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Fitch Affirms Tyson Foods at 'BBB/F2' on $4.2B APFH Acquisition; Outlook Stable
April 25, 2017 / 8:46 PM / 8 months ago

Fitch Affirms Tyson Foods at 'BBB/F2' on $4.2B APFH Acquisition; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, April 25 (Fitch) Fitch Ratings has affirmed the 'BBB/F2' ratings of Tyson Foods, Inc. (Tyson: NYSE: TSN) following the company's announcement that it has entered into a definitive agreement to acquire AdvancePierre Foods Holdings, Inc. (AdvancePierre; NYSE: APFH). The Rating Outlook is Stable. The $4.2 billion acquisition, which represents 14x APFH's $300 million of EBITDA and 2.6x its $1.6 billion of yearly sales, will be debt financed resulting in pro forma total debt and total debt-to-EBITDA of approximately $10.5 billion and 2.7x, respectively. Debt reduction will be a priority as Tyson suspends discretionary share buybacks and utilizes FCF and proceeds from the divestitures to return net debt-to-EBITDA to the company's targeted 1.5x - 2.0x range. Tyson also announced plans to divest its non-core frozen bakery, soups, sauces, sides, and Van's frozen breakfast and snack food brands. Tyson expects the transaction to close in the third quarter of fiscal 2017 that ends in June. Fitch does not expect closing delays due to anti-trust issues or a lack of shareholder approval. Tyson has limited exposure to value-added lunch/dinner protein sandwich products for which APFH is a leader. Moreover, the transaction has been approved by the Boards of Directors at both companies. APFH's largest shareholder, Oaktree Capital Management, L.P., which owns 42% of its outstanding stock, has also entered a tender and support agreement for the buyout. The company is targeting a $200 million run rate of annual synergies within three years of transaction closing. Cost savings will be created by a consolidated manufacturing footprint, procurement efficiencies, distribution network consolidation, redundant sales and marketing functions, and duplicative corporate overhead. Fitch views the synergy target, which represents about 5% of the combined entities approximate $4 billion of pro forma EBITDA, as achievable and views integration risk as minimal given Tyson's track record with the 2014 purchase of The Hillshire Brands Co., which was more than two times the size of APFH based on sales. The ratings affirmation reflects Fitch's view that the acquisition is complementary to Tyson's existing portfolio and consistent with the company's strategy of transitioning from a commodity meat and poultry processor to a higher margin protein-packed foods firm. Fitch expects total debt-to-EBITDA to decline to the low 2.0x range within a year of transaction closing with gradual continued deleveraging thereafter. KEY RATING DRIVERS Significant Scale and Diversification: Tyson's ratings benefit from its significant scale with LTM (December) sales of $36.9 billion and EBITDA of $3.8 billion, leading position in U.S. protein, and product diversification that includes a growing portfolio of branded packaged food and value-added products. Tyson is one of the world's leading food companies with No. 1 and No. 2 share in large and growing protein categories such as frozen breakfast and smoked sausage under the Jimmy Dean and Hillshire brands. Tyson's sales and earnings are subject to periodic volatility caused by changes in input costs and protein prices due to supply/demand dynamics of commodity products. However, risk is partially mitigated by the company's operating efficiency and diversification in chicken, beef, pork, and prepared foods. For the year ended Oct. 1, 2016, segment contribution to sales and operating earnings excluding was as follows: chicken (29% and 46%), beef (38% and 12%), pork (13% and 19%), prepared foods (19% and 26%), and other which consists mainly of foreign operations (1% and negative 3%). Fitch expects the acquisition of APFH to modestly increase the contribution from prepared foods. Structural Changes, Prepared Foods Volume Trends: Structural changes have enhanced Tyson's margins and are providing increased earnings stability. Changes implemented over the past several years include improved operating efficiency and closure of inefficient processing facilities. Moreover, Tyson has de-risked its operations by utilizing more short-term and fewer fixed-price customer contracts, instituting a more disciplined risk management strategy, and using a buy versus grow strategy in chicken when appropriate. Tyson has also increased its percentage of value added and prepared food products which offer higher margins and more stable cash flow than commodity proteins due to less price volatility. However, value-added and branded packaged foods are susceptible to volume pressures as consumer preferences change. Prepared foods volume rose 2.9% in the quarter ended Dec. 31, 2016 but was down 2.8% in fiscal 2016 due in part to an extra week in 2015, a voluntarily reducing volume in lower margin categories at retail, and slower than planned price reduction reflected on retail shelves. Core volume growth at APFH was 2.3% in the year ended Dec. 31, 2016. Fitch continues to view 1% - 2% volume growth as realistic over the long term with continued innovation and marketing support. Momentum Continues, Modest Volatility Possible Longer Term: Tyson's robust operating performance, which began in fiscal 2010, should continue through fiscal 2017. Momentum has been driven by the continuation of favorable industry fundamentals related to low grain costs, ample livestock supply, steady global demand which partially offset the negative impact of increased industry supply on selling prices, and effective margin management in non-vertically integrated beef and pork operations. Results also benefit from the