The Kraft Heinz Company (KHC) sold US$3bn of new bonds in three parts Monday in large part to help pay down certain outstanding debt, while high leverage, coupled with declining revenues and M&A-related event risk, continue to pressure the company’s stock.

In mid-morning trading activity Tuesday, shares of KHC had fallen more than 1% to around US$57.80 after plunging over 38.4% year-on-year. The value of KHC stock has also dropped close to 37.25% against the Invesco Dynamic Food & Beverage ETF (PBJ) over about the same period. 

KHC has been struggling with elevated leverage levels since the Kraft-Heinz tie-up closed in July 2015. While the merged entity has managed to lower its position from about 5x to a little more than 4x in 2017, its hefty debt burden continues to weigh on its balance sheet.

At the end of December 2017, KHC’s total debt amounted to more than US$32bn.

(Click on image to enlarge)

To help it meet its payment obligations, the Chicago-headquartered company said it intends to use the proceeds from its US$3bn note sale to repay certain U.S. dollar and Canadian dollar-denominated debt, as well as to help wind-down its domestic securitization program, refinance commercial paper and for other general corporate purposes.

Bond buyers lured by shorter-end of curve

Demand for the new ‘BBB’-rated, 3-, 5- and 10-year bonds was decent, with the majority of buyers focused on the shortest-dated tranche.

Indeed, most investors flocked to the firm’s US$300m of 3.375% 3-year notes, which saw a massive US$1.5bn in orders. The spread on the issuance, due June 15, 2021, compressed by 20bps from initial price talk to 75bps more than comparable U.S. Treasuries.

The offering was priced against the benchmark 2.625% 3-year US Treasury note, with a yield to maturity of 3.402%.

While less in demand, the company’s 5-year and 10-year notes managed to muster oversubscription rates of more than 1.5x each, with 5-10bps of spread tightening over the course of their pricing evolution.

Overall, bond investors continue to reach for the yield offered in the investment-grade corporate primary market.

For the week ended May 30, high grade corporate funds saw inflows of almost US$850m, contributing to the more than US$43.82bn of inflows in 2018, year-to-date.

Credit profile challenges

Meanwhile, KHC’s bond sale comes amid a recent fall in revenues and slowing growth, as the U.S. consumer staples sector generally suffers from higher commodities costs, and as premium brands contend with discount retailers.

Strategists at Janney Montgomery recently noted that concerns in the industry generally center on better economic growth and higher interest rates, which are causing a rotation out of defensive bond surrogates. Also, while pricing power for premium brands is being challenged by online and discount retailers, they added “steady growth and high dividends make this sector an appealing anchor.”

However, other analysts point out that KHC’s hefty dividend has resulted in little or no free cash flow, and with its high leverage, the company will likely need to use cash or sell assets to cut debt.

At the end of December 2017, KHC held roughly US$1.6bn in cash – 68.75% of which was based overseas – as well as US$3.5bn available under its US$4bn senior unsecured revolving credit facility.

Included in its debt load at the end of March 2018, the company had US$500m outstanding in connection with the wind-down of its U.S. securitization program, as well as US$965m of commercial paper indebtedness outstanding.

Although KHC’s leverage is likely to remain in the area of 4x over the near to medium term, market participants widely anticipate the pursuit of another acquisition following its failed US$143bn bid for Unilever (UL) in early 2017.

According to Fitch Ratings, the “Unilever overture affirmed Kraft Heinz's interest in seeking greater scale, geographic expansion and cost-cutting opportunities that could offset the challenging organic top-line growth environment, but would have delayed Kraft Heinz's deleveraging timeframe.”

KHC posted a 2.6% fall in its Q1’18 adjusted EBITDA from the same year-ago quarter to US$1.8bn, which the firm mainly attributed to higher input costs, lower volume/mix and strategic initiatives.Net sales declined 0.3% year-on-year to US$6.3bn.

Rising input costs

In the meantime, investors have also been closely watching certain agricultural commodity-linked companies such as KHC, General Mills (GIS), Kellogg’s (K), Mondelez International (MDLZ), Campbell Soup (CPB) and Archer Daniels Midland (ADM) as U.S. interest rates notch higher.

Some U.S. agriculture industry experts note American farmers, having been accustomed to cheap debt after the Fed rolled out its unprecedented economic stimulus measures about ten years ago, are now struggling to combat declining profits and liquidity. Many think the farm sector’s profitability could further be dented as debt servicing costs increase alongside rising interest rates – especially as the central bank continues to unwind its accommodation.

Continued farm-related profit deterioration could spur even higher prices of certain commodities such as wheat and corn, which would likely have an adverse impact on the consumer staples sector.

Tightening in some firms’ CDS levels intraday Tuesday indicated the market’s perception of the industry’s creditworthiness is likely to improve after a bout of spread widening over the past three months.

Recent quotes on 5-year CDS spreads on certain commodities-linked companies:

Cash spreads in the consumer staples sector remained flat on the day Tuesday at an OAS of 98bps. All cash bonds widened around 0.5bps, while the IG CDX index – a gauge of credit market sentiment – widened by almost 1bp on the day to roughly 64.8bps.