S&P: Del Monte Foods Inc. 'B-' Corporate Credit Rating Affirmed; Outlook Remains Negative
At the same time, we affirmed our issue-level ratings on the company's first - and second-lien senior secured term loans. The first lien is rated 'B-' with a '3' recovery rating, indicating our expectation for meaningful recovery (50%-70%, lower half of the range) in the event of a payment default. The second lien is rated 'CCC' with a '6' recovery rating, indicating our expectation for negligible recovery (0%-10%) in the event of a payment default.
"The affirmation reflects our view that performance will improve and the company will improve EBITDA to above $177 million (lease adjusted) and pay down its asset-backed lending (ABL) borrowings in fiscal 2017; otherwise, we will lower the rating," said S&P Global Ratings analyst Amanda Cusumano. "We are not lowering the rating at this time because the company has sufficient liquidity, with over $200 million of ABL availability at the fiscal year end, and we do not believe the company's capital structure is unsustainable. The company's excess inventory of shelf-stable products will lower the amount of inventory needed to be produced in 2017 and the ABL borrowings associated with it. The company should be able to reduce leverage and generate positive free operating cash flow if it manages inventory levels accordingly."
Del Monte's weak financial performance during fiscal 2016 led to debt to EBITDA over 8x. The company missed its revenue and EBITDA plan for fiscal 2016, generated negative free operating cash flow, and had ABL borrowings of $225 million ($110 million over expectations). Continued operational missteps, including over building inventory and the acquisition of Sager Creek (which is negatively impacting profitability), have led to higher-than-anticipated ABL balances and overall debt leverage levels, as well as negative free operating cash flow. S&P Global Ratings' EBITDA calculation does not add back expenses associated with the Sager Creek acquisition, enterprise resource planning implementation, and plant closures to EBITDA. ABL borrowings were elevated and working capital was a larger use of cash as the company increased its inventory levels in anticipation of winning government U. S. Department of Agriculture contracts. The company did not win all of these contracts and now has excess inventory going into fiscal 2017. The company must now manage its inventory levels and ABL borrowings more closely in fiscal 2017, because it had approximately $220 million of availability at the end of fiscal 2016. Peak ABL borrowings were $383 million in 2016, which led to the company requesting a waiver to its 1x springing fixed-charge covenant in anticipation of a possible covenant trigger.
The negative outlook reflects the potential for a lower rating over the next few quarters if the company is unable to substantially improve performance and strengthen its weak credit metrics, including reducing debt to EBITDA close to 8x. A failure to materially improve performance could result from missteps in managing its seasonal inventory needs in order to reduce its ABL balance, which could lead to continued high inventory balances and negative free operating cash flow. Additionally, if we come to determine that the capital structure is unsustainable or if leverage is sustained above 10x, we could lower the ratings.
S&P Global Ratings could revise the outlook to stable if Del Monte's financial results in the first half of 2017 illustrate progress toward improving EBITDA, as demonstrated by leverage approaching 8.0x from improved inventory management, positive free operating cash flow generation, and reduced ABL borrowings. The company can achieve greater EBITDA growth through pricing, higher volumes, and product innovation while reducing its variable costs.