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Fitch Revises Premier Foods' Outlook to Negative; Affirms at 'B'
May 18, 2017 / 8:59 AM / 4 months ago

Fitch Revises Premier Foods' Outlook to Negative; Affirms at 'B'

(The following statement was released by the rating agency) LONDON/MILAN, May 18 (Fitch) Fitch Ratings has revised Premier Foods plc's Outlook to Negative from Stable, and affirmed the company's Long-Term Issuer Default Rating (IDR) at 'B'. Premier Food Finance plc's GBP175 million senior secured floating-rate notes and GBP325 million senior secured fixed-rate notes have been affirmed at 'B' with a Recovery Rating of 'RR4'. Fitch has also assigned an expected rating of 'B(EXP)' with Recovery Rating of 'RR4' to Premier Foods Finance plc's proposed GBP210 million floating rate notes maturing 2022. Proceeds from the notes will be used to repay the existing GBP175 million notes and other debt. The proposed notes rank pari passu with the company's existing debt and are guaranteed by the parent Premier Foods plc and the same subsidiaries that guarantee the revolving credit facility, the GBP325 million notes due in 2021, hedging and pension obligations. The final rating on the notes is contingent upon receipt of final documentation conforming to the information already received by Fitch. Management is reacting to the difficult trading environment with cost-saving initiatives and Premier's cash flow should benefit from agreements to reduce pension contributions, However, the Negative Outlook reflects the company's continued exposure to product competition and to downward price pressure from UK retailers, and concerns that its cost-saving measures may not be sufficient to protect operating profit. The rise in raw-material costs, combined with recent signs of falling consumer confidence, may constrain Premier's ability to recover to its profit in the financial year ended 2 April 2016 (FY16) and deliver sufficient free cash flow to reduce Premier's high leverage to levels more commensurate with the rating. Any continuing evidence of eroding volumes and margins, resulting in downward pressure on profitability will be negative for the rating. However, we believe that the business profile demonstrates characteristics in line with the 'BB' rating category. KEY RATING DRIVERS Weak Trading Performance: Management aims to deliver GBP20 million in cost savings by FY19 and is confident that these initiatives may be sufficient to deliver a mild profit recovery. However, in our rating case, we do not assume Premier's EBIT margin will recover after its fall to 10.1% in FY17 from FY16's high of 11.8%. This resulted from the combination of higher input costs and continued elevated investments in advertising & promotion. Any further erosion in volumes or margins, or increase in raw materials that are not passed on in a timely manner, that result in reduced profitability will be negative for the rating. Brexit Poses Challenges: We view the uncertainty surrounding the triggering of Article 50, depreciation of the sterling and falling consumer confidence as key rating drivers for Premier. The potential for further erosion in profitability is high, which underpins our Negative Outlook. Premier's ability to pass on cost increases is heavily reliant on cooperation with the supermarkets, which leaves its bargaining power weak. High Leverage: Premier's FFO-adjusted net leverage is very high at 8.4x at FYE17 and is not commensurate with a 'B' rating. We expect Premier to deleverage to around 6.0x-6.2x by FY19, which would be just outside of our negative sensitivity of 6.0x. Offsetting this weakness, we believe that the business profile demonstrates characteristics in line with the 'BB' rating category. Premier has some well-known brands, long-term relationships with its customers and good opportunities for international growth, which should support its revenue. Reliance on Challenging UK Market: Premier's revenue is mainly generated from the four largest retailers in the UK: Tesco (BB+/Stable), Asda, J Sainsbury's and Morrisons. These major retailers have pursued a strategy of protecting the spending power of consumers by pressuring their suppliers to absorb higher input costs following the sharp depreciation of the sterling in 2016. Additionally, an ongoing shift in consumer shopping behaviour from these traditional big retailers to hard discounters, online and convenience stores is challenging Premier's performance, prompting it to adapt its product offerings and keep a lean cost base. Leading UK Ambient Food Producer: Premier enjoys a strong position as one of the UK's largest ambient food producers, with an almost 5% share in the fragmented and competitive GBP28.7 billion UK ambient grocery market. The company enjoys benefits in manufacturing, logistics and procurement in the UK from its wide range of branded and non-branded food products, but the company mainly competes in mature segments such as ambient desserts and ambient cakes. This product portfolio, which the company currently has limited financial resources to complement with the entry into higher-growth categories, limits its growth prospects. As a result, Premier relies on continuing its marketing and innovation efforts to protect its market share. Average Senior Secured Notes' Recoveries: The 'B'/'RR4' senior secured rating reflects average recoveries (31%-50%), albeit at the low end (34%), for senior secured noteholders in the event of default. Fitch assumes that the enterprise value (EV) of the company and the resulting recovery of its creditors (including the pension trustees) would be maximised in a restructuring scenario under our going-concern approach rather than in a liquidation due to the asset-light nature of the business as well as the strength of its brands. Furthermore, a default would likely be triggered by unsustainable financial leverage, possibly as a result of weak consumer spending affecting sales and profits and combined with ongoing punitive pension deficit contributions. Fitch has applied a 25% discount to EBITDA and a distressed EV/EBITDA multiple of 5.0x, reflecting challenging market conditions in the UK and the reliance on a single country, which are partially offset by a portfolio of well-known product brands. The notes rank equally with the pension schemes for up to GBP450 million and are included as a senior obligation in the debt waterfall within our recovery calculation. DERIVATION SUMMARY Premier Foods is one of the largest UK food producers, selling and distributing a wide range of branded products. Similar to Labeyrie Fine Foods SAS, it is not well-diversified geographically and by customer, with most of its revenue generated from the four major in the UK. Operating margins are higher than the majority of peers, however the group's FCF generation is more volatile and leverage is also higher. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Top line growth of 1.4%-1.5% a year from FY18 onwards - Fairly stable EBIT margin at 10%. - FFO to remain affected by pension contributions over GBP40 million a year as per agreements with Pension Trustees (however reduced compared to previous forecasts) - Low and stable capex of at GBP25 million-27 million a year (about 3% of sales) - No dividend distribution or M&A RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Trading performance recovering (consistently positive organic revenue growth) and the ability to maintain EBIT margin above 12% after having sufficiently invested in advertising and promotions to protect its market position and drive growth. - Visibility that FFO-adjusted net leverage is reducing below 6.0x (pension deficit contributions are deducted from FFO). - FFO fixed-charge coverage above 2.5x on a sustained basis (1.5x in FY17). - FCF margin sustained in positive territory (FY17: 1.5%) after adequate capital investments Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Evidence of weaker pricing power in the UK market. - Failure to stabilise performance with continued revenue decline and margin deterioration with EBIT falling below 10%. - Neutral to negative FCF on a sustained basis due to profitability erosion, higher or unexpected capex and increases in pension contribution or funding costs. - FFO-adjusted net leverage remaining around 6.0x in FY19 (pension deficit contributions are deducted from FFO). - FFO fixed-charge coverage below 1.8x on a sustained basis. LIQUIDITY Adequate Liquidity: Premier's liquidity is supported by its GBP217 million revolving credit facility prolonged to 2021 and positive projected FCF of up to GBP15 million a year in the next two years. Refinance risk is manageable. Contact: Principal Analyst Marialuisa Macchia Associate Director +39 02 879 087 213 Supervisory Analyst Paula Murphy Director +44 20 3530 1718 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Giulio Lombardi Senior Director +39 02 879087 214 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. 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