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Fitch Publishes Royal FrieslandCampina NV's First-time IDR 'BBB+'; Stable Outlook
September 7, 2017 / 9:12 AM / 12 days ago

Fitch Publishes Royal FrieslandCampina NV's First-time IDR 'BBB+'; Stable Outlook

(The following statement was released by the rating agency) MILAN/PARIS/LONDON, September 07 (Fitch) Fitch Ratings has published Dutch dairy company Royal FrieslandCampina NV's (RFC) Long-Term Issuer Default Rating (IDR) of 'BBB+' with a Stable Outlook. Fitch has also published RFC's Short-Term IDR of 'F2' and senior unsecured rating of 'BBB+'. RFC's ratings are underpinned by its strong business profile among its direct dairy peer group, notably due to the reliability of its supply, its high exposure to value-added products and a strong presence in emerging countries. The ratings are supported by a conservative balance sheet, but are constrained by its smaller scale and higher profit volatility relative to 'A'-rated global packaged food peers. Fitch forecasts EBITDA margin to remain between 10% and 11% over the next four years, supported by past investments in capacity and efficiency, and further diversification into more profitable regional markets. This and the expected maintenance of a conservative financial policy despite likely bolt-on M&A activity underpin the Stable Outlook. KEY RATING DRIVERS Strong Business Profile RFC enjoys a strong business profile, underpinned by its scale in the global dairy industry, well-recognised brands in the Netherlands and various developing markets, as well as its product and geographic diversification. The group is the fith-largest company in the global dairy market. It benefits from a high exposure to value-added products (more than 80% of revenue in 2016 according to management) and to emerging markets (over a third of revenue in 2016). These provide it with specific advantages over peers, including a higher resilience in profitability throughout the dairy commodities price cycles and beneficial growth prospects. Cooperative Set-up Neutral to Ratings Overall, the co-operative set-up does not result in any notching to RFC's rating. Fitch recognises the benefits of a reliable and stable source of high-quality raw materials linked to its cooperative setup. However, this is partly offset by the fact that RFC is compelled to collect and purchase all the milk produced by its farmer members. We also view positively the mechanism of the performance premium paid to farmers as a percentage of net profit. Although this covers a fairly small portion of the end milk price, it acts as a profitability cushion by making discretionary part of the milk price due to the farmers. We believe it encourages the alignment of the interests of the member farmers with those of RFC. Post-quota Market Conditions Fitch expects RFC to maintain adequate profit resilience over the next four years despite likely challenges from further market volatility. The group fared well through the sharp market swings created by the end of the quota regime in Europe in 2015 and exacerbated by the Russian food import ban that was introduced in mid-2014. In 2016, despite a strong decrease in milk prices in the first half of the year due to overproduction, RFC's operating profit contracted only modestly in the year. Milk prices grew back from September 2016 as a combination of reducing milk production in several EU countries and recovering demand. Strengthening Profitability We forecast RFC's EBITDA margin to be sustainable at around 10% to 11% through commodity price and demand cycles. The company's EBITDA margin has reached 11% already in 2015 (2014: 7.6%) thanks to an improved exposure to value-added products, the good progress made in restructuring the European operations, as well as past investment to optimise its production capacity and efficiency. Fitch expects further support from growing demand for value-added products especially in emerging markets, where the company is currently focusing its growth strategy. Investments Support Growth Prospects RFC is shifting its focus for capital expenditure allocation and external growth towards emerging markets and in particular Asia, where long-term growth fundamentals are strong, in particular regarding demand for value-added products. The company has completed the restructuring of its European operations, including capacity expansion and processing optimisation. We believe management's expansion strategy entails manageable execution risk due to RFC's degree of diversification and its strong track record. Strong Financial Flexibility Fitch expects RFC's Funds Flow from Operations (FFO) adjusted gross leverage to remain at about 2.0x over the next four years (2016: 1.9x), with consistently positive although low Free Cash Flow (FCF), which we expect to be mostly allocated to bolt-on M&A. Furthermore, the group had a healthy liquidity score of 3.2x at end-2016 (readily available cash plus available undrawn committed facilities/short-term debt) despite a high amount of restricted cash taking into account Fitch's estimation of cash in transit between foreign subsidiaries and the holding company, where most of the debt is issued, and cash held in non-investment-grade countries. Fitch expects the group's FFO fixed-charge cover to remain at a healthy level of 7.0x-8.0x over 2017-2020 (2016: 8.0x). The planned issuance of a EUR1 billion commercial paper program in September 2017 should