S&P Downgrades Coca Cola (KO) to 'AA-'; Outlook Stable

(Updated - February 25, 2016 2:04 PM EST)

Standard & Poor's Ratings Services today lowered all of its long-term ratings on The Coca-Cola Co. (NYSE: KO), including the corporate credit rating to 'AA-' from 'AA'. We also affirmed our 'A-1+' short-term and commercial paper ratings on the company. The outlook is stable. Debt outstanding as of Dec. 31, 2015, was $44 billion.

"The downgrade reflects our opinion that the projected deleveraging we anticipate from Coke's bottler refranchising over the next two years will not be sufficient to support an 'AA' rating," said Standard & Poor's credit analyst Chris Johnson.

Standard & Poor's expects Coke to reduce debt primarily with bottler divestiture proceeds, while steadily building cash balances as its free cash flows exceed projected dividend and share repurchases. This should result in a ratio of debt to EBITDA approaching 2x over the next two years, while funds from operations (FFO) to debt improves to closer to 40%. Although these projected ratios are improvements from our estimates of about 2.6x and 30%, respectively, for fiscal year-end 2015, they are weaker than our expectations for the 'AA' ratings, which included debt to EBITDA below 2x and FFO to debt above 45% by 2017.

Once the company refranchises its bottling operations we do believe its debt to EBITDA will be sustained near 2x and possibly lower. We believe a sustained low-2x debt to EBITDA post refranchising supports a higher rating than indicated by Coke's business and financial risk profile. Therefore, the 'AA-' corporate credit rating includes a one notch favorable adjustment to reflect our expectations that debt to EBITDA will be sustained at the very low end of the 2x to 3x range that supports the company's financial risk profile once the refranchising is complete.

The stable outlook reflects our expectation that the company will maintain fairly stable operating income as operating costs decline with the company's bottling divestitures, reduce debt with bottler sale proceeds, and improve debt to EBITDA to closer to 2x over the next two years. During this time we anticipate the company will make annual dividends and share repurchases of at least $8 billion while reducing adjusted net debt by at least $4 billion. Based on the uncertainty surrounding the actual timing of any bottler sale proceeds, we expect the anticipated deleveraging to be uneven, with leverage possibly staying near 2.5x for several quarters prior to improving.

We could lower the ratings if the company does not execute as planned on its refranchising and productivity plans over the next two years while materially increasing shareholder returns, such that debt to EBITDA remains near or above 2.25x by the second half of fiscal 2017. Assuming the company receives the anticipated sales proceeds from its bottler divestitures, we estimate debt to EBITDA could still remain above 2.25x if the company doubles its announced share repurchase intentions to $4 billion and EBITDA margin expansion falls 200 basis points short of our anticipated near-10% margin expansion once the bottlers have been divested. If we lower the long-term rating to 'A+' we would also lower the short-term, commercial paper rating to 'A-1'.

We could raise the ratings if the company reduces debt as anticipated over the next two years and commits to maintaining debt to EBITDA well below 2x thereafter. However, we do not anticipate this occurring within the next two years because we do not believe the company will repay the requisite debt to achieve ratio levels appropriate for a higher rating until its refranchising is complete.

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