NEW YORK--Fitch Ratings has affirmed Conagra Brands, Inc.'s (Conagra) long-term Issuer Default Rating (IDR) at 'BBB-'. The Rating Outlook has been revised to Positive from Stable. A full list of ratings follows at the end of this release.
The Positive Outlook recognizes Conagra's evolution to a business model that should align well with the largest U.S. packaged food companies, given the potential for low-single digit organic growth and a mid-teens operating margin structure. Following a series of divestitures Conagra is emerging as a pure play portfolio of generally strong branded businesses. Given the company's focused investments in product innovation and marketing, Fitch believes the company could stabilize sales beginning fiscal 2018 (ending May 2018) after several years of modest declines. Positive rating momentum would occur upon evidence of stabilization in sales and upward momentum in operating margin from the current 13% level, while maintaining leverage within 3x.
KEY RATING DRIVERS
Transition to Pure Play Branded Packaged Food Firm:
Conagra has transitioned to a pure play branded packaged food company over the past year by divesting and spinning off its private brand and commercial businesses. In July 2015, the company announced plans to sell the private label business (fiscal 2015 sales of approximately $4.1 billion and EBITDA of $370 million), acquired in January 2013, which had been generating weak operating performance due to a highly competitive bidding environment, combined with service-related issues and execution shortfalls. In February 2016, the company completed the sale to Tree House Foods, Inc., for $2.6 billion in cash. Conagra used a majority of the proceeds to pay down debt and ended fiscal 2016 with leverage of 2.8x compared to 3.6x in fiscal 2015.
The company also generated approximately $488 million in net proceeds from the July 2016 sales of Spicetec Flavors & Seasonings and JM Swank businesses. On November 9, 2016, the company completed the separation of ConAgra Foods, Inc. into two publicly traded companies, Conagra Brands, Inc. and Lamb Weston Holdings, Inc. (Lamb Weston), which is the frozen potato business previously classified under its commercial segment. Lamb Weston generated approximately $3 billion in revenues and $593 million in adjusted EBITDA in fiscal 2016. Conagra retired $1.44 billion in debt and received a cash distribution of $823.5 million following the spinoff, with leverage further declining to 2.2x.
Excluding the divested businesses, Conagra generated $8.2 billion in revenues and approximately $1.4 billion in EBITDA in fiscal 2016, which compares to $15.8 billion in revenue and $2.2 billion in EBITDA in fiscal 2015 prior to the divestitures. 90% of the predominantly branded business is based in North America with 85% of the business going through the retail channels. Despite the presence of some tertiary brands in the company's portfolio, 80% of sales were generated from brands with #1 or #2 category positions such as Marie Calender's, Hunt's, Slim Jim and Reddi-wip.
Over the medium term, Conagra is targeting low-single digit organic sales growth driven by focused investments in brands with higher growth potential and product innovation. The company is repositioning some of its major brands such as Banquet (approximately $850 million in retail revenues) at a higher price point, with the aim of achieving higher EBIT dollars despite some initial losses. Conagra is also working to revitalize some of its brands by improving the food quality and packaging as well as supporting brands through disciplined advertising and controlled promotions.
The repositioning cost 4% in top line in fiscal 2016 and the impact is expected to be similar in fiscal 2017 but realized product margins have improved and should support EBIT dollar growth over the next few years should the company be able to stabilize volume beginning fiscal 2018. The company expects to support its low single organic sales growth with the acquisition of premium food brands such as its recent purchase of the packaged foods business of Frontera Foods, Inc. to reorient the brand mix towards changing consumer preferences that favor more specialty, natural and organic options.
Margin Enhancement Initiatives Underway:
Conagra's EBIT margins in the low-teens at 12.8% in fiscal 2016, below the average 18.4% for the four largest U.S. packaged food companies (with a range of 15.5% - 25%). The company attributed its lower margins to sales being volume driven and offering under-priced and over-promoted products, which it is addressing by resetting its volume base at higher price points. Conagra improved its adjusted gross margin 260 bps to 29.1% in fiscal 2016 and Fitch expects there could be another 150-200 bps opportunity over the next two to three years.
