Fitch Rates Kellogg's EUR600MM Sr Unsecured Notes 'BBB+'; Outlook Negative

Fitch Ratings has assigned a 'BBB+' rating to Kellogg Company's EUR600 million 1.250% senior unsecured notes due March 10, 2025. The company intends to use the net proceeds from this issuance for general corporate purposes including the repayment of commercial paper (CP). The notes rank pari passu with Kellogg's other unsecured debt and contain a Change of Control Repurchase Event provision at 101. The notes are issued under the company's indenture dated May 21, 2009, which contains standard investment grade limitations on liens, sale-leasebacks, mergers, etc. but does not contain financial covenants.

The Rating Outlook is Negative.

A full list of ratings follows at the end of this release.

KEY RATING DRIVERS

Strong Brands, but Predominantly in Developed Markets: Kellogg's ratings incorporate its leading market shares, strong brand equities in breakfast foods and snacks, as well as ample liquidity. The company has good geographic diversification, with nearly 40% of its sales generated outside the United States. However, with 85% of the company's sales in North America and Europe, Kellogg's growth has been hampered by significant exposure to slow growing mature markets, with modest exposure to faster growing emerging markets. U.S. Morning Foods and U.S. Snacks generated top line declines in both 2013 and 2014. Improving these businesses is a key near-term priority. However, it is a difficult proposition to reverse declines in its core cereal business. The company would need to stabilize this business and also generate growth in snacks to hit its long term target of 1%-3% comparable sales growth.

Near Term Leverage and Cereal Declines are Concerns: The Negative Outlook reflects Fitch's current expectation that gross leverage (total debt to operating EBITDA) is likely to rise modestly in 2015 to be in the 3.0x range. This incorporates Fitch's concerns regarding Kellogg's mid-single digit decline in comparable net sales in its U.S. Morning Foods segment, which is mainly cereal. Kellogg is likely to borrow at least $200 million to fund estimated net share repurchases, and debt could rise further as cash continues to grow overseas. For 2014, total debt was 2.7x, funds from operations (FFO) adjusted leverage was 4.4x and operating EBITDA to interest expense was 12.6x. While 2014 leverage was in line with Fitch's previous expectations for relatively flat leverage, top line remains weak and operating earnings are expected to decline in the mid-single digit range in 2015. The company is not likely to return to growth until 2016 at the earliest, if some of the benefits from Project K start accruing but significant business headwinds remain.

Project K's Substantial Cost: In November 2013, Kellogg announced Project K, a global four-year efficiency and effectiveness program, to improve its long term growth prospects and cost structure. Kellogg expects total pretax program charges of $1.2 billion to $1.4 billion plus about $300 million incremental capital expenditures. The company estimates total cash costs for the program at $1.2 billion to $1.4 billion. The project's substantial cash cost has negatively impacted free cash flow (FCF) as discussed below. Kellogg has reiterated its plan for Project K pretax savings of $425 million to $475 million annually by 2018, with more than half of the cost savings coming from the supply chain. Kellogg expects pretax Project K costs of $400 million to $450 million in 2015, along with incremental cost savings of $90 million to $100 million. However, Kellogg intends to invest these cost savings back in the business.

FCF Constrained in Near Term: Kellogg generated significant FCF (cash flow from operations less capital expenditures and dividends), which averaged approximately $500 million annually during the past four years. Fitch expects $350 million of FCF including Project K cash cost in 2015. FCF could grow beyond 2015 as Project K cash costs decline, if earnings growth gains traction.

Sizeable Liquidity and Manageable Maturities: Kellogg's $2.4 billion liquidity included its undrawn $2 billion revolving bank facility plus $443 million cash and equivalents at Jan. 3, 2015. The company maintains a $2 billion revolver expiring in February 2019. The company had $777 million of commercial paper (CP) at year end. Kellogg is likely to refinance upcoming debt maturities, which include $350 million remaining in 2015, and $1.3 billion notes due in 2016 and $660 million due in 2017, with potential for incremental debt to support share buybacks.

KEY ASSUMPTIONS

--2015 top line growth approximately flat on a comparable basis. Factoring in negative currency impact and the absence of a 53rd week, net sales estimated to fall mid-single digits. Beyond 2015, Fitch expects top line to grow at the low end of 1%-3%.

--2015 operating profit down mid-single digits, including a 3%-4% headwind from the reinstatement of incentive compensation.

--FCF of approximately $350 million in 2015, resulting in at least $200 million borrowings for share repurchases. FCF includes approximately $350 million cash cost from Project K. FCF is expected to improve over the forecast period after 2015, if earnings strengthen and Project K cash costs decline.

--Cash and gross debt continue to grow over the forecast period in the absence of overseas acquisition opportunities.

--Leverage (gross debt to EBITDA) likely to be at or near 3.0x in 2015. Leverage could stay at this level assuming flat to modest growth in operating earnings, or improve with better than anticipated top line and earnings growth.

RATING SENSITIVITIES

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

--A negative rating action could occur if Kellogg's operating performance stays within Fitch's current expectations outlined above or underperforms, resulting in leverage at or above the 3.0x range. Continued or accelerating negative volume trends would support a downgrade.

--Lack of pullback on share repurchases with further earnings weakness would also support a downgrade.

--Material debt financed acquisitions where leverage is sustained above the 3.0x range or other leveraging transactions.

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

--A return to a Stable Outlook could occur with a demonstrated ability to maintain leverage in the mid 2x range for an extended period. This could occur with outperformance versus current expectations on free cash flow, operating margins and top line growth. Positive volume and market share trends in key business lines, particularly in developed markets cereal, would also be supportive.

--A material pullback in share repurchases could also support returning to a Stable Outlook.

Fitch currently rates Kellogg and its subsidiaries as follows:

Kellogg

--Long-term Issuer Default Rating (IDR) 'BBB+';

--Senior unsecured debt 'BBB+';

--Bank credit facility 'BBB+';

--Short-term IDR 'F2';

--Commercial paper (CP) 'F2'.

Kellogg Europe Company Limited

--Long-term IDR 'BBB+';

--Short-term IDR 'F2';

--CP 'F2'.

Kellogg Holding Company Limited

--Long-term IDR 'BBB+';

--Short-term IDR 'F2';

--CP 'F2'.

Kellogg Canada, Inc.

--Long-term IDR 'BBB+';

--Senior unsecured debt 'BBB+'.

The Rating Outlook is Negative.

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

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=980583

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