MRO Magazine

Fitch Upgrades H.J. Heinz’ IDRs to ‘BBB-‘ on Merger with Kraft Foods Group


June 25, 2015
By Business Wire News

CHICAGO

Fitch Ratings has upgraded and removed H.J. Heinz Company (Heinz) and its subsidiaries’ ratings from Rating Watch Positive and taken the rating actions outlined below. The Rating Outlook is Stable. These rating actions reflect the refinancing related to the merger of Kraft Foods Group (Kraft) and H.J. Heinz Company to form The Kraft Heinz Company (Kraft Heinz) in a stock and cash transaction. The definitive agreement was announced on March 25, 2015 and Fitch estimates that the deal will close shortly after the Kraft shareholders’ vote on July 1, 2015, as key regulatory approvals have been received.

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 level post-merger is expected to be approximately $33 billion, factoring 100% debt for $8 billion in preferred stock (details below).

Fitch has upgraded the following:

H.J. Heinz Holding Corp. (to be renamed Kraft Heinz Company) (Parent)

–Long-term Issuer Default Rating (IDR) to ‘BBB-‘ from ‘BB-‘.

H.J. Heinz Co. (to be renamed Kraft Heinz Foods Company)

–Long-term IDR to ‘BBB-‘ from ‘BB-‘;

–$1.2 billion second-lien secured notes due Feb. 2025 to ‘BBB’ from ‘BB’;

–$430 million senior unsecured notes to ‘BBB-‘ from ‘BB-‘.

H.J. Heinz Finance Co. (debt moving to Kraft Heinz Foods Company)

–$1.5 billion senior unsecured notes to ‘BBB-‘from ‘BB-‘.

H.J. Heinz Finance UK Plc.

–125 GBP 6.25% second lien secured notes due Feb. 2030 to ‘BBB’ from ‘BB’.

Concurrently, Fitch has assigned the following ratings to Kraft Foods Group, Inc.’s existing debt which will be rolled over under the Kraft Heinz Foods Company:

–$8.6 billion senior unsecured notes at ‘BBB-‘

Fitch has also assigned the following ratings:

H.J. Heinz Co. (to be renamed Kraft Heinz Foods Company):

–$4 billion new unsecured credit facility due 2020 at ‘BBB-‘;

–$600 million new unsecured term loan due 2022 at ‘BBB-‘;

–$11.5 billion unsecured notes (US$10 billion, EUR750 million, GBP400 million) at ‘BBB-‘.

Kraft Canada (operating subsidiary):

–Long-term Issuer Default Rating (IDR) at ‘BBB-‘;

–CAD1 billion unsecured notes at ‘BBB-‘.

The Rating Outlook is Stable.

Kraft Heinz will use proceeds from new debt issuance to pay down approximately $10.3 billion of H.J. Heinz Co.’s first lien term loans and second lien notes (including $3.1 billion due 2020 and $800 million due 2025). As a result, Fitch has withdrawn its ratings on the following debt:

–$2.0 billion 1st lien secured revolving credit facility rated ‘BB+’;

–$6.4 billion 1st lien secured term loans due June 2019 and June 2020 rated ‘BB+’;

–$3.1 billion second-lien secured notes due Oct. 2020 rated ‘BB’;

KEY RATING DRIVERS:

Low Investment-Grade Credit Profile: Fitch estimates that initial pro forma debt/EBITDA leverage for Kraft Heinz will be close to 5x, based on total pro forma debt of $33 billion and EBITDA of approximately $6.7 billion. Pro forma debt factors in the $8 billion preferred stock (owned by Berkshire Hathaway) as 100% debt, since Kraft Heinz expects to refinance it with debt at the first call date in June 2016. Replacing the 9% preferred stock with lower cost debt is projected to result in $450 million to $500 million annual cash savings (assuming the tax benefit of issuing debt) relative to the current $720 million annual preferred dividend.

