Kraft Heinz Junk Downgrade Reawakens Corporate Bond Market Fear

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(Bloomberg) — Kraft Heinz Co., the iconic food giant created in a merger five years ago, was downgraded to junk by Fitch Ratings, raising fresh worries among investors that a slowing economy could threaten the broader corporate bond market.

The packaged-food company was cut one level to BB+, its first high-yield rating. Similar action from S&P Global Ratings or Moody’s Investors Service would officially dub Kraft Heinz as a fallen angel, taking it out of investment-grade indexes.

Though Kraft Heinz, with just under $30 billion of debt, is a relatively small investment-grade issuer, it would become one of the top three in high yield if another credit rater follows Fitch. It’s just one of many companies that have wound up with a massive debt load as the result of deals, jeopardizing credit ratings in the process.

The food giant, created in a merger orchestrated by Warren Buffett and the private equity firm 3G Capital, is in the midst of a turnaround as its brands fall out of favor with consumers. It reported a drop in fourth-quarter sales Thursday that sent its bonds and stock tumbling, the latest sign that the company’s turnaround plan still has a long way to go.

“Kraft is to investment grade as Velveeta is to cheese,” said Christian Hoffmann, a portfolio manager at Thornburg Investment Management. “The ingredients dictate what something is and Kraft Heinz is junk.”

Keeping Dividend

Fitch cut the company one level to its highest junk rating and has a stable outlook. It said Kraft Heinz may need to divest a sizable portion of its business in order to reduce debt. Kraft Heinz also needs to cut its dividend, Fitch said in August, but the company said Thursday it would maintain the annual $2 billion payout to shareholders.

“We believe it’s important to Kraft Heinz shareholders to maintain our dividend during this time of transformation,” Michael Mullen, a spokesman for the company, said in an emailed statement. Kraft Heinz remains committed to reducing leverage “over time,” he said. The company plans to release a more detailed turnaround plan around the time of its next earnings report in early May.

Until then, the maker of Jell-O and Classico pasta sauce is giving credit raters little reason to be patient. S&P rates the company one step above junk and is reviewing it for downgrade, while an equivalent rating from Moody’s now carries a negative outlook as of Friday.

Read more: Kraft Heinz on Junk Rating Chopping Block After Weak Earnings

Kraft Heinz is one of many companies with BBB ratings, the lowest level of investment grade, which now comprises half of the broader $5.9 trillion market. It’s grown steadily since the financial crisis, as a decade of low interest rates prompted companies to load up on debt for mergers and acquisitions, often at the expense of credit ratings.

But a wave of fallen angels, which some investors fear, has yet to follow. Many strategists contend that BBB companies have the ability to defend their investment-grade ratings, whether by selling assets or cutting dividends. Companies like General Electric Co. and AT&T Inc. have done just that to stave off downgrades.

Kraft Heinz debt is already on the way to trading like junk. Its 4.625% bonds due 2029 now yield 3.6%, compared to the 2.88% for the average BBB company with similar duration. It’s the worst-performing issuer in both the U.S. and European markets Friday, and the cost to protect its debt against default has spiked to levels last seen in October.

–With assistance from Claire Boston, Tasos Vossos and Katherine Chiglinsky.

To contact the reporters on this story: Molly Smith in New York at msmith604@bloomberg.net;Jonathan Roeder in Chicago at jroeder@bloomberg.net

To contact the editors responsible for this story: Nikolaj Gammeltoft at ngammeltoft@bloomberg.net, ;Sally Bakewell at sbakewell1@bloomberg.net, Larry Reibstein

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