DBRS Confirms Kellogg at A (low) and R-1 (low)

DBRS has today confirmed the Senior Unsecured Debt and Commercial Paper ratings of Kellogg Company and related entities (Kellogg or the Company) at A (low) and R-1 (low), respectively. The trends are Stable.

The Company’s earnings profile continues to be supported by its strong portfolio of brands and market position, large scale and improving product and geographic diversification. These strengths have allowed Kellogg to maintain earnings growth, despite the effects of high commodity costs and consumer weakness stemming from the global recession. For the year ended January 3, 2009, Kellogg’s internal sales growth (excluding the impact of acquisitions, shipping days and forex) was flat year-over-year (yoy) at 5.4% and in line with guidance. As expected, sales growth was increasingly driven by pricing, as volumes were lower in certain geographic segments (Europe and Latin America). Gross margins declined to 44.8% from 47.1%, as higher commodity, energy and fuel costs could not be fully offset by efficiencies and pricing. However, effective control of S,G&A expenses allowed the Company to limit the impact on operating margins and grow operating profit by 4.2% yoy on an internal basis compared with 3.1% in F2007.

Despite DBRS’s expectation of lower volumes in F2009 due to recessionary pressures (trading down and softer sales in the discretionary category – i.e. snacks), DBRS believes that price/mix improvements, moderating commodity cost increases and benefits from cost-reduction initiatives will continue to support the Company’s guidance of internal net sales growth of 3% to 4% and operating earnings growth in the mid-single digits. Factoring in the strong U.S. dollar, however, reported earnings growth is expected to decrease modestly in F2009, although this will not affect the Company’s strong earnings profile. DBRS forecasts net income will be approximately 4% lower in F2009 at $1.1 billion, based on current exchange rate assumptions.

Lower free cash flow, increased acquisitions and steady share repurchases resulted in a modest increase in debt levels in F2008 (+$231 million). Metrics remained relatively stable, however, maintaining Kellogg’s strong financial profile and keeping the Company comfortably within the current rating category.

Cash flow from operations is expected to remain relatively stable in F2009 as lower net earnings are offset by a reduction in pension funding. DBRS expects that capital expenditures and dividends will be lower in F2009, which should result in the return of free cash flow (before changes in working capital) toward historic levels – approximately $500 million. Share repurchases of $650 million will again use Kellogg’s free cash flow in F2009 and may result in a modest increase in debt for the year, assuming no major acquisitions. DBRS expects this will cause coverage and leverage metrics to weaken slightly – lease-adjusted debt-to-EBITDAR of 2.7 times (x) compared with 2.6x at year-end F2008. However, DBRS does not expect this to have an impact on the Company’s financial profile or ratings. Over the longer term, DBRS expects Kellogg will maintain its stable financial profile as cash flow improves and acquisitions and share repurchases generally remain in line with free cash flow. However, should debt levels grow disproportionately to cash flow and result in a continuing increase in leverage (i.e., approaching lease-adjusted debt-to-EBITDAR of 3.0x), the ratings could come under pressure.

Note:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Consumer Products, which can be found on our website under Methodologies.

This is a Corporate rating.