AdvancePierre Foods Inc. New Bonds Rated #B-#; #B+# Rating Affirmed Following R Outlook Stable

Stocks and Financial Services Press Releases Tuesday November 29, 2016 09:14
NEW YORK--29 Nov--S&P Global Ratings

NEW YORK (S&P Global Ratings) Nov. 28, 2016--AdvancePierre Foods Holding Inc. issued $350 million in new senior unsecured notes due in 2024. The proceeds will be used to pay off that amount of the first-lien term loan.

S&P Global Ratings today said that it affirmed the 'B+' corporate credit rating and assigned a 'B-' issue level rating on the new senior unsecured notes with a '6' recovery rating, indicating our expectation for negligible recovery (0%-10%) in the event of a payment default. We also affirmed the 'B+' issue-level rating on the first-lien term loan and revised the recovery rating to '3' from '4', indicating our expectations for 59% recovery (at the low end of the 50%-70% range) in the event of a payment default.

The outlook remains stable, reflecting the expectation that leverage will decline below 4.5x over the next year from improving operating margins.

The rating reflects our expectation that the company will continue to deleverage post IPO and maintain debt to EBITDA well below 5x. In addition, we believe there will be continued EBITDA margin improvement and fairly low capital expenditure (capex) requirements of about $40 million annually, and we expect the company will generate annual free cash flow of more than $100 million, which should allow the company to fund dividends of about $45 million annually while reducing leverage to below 4.5x over the next year.

AdvancePierre is narrowly concentrated in the value-added protein segment of the highly competitive packaged food industry, especially within the cyclical foodservice distributor channel, which is subject to consumer discretionary spending. Better pricing discipline, improved operating efficiencies, and product mix have helped the company improve its profitability and cash flows by reducing its exposure to volatile commodity costs, primarily those of beef. The company's pricing is now done on a forward basis as opposed to a lagging index and therefore should better protect future gross margins and mitigate rapid input cost movements. AdvancePierre also has limited international diversity; we estimate more than 90% of its sales are in the U.S. and the balance is primarily in Canada.

Our 2016 and 2017 forecast is for credit metrics to be below 4.5x, slowly deleveraging as a result of the company implementing several price increases. Also, ongoing cost savings programs are resulting in expanding EBITDA margins and generating higher levels of free cash flow. We believe the company will use the cash to pay dividend distributions of about $45 million annually now that it is public.

Other base-case scenario assumptions include:
About 4% of increased sales in 2016 and 2017, reflecting continued volume growth, including new products with existing customers;
Adjusted EBITDA margin sustained near 16% in 2016 and 2017, reflecting increased realization of operating cost savings and pricing actions as commodity cost inflation remains moderate;
Capex of about $45 million in 2016 and $40 million in 2017; and
No major acquisitions.

We believe AdvancePierre will maintain adequate liquidity and that sources of cash will likely exceed uses by 1.6x for the next 12 months. Our view of the company's liquidity profile also incorporates our expectation that liquidity sources would continue to cover uses if EBITDA were to decline by 30%. We believe the company's covenant-lite terms on its bank facilities are favorable. However, based on its speculative-grade pricing, we do not believe the company has a high standing in the credit markets. We also believe the company would not be able to absorb high-impact, low-probability events (such as sustained high commodity costs) without refinancing.

Principal liquidity sources:
Cash balance of about $115 million as of Oct. 1, 2016;
Asset-backed lending (ABL) revolver of $175 million subject to a borrowing base availability of about $130 million; and
2016 funds from operations (FFO) of $166.7 million.
Principal liquidity uses:
We estimate total capex to be near $45 million in 2016;
Peak working capital borrowing in July and August, before the school year; and
Dividends of about $45 million annually.

The outlook is stable, reflecting the expectation that leverage will decline below 4.5x by fiscal year-end 2017 as a result of improved operating margins from better pricing, cost cuts, and muted meat commodity costs. In addition, we believe cash flows will be used primarily for dividend and possible future investments, and to a lesser extent for debt repayment.

We could downgrade the company if operating performance deteriorates, possibly because of the loss of a key customer, the inability to pass along price increases, or commodity meat inflation resulting in leverage well above 5x. Debt to EBITDA could also exceed 5x if the company adopts more aggressive financial policies, possibly including large dividend payouts or large debt-financed acquisitions.

We could upgrade AdvancePierre if the company reduces its financial sponsor ownership to below 40% and commits to sustaining debt to EBITDA below 4x. We believe this is not likely without a future secondary equity offering further reducing Oaktree's ownership. In addition, we believe the company would have to sustain EBITDA margin near 15% and apply a portion of its anticipated discretionary cash flow to debt repayment to sustain debt to EBITDA below 4x.

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