DBRS Morningstar Changes Trend on The Coca-Cola Company to Stable from Negative, Confirms Issuer Rating at A (high), and Discontinues and Withdraws the Short-Term Issuer Rating

DBRS Limited (DBRS Morningstar) changed the trend on The Coca-Cola Company’s (Coke or the Company) Issuer Rating to Stable from Negative and confirmed the rating at A (high). DBRS Morningstar also discontinued and withdrew Coke’s Short-Term Issuer Rating. The discontinuation does not reflect any change in DBRS Morningstar’s view of the Company’s credit quality. The trend change reflects Coke’s stronger-than-expected 2020 operating results and DBRS Morningstar’s view that, while there are still uncertainties relating to the pace of the global distribution of the Coronavirus Disease (COVID-19) vaccine, relaxation of virus containment measures, and the macroeconomic aftereffects, the Company is now well placed to navigate the current environment within the A (high) rating category without the need for materially stringent capital conserving measures. Coke’s ratings continue to be supported by its strong brands, solid market positions, and geographic diversification as well as its large size, scale, and efficient operations. The ratings also continue to consider the intense competitive environment in which the Company operates, its mature core markets and product categories, and ongoing changes to consumer preferences.

On May 7, 2020, DBRS Morningstar changed the trend on Coke’s Issuer Rating to Negative from Stable and confirmed the Issuer Rating at A (high). The trend change reflected DBRS Morningstar’s expectations at the time that the pandemic and related macroeconomic aftereffects would pressure Coke’s business risk profile and that key credit metrics would deteriorate beyond the level considered appropriate for the current rating category for an extended period.

As expected, Coke’s topline and earnings were pressured by the contraction in demand from the away-from-home channel and a change in mix to multiserve packs in 2020, which was partially offset and moderated by the Company’s cost-cutting, portfolio streamlining, and productivity improving initiatives. The Company increased its stake in fairlife, LLC (Fairlife) to 100% from 57.5% in 2020, which also benefitted earnings. Consequently, EBITDA declined to approximately $11.7 billion in 2020 from approximately $12.2 billion in 2019. In terms of the Company’s financial profile, free cash flow (FCF) after dividends and before changes in working capital decreased to less than $1.0 billion in 2020 from approximately $1.2 billion in 2019. This was attributable to lower operating cash flows which trended in line with the contraction in earnings and an increase in the dividend outlay to just over $7.0 billion from approximately $6.8 billion in 2019, while capital expenditure (capex) decreased to approximately $1.2 billion from just over $2.0 billion in 2019 as Coke deferred discretionary capex. The Company also refrained from share buybacks to further preserve liquidity. Coke applied its internally generated cash flows and available liquidity to finance acquisitions of approximately $1.05 billion, of which approximately $979.0 million related to the Fairlife acquisition, and repaid approximately $1.9 billion of net debt. Debt-to-EBITDA weakened modestly as EBITDA declined by a greater proportion than the reduction in debt, and persisted at levels relatively high for the current rating.

DBRS Morningstar believes that the ongoing impact of the coronavirus pandemic and related containment measures, coupled with the global availability of vaccines, will influence Coke’s earnings trajectory in the near term. The Company’s away-from-home volumes will continue to trend in line with population mobility and should recover by the second half of 2021 as the dissemination of vaccines gains momentum globally. Consequently, DBRS Morningstar forecasts revenue to increase in the mid-single digits in the near term. DBRS Morningstar believes that EBITDA margins will modestly decline in 2021 due to the impact of commodity and operating cost inflation and exchange rate volatility. The anticipated margin contraction as a result of these factors is expected to more than offset margin growth from a shift in channel and package mix. While margins should also continue to benefit from the Company’s ongoing cost-saving and productivity improving initiatives, some cost outlays that were temporarily suspended in 2020 should resume as the Company’s operations normalize. As such, DBRS Morningstar forecasts EBITDA to increase to more than $12.1 billion in 2021. Thereafter, DBRS Morningstar expects EBITDA to grow above $12.6 billion as the impact of the coronavirus pandemic on channel and package mix normalizes and earnings continue to benefit from operating leverage.

The anticipated growth in operating income and corresponding cash flow will strengthen Coke’s financial profile and key credit metrics. DBRS Morningstar forecasts FCF after dividends and before changes in working capital to be more than $1.5 billion in 2021, as operating cash flows trend upward as earnings rebound, capex increases to approximately $1.5 billion, and the Company continues to grow its dividend outlay. DBRS Morningstar anticipates that, in the near term, Coke will use its FCF and available liquidity to continue to pursue acquisitions that enhance its product portfolio, including the planned acquisition of a controlling stake in BA Sports Nutrition, LLC which produces BodyArmor, a premium line of sports performance and hydration drinks. That said, DBRS Morningstar expects leverage to improve toward 3.5 times (x) from current highs over the near to medium term, based primarily on the expected growth in operating income. Should leverage remain high for the A (high) rating as a result of weaker-than-expected operating performance and/or more aggressive financial management, the ratings will be pressured. Although unlikely, a positive rating action could be influenced by a material reduction in leverage below 3.0x on a normalized and sustainable basis, based primarily on the growth in operating income.

DBRS Morningstar notes that, in late 2020, the United States Tax Court (the Tax Court) issued an opinion in favour of the Internal Revenue Service (the 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 $4.6 billion. 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 $12 billion aggregate incremental tax liability (inclusive of interest) for all years up to and including 2020.

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 methodologies are Rating Companies in the Consumer Products Industry (July 30, 2020; https://www.dbrsmorningstar.com/research/364690/rating-companies-in-the-consumer-products-industry) and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 2, 2020; https://www.dbrsmorningstar.com/research/369167/dbrs-morningstar-criteria-rating-corporate-holding-companies-and-parentsubsidiary-rating-relationships), 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 3, 2021; https://www.dbrsmorningstar.com/research/373262).

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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 info@dbrsmorningstar.com.

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 info@dbrsmorningstar.com.

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