S&P: SunOpta Inc. CCR Lowered To 'B-' From 'B' On Weaker Earnings And Credit Metrics; Outlook Negative
"We base the downgrade on the company's weaker earnings and credit metrics, along with weak cash flow visibility that could lead to a material liquidity deficit," said S&P Global Ratings credit analyst Nayeem Islam.
The ratings on SunOpta reflect what we view as the company's weak business risk profile, characterized by SunOpta's small position in the fragmented global ingredients and packaged foods industry. The company's business segments include the global sourcing of ingredients for resale, a portion of which also supplies the company's consumer products segments that makes healthy beverages and snacks.
Year-to-date operations were affected by the product safety recall relating to sunflower kernels at SunOpta's Crookston, Minn., facility. Although less than 1% of annual sales are attributed to the affected product lines, customer demand has not been met due to curtailing production, resulting in additional customer losses and lower margins from capacity under-utilization. In addition, we expect operations will be affected by significant legal and staffing expenses relating to the recall, along with higher costs for ramping-up production and integrating acquisitions. SunOpta holds the appropriate insurance for the affected sunflower kernels, and as of July 2, 2016, estimated about US$16 million of losses relating to this recall. However, there is significant risk that total liability claims from customers could exceed SunOpta's maximum insurance coverage and negatively affect cash flow and liquidity. Such a scenario could occur if customers affected by the recall submit claims based on the higher value end-product (such as granola bars or cereal), rather than submitting claims based only on the affected ingredient. In addition, the lengthy negotiation and legal process could potentially lead to customer losses and reputational damage.
We believe the recent acquisition of Sunrise Growers adds some earnings diversity, but offers limited benefit in key business drivers of improving market share, economies of scale, or efficiency.
Our revised financial risk profile of highly leveraged reflects the company's high debt burden, weaker earnings prospects, and deteriorating credit metrics. We believe SunOpta's ability to deleverage through modest debt repayment will be constrained by significant restructuring and legal charges over the next year.
The negative outlook on SunOpta reflects deteriorating credit metrics owning to a high debt burden and lower earnings, along with weak cash flow visibility that could lead to a material liquidity deficit.
We could lower the ratings if there is a material liquidity deficit due to negative free cash flow generation. We believe such a scenario would be precipitated by EBITDA margins deterioration due to ongoing operational challenges, loss of customers, and higher-than-expected costs relating to the product recall.
We could revise the outlook to stable if the company demonstrates sustained EBITDA cash interest coverage above 1.5x, improves margins, and maintains sufficient liquidity to fund product recall liability claims and approximately US$70 million of interest and capital expenditure requirements.