Fitch Affirms Big Heart Pet's IDR at 'B'; Outlook Stable; Upgrades Term Loan and Notes

CHICAGO--()--Fitch Ratings has affirmed Big Heart Pet Brands' (Big Heart Pet, formerly known as Del Monte Corporation) long-term Issuer Default Rating (IDR) at 'B'. In addition, Fitch has assigned a 'BB/RR1' rating to Big Heart Pet's new $225 million asset-based loan (ABL) revolver due in 2019, which replaced Del Monte Corporation's $750 million asset-based loan (ABL) revolver that was due in 2016.

Concurrently the following ratings were upgraded based on recovery:

--$1.7 billion secured term loan B to 'BB/RR1' from 'BB-/RR2';

--$900 million unsecured notes to 'B/RR4' from 'CCC+/RR6'.

The Rating Outlook is Stable. At Jan. 26, 2014, Del Monte Corporation had approximately $3.9 billion of total debt. After approximately $1.3 billion debt repayment, Big Heart Pet's total debt is currently approximately $2.6 billion.

KEY RATING DRIVERS:

Leverage Improvement with Sale of Consumer:

On Feb. 18, 2014, Del Monte Corporation completed the sale of its consumer products business to Del Monte Pacific Limited for US$1.675 billion, plus a preliminary working capital adjustment of approximately $110 million, subject to a true-up. In connection with the sale, Del Monte Corporation changed its name to Big Heart Pet Brands and completed significant debt reduction. On Feb. 24, 2014, Big Heart Pet paid down $881 million of its term loan B, leaving a remaining balance of $1.726 billion and repriced the term loan more favorably to a LIBOR floor of 0.75% plus 275bps. The company also extended the term loan B maturity by two years to March 2020. On March 6, 2014, Big Heart Pet replaced its prior $750 million, five-year ABL with a new $225 million, five-year ABL due in March 2019. The smaller ABL should be adequate given the company's greatly reduced seasonal working capital needs after the consumer divestiture. On March 13, 2014, Big Heart Pet redeemed $400 million senior notes at 103.813% principal plus accrued interest, leaving $900 million notes outstanding which are due in 2019.

Per Fitch, total debt-to-operating EBITDA, pro forma for the debt reduction and an estimated $260 million annualized sales from Natural Balance Pet Foods, Inc. (Natural Balance, acquired July 15, 2013), was approximately 5.4x for the latest 12-month (LTM) period ended Jan. 26, 2014. This is significant improvement from 6.9x leverage for the fiscal year ended April 28, 2013 and Fitch's previous expectations that consolidated leverage including the consumer business would be in the low 6x range in fiscal 2014.

Higher Margins, Smaller Scale:

Recent leverage improvement is balanced with Big Heart Pet's smaller scale and less diversification as a stand-alone pet food company with approximately $2.2 billion annual sales (including annualized sales for Natural Balance), and slightly under $500 million EBITDA. This equates to EBITDA margins in the low 20% range, which is among the best of the packaged food companies. Fitch views the exit from the low-margin, working capital-intensive consumer business positively. However, the mainstream pet food business has been highly promotional lately, and Big Heart Pet is likely to continue to invest in promotions to try to hold share. However, its longer term strategy focuses on brand building and innovation. Fitch believes the company will remain acquisitive, particularly in pet snacks and treats, as well as pet specialty. Organic sales growth has been sluggish, with top line growth primarily from Natural Balance, and declines in existing products. Fitch will assess Big Heart Pet's financial strategy, as well as its sustainable cash flow generation, which should be materially positive given Big Heart Pet's high margins and less volatility without the consumer business.

Well-Known Brands

Big Heart Pet's ratings reflect the company's high financial leverage, good cash flow generation, adequate liquidity, and competitive market position. Big Heart Pet has well-known brands, many of which hold No. 1 and No. 2 market share positions, in categories facing favorable demographic trends. Pet food/snacks is benefiting from significant household dog and cat ownership. Big Heart Pet is committed to driving innovation and investing behind its brands, which include Milk-Bone, Meow Mix, 9 Lives, Kibbles 'n Bits, Pup-Peroni, Milo's Kitchen and Natural Balance.

Liquidity, Refinancing Risk:

Although leverage is high, liquidity is adequate and Big Heart Pet does not have refinancing risk over the intermediate term. Big Heart Pet's pro forma liquidity is approximately $175 million, including estimated net availability under the new ABL of $150 million and approximately $25 million cash at Jan. 26, 2014. Cash is down significantly after the company used cash on hand for the $334.6 million net acquisition price of Natural Balance in July 2013.

Annual term loan amortization payments, after the debt repayment noted above, of $17.3 million are due in fiscal 2015 through fiscal 2019. The company is subject to mandatory term-loan debt prepayment with up to 50% of excess cash flow, starting in fiscal 2015, 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.

Recovery and Covenants:

As Fitch anticipated, the recovery and corresponding ratings for the secured term loan and senior unsecured notes improved based on the substantial debt repayment achieved. Big Heart Pet amended its term loan agreement to allow for the repayment of a portion of the notes. Big Heart Pet's new 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 Big Heart Pet'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. Fitch's recovery analysis assumes ABL net availability at approximately $160 million if the company was in distress. All of Big Heart Pet's debt is guaranteed by domestic operating subsidiaries. The ABL facility is bound by a springing fixed-charge coverage ratio of 1.0x. Big Heart Pet is not subject to a maximum leverage or minimum EBITDA covenant.

The 'RR1' Recovery Rating on Big Heart Pet's ABL revolver and term loan B indicate that Fitch views recovery prospects on these obligations as outstanding at 91% or better. The 'RR4 rating on Big Heart Pet's 7.625% notes reflects Fitch's opinion that recovery for unsecured bondholders could have average recovery prospects given default of 31% to 50%.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to a negative rating action include:

Significant margin compression, such as from a heightened competitive environment or much higher input costs, materially lower than expected cash flow, or increases in debt such that total debt-to-operating EBITDA is sustained in the 6.5x range or higher, could result in a downgrade.

Large debt-financed acquisitions or dividends paid to Big Heart Pet's private equity sponsors, particularly during difficult operating environments, could also result in a rating downgrade.

A considerable loss of market share, possibly from a widespread pet food scare or competitive pricing, would be viewed negatively.

Future developments that may, individually or collectively, lead to a positive rating action include:

Leverage that appears sustainable in the low- to mid-5x range or better, as well as the ability to generate consistent, solid free cash flow, could result in an upgrade.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (August 2013);

--'Recovery Ratings and Notching Criteria for Non-financial Corporate Issuers' (November 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=721836

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=824101

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Contacts

Fitch Ratings
Primary Analyst:
Judi M. Rossetti, CFA, CPA, +1-312-368-2077
Senior Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst:
Carla Norfleet Taylor, CFA, +1-312-368-3195
Director
or
Committee Chairperson:
Wesley E. Moultrie II, CPA, +1-312-368-3186
Managing Director
or
Media Relations:
Alyssa Castelli, New York, +1 212-908-0540
alyssa.castelli@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst:
Judi M. Rossetti, CFA, CPA, +1-312-368-2077
Senior Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst:
Carla Norfleet Taylor, CFA, +1-312-368-3195
Director
or
Committee Chairperson:
Wesley E. Moultrie II, CPA, +1-312-368-3186
Managing Director
or
Media Relations:
Alyssa Castelli, New York, +1 212-908-0540
alyssa.castelli@fitchratings.com