Fitch Ratings places ratings of Kellogg and its subsidiaries on watch negative following company's agreement to acquire Pringles brand from P&G

Nevin Barich

NEW YORK , February 16, 2012 (press release) – Fitch Ratings has placed the ratings of Kellogg Company (Kellogg) and its subsidiaries, as indicated below, on Rating Watch Negative following Kellogg's agreement to acquire Procter & Gamble's (P&G) Pringles business for $2.695 billion in a primarily debt financed transaction.

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 Watch will be resolved when Fitch obtains additional information regarding Kellogg's financing plans and the pace of debt reduction over the next 18 to 24 months. Fitch estimates pro forma leverage of slightly above 3.0x, which is a material increase from 2.5x estimated for the year ended Dec. 31, 2011, particularly during a time of macroeconomic uncertainty and increasing commodity costs. Fitch believes that any potential downgrade would be limited to one notch. Kellogg has committed to reduce debt significantly by refraining from share repurchases beyond offsetting the dilution from stock option exercises, estimated at less than $200 million annually, in order to focus on debt reduction. If Fitch's review shows that debt reduction would result in restoration back to mid-2x leverage within 18 to 24 months of the transaction closing it would support affirmation of the current ratings.

Pringles generated sales and EBITDA of $1.5 billion and $243 million, respectively, in 2011 across 140 countries. The transaction willbe financed with new debt issuance and a portion of Kellogg's $460 million cash balance at Dec. 31, 2011. The $2.695 billion purchase price represents approximately 11 times (x) latest 12-month (LTM) EBITDA and approximately 9x EBITDA net of tax benefits and working capital estimated at $490 million. Pringles will significantly enhance Kellogg's existing snacks business and expand its global diversification. The companies expect to complete the transaction this summer, pending regulatory approval.

Kellogg's ratings incorporate its leading market share positions, strong brand equities and high margins for the packaged food industry. The company is diversified geographically, with nearly 40% of sales generated outside of the United States (prior to Pringles). However, Kellogg has significant exposure to slow-growing, mature European markets and little exposure to faster growing emerging markets. Kellogg's ample historical free cash flow (FCF) (cash flow from operations less capex and dividends) averaged more than $500 million annually from 2006-2009. In 2010 FCF dropped primarily due to large pension contributions to improve funding levels. In 2010 FCF was negative $50 million including $643 million pension and post-retirement contributions. FCF improved in 2011 back to $397 million, including approximately $200 million of pension contributions. Fitch expects that pension and postretirement contributions will be modest while Kellogg concentrates on debt reduction

Kellogg restored top-line growth in 2011 with sequentially higher price realization. Internal net sales growth (price/volume/mix) was 4.5%, generated entirely from higher price/mix as volume was flat. This is adequate performance given the high inflationary environment. Internal operating profit was down 2.9% for the year, which was within the company's guidance. Kellogg's benefit from lapping the company's cereal box liner recall and Eggo supply chain disruption in 2010 was more than offset by commodity cost inflation, supply chain reinvestment and restoring incentive compensation back to target levels. The company's input cost inflation is expected to remain elevated for a second year in 2012.

Kellogg's liquidity includes $460 million of cash and cash equivalents, which is primarily located overseas, at Dec. 31, 2011. This acquisition will allow Kellogg to efficiently utilize overseas cash for debt reduction. The company's committed unsecured credit facility expiring in March 2015 is undrawn. This credit facility allows the company to borrow up to $2 billion and obtain $75 million of letters of credit. Kellogg's total debt at Dec. 31, 2011 was $6 billion, up significantly from $4.9 billion at Jan. 2, 2010.

Fitch believes Kellogg is likely to pay down a portion of upcoming debt maturities, which include $750 million 5.125% notes due Dec. 3, 2012 and $750 million 4.25% notes due March 6, 2013.

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