DBRS Morningstar Confirms The Coca-Cola Company’s Issuer Rating at A (high) With a Stable Trend

DBRS Limited (DBRS Morningstar) confirmed The Coca-Cola Company’s (Coke or the Company) Issuer Rating at A (high) with a Stable trend. The rating confirmation acknowledges Coke’s solid operating performance in 2021 against the backdrop of an evolving Coronavirus Disease (COVID-19) pandemic. The Stable trend reflects DBRS Morningstar’s expectation that the Company will navigate the challenging operating environment presented by rising inflation, increasing labour costs, and supply chain disruptions in a manner that maintains its earnings profile. Coke’s rating continues to be supported by its strong brands, solid market positions, wide geographic footprint, and economies of scale. The rating also continues to consider the intense competitive environment in which the Company operates, its mature core markets and product categories, and ongoing changes to consumer preferences.

In 2021, revenue increased to approximately $38.7 billion and EBITDA to approximately $12.9 billion from $33 billion and $11.7 billion respectively in 2020, as volumes continued to recover and grow in geographies where pandemic-related uncertainty was abating. The topline and earnings also benefitted from pricing efforts and a favorable channel and package mix. This was partially offset and moderated by the impact of input and operating cost inflation and supply chain pressure, as well as higher marketing costs. In terms of the Company’s financial profile, free cash flow (FCF) after dividends and before changes in working capital was under $3 billion, as operating cash flow trended in line with earnings growth, while capital expenditure (capex) and dividends increased to approximately $1.4 billion and $7.3 billion, respectively. Coke’s liquidity also benefitted from working capital initiatives, which contributed approximately $1.3 billion in cash inflows, and net proceeds of $3.3 billion from the disposition of investments and equity method investments. The Company directed these cash flows toward acquisitions of approximately $4.8 billion, which primarily related to the acquisition of the remaining ownership interest in BA Sports Nutrition, LLC (BodyArmor). As a result of the combined benefit of EBITDA growth and relatively stable debt levels, lease-adjusted debt-to-EBITDA improved to 3.42 times (x) in 2021 from 3.79x in 2020.

DBRS Morningstar believes that Coke’s earnings profile will remain stable in the near to medium term, supported by its leading brands, geographic diversification, and efficiency-improving initiatives. DBRS Morningstar forecasts revenue to grow in the mid-single digits in 2022, as pricing initiatives will more than offset any volume declines. Coke will continue to take pricing actions in response to ongoing commodity, inflationary, and operating pressure, which DBRS Morningstar anticipates will have a modestly negative effect on volumes. That said, DBRS Morningstar believes that the continued normalization in consumption in line with global population mobility will moderate these volume declines. The topline will also benefit from Coke’s 100% stake in BodyArmor. DBRS Morningstar believes that EBITDA margins will remain pressured by inflationary pressure in the near term, notwithstanding price increases, the benefit of a shift in channel and package mix, and ongoing cost-cutting, portfolio streamlining, and productivity-improving initiatives. Consequently, DBRS Morningstar forecasts EBITDA to be approximately $13.5 billion in 2022. In the medium term, DBRS Morningstar forecasts EBITDA to grow toward $15 billion, on the back of input and operating cost relief and efficiency improving initiatives.

The forecast growth in operating income and corresponding cash flow will strengthen Coke’s financial profile and improve credit metrics in the medium term. DBRS Morningstar forecasts FCF after dividends and before changes in working capital to grow toward $3 billion in 2022, as operating cash flow continues to trend in line with earnings growth, capex increases to $1.5 billion, and the Company continues to grow its dividend outlay. DBRS Morningstar expects Coke to direct its FCF after changes in working capital, and proceeds from refranchising certain Asia Pacific bottling operations, for share repurchases of $500 million and to invest in growth, while maintaining stable debt levels. As EBITDA is expected to increase modestly from 2021 levels, DBRS Morningstar forecasts lease-adjusted debt-to-EBITDA to be approximately 3.30x in 2022, and to improve to approximately 3.00x in the medium-term based primarily on the expected growth in EBITDA. Should credit metrics deteriorate for a sustained period as a result of weaker-than-expected operating performance and/or more aggressive financial management, the rating will be pressured. Although unlikely, DBRS Morningstar could take a positive rating action should the Company’s business risk profile meaningfully strengthen and credit metrics improve on a normalized and sustainable basis.

DBRS Morningstar notes that, in late 2020, the United States Tax Court (the Tax Court) ruled in favour of the Internal Revenue Service (IRS) regarding its dispute with Coke over the latter’s transfer pricing policy. Consequently, Coke is liable for the payment of approximately $3.3 billion of additional federal income taxes for the 2007–09 period plus interest, which the Company estimates could aggregate to approximately $4.9 billion (including interest accrued through December 31, 2021), plus additional interest accrued through the time of payment. The Company intends to appeal the Tax Court’s decision on the basis that the transfer pricing methodology applied by the IRS to Coke’s 2007–09 tax years was different to the methodology previously agreed to and audited by the IRS. Coke must settle the tax and interest liability upfront, of which some or all would be refunded should the Company prevail on appeal. As the payment date is uncertain, DBRS Morningstar excluded the impact thereof from its outlook. Should payment be required in the near to medium term, the Company’s deleveraging strategy could be delayed. That said, DBRS Morningstar expects that, through its operating performance and financial management, the Company’s credit metrics should subsequently improve. If the Tax Court’s decision is ultimately upheld and the new transfer pricing methodology is applied to subsequent years, Coke estimates a $13 billion aggregate incremental tax liability (inclusive of interest) for all years up to and including 2021.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodology is Rating Companies in the Consumer Products Industry (July 26, 2021; https://www.dbrsmorningstar.com/research/382072), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 03, 2021; https://www.dbrsmorningstar.com/research/373262.)

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at [email protected].

This rating was not initiated at the request of the rated entity.

The rated entity or its related entities did not participate in the rating process for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

This is an unsolicited credit rating.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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