Fitch: affirms several Kraft ratings, outlook stable

Northfield / IL. (bw) Dual-headquartered in New York and London with 50 offices worldwide, Fitch Ratings has taken the following rating actions on Kraft Foods Inc. and its subsidiaries: The global rating agency has affirmed …

• Kraft Foods Inc.: Long-term Issuer Default Rating (IDR) at «BBB-»; Senior unsecured debt at «BBB-»; Credit facility at «BBB-»; Short-term IDR at «F3»; Commercial paper at «F3».
• Cadbury PLC: Long-term IDR at «BBB-».
• Cadbury Schweppes U.S. Finance: Senior unsecured debt at «BBB-».
• Fitch also assigned a long-term IDR of «BBB-» to Cadbury Schweppes U.S. Finance.

The Rating Outlook is Stable. Additionally, Fitch withdrew the «F3» short-term IDR of Cadbury PLC. The rating withdrawal reflects that Kraft does not intend to issue any additional debt at the Cadbury level. Kraft terminated Cadbury´s 450 million GBP credit facility in June 2010. However, Cadbury Schweppes U.S. Finance does have long-term debt outstanding. Kraft successfully obtained consents during 2010 to make the following changes to Cadbury´s subsidiary debt:

• The obligor on Cadbury Schweppes Finance PLC´s notes due in 2014 and 2018 was changed to Kraft Foods Inc.
• A Kraft Foods Inc. guarantee was added to the Cadbury Schweppes U.S. Finance notes and the covenants were aligned with Kraft´s indenture.

The ratings continue to reflect Kraft´s prominent size and scale within the global packaged foods industry, its leading market share positions in most of its categories, and many strong brand equities. The ratings also consider the strategic benefits of acquiring Cadbury´s confectionery business, offset by the material increase in leverage. Kraft acquired Cadbury for 18,5 billion USD (60 percent cash and 40 percent stock) and assumed 2,4 billion USD of Cadbury debt in 2010. The combination with Cadbury strengthens Kraft´s platform in confectionery and provides it with greater geographic reach, particularly in faster growing developing markets. Although integration risk remains, it has largely been reduced as Kraft has assimilated its operations and cultures. As the company works to integrate Cadbury and focuses on debt reduction, Fitch expects share repurchases to be minimal.

Kraft´s pro forma total debt from the Cadbury transaction was initially 31 billion USD, resulting in pro forma leverage of approximately four times total debt to operating Ebitda. Kraft´s debt reduction in 2010 is likely to be greater than Fitch had anticipated due to Kraft´s 1,5 billion USD debt tender which was mostly funded from cash. Fitch estimates that Kraft´s total debt is approximately 29 billion USD at December 31, 2010. Year to date through September 30, 2010, organic revenue grew 2,6 percent to 34,9 billion USD, which was below the company´s guidance of three percent to four percent growth for the year and reduced by declines in U.S. Cheese and U.S. Grocery. Base Kraft operating income grew 4,9 percent to 4,2 billion USD for the same period but decelerated in the third quarter of 2010 to a nearly flat level primarily due to increased advertising expense.

Although operating performance through the first nine months of 2010 has trailed Fitch´s expectations, year-end leverage of approximately 3,5 times to 3,7 times is within Fitch´s expectation for modest leverage improvement in the year of the transaction. Fitch expects Kraft to reduce leverage in 2011 due to increased profits and debt reduction from internally generated funds or cash on hand. Leverage at or near three times, combined with improvement in operating performance and cash flow, could result in positive ratings momentum. Fitch also expects a commitment from Kraft to operate with less leverage over an extended period of time. Heightened commodity costs may be a headwind to achieving near-term debt reduction goals, as recent pricing actions have lagged the surge in commodity costs. Also, with consumers remaining value conscious, they are not likely to be receptive to higher prices and, as a result, volumes and profitability are likely to be pressured in the near term.

Free cash flow in 2011 should improve materially from 2010. Cash flow was adversely affected by non-recurring items such as the up-front cash costs to achieve synergies, acquisition related costs, and 1,2 billion USD estimated tax payments on the frozen pizza divestiture. The costs to achieve synergies are front-end loaded, with approximately 750 million USD of the integration program costs likely incurred in 2010 and an additional 450 million USD in 2011. Kraft expects to incur total implementation costs of 1,5 billion USD to achieve pretax cost savings of 750 million USD by the end of the third year after completion of the acquisition. Kraft also incurred transaction related fees of 217 million USD and acquisition financing fees of 96 million USD through September 30, 2010.

Kraft has ample liquidity with more than two billion USD in cash at September 30, 2010 and 4,5 billion USD of undrawn capacity on its three-year senior unsecured revolving credit facility expiring in November 2012. Kraft´s only financial covenant is a minimum total shareholders´ equity requirement, which excludes accumulated other comprehensive income/(loss), of at least 28,6 billion USD in its credit facility. At September 30, 2010 there was a considerable cushion with this shareholders´ equity calculation at 39,6 billion USD. The revolving credit facility supports Kraft´s commercial paper (CP) program. There was no CP outstanding at September 30, 2010. Near-term debt maturities are significant, with approximately 1,1 billion USD remaining in 2011; 3,7 billion USD in 2012 and 3,6 billion USD in 2013 which are expected to be repaid with a combination of cash and refinancing.