures) of $500 million during the past few years. Our liquidity assessment assumes that near- to intermediate-term debt maturities, including $450 million due December 2012 and $250 million due May 2013, will be refinanced. Outlook The positive rating outlook reflects the likelihood that we could raise the ratings if DPS can sustain its current credit measures, including leverage below 2.5x and FFO to total debt near 30%, despite lingering weak macroeconomic conditions and higher commodity costs. We believe this could occur if the company meets our aforementioned baseline forecast while debt levels remain near current levels. Alternatively, we could revise the outlook to stable if DPS were to engage in more shareholder-friendly initiatives, including debt-financed share repurchases, resulting in higher debt balances and FFO to total debt approaching 25% or below. We believe this could occur if the company's adjusted debt levels increased by about $500 million from 2011 level, all other assumptions remaining constant. Related Criteria And Research -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Criteria For Rating The Global Branded Nondurable Consumer Products Industry, April 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings affirmed; Outlook Revised To From Dr Pepper Snapple Group Inc. Corporate credit rating BBB/Positive/A-2 BBB/Stable/A-2 Ratings Affirmed Dr Pepper Snapple Group Inc. Commercial paper A-2 Senior unsecured BBB Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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