Fitch Ratings has downgraded the long-term ratings of The Coca-Cola Company to ‘A’ from ‘A+’. The Rating Outlook is Stable.
The ratings downgrade reflects materially higher net leverage compared to Fitch’s previous expectations following Coca-Cola’s public announcement of its long-term financial targets. The targets include a net debt leverage ratio of 2.0x to 2.5x, using $7 billion of off-shore cash to pay down debt, a $4.6 billion tax on accumulated foreign earnings, share repurchases of up to $1 billion in 2018 and a long-term dividend pay-out ratio of 75%.
Fitch believes Coca-Cola’s net leverage target provides greater certainty around the company’s long-term capital structure particularly given that tax reform gives Coca-Cola greater access to its off-shore cash stockpiles. The $7 billion of gross debt repayment is a credit positive that lessens the divergence between gross and net leverage metrics and demonstrates management’s commitment to maintaining gross leverage that Fitch views as acceptable for Coca-Cola’s ‘A’ credit rating.
Fitch also views the new targets as providing Coca-Cola with additional flexibility to pursue strategic bolt-on M&A to broaden the beverage portfolio in on-trend categories while continuing to return value to shareholders through higher dividends and share repurchase opportunities. As such, significant additional debt reduction is not expected to be a priority.
Mid-2x Net Leverage: Fitch expects Coca-Cola’s net leverage (based on Fitch’s adjustment for readily available cash) will be in the mid-2x range by the end of 2019. Fitch made estimated adjustments to Coca-Cola’s cash that is required for system working capital, discounts to certain marketable securities per criteria and cash located in certain foreign jurisdictions that is not considered readily available by Fitch. Consequently, Fitch’s net leverage metric is roughly 0.5x higher than Coca-Cola’s calculation. For 2018, Fitch anticipates net leverage of approximately 2.5x, which compares to 2.8x at the end of 2017 as net leverage declines due primarily to the sale of the South African bottling operations. Gross leverage is expected to improve to 3.3x in 2018 compared to 4.1x at the end of 2017 as Coca-Cola repatriates $7 billion in offshore cash to reduce total debt.
Long-Term Business Model Strengthening: Fitch believes Coca-Cola’s long-term business model will strengthen as a result of refranchising plans that were completed in late 2017. Refranchising has caused some near-term dilution with EBITDA declining by approximately 9% in 2017 to $11.6 billion (including bottler dividend). This compares to EBITDA of $13 billion in 2015. However, Fitch expects materially improved results in 2018 as cost reduction initiatives gain further traction driven by refranchising and productivity initiatives.
By end of 2019, Fitch’s base case assumes gross margin improvement to approximately 66% (62.6% in 2017) and operating margin improvement to approximately 34% (28% in 2017) that leads to EBITDA growing to roughly $13 billion. Consequently, Fitch expects Coca-Cola’s underlying cash flows should be more stable with lower capital intensity, thus providing greater support to its longer-term credit profile. Refranchising benefits are weighed against any challenges with the newly franchised bottlers maintaining a consistent and unified long-term vision, particularly around future investment requirements.
Productivity Benefits: Fitch views the low end of Coca-Cola’s longer-term 4%-6% revenue growth and 6%-8% profit before tax financial targets as achievable particularly as emerging and developing markets more fully recover. These financial targets are supported by Coca-Cola’s $3 billion productivity program to be completed by 2019 that should provide additional benefits. Through 2017, the productivity program has resulted in more than $2 billion in savings. While Coca-Cola is using a portion of these savings to support brand strength by increasing media and R&D spending to drive top-line growth while cost reductions should also help drive growth in operating profit.
Strong Global Brands: As the world’s largest global beverage company, Coca-Cola’s ratings are supported by its strong market shares, extensive geographic diversity in more than 200 markets, strong distribution platform and valuable brand equity.
Coca-Cola has 21 $1 billion-plus brands, including: Coca-Cola, Sprite, Powerade, smartwater, Gold Peak Tea, Minute Maid juices, Fanta Orange, Schweppes and Dasani. The strong brands, geographic reach, market position and diversification afford considerable support to Coca-Cola’s business profile which Fitch expects should generate long-term stable, sustainable cash flows.