further enhance the diversification of the group's sources of financing. Conservative Financial Structure Fitch expects RFC's FFO adjusted gross leverage to remain stable at or slightly above 2.0x over the next four years (2016: 1.9x). These projections reflect Fitch's view that RFC will maintain a relatively conservative financial policy in terms of cash performance payments, capex and M&A, while its past and current investment strategies support a solid level of profitability and growth prospects. Such credit metrics are aligned with the 'A' rating category for packaged food companies. They compensate for the group's low and volatile profitability relative to the packaged food sector. DERIVATION SUMMARY RFC is a global dairy company that is well positioned relative to its closest peers in the dairy market, such as Nestle SA (AA-), Fonterra Co-operative Group Limited (A) and Land o Lakes Inc. (BBB-). We expect RFC to benefit from improving product and geographical diversification, in turn leading to stable profit margin relative to dairy companies that mostly sell commoditised products. RFC is able to mitigate risks of volatility in milk prices and exposure to foreign-exchange headwinds through a high percentage of value added products, strong innovation capability and a proven ability to pass through price movements, albeit with a time lag. Furthermore, RFC benefits from a stronger financial structure and financial flexibility than other dairy companies and manufacturers sharing comparable operating margin profile and size. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for RFC include: - Recovery in revenue growth (at high single digits) in 2017 driven by the combination of better prices, volumes and product mix; then stabilising at mid-single digits in 2018-20; - EBITDA margin consistently at or above 10%; - Stable profit distribution policy (55% added to equity, 10% distributed to farmers shareholders as fixed-member bonds and 35% distributed as performance premium in cash - accounted as dividends by Fitch). - Annual capex at about EUR500 million; - FCF slightly decreasing in 2017 due to a high working capital outflow, margin improving towards 2% by 2019-2020 - Full-year contribution of Engro Foods from 2017 (EUR450 million revenue and EUR30 million EBITDA) with no distribution of minority dividends; - EUR50 million M&A spending in 2017 and EUR400 million a year thereafter. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action: - A further increase of scale through profitable and stable businesses, enhancing product and geographic diversification and reducing the proportion of sales from the more volatile Cheese, Butter and Milk Powder unit - Further improvement in global diversification and/or cost savings driving EBITDA margin sustainably above 12% - FCF margin consistently above 2% - FFO adjusted net leverage remaining at or below 1.5x (gross: 2.0x) Future Developments That May, Individually or Collectively, Lead to Negative Rating Action: - Evidence that the group's earning profile is subject to increased volatility - Increasing competitive pressures or poorer product/geographic mix resulting in EBITDA margin falling persistently below 9% - Negative FCF, in the low single digits of sales, for more than two years - FFO adjusted net leverage persistently above 2.5x (gross: 3.0x) LIQUIDITY Strong Liquidity: As of 31 December 2016 the company had over EUR1.1 billion liquidity available, of which EUR321 million relates to readily available cash on balance sheet and EUR1.25 billion is represented by the undrawn portion under its EUR1.5 billion Revolving Credit Facility maturing in April 2021. Fitch believes that expected recurring FCF generation and the availability of committed facilities in a comfortable amount are adequate to support future capex and bolt-on acquisitions. FULL LIST OF RATING ACTIONS Royal FrieslandCampina NV --Long-Term IDR: 'BBB+', Stable Outlook - Short-Term IDR: 'F2' --Senior Unsecured rating: 'BBB+' Contact: Principal Analyst Marialuisa Macchia Associate Director +39 02 8790 87213 Supervisory Analyst Anne Porte Director +33 1 44 29 91 36 Fitch France SAS 60, rue de Monceau 75008 Paris Committee Chairperson Giulio Lombardi Senior Director +39 02 8790 87214 Date of relevant committee: 28 August 2017 Summary of Financial Statement Adjustments - Leases: Fitch has adjusted end-2016 debt by applying a multiple of 8x the yearly operating lease expense related to long-term assets (EUR53.4 million estimated as 100% of the group's leased building assets and 50% of its other leased assets). - EBITDA: Fitch excludes from its EBITDA calculation the milk price paid to member dairy farmers in the form of performance premium and issuance of member bonds. - Member bonds and perpetual shareholder loan: Fitch has assigned 100% equity credit to RFC's EUR1,564 million member bonds and EUR296 million perpetual shareholder loan outstanding at end-2016. - Dividends: Fitch treats as common dividends the cash part of the performance premium paid out to the member dairy farmers. - Readily available cash: Fitch has excluded from readily available cash the cash held in non-investment-grade countries and has applied a discount of 30% to the cash held in countries that are experiencing high currency volatility. Total cash excluded amounted to EUR193 million at end-2016. Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. 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