Fitch estimates that leverage will trend towards the mid-3x range by the end of 2017 due to a combination of $2 billion of expected debt reduction and realizing a substantial portion of the targeted $1.5 billion in annual synergies. The company expects to achieve both COGS and SG&A synergies through fixed cost and overhead reduction, rationalizing the manufacturing footprint, and realizing procurement savings on increased scale. Fitch anticipates total cash costs to realize these cost savings at approximately $2 billion.

Strong Owner/Operators: The ratings incorporate significant qualitative benefits from the company’s majority owners, 3G and Berkshire. Both have financial strength and are proven operators. 3G has increased operating profitability substantially and delevered acquired firms including Heinz, Restaurant Brands International, Inc. (formerly Burger King) 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 (factoring 50% equity credit for the $8 billion preferred stock), down substantially from 8.9x in 2013 (3G and Berkshire had acquired the company in June 2013). The improvement was driven by more than $1 billion in debt repayment and a 35% EBITDA increase due to lower overhead and manufacturing costs.

Improved Debt Structure: Kraft Heinz plans to refinance $10.3 billion of Heinz’s existing secured debt (and the $8 billion preferred stock in 2016) with lower-cost unsecured debt. Fitch estimates that $1.2 billion in Heinz’ $2 billion second-lien notes due in 2025, its GBP125 million second-lien notes, and approximately $1.9 billion unsecured debt will remain outstanding, as well as Kraft’s $8.6 billion debt.

Significant Free Cash Flow (FCF) and Deleveraging: Fitch estimates that initially, FCF will be impacted heavily 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 by the end of 2017. FCF will also be impacted by the company’s decision to maintain Kraft’s current dividend per share on a share base that will almost double, resulting in a pro forma annual dividend of approximately $2.7 billion, and growing thereafter. Refraining from share repurchases over a two-year period supports the company’s commitment to debt reduction. Meaningful working capital improvement opportunities are also expected to contribute to FCF generation.

Increased Size and Diversification, but Heavy Exposure to Mature North American Market: The company will generate approximately $29 billion of combined annual revenue. The portfolio will include eight $1 billion-plus brands and many other large and well-known household brands. In the near term, Kraft Heinz will be heavily exposed to the mature, highly competitive NA market which makes up about 76% of sales. Fitch believes this exposure puts significant pressure on the top line and could result in low single-digit organic volume declines that could potentially offset some of the benefits from cost synergies.

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 pressured 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.

KEY ASSUMPTIONS:

–Fitch estimates initial pro forma leverage (total debt-to-EBITDA) at almost 5.0x based on pro forma debt of $33 billion and EBITDA of $6.7 billion.

–Fitch estimates that leverage will trend towards the mid-3x range by the end of 2017 due to a combination of $2 billion of expected debt reduction and realizing a substantial portion of the targeted $1.5 billion in annual synergies.

–No net share repurchases for the first two years post-transaction.

–Cash cost to achieve synergies estimated at approximately $2 billion.

–Meaningful working capital improvement also supports the achievability of debt reduction.

–Approximately $2.7 billion initial annual dividend, growing moderately over forecast period.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to a negative rating action include:

–Sustained weak operating trends due to continued weakness in top line growth and potential market share loss in major categories; slow progress or inability to achieve targeted cost synergies, leading to insufficient FCF or cash on hand to pay down debt, which results in total debt to EBITDA sustaining around the 4.0x range at the end of 2017.

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 due to the company’s increased leverage post the transaction.

–Over the long term, a positive rating action could be supported by consistent positive organic volume growth, substantial and growing FCF generation, along with meaningful debt reduction that takes leverage down to the low-3x range.

Additional information is available at ‘www.fitchratings.com‘.

Applicable Criteria

Corporate Rating Methodology – Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=986952

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=986952

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Fitch Ratings
Primary Analyst
Judi M. Rossetti, CFA/CPA
Senior Director
+1-312-368-2077
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Grace Barnett
Director
+1-212-908-0718
or
Committee Chairperson
Mike Weaver
Managing Director
+1-312-368-3156
or
Media Relations:
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alyssa.castelli@fitchratings.com