Fitch Ratings has downgraded Nestle SA’s (Nestle) long-term issuer default ratings (IDR) and senior unsecured ratings to ‘AA-‘ from ‘AA’, and affirmed the company’s short-term IDR at ‘F1+’. However, the company’s outlook on the long-term IDR remains stable.
The downgrade follows Nestle’s announcement of a CHF20 billion share buy-back programme commencing from 4 July 2017.
This, according to Fitch would increase funds from operations (FFO) adjusted net leverage to around 2.2x by 2020 and reduce free cash flow (FCF) margin to an average of 2.7%, which will weaken the group’s financial flexibility.
Fitch expects the company’s operating environcment to remain challenged by innovation, changing consumer habits and slowing organic growth.
The rating agency says the ratings of Nestle continue to reflect the stability and strength of its business as the world’s largest food company, benefiting from scale and geographic diversification.
“The group is well-placed to continue defending its operational scale and market share, despite more subdued growth potential and changes in supply chain dynamics, and to improve margins, thus supporting our stable outlook,” Fitch noted.
One of the key drivers of the ratings include weakened financial profile from its announced share buy-back.
“We expect Nestle to fund the announced share buyback programme predominantly from debt, which will increase FFO adjusted net leverage to 2.2x by 2020, above our negative guidance of 2.0x,” fitch stated, adding “such leverage is not commensurate with a ‘AA’ rating, supporting a downgrade of the rating by one notch to ‘AA-‘. In our rating case projections, we also factor in the sale of Nestle’s US confectionary business in 2018.”
Another rating driver is scope of Nestle to grow profit margins as Fitch conservatively expects profit margins to increase only moderately by 2020.
“In line with its peer Unilever NV/PLC (A+/Negative), we expect Nestle to be able to identify cost efficiencies and to achieve some margin uplift. However, this will likely take time to deliver and involve execution risk.” It said.
Fitch, however, estimates that FFO margin will decline to 14 percent through to 2020 from an average of 15 percent during 2012-2016 due to higher cash interest and tax costs. This, together with by capex (including intangibles) remaining above five percent of sales, will constrain FCF margin (after dividends) to an average 2.7 percent over 2017- 2020, below our prior negative sensitivity of percent.
Other rating drivers include softening in organic revenue growth, solid business profile, business stability and foreign exchange volatility.
“We expect overall group revenue growth to be lower in the range of three to four percent over 2017-2020 due to a structural shift towards healthier foods, changing consumer habits and increasing competition.”
Nestle has revised down its organic growth target for 2017 to two – four percent and to mid-single digits by 2020, from its historical long-term target of five to six percent.
Fitch stated that Nestle’s organic growth performance remains at the top end of major fast-moving consumer goods peer group and the group continues to achieve market share gains in several categories and countries, keeps Nestle’s business risk profile in line with the ‘AA’ rating category for the sector.
Nestle is well-positioned as the largest food company in the world by revenue and profit and enjoys balanced geographical diversity between developed and emerging markets. The announced CHF20 billion share buyback programme weakens Nestle’s financial profile, which is now more commensurate with a ‘AA-‘ rating relative to other sector peers. No country-ceiling, parent/subsidiary or operating environment aspects impact the ratings.
Frontpage August 22, 2019