The “57 Varieties” on ketchup bottles mean nothing – Henry Heinz simply thought it was a lucky number…..
Shortly after the Kraft Heinz merger was completed in 2015, the company issued approximately $12bln of new debt in the credit markets to help finance the transaction. At the time, management was very clear with would-be credit investors in stating that the retention of an investment grade rating was not only desirable, but also necessary given the quantum of the company’s debt relative to the size of the high yield market.
However, last Friday, following another set of mediocre operating results and a failure to take remedial action such as cutting the dividend, both S&P and Fitch Ratings finally lost patience and downgraded the company to high yield. With approximately $28bln of debt outstanding, the market reaction was relatively severe, with long-dated dollar bonds as much as 10% lower in price. Such a move confirms that Kraft Heinz is indeed a substantial pill for the high yield market to swallow, particularly given the $10bln or so of debt maturing beyond 10 years. There is low appetite in the market to lend to riskier companies for such long periods.
It also confirms the importance of not only assessing the credibility of a company’s strategy, but also understanding the commitment and incentives of management and stakeholders. Lower interest rates and compressed credit spreads mean that for the company, the incremental cost of operating as a high yield company – rather than an investment grade one – is lower than it was in 2015. This compression in spreads (between the high yield and investment grade markets) has clearly altered management’s priorities. The company’s ongoing travails in adjusting its offering in a world of rapidly changing consumer tastes will obviously present an ongoing challenge to management although concerns over the strategic direction of the business will no doubt be assuaged in some corners of the equity market by the board’s willingness to maintain a generous dividend.
So what are the lessons for the bond market from this episode? What constituted an efficient balance sheet in 2015 is clearly not the same for some corporate treasurers in 2020. Assessing that changing market dynamic – and by definition how it can influences corporate behaviour – is integral to our ESG analysis and overall investment process at Kames, and one of the main reasons we didn’t have exposure to any of the 57* varieties of this credit.
*there are actually 58 bonds outstanding according to Bloomberg.