In addition, Conagra is implementing a $300 million efficiency program, which includes $$200 million in SG&A reductions and $100 million of trade efficiency. These initiatives focus on cost-saving opportunities in procurement, manufacturing, logistics, and customer service, as well as general and administrative overhead levels.
Fitch expects EBIT margin to trend towards 15%-16% over the next 24 months. Fitch's expectations are lower than the company's medium term target of 32% for gross margin and 16.5% for operating margin, given that our sales growth expectations are lower at flat to modestly positive annually and our assumption that the company will have to reinvest some of the savings back into the business in order to drive top-line as major packaged food companies vie for share in a low growth sector.
Leverage Expected to be Sustained within 3x:
The company paid down approximately $2.5 billion of debt in fiscal 2016 following the private brands divestiture as well as the $550 million notes that matured in July 2016. Post the spin-off of Lamb Weston, Conagra has approximately $3.5 billion in total debt, which includes the retirement of an additional $1.4 billion of notes, resulting in leverage of 2.2x.
M&A is an important part of Conagra's long-term growth strategy and Conagra could issue $1 billion in incremental debt for a bolt on acquisition while maintaining leverage within 3x. A potential risk to its current rating is a transformative transaction that drives leverage beyond 3.5x on a sustained basis.
Fitch's assumptions in its base case projections are as follows:
--Revenue is expected to be approximately $7.8 billion in fiscal 2017, pro forma for the spin-off of Lamb Weston. Organic growth is expected to be flattish to modestly positive over beginning fiscal 2018.
--Gross margin is expected to grow to 30% in fiscal 2017 and improve modestly thereafter to 31%.
--EBIT margin is expected to improve to approximately 15% over the next 24 months, while EBITDA is expected to trend towards the $1.5 billion range.
--FCF is expected to be approximately $350 million - $400 million annually over the next 24-36 months. Fitch expects this to be directed towards the company's share buyback program but could also be used for bolt-on acquisitions.
--Total debt/EBITDA is expected to be within 3x.
Future developments that may, individually or collectively, lead to a negative rating action include:
--Execution of the company's strategic plan such that organic growth is in the low-single digit range and operating margins improve to high-teens, bringing the company in line with the industry average.
--Leverage (total debt-to-operating EBITDA) is sustained under 3x.
Future developments that may, individually or collectively, lead to a negative rating action include:
--If the company loses momentum and organic sales growth remains modestly negative, or a sizeable debt financed acquisition occurs, such that leverage (total debt-to-operating EBITDA) trends towards the mid-3.0x range.
Ample Liquidity, Manageable Maturities: Pro forma for cash proceeds from the Lamb Weston spin-off, Conagra had a cash balance of $1.5 billion as of August 28, 2016. The company maintains an undrawn $1.5 billion revolving credit facility expiring September 14, 2018 that provides backup to its commercial paper program. The company had no amount outstanding under its commercial paper program.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Conagra Brands, Inc. (previously ConAgra Foods, Inc.)
--Long-term Issuer Default Rating (IDR) at 'BBB-';
--Bank credit facility at 'BBB-';
--Senior unsecured notes at 'BBB-';
--Subordinated notes at 'BB+';
--Short-term IDR at 'F3';
--Commercial paper at 'F3'.
The Rating Outlook is revised to Positive from Stable.
Fitch has withdrawn the following ratings:
Ralcorp Holdings, Inc.
--Long-term IDR 'BBB-';
--Senior unsecured notes 'BBB-'.
Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:
--Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation and exclude restructuring charges. For example, Fitch added back $45 million in non-cash stock-based compensation and $680 million in restructuring charges to its EBITDA calculation in fiscal 2016.
Additional information is available at 'www.fitchratings.com'.
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
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