Aug 21 -
-- We believe that U.K.-based food producer Bakkavor Group ehf (Bakkavor) continues to face a challenging operating environment that will constrain a significant medium-term improvement in its profitability, and we forecast that EBITDA interest coverage will remain less than 2x on a Standard & Poor's-adjusted basis in 2012.
-- We continue to assess the company's liquidity as "less than adequate," in accordance with our criteria. In addition, we consider that our forecast of modest free cash flow generation and leverage in excess of 5x in 2012 contributes to the refinancing risk associated with the company's medium-term debt maturities.
-- We are therefore lowering our long-term corporate credit rating on Bakkavor to 'B-' from 'B'.
-- The stable outlook reflects our view that over the next 12 months, Bakkavor should be able to manage its liquidity position, generate modest free cash flow, and maintain interest coverage of between 1.5x-2.0x on a fully adjusted basis.
On Aug. 21, 2012, Standard and Poor's Rating Services lowered to 'B-' from 'B' its long-term corporate credit rating on U.K.-based food producer Bakkavor Group ehf (Bakkavor).
At the same time, we lowered to 'B-' from 'B' our issue rating on Bakkavor's GBP350 million 8.25% senior secured notes due 2018. The recovery rating on the notes is unchanged at '4', indicating our expectation of average (30%-50%) recovery prospects in the event of a payment default.
The downgrade reflects our view that, like many U.K. food manufacturers, Bakkavor continues to face sluggish consumer demand in its core U.K. market, persistently high raw material prices, and high price sensitivity among retailers. We believe that prevailing macroeconomic conditions will continue to constrain Bakkavor's operating performance and will prevent a significant improvement in the company's profitability over the medium term. In addition, we forecast that EBITDA interest coverage will remain less than 2x on a Standard & Poor's-adjusted basis in 2012.
Furthermore, Bakkavor has significant medium-term debt maturities as its GBP260 million term loan and GBP90 million revolving credit facility (RCF) mature in June 2014. Our base-case operating scenario for 2012 and the first half of 2013 forecasts modest free cash flow and leverage of more than 5x, which we believe contributes to the refinancing risk associated with this debt. While the company reported negative free cash flow of GBP5 million in 2011, it generated about GBP3 million of positive free cash flow in the first half of 2012.
We continue to assess Bakkavor's liquidity as "less than adequate" under our criteria. This reflects our forecast of tight (5%-15%) covenant headroom under the company's leverage covenant in 2012. We note that the company has amended this covenant for 2012. However, the covenant has yet to be reset for 2013 and 2014, because this is conditional on the completion of a corporate restructure by Sept. 30, 2012. We understand that the company expects to complete this restructure within the required timeframe. The restructure also permits the raising of an additional GBP20 million of equity in 2012.
Bakkavor reported like-for-like revenue growth of 3% in the half year to June 30, 2012, and increased its EBITDA margin by 40 basis points to 6.6% on a fully adjusted basis. We do not forecast any significant improvement in operating performance over the remainder of 2012 and 2013. Although the company recovered about two-thirds of cost inflation in 2011 through increased prices, we believe that further price increases may prove difficult to achieve in the current macroeconomic environment.