New Credit Rating: Coca-Cola Company

Morningstar is initiating credit coverage of The Coca-Cola Company with an issuer rating of AA-, in line with our rating for Cola War foe PepsiCo . Coke's control over syrup prices (and in some cases retail prices) means that it holds the aces in its bottler relationships and is able to keep the lion's share of economic rents generated by the Coke system as a whole. PepsiCo's much-ballyhooed bottler consolidation is changing the competitive landscape in North America. If Pepsi can demonstrate a competitive advantage in its route to market, Coke may be forced to follow suit. That said, we believe such an undertaking would diminish Coke's creditworthiness only marginally.

Indeed, we expect to Coke to generate strong operating margins and enviable free cash flow regardless of its downstream ambitions. On a stand-alone basis, we expect cash plus cash generation to cover cash commitments 3.9 times over the next five years (Morningstar's Cash Flow Cushion ratio), and to cover total debt (including maturities beyond 2013) 3.1 times. Adding Coca-Cola Enterprises' cash flows to the picture diminishes our coverage estimates to 2.5 times and 1.3 times respectively, in effect, making Coca-Cola look a whole lot more like PepsiCo. A quick glance at traditional credit relevant ratios suggests a similar picture: Debt-to-book capital swells from 0.39 to 0.62 and pro forma 2009 EBTIDA-to-interest coverage diminishes from 25.9 to 9.7 (all ratios adjusted for debt-like commitments such as pensions).

Notably, Coke's cash flow cushion under either scenario is somewhat thinner than that projected for our typical AA minus-rated issuer. However, given the company's incredibly low cash flow variability (EBITDA margin has averaged 30% for a decade, varying by no more than a percentage point from year-to-year), these seemingly modest ratios are much more robust than they might otherwise appear and, in our view, afford debt investors a sufficient margin of safety. From a methodological perspective, we capture Coke's low cash flow variability in the more qualitative Business Risk component of our credit rating. Here, Coke scores extremely well, owing to a demonstrable economic moat and very low sensitivity to the economic cycle.

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