According to Fitch Ratings, there is no immediate change to Del Monte Corporation’s (DMC) ratings based on DMC’s divestiture announcement.
On Oct. 10, 2013, DMC announced a definitive agreement to sell its Consumer Products business, including Del Monte brand rights in the United States and South America, to Del Monte Pacific Limited (DMPL) for US$1.675 billion. The transaction is expected to close by the first quarter of calendar 2014 and is subject to customary approvals and a working capital adjustment. DMPL put US$100 million cash in escrow that would be released to DMC if the transaction does not close. Fitch believes the transaction has a high likelihood of closing. DMC plans to change its name to reflect the pet products business. DMC’s Consumer Products include #1 branded market share positions in major processed fruit and vegetable categories and #2 positions in tomato and broth.
Potential Deleveraging from Transaction:
According to DMC’s term loan agreement, the Net Cash Proceeds from the transaction, as defined, must be utilized for debt reduction. However, significant uncertainty remains regarding the magnitude and timing of debt reduction because gross proceeds may be reduced by items including taxes, reasonable reserves, debt secured by liens, reasonable fees and amounts reinvested or committed to be reinvested in the business within 12 months. A potentially low tax basis and other carve outs above could exclude a significant amount of the proceeds from mandatory debt reduction.
Per Fitch, total debt-to-operating EBITDA was 6.5 times (x), operating EBITDA-to-gross interest expense was 2.4x, and funds from operations (FFO) fixed charge coverage was 1.8x for the latest 12 month (LTM) period ended July 28, 2013. These credit measures are in line with the rating category. At July 28, 2013, DMC had approximately $3.9 billion of total debt.
Recovery Could Improve:
Given Fitch’s assumptions regarding the enterprise value of the remaining Pet Products business and the amount of debt remaining subsequent to any prepayments, Fitch anticipates that recovery and corresponding credit ratings for the secured term loan and senior unsecured notes could be upgraded if a substantial amount of the gross proceeds are applied to reduce the secured term loan.
Future Capital Structure Uncertain:
Regardless of the amount of debt reduction related to the transaction, DMC’s capital structure and management’s financial strategy may change as a stand-alone Pet company. Depending on the new capital structure, ratings could go up or down. Fitch believes the company is likely to continue to be acquisitive, as evidenced by the company’s recent Natural Balance Pet Foods net acquisition for $337.5 million. DMC used cash for that acquisition. Fitch estimates that this acquisition could add approximately $300 million in annual sales. The Pet Products company plans to place greater emphasis on pet snacks and the pet specialty channel.
Smaller Company, Higher Margins:
The Pet Products segment generated 53% of the combined company’s sales for the LTM period ending July 28, 3013, and 73% of EBITDA. Per Fitch, sales and EBITDA of the remaining company are approximately $2 billion and $450 million, respectively. Fitch estimates that Pet Products’ margins are nearly 23%, dwarfing the roughly 9% margins in Consumer Products.
While the divestiture could be a deleveraging event, DMC’s Issuer Default Rating (IDR) would also incorporate the firm’s smaller size, lack of diversification, currently promotional landscape and much larger, better capitalized competitors such as Nestle (‘AA+’/Outlook Stable) and Mars. Fitch expects the operating environment to remain competitive but Del Monte should benefit from moderation in cost inflation offset by COGS productivity.
In the first quarter of fiscal 2014, Pet Products benefited from price realization but experienced softer volumes in existing products. The company expects stronger Pet Products innovation in the second half of the fiscal year. DMC is committed to driving innovation and investing behind its brands, which include Milk-Bone, Meow Mix, 9 Lives, Kibbles ‘n Bits, Milo’s Kitchen and Natural Balance. Del Monte has well-known brands, many of which hold leading market share positions, in subcategories facing favorable demographic trends. Pet food/snacks is benefiting from significant household dog and cat ownership.
Liquidity, Maturities, Debt Terms:
DMC’s current ratings reflect the company’s high financial leverage, good cash flow generation, ample liquidity, and competitive market position. The ratings of the stand-alone pet company will incorporate the company’s prospects for leverage, free cash flow (FCF) generation, and liquidity. Although leverage is currently high, liquidity is adequate at $624 million at July 28, 2013.
The company’s asset-based loan (ABL) revolver expires March 2016, $2.6 billion of term loans mature March 2018, and $1.3 billion of 7.625% notes are due in February 2019. Annual term loan amortization payments of $26.4 million are due in fiscal 2015 through fiscal 2017. The company is subject to mandatory term loan debt prepayment with up to 50% of excess cash flow, as defined by the company’s credit agreement. The requirement steps down to 25% if leverage is less than or equal to 5.5x or 0% if leverage is less than or equal to 4.5x.
Del Monte’s ABL revolver has a first-priority lien on accounts receivable, inventory and cash (ABL Priority Collateral) which are more liquid assets. The ABL revolver has a second-priority lien on substantially all of Del Monte’s other assets. The company’s secured term loan has a first-priority lien on substantially all other assets and a second-priority lien on ABL Priority Collateral.
The current ‘RR1’ Recovery rating (see end of press release for ratings) on Del Monte’s ABL revolver indicates that Fitch views recovery prospects on these obligations as outstanding at 91% or better. The existing ‘RR2’ rating on the secured term loan reflects Fitch’s opinion that recovery would be superior in the 71% – 90% range. The current ‘RR6’ rating on Del Monte’s 7.625% notes reflects Fitch’s opinion that recovery for unsecured bondholders could be poor at 10% or less if there were a restructuring event.
Fitch currently rates Del Monte Corporation as follows:
–Long-term Issuer Default Rating (IDR) at ‘B’;
–$750 million asset-based loan (ABL) revolver at ‘BB/RR1’;
–$2.6 billion secured term loan B at ‘BB-/RR2’;
–$1.3 billion unsecured notes at ‘CCC+/RR6’.
The Rating Outlook is Stable.
From: Fitch Ratings, Inc.
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