Fitch Rates Kellogg's $1.45 Billion Senior Unsecured Notes 'BBB+'

Fitch Ratings has assigned a 'BBB+' rating to Kellogg Company's (Kellogg) $1.45 billion senior unsecured notes issuance in the following tranches:

--$350 million due in 2015;
--$400 million due in 2017; and
--$700 million due in 2022.

Kellogg's Rating Outlook is Negative.

Kellogg intends to use the net proceeds from this debt issuance to finance a portion of the acquisition of Procter & Gamble's Pringles business (Pringles) for approximately $2.7 billion. The acquisition is expected to close by mid-2012, pending regulatory approval. Kellogg's financing of Pringles is also expected to include other new long and short-term debt and a portion of Kellogg's $404 million cash and cash equivalents at March 31, 2012.

The new notes contain a Change of Control Repurchase Event. Upon the occurrence of both a Change of Control and rating downgrades below investment grade, unless Kellogg exercises its right to redeem the notes, the company will be required to make an offer to purchase the notes at a price equal to 101% of the aggregate principal amount plus accrued and unpaid interest. The notes were issued under a new indenture, which contains limitations on liens and sale-leasebacks but does not contain financial covenants.

Pringles will significantly enhance Kellogg's existing snacks business, which is primarily in North America, and provide it with a stronger platform for product and geographic expansion. Pringles generated sales and EBITDA of $1.5 billion and $243 million, respectively, in 2011 across 140 countries. Fitch estimates that Pringles will add about six months of sales to Kellogg but little if any operating earnings in 2012 due to one-time costs to achieve synergies and Kellogg's planned investment in this business for future growth. Kellogg estimates it will spend approximately $160 million to $180 million one-time costs to achieve annual synergies of $50 million to $75 million by 2014. Fitch believes these goals are achievable and that most of the costs will be incurred in 2012 and 2013.

Kellogg's ratings incorporate its #1 and #2 market share positions, strong brand equities, and ample liquidity. The company is diversified geographically, with nearly 40% of 2011 sales generated outside of the United States. However, Kellogg has significant exposure to slow-growing, mature markets and modest exposure to faster growing emerging markets. Although Pringles will provide Kellogg with a vehicle to expand Kellogg's snacks business to emerging markets, Pringles also generates approximately 70% of its sales in mature markets in Western Europe and North America, where Kellogg's is incurring operating earnings declines.

The ratings also reflect Fitch's view that operating earnings growth beyond 2012, combined with significant debt reduction from free cash flow, could restore leverage near pre-acquisition levels within two years of the acquisition closing. Kellogg has committed to reduce debt by refraining from share repurchases beyond offsetting the dilution from stock option exercises, in order to focus on debt reduction.

The Negative Outlook reflects that near-term leverage (total debt to operating EBITDA) of slightly more than 3.0 times (x) will be high for the rating level and a significant increase from 2.5x for the latest 12 months ended March 31, 2012. The Outlook also considers that Kellogg's debt reduction plans may be impeded by current operational challenges, significant reinvestment in its supply chain and the Pringles integration. These factors are compounded by persistently high commodity inflation, with 7% inflation anticipated in 2012, macroeconomic uncertainty, and some consumer resistance to recent food price increases.

A one notch downgrade could occur if Kellogg's operating performance, which factors in the company's recently lowered guidance, substantially deteriorates from current expectations, or if debt reduction is slower than anticipated, resulting in leverage that is likely to be at or near 3.0x in mid-2014. A downgrade could also occur if Kellogg becomes more aggressive with share repurchases or acquisitions. Conversely, Fitch could revise the Outlook to Stable if Kellogg's operating earnings trends show sustainable improvement, or if debt reduction occurs at a faster rate than anticipated so that leverage appears likely to be sustainable in the mid-2x range by mid- 2014.

Kellogg recently revised its top line and earnings expectations downward for 2012, reflecting weakness in its core ready-to-eat cereal business in Europe and the U.S., primarily due to recently implemented price increases that are receiving a tepid response from consumers. Kellogg currently anticipates internal operating earnings (excluding currency and acquisitions/divestitures) to fall 2% to 4% in 2012, after a 3% decline in 2011 and flat results in 2010. Kellogg's guidance also incorporates approximately $100 million in permanently higher level of investment in its supply chain after it had cut back too far in previous years.

The company's ample free cash flow (FCF, cash flow from operations less capital expenditures and dividends) has averaged almost $400 million annually during the past five years. Excluding pension and postretirement contributions, which have been substantial, FCF has averaged almost $700 million annually for the same period. Fitch anticipates that Kellogg can return to this level of FCF in 2014 or 2015, but in the near-to intermediate term heightened capital expenditures, earnings pressure, reinvestment in Pringles and cash costs to achieve synergies will reduce cash flow significantly.

Kellogg's sizeable liquidity includes $2 billion available on its unutilized revolving bank facility expiring in March 2015 and $404 million of cash and cash equivalents. Kellogg plans to utilize a substantial amount of its cash for the Pringles acquisition. On March 16, 2012, Kellogg also entered into an unsecured 364-day term loan agreement which will allow the company to borrow up to $1 billion to partially fund the acquisition and to pay related fees and expenses. Kellogg's total debt at March 31, 2012 was $5.8 billion. Pro forma for the transaction Kellogg's debt will be approximately $8 billion.

Kellogg's upcoming debt maturities include $750 million 5.125% notes due Dec. 3, 2012 and $750 million 4.25% notes due March 6, 2013. Debt reduction over the next two years could include a portion of these maturities and debt that will be issued for the Pringles deal.

Fitch rates Kellogg and its subsidiaries' as follows:

Kellogg
--Long-term Issuer Default Rating (IDR) 'BBB+';
--Senior unsecured debt 'BBB+';
--Bank credit facility 'BBB+';
--Short-term IDR 'F2';
--Commercial paper (CP)'F2'.

Kellogg Europe Company Limited
--Long-term IDR 'BBB+';
--Short-term IDR 'F2';
--CP 'F2'.

Kellogg Holding Company Limited
--Long-term IDR 'BBB+';
--Short-term IDR 'F2';
--CP 'F2'.

The Rating Outlook is Negative.

Additional information is available at www.fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 12, 2011).

Applicable Criteria and Related Research:
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229

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