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 its related entities (collectively, Kellogg or the Company) at A (low) and R-1 (low), respectively. The trends are Stable. The Company has maintained strong financial performance despite a challenging economic environment. Underpinning the rating is Kellogg’s strong portfolio of brands and market positions (the world’s largest breakfast cereal company and second largest cracker company), large scale and improving product and geographic diversification.

The weaker global economic environment increased the stress level on consumers, which translated into moderating top-line growth in F2009. Overall internal sales (which exclude the impact of acquisitions, shipping day differences and foreign exchange) grew by 3.0% in F2009 year over year (yoy), which is in line with 2009 guidance, compared with 5.4% in F2008 yoy. The increase in overall sales was driven by pricing/mix, but it was partly offset by declines in volume brought on by operational difficulties in the United States and shifts in business from lower-margin products to higher-margin branded products in Russia and China. The largest impact on sales growth was in North America, which represents approximately 67.7% of total F2009 sales.

Gross margins improved by approximately 100 basis points in F2009 as a result of product pricing/mix improvements, savings from productivity and technological initiatives, commodity hedges and fixed-price contracts to offset or reduce the cost of product ingredients and packaging. The Company was able to generate significant cost savings ($400 million in F2009) through its three-year, $1 billion cost-savings program, starting in F2009. This helped the Company’s overall operating profit on an internal basis grow by 10.3% yoy compared with 4.2% in 2008 yoy.

The Company continued to generate solid net free cash flow in F2009 as a result of higher earnings, lower capex spending and no acquisitions during the year, which was partly offset by working capital and slightly higher dividends. The Company issued $1.25 billion in debt securities during the year, which enhanced its financial flexibility, and opted to use its free cash flow to reduce its commercial paper balances to zero, improving coverage metrics yoy and keeping its financial profile commensurate with the current rating. The Company’s liquidity remained strong at the end of Q1 2010, with strong cash balances of $387 million and full availability under its credit line of $2.3 billion. This is more than sufficient to meet upcoming maturities in F2011.

Going forward, DBRS believes that pricing/mix improvements, volume increases, stable commodity costs and benefits from cost-reduction initiatives will continue to support the Company’s guidance of internal net sales growth of 2% to 3% and operating earnings growth of 8% to 10% on a currency-neutral basis. Volumes are expected to increase once operational issues have been resolved, and capacity is restored and additional capacity is brought online. However, these estimates may be negatively affected by the June 2010 voluntary product recall of certain cereals. DBRS does not expect the financial impact of the recall to be material to overall results. However, if the impacts of the recall are substantially higher than anticipated, this could lead to a negative rating action.

Despite expected higher cash flow from operations, free cash flow is expected to remain at levels comparable with 2009 because of higher capex and dividend spending. Kellogg plans to spend approximately 33% more in capex during 2010 to expand manufacturing capacity and enhance information technology. The Company also announced an 8% dividend increase commencing in Q3 2010.

Kellogg is not expected to use cash flow for any meaningful debt reduction but rather to buy back shares during the year. In early F2010, the Company announced a three-year, $2.5 billion share repurchase program (January 1, 2010, to December 31, 2012) to replace existing programs. Debt levels are expected to stay relatively constant in F2010 relative to F2009 as the Company generally keeps acquisitions and share repurchases in line with free cash flow. As well, DBRS expects that the Company will be judicious in its share repurchase such that metrics will continue to stay in line with the current rating category.

Notes:
The Kellogg Company guarantees commercial paper issued by Kellogg Canada Inc., Kellogg Europe Company Limited and Kellogg Holding Company Ltd.

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 (Consumers) rating.