S&P: Pinnacle Operating Corp. Downgraded To 'CCC+' On Expected Weak Operating Environment; Outlook Stable
We also revised our recovery rating on the company's first-lien debt to '4' from '2' and revised the associated issue-level rating to 'CCC+' from 'B.' The '4' recovery rating indicates our expectation of average (upper half of the 30%-50% range) recovery in the event of payment default. At the same time, we are lowering the issue-level rating on the company's second-lien debt to 'CCC-' from 'CCC.' The associated recovery rating remains '6,' indicating our expectation of negligible (0%-10%) recovery in the event of payment default.
"We believe that Pinnacle Operating Corp.'s operating performance will be slow to recover from a historically weak 2015, given the weak operating environment that is affecting the sector in general," said S&P Global Ratings credit analyst Allison Schroeder. "Despite improvements from acquisition-related EBITDA, we expect our adjusted credit metrics to be weaker in 2016 and 2017 than we previously assumed," she added. We believe that industry risks, including adverse pricing, have affected the company's ability to successfully achieve projected leverage metrics. Additionally, we believe there are risks associated with the company's debt maturity profile, with the asset-based loan (ABL) coming due in November 2017.
We characterize Pinnacle's business risk profile as weak, largely due to geographic concentration risk and smaller scale than key competitors, which makes the company more vulnerable to regional weather conditions, planting decisions, and farm economics. Although the company has expanded operations significantly during the past two years, its operations are still heavily concentrated in the southern U. S. We also see the potential for operational risks associated with rapid growth, although we believe the company has managed these risks well to date. Offsetting positive factors include a well-established position in its region with long-standing customer and supplier relationships, a well-balanced product portfolio, experienced management, policies that minimize commodity risk, and still good profitability.
We could lower ratings if the company's leverage increases further, against our expectations for improvements, which could be prompted by the undertaking of any debt-funded acquisitions or if earnings were to weaken due to erosion in margins, which could result from product mix shifts, operating inefficiencies related to acquisitions, higher selling, general, and administrative expenses, or a prolonged period of severe weather or other adverse industry conditions, to name a few possible causes. Similarly, we could lower ratings if liquidity falls to less than adequate or if the company is unable to refinance or extend its ABL maturity that is coming due in 2017. We could also lower ratings should the company face any problems pertaining to covenant compliance. Lastly, we could lower ratings if we no longer deem management or financial-sponsor ownership to be supportive of the company's overall financial policy.
We could raise the ratings if the company is able to improve leverage, either through management actions or through improvements in operating performance, such that FFO to debt improves to the mid - to high-single digits over the next year, and we believe such improvement is sustainable. We would expect the company to at least maintain current liquidity. For this to happen, we would expect there to be improvement in the agricultural sector outlook. Equally important to upward ratings potential would be a successful refinancing of the company's ABL, which is due in November 2017.