Fitch Affirms Kellogg's IDRs at 'BBB+/F2'; Outlook Revised to Stable

Wed May 1, 2013 4:29pm EDT

(The following statement was released by the rating agency) CHICAGO, May 01 (Fitch) Fitch Ratings has affirmed the following ratings for Kellogg Company (Kellogg) and its subsidiaries: Kellogg --Long-term Issuer Default Rating (IDR) at 'BBB+'; --Senior unsecured debt at 'BBB+'; --Bank credit facility at 'BBB+'; --Short-term IDR at 'F2'; --Commercial paper (CP) at 'F2'. Kellogg Europe Company Limited --Long-term IDR at 'BBB+'; --Short-term IDR at 'F2'; --CP at 'F2'. Kellogg Holding Company Limited --Long-term IDR at 'BBB+'; --Short-term IDR at 'F2'; --CP at 'F2'. Kellogg Canada, Inc --Long-term IDR at 'BBB+'; --Senior unsecured debt at 'BBB+'. The Rating Outlook is revised to Stable from Negative. Kellogg's debt balance was $7.9 billion at year end 2012, up from $6 billion in 2011 due to the primarily debt financed $2.7 billion Pringles acquisition which closed in May 2012. The year-end debt balance factors in Kellogg's nearly $400 million debt reduction since the Pringles acquisition. KEY RATING DRIVERS: The ratings affirmations and Outlook revision to Stable reflect that Fitch's expectations for operating earnings improvement, combined with significant debt reduction from free cash flow (FCF, cash flow from operations less capital expenditures and dividends), should restore leverage to pre-Pringles acquisition levels in the mid-2x total debt to EBITDA range in 2014. Kellogg's leverage was 3.1x at year end 2012 and was modestly better than Fitch's expectations. Kellogg has committed to continue to reduce debt in 2013 by refraining from share repurchases beyond offsetting the dilution from stock option exercises, in order to focus on debt reduction. This, in addition to higher profitability, should result in improved credit protection measures in the near term. Kellogg's ratings incorporate its #1 and #2 market share positions, strong brand equities, and ample liquidity. The company is diversified geographically, with approximately 40% of 2012 sales generated outside of the United States. However, Kellogg has significant exposure to slow-growing, mature markets and currently modest exposure to faster growing emerging markets. Financial Performance: In 2012 the company's revenues increased 7.6% as 6.5% in net acquisitions and 2.5% of internal growth (price/volume/mix) more than offset 1.4% of negative foreign exchange translation. In 2013, Fitch anticipates gross margins will be down slightly due to the lower margins of Pringles, but more benign cost inflation of 5% should provide some relief on the cost side as most of the inflation will be offset by cost savings projects. Kellogg adopted a new method for accounting for pensions which resulted in a non-cash mark-to-market charge of $452 million in operating profit. Fitch excluded this charge and one-time costs related to the Pringles acquisition, resulting in EBITDA of $2.6 billion in 2012 or a 3% improvement over a similar pro forma adjustment to 2011's EBITDA of $2.5 billion. In 2013, despite a slight decline in gross margins, increased sales from a full year of Pringles and organic growth should result in a solid increase in EBITDA. The company's ample free cash flow (FCF, cash flow from operations less capital expenditures and dividends) was over $600 million in 2012 after averaging just $400 annually during the past five years. The lower levels had been influenced by substantial pension and post-retirement contributions. Fitch estimates 2013 FCF will be approximately $450 million to $550 million due to higher capital expenditures and dividends. However, this level of FCF still supports the company's commitment to rapid deleveraging. Kellogg repaid down its $750 million notes due in March 2013, and future debt maturities are manageable. Upcoming debt maturities include CAD$300 million notes issued by Kellogg Canada, Inc. (under a full parent guarantee) due in 2014, $600 million notes due in 2015, and notes totaling $1.3 billion due in 2016. Only the company's 2031 notes lack a change of control provision. With $2 billion of revolving credit availability, high levels of free cash flow and excellent access to the capital markets, the company's liquidity remains considerable. RATING SENSITIVITIES: Future developments that may, individually or collectively, lead to a positive rating action include: --A positive rating action is not anticipated in the near to intermediate term. However, it could occur with significant debt reduction beyond current expectations following the Pringles acquisition, and a commitment to maintain leverage in the low 2.0x range or lower, along with strong free cash flow. Future developments that may, individually or collectively, lead to a negative rating action include: --A downgrade could occur if Kellogg's operating performance substantially deteriorates from current expectations, or if debt reduction is significantly slower than anticipated, resulting in leverage that is likely to be sustained at approximately 3.0x or higher. --A downgrade could also occur if Kellogg becomes very aggressive with share repurchases or acquisitions. Contact: Primary Analyst Judi M. Rossetti, CPA/CFA Senior Director +1-312-368-2077 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst Grace Barnett Director +1-212-908-0718 Committee Chairperson Michael Zbinovec Senior Director +1-312-368-3164 Media Relations: Brian Bertsch, New York, Tel: +1 212-908-0549, Email: brian.bertsch@fitchratings.com. Additional information is available at 'www.fitchratings.com'. Applicable Criteria and Related Research: --'Corporate Rating Methodology' (Aug. 8, 2012). 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