realization of a targeted $700 million of annual synergies related to the Hillshire acquisition by fiscal 2018 and continued operating efficiency. Synergies are being sourced from operational improvements, manufacturing, procurement, logistics, and organizational duplication, have exceeded $620 million to date and should be sustainable over the long term. As mentioned previously, Tyson is targeting $200 million of annualized synergies associated with the APFH acquisition by 2020. Tyson's views normalized operating margins for its segments to be as follows: prepared foods (10% - 12%), chicken (9% - 11%), pork (6% - 8%), and beef (1.5% - 3%). During the quarter ended Dec. 31, 2016, each of Tyson's core segments performed within or above their normalized range. The company's consolidated operating margin was 10.7%, reflecting a continuation of Tyson's strong operating momentum and record results. Fitch expects performance in prepared foods and chicken to drive future growth, given they are Tyson's highest margin segments. Disciplined Financial and Acquisition Strategy: Tyson maintains a conservative financial strategy, targeting net debt-to-EBITDA of 1.5x - 2.0x over time (which approximates gross debt-to-EBITDA in the high-1x - low-2x range assuming cash of $200 million - $300 million). The company also strives to maintain overall liquidity of at least $1 billion. Fitch believes Tyson's conservative stance is due to potential operating earnings volatility. For the LTM ended Dec. 31, 2016, total debt-to-EBITDA was 1.6x, down from 4.3x at the end of fiscal 2014 following the acquisition of Hillshire, and FCF was $1.8 billion. The decline has been due to cash flow growth, significant synergy capture, and debt reduction. Tyson reduced debt by roughly $2.2 billion to $6 billion since the end of fiscal 2014. As seen by the above mentioned APFH acquisition, Tyson has remained open to strategic M&A, particularly of companies with value added and branded protein related products, even though organic growth continues to be an important driver of sales and operating earnings. Nonetheless, the company remains committed to maintaining a strong balance sheet by using cash flow to deleverage following debt-financed deals. Following the acquisition of APFH, Tyson expects to pull back on share repurchases and use FCF and divestiture proceeds to return leverage back to its targeted 1.5x - 2.0x as quickly as possible. Fitch views this as possible within two years of acquisition closing. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Tyson's fiscal years include: --Consolidated revenue increases at a low single-digit rate in 2017 and 2018 reflecting lower sales prices and the acquisition of APFH; --Operating margins for each of Tyson's business segments are at or above the normalized range in 2017 and 2018 reflecting continued strong demand and low or manageable commodity input prices; --Consolidated EBITDA of about $3.8 billion in 2017 and $4.1 billion in 2018 reflecting the acquisition of APFH and continue strong operating fundamentals; --FCF averaging $1 billion in 2017 and 2018, with the majority deployed towards debt reduction in 2018; --Total debt-to-EBITDA of approximately 2.8x in 2017 and 2.2x in 2018. RATING SENSITIVITIES Positive Triggers: Continued progress transitioning towards a protein centric packaged foods company as exhibited by reduced variability in operating earnings and better than expected volume trends in prepared foods. The ability to sustain normalized consolidated EBIT margins above the 6% - 7% range while maintaining total debt-to-EBITDA below 2x, and an FCF margin of over 2.5% (more than $1 billion annually) would be key indicators of continued progress. Negative Triggers: A sustained period of total debt-to-EBITDA above 2.5x due to sluggish earnings growth, slower than expected debt reduction following the APFH acquisition, or a change in financial policy would result in a negative rating action. Worsening industry fundamentals caused by meaningfully higher feed costs or a prolonged protein supply/demand imbalance would be leading indicators of a potential downturn in earnings. A sustained loss of market share in branded packaged meats would be of concern. LIQUIDITY Fitch views Tyson's liquidity as ample. Liquidity is supported by good FCF generation, a $1.25 billion unsecured revolver that can be upsized by $500 million, and the maintenance of moderate cash balances. At Dec. 31, 2016, Tyson had $1.6 billion of liquidity consisting of $311 million of cash and short-term investments and $1.2 billion available under its revolver. Tyson's revolver matures on Sept. 25, 2019. The facility subjects the firm to a maximum debt-to-capitalization ratio of 60% and a minimum interest expense coverage ratio of 3.75x for which the company has significant cushion. Maturities of long-term debt over the next three years include $120 million of 7% notes due May 2018 and 2.65% notes due August 2019. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: Tyson Foods, Inc. (Parent) --Long-term Issuer Default Rating (IDR) at 'BBB'; --Unsecured bank credit facilities at 'BBB'; --Senior unsecured notes at 'BBB'; --Short-term IDR at 'F2'. The Hillshire Brands Co. (Operating Subsidiary) --Long-term IDR at 'BBB'; --Senior unsecured notes at 'BBB'. The Rating Outlook is Stable. Contact: Primary Analyst Carla Norfleet Taylor, CFA Senior Director +1-312-368-3195 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst Bill Densmore Senior Director +1-312-368-3125 Committee Chairperson Philip W. Smyth, CFA Senior Director +1-212-908-0531 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity are disclosed below: --Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation expense as reported in financials. 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