Nestle made its first concession to activist investor Dan Loebwhen it announced Tuesday a $21 billion share buyback plan to boostits stock price. Don't expect Loeb's Third Point to stop there.

Loeb is pushing for Europe's largest company to follow many ofits blue-chip peers in sacrificing its top-notch credit ratings tocapitalize on rock-bottom interest rates.

Two days after the hedge fund manager announced his stake inNestle, the company announced the share repurchase plans, whichwould boost its leverage to 1.5 times a measure of earnings by 2020from a ratio of about 1 time. That's unlikely to please Loeb, whois urging the packaged food giant to increase leverage to at least2 times to “produce enormous capacity for share buybacks,”according to a letter to investors in his hedge fund ThirdPoint.

While Nestle's willingness to push up its leverage slowly is areversal of CEO Mark Schneider's previous policy on buybacks, itwould put the company more in line with other corporate titans thathave let credit ratings slip in an effort to boost a measureof profitability. Schneider said in February in his first publicappearance as CEO that buying back stock is a lower priority thanreinvesting in Nestle's business and paying dividends.

Fitch Ratings and S&P Global Ratings downgraded Nestle'scredit rating one step to AA-, the fourth-highest grade, onWednesday. Moody's Investors Service maintained its Aa2 rating onthe company's debt. The shares rose 1.3% in Zurich.

“Third Point needs the success more than Nestle, as they haven'tlanded a real coup in a while,” said Christian Zogg, head of equityand fixed income at LLB Asset Management in Vaduz, Liechtenstein,which holds Nestle shares. “From the outside, the impression isoften that these giant tankers are moving slowly or not at all, butin fact there are permanent portfolio adjustments.”

Loeb is betting that pushing Nestle's debt levels to at leasttwo times earnings before interest, tax, depreciation andamortization wouldn't have a dramatic impact on its credit ratingand put its leverage ratio in line with its competitors. While theshares have rallied to a record high this year, his pitch toborrow to buy back stock is underpinned by a belief that Nestle canaccelerate sales growth and boost earnings in comingyears.

Negative interest rates in Switzerland also make repurchasingstock attractive. Cheap borrowing costs mean the company can buyback shares, reduce dividend payments, and thereby boost cashflow.

A representative for Vevey, Switzerland-based Nestle declined tocomment. A spokesperson for Third Point in New York wasn'timmediately available for comment.

The company generates enough cash that it won't need to sellassets or issue bonds to support the repurchases and will probablykeep its near-perfect credit rating, said Bloomberg Intelligenceanalyst Duncan Fox. Methodology that Moody's Investors Service usesto assign grades shows a leverage ratio of 1.5 times Ebitda couldbe consistent with Nestle's current AA-tier grade.

“They're going to be generating a huge amount of free cash on anannual basis,” Fox said in an interview. “They could have done thisat any time, and I expect Mark Schneider was thinking of doingit.”

Declining Ratings

Ratings across investment-grade issuers have declined in partbecause nearly a decade of ultra-low interest rates worldwide hasalready allowed legions of companies to pile on debt in an effortto increase their stock prices.

Less than 11% of corporate investment-grade debt outstandingcarries top AAA or AA grades, according to Bloomberg Barclays indexdata. A decade ago, more than 35% did. The share of notes that arerated in the lowest tier, BBB, has jumped to more than 43%, fromabout 25% a decade ago.

Nestle has long had the highest ratings among its peers. Loebwrote in his investor letter that such creditworthiness “serves noreal business purpose” for a company like Nestle, which has strongcash flow and is in an industry that fares better in economicdownturns. Unilever NV is rated two steps below Nestle, whileDanone and Kerry Group Plc are ranked in the triple-B range, thelowest tier of investment-grade.

Debt financing remains cheap enough that companies don't facesteep increases in their borrowing costs if their ratings slip,said Philip Zahn, an analyst at Fitch. The average nonfinancialcompany worldwide pays about 4.62% annually to borrow in the debtmarkets, compared with 9.84% for equity, according to data compiledby Aswath Damodaran, a finance professor at the Stern School ofBusiness at New York University.

“It doesn't really cost you very much to move down the ratingsscale given the current interest rate environment,” Zahn said “Thatcan and undoubtedly will change in time.”

The average AA-rated bond yields about 1.94%, according toBloomberg Barclays index data. Single-A notes yield an average of2.32%.

Profit Focus

Ratings companies have dinged issuers for buyback programs inthe past. Moody's has a negative outlook on Microsoft's top creditrating and said it could downgrade the company if it “continueswith aggressive shareholder returns.” Fitch Ratings cut the creditgrades on Jack Daniel's producer Brown-Forman Corp. and Chili'sGrill & Bar operator Brinker International Inc. last year,citing their stock repurchases.

So far, Nestle's bondholders are shrugging off the risk. Thecompany's 1.25% bonds due in 2018 gained 0.01 cent to 99.94 centson the dollar at 8:33 a.m. Wednesday in New York, according toTrace, the bond-price reporting system of the Financial IndustryRegulatory Authority.

CEO Schneider seems more focused on boosting profit thanrejiggering Nestle's balance sheet and risking a ratingsdowngrade, CreditSights analysts Simon Atkinson and Maryum Alisaid. “We wouldn't be lightening up on a Nestle bond holding justyet,” they wrote in a note to clients Monday.

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