Fitch Affirms Flowers' IDR at 'BBB'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed the long-term Issuer Default Rating (IDR) at 'BBB' for Flowers Foods Inc. (Flowers). The Rating Outlook is Stable.

A full list of ratings follows at the end of this release.

KEY RATING DRIVERS

Leading Position in Consolidating Industry:

Flowers' ratings reflect its leading position as the second largest producer of baked goods in the U.S., with annual revenue of $3.7 billion, good margins for the industry, as well as a history of successful acquisition integration and adjacent geographic expansion. Flowers is a