Fitch Places H.J. Heinz on Rating Watch Positive on Kraft Foods Merger Announcement
March 25, 2015 | By Business Wire News
CHICAGO
Fitch Ratings has placed its ratings on H.J. Heinz Company (Heinz) and its subsidiaries on Rating Watch Positive following a definitive merger agreement with Kraft Foods Group (Kraft) to form The Kraft Heinz Company (Kraft Heinz) in a stock-for stock transaction.
Fitch currently rates Heinz’s long-term Issuer Default Rating (IDR) ‘BB-‘. A full list of ratings is shown below.
Kraft shareholders will own 49% and Heinz shareholders, primarily 3G Capital (3G) and Berkshire Hathaway (Berkshire), will own 51% of the combined entity. In addition, Kraft’s shareholders will receive a cash payment of $16.50 per share, or roughly $10 billion, funded by 3G and Berkshire. The combined debt levels post the merger is not expected to increase. The transaction is expected to close in the second half of 2015 and is subject to approval by Kraft’s shareholders and customary regulatory approvals.
KEY RATING DRIVERS:
Watch Positive Reflects Lower Leverage of Combined Company: The Rating Watch Positive reflects the projected decrease in financial leverage for the combined company versus Heinz’s leverage (total debt to EBITDA) of 6.2x on a stand-alone basis (with 50% equity credit for $8 billion preferred stock). Fitch estimates that initial pro forma leverage will be in the mid-4x range, based on 2014 debt of $31.3 billion and EBITDA of $6.6 billion. Pro forma debt factors in the $8 billion preferred stock as 100% debt since it will be refinanced with debt at the first call date in 2016. Replacing the 9% preferred stock with lower cost debt is projected to result in $450 million to $500 million annual cash savings.
Fitch estimates that leverage could fall to the mid-3x level within approximately two years of the transaction close due to a combination of debt reduction and achievement of most of the combined company’s estimated $1.5 billion annual cost savings. The company plans to implement Zero-Based Budgeting, rationalize the manufacturing footprint, optimize distribution, productivity and procurement, as well as streamline the organization and optimize marketing expenditures. The ability to reduce leverage to the mid-3x level within 24 months of the transaction close would indicate a low ‘BBB’ rating.
Strong Owner/Operators: The ratings incorporate significant qualitative benefits from the company’s owners, 3G and Berkshire. Both have significant financial strength and are proven operators. 3G has a proven ability to increase operating profitability substantially and deleverage acquired firms including Heinz, Burger King Worldwide, Inc. and Anheuser Busch InBev NV/SA (Fitch IDR ‘A’/Outlook Stable). Heinz’s total debt to EBITDA for the 12 months ended Dec. 28, 2014 was 6.2x, down substantially from 8.5x in the previous year on nearly 35% EBITDA improvement due to lower overhead and manufacturing costs.
Improved Debt Structure: The combined debt levels post the merger is not expected to increase, although the cost of funding is expected to be lower. Kraft Heinz plans to refinance $9.5 billion of Heinz’s existing high yield debt and the $8 billion preferred stock will be replaced with much lower cost debt next year. Fitch estimates that Heinz’ $2 billion second lien notes due in 2025, its 125GBP second lien notes and approximately $1.7 billion unsecured debt will remain outstanding, as well as Kraft’s $10 billion debt.
Significant FCF and Deleveraging: Fitch estimates that initially, FCF will be heavily impacted by merger and restructuring costs, as was the case in the Heinz deal two years ago. However, FCF should then strengthen to allow debt repayment in the $2 billion range the company has indicated within two years. FCF will also be impacted by Kraft’s decision to maintain its current dividend per share on a share base that will almost double. Refraining from share repurchases over a two year period supports the company’s commitment to debt reduction.
Increased Size and Diversification, but Heavy Exposure to Mature North American Market: The company will generate approximately $28 billion of combined annual revenue. The portfolio will include eight $1 billion-plus brands and many other large brands. In the near term it will be heavily exposed to the slow growth, highly competitive North American market comprising about 76% of sales. However, there are significant cost synergies with the overlapping geographies and complimentary portfolios with limited overlap.
Longer-term, the company should benefit from revenue synergies resulting from greater international growth as Kraft products can be distributed on Heinz’s international networks. Heinz generates about 60% of its sales outside the U.S., with emerging markets comprising approximately 25% of the firm’s $11 billion annual revenue. However, Heinz’ top line weakness remains a concern for Fitch. The weak top line has been impacted by soft category trends in U.S. frozen foods as well as the company’s intentional pruning of lower margin products, with volume declines partially offset by price increases. Fitch anticipates that top line organic growth should improve over time, as emerging markets exposure expands and partially offsets sluggishness in developed markets.
KEY ASSUMPTIONS:
–Fitch estimates initial pro forma leverage (total debt to EBITDA) in the mid 4x range based on 2014 pro forma debt of $31 billion and EBITDA of $6.6 billion.
–Gross leverage is expected to fall to the mid 3x level by 2017 based on substantial EBITDA improvement given targeted $1.5 billion annual cost savings and $2 billion in debt reduction.
–Transaction closing by the end of 2015.
RATING SENSITIVITIES
Assuming the successful close of the transaction and based on preliminary analysis and expectations for leverage in the mid-3x range by the end of 2017, Fitch expects that Heinz’s long-term IDR could move to low investment grade.
If the deal does not close, Fitch expects to affirm the company’s current ratings, or re-evaluate if industry conditions and performance change substantially.
Fitch has placed the following ratings on Rating Watch Positive:
H.J. Heinz Holding Corp. (Formerly Hawk Acquisition Holding Corp). (Parent)
–Long-term Issuer Default Rating (IDR) ‘BB-‘.
H.J. Heinz Co. (Heinz)
–Long-term IDR ‘BB-‘;
–1st lien secured credit facilities ‘BB+’;
–2nd lien secured notes ‘BB’;
–Senior unsecured notes ‘BB-‘.
H.J. Heinz Finance Co.
–Senior unsecured notes ‘BB-‘.
H.J. Heinz Finance UK Plc.
–2nd lien secured notes ‘BB’.
Additional information is available at ‘www.fitchratings.com‘.
Applicable Criteria and Related Research:
–‘Corporate Rating Methodology’ (May 2014);
–‘Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis’ (November 2014).
Applicable Criteria and Related Research:
Corporate Rating Methodology – Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis – Effective Dec. 13, 2012 to Dec. 23, 2013
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696670
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=813588
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=981868
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