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Demand for yield creates opportunity for KHC

| September 13, 2019

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

While the Kraft Heinz Company (KHC) needs to be reducing debt in order to bring leverage below 4.0x to stave off a downgrade to junk, management took advantage of new issue/yield demand to improve its maturity profile. KHC announced that it was tapping the debt market across the 10s/20s/30s maturities concurrently with the launch of a $1 billion tender for 2022-2025 paper and a $500 million partial redemption for its 2.8% 2020 notes. This is the second partial redemption announced this month for the 2.8% 2020 notes. Initial price talk on the new debt was very attractive at nearly 50 bp wide to existing debt, creating over $16 billion in demand across the tranches. KHC ultimately ended up pricing $3 billion in total at levels roughly 35 bp tighter from initial price talk. Strong demand for yield enabled KHC to allocate $1.5 billion to the 30-year tranche, while pricing $1 billion of a 10-year and $500 million of a 20-year. Subsequent to launching the new deal, KHC upsized its tender offer to $2.5 billion while maintaining the $500 million redemption, making the deal/tender leverage neutral.

The new deal/tender announcement comes on the heels of some debt reduction funded with asset sale proceeds. Most recently, KHC used proceeds from the sale of its Canadian Cheese business ($1.6 billion) to help fund the any and all tender of its 5.375% 2020 notes (of which $495 million were successfully tendered), as well as the redemption of its C$300 million 2.7% notes due 2020 and the $800 million partial redemption of its 2.8% 2020 notes. Between the tender/redemption announced this week as well as the debt reduction announced last week, KHC has made good progress in addressing its near term debt maturities, effectively buying them some time to come up with a strategy to stem the EBITDA decline and reduce leverage.

Exhibit 1: KHC 2020 debt maturity schedule

Source: KHC company filings, Bloomberg, Amherst Pierpont Securities

The Tender Offer

KHC launched a waterfall tender for $2.5 billion of bonds across four tranches of 2022-2025 debt with a combined $5.8 billion of principal outstanding.  The tender has acceptance priority levels with KHC prioritizing its shortest maturities. Tender levels seem to be in line with recent tender offers at approximately 20-to-25 bp tighter than pre-tender trading levels. It is important to note that tender spreads include a $3 point early tender premium per bond.  The early tender expiration date is set for 5pm NYC time on September 24, 2019, with the fixed tender spread reduced by the $3 point premium after the early tender expiration date.

Exhibit 2: KHC note tender – $2.5 tender cap

Source: KHC reports, Amherst Pierpont Securities

Leverage Remains High

Even with the recent debt reduction efforts, leverage remains high and is likely to remain elevated as debt reduction is not enough to offset the EBITDA deterioration.  On a last twelve months (LTM) basis ended 6/29/19, estimated leverage was roughly 5.0x. Absent any further EBITDA declines in 2H, leverage should decline to the 4.7x area at year end with the recent debt reduction. However with full year EBITDA guidance pulled in 2Q, street estimates are now calling for KHC to end the year with EBITDA of roughly $6.0 billion, down from the $6.28 billion on a LTM basis at 2Q. That said, EBITDA declines would fully offset the debt reduction as KHC would end the year with leverage of 5.0x.

While new management has reiterated its commitment to IG ratings, KHC will likely take the rest of the year to figure out a strategy to best approach its operational issues and leverage. Absent any asset sales or further cut to the dividend, debt reduction is likely to remain muted. Should KHC choose to rely on asset sales for further debt reduction, the company’s margin profile could further be pressured if they choose to sell good assets in an effort to receive better valuations.

Relative Value

With tender spreads on average 20-to-25 bp tighter than pre-tender trading levels, the tender is an attractive opportunity to reduce exposure to the KHC name. Holders looking to participate in the offer are strongly urged to tender their bonds before the early tender expiration date. Given the duration of the bonds being tendered, the $3 point early tender premium represents all of the premium and then some, making it counter intuitive to participate in the tender post the early tender expiration date.

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