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Moody's: Tax overhaul credit positive for Coca-Cola, Pepsi

Moody's said Feb. 7 that the U.S. tax overhaul is broadly credit positive for large beverage companies based in the U.S. only if they use repatriated cash to meaningfully reduce debt.

The ratings agency said Coca Cola Co. and PepsiCo Inc. respectively hold $24.7 billion and $17.5 billion in cash overseas, and the new tax law will allow them to bring back cash held overseas without further tax cost. Coke and Pepsi are also expected to see cash flow benefits from lower effective tax rates, and Moody's analysts expect the lower tax rates to add several hundred million dollars each year to each company's free cash flow.

Moody's, however, warned that failure to use the freed-up cash to repay debt could have a negative ratings impact on the companies as current ratings of Coca-Cola and Pepsi incorporate the expectation of applying repatriated cash towards debt reduction.

Moody's noted that both Coca-Cola and Pepsi have a history of repurchasing shares with excess cash, and in some cases, buybacks have exceeded free cash flow, and they will likely be pressured to use the repatriated cash for stock buybacks.

However, the ratings agency warned that using the repatriated cash for buyback, or large dividend increases or special dividends, could put downward pressure on the companies' ratings.

"Coke has very little scope for such payouts at its current rating, given its high gross leverage, whereas Pepsi's rating would also come under pressure if it made such payouts, although it would take less debt repayment to bring its metrics in line with levels appropriate for its rating," according to the agency.

Moody's added that using the cash for mergers and acquisitions could have less negative implications, depending on the business acquired.

Under the new tax law, Coca-Cola and Pepsi are also expected to see cash flow benefits from lower effective tax rates and total effective tax rates lowered by more than 100 basis points and as much as several hundred basis points from the low- to mid-20% range. Both companies are likely to bring back cash in the future regularly with lower tax rate on future foreign earnings, Moody's wrote.