The fall of Kraft Heinz to high-yield is a worst-case scenario for investors who put their faith behind liability management exercises that were expected to save it from such a fate.
In 2019 companies such as Kraft were praised for their ability to issue long-dated debt that funded tender offers for shorter maturities.
This was supposed to give them a runway to grow sales, sell assets and cut dividends as a way to deleverage and ultimately maintain investment grade ratings.
Bondholders gladly participated in those liability management trades based on those expectations.
But with Kraft falling into junk territory last week some investors are regretting such assumptions and questioning the long-term strategies of Kraft and other issuers on the cusp of junk ratings.
"Was that a prudent move by a company to manage its front-end maturities or was it a move to prepare itself to exist and live as a high-yield company without investment-grade ratings?" asked Jason Shoup, head of global credit strategy at Legal & General Investment Management America.*
"We don't know yet, but Kraft Heinz illustrates that there are examples of the latter out there."
Before Fitch and S&P dropped Kraft's nearly US$30bn of debt to BB+ earlier this month, the company priced a US$3bn three-part bond in September to part-refinance close to US$10bn in short and medium-term debt.
Despite credit concerns, order books swelled to US$16.2bn in part because former CFO David Knopf said in an earnings call that the company was committed to its investment-grade ratings and that it had sufficient cashflows to deleverage and pay dividends.
"If you had told those same investors [from September], ‘We might not be committed to investment grade', the cost at which they extended that debt and created that runway would have been totally different," Shoup said.
"Any creditor wants to make sure companies are able to do things to enhance their creditworthiness and removing front-end debt tends to do that. But if at the same time that removes an incentive to remain investment grade we’ll have to be very careful about doing that in the future."
Kraft's liability management exercises reduced its debt maturities to US$1bn in each of 2020 and 2021 with another US$2.1bn maturing in 2022, according to CreditSights.
Ultimately such moves have left the company in a comfortable position to handle short-term maturities as a high-yield credit, Barclays analysts said in a research note.
Kraft generated free cashflow of US$1.05bn last year and held US$2.3bn on hand at the end of the year to cover its maturities, the report added.
And Kraft has been reiterating a similar mantra, only without its commitment to an investment grade.
“We believe it's important to Kraft Heinz shareholders to maintain our dividend during this time of transformation," Michael Mullen, SVP of corporate affairs, said in response to questions about investor concerns.
"We also remain committed to reducing leverage over time as we reposition the company for sustainable growth and returns.”
Indeed, clinging to an investment-grade rating may have made little sense for Kraft given the buoyant backdrop for junk credits.
With the BBB-BB spread differential hovering at 73bp, near post-financial crisis lows, according to ICE BofA data, the cost of a downgrade to junk has become less painful.
Even so, other companies seem less willing to forgo their investment-grade rating.
Anheuser-Busch InBev kicked off the liability management trend last year with a US$15.5bn deal but, unlike Kraft, seems to be protecting its investment grade ratings.
The bonds have tightened as the company paid down debt through the sale of its Australian subsidiary for US$11.3bn and the IPO of its Asia unit that raised US$5bn.
Still, investors worry about AB InBev's connection to Kraft. Both companies are owned by Brazilian investment firm 3G Capital and in July Miguel Patricio came from Anheuser-Busch to take the CEO job at Kraft.
There are a host of other cuspy Triple B names that have issued liability management trades in the past year that could be called into question, including Mexican petroleum company Pemex, retailer Macy's and midstream company EQT, which recently received its second high-yield rating.
"What we saw last week with Kraft Heinz is a reminder that you need to be able to go in there and do that credit work and understand the incentives of management teams," one investor said.
"In Kraft Heinz's case clearly they were comfortable with a slide in their credit rating."
* This sentence was changed to correct the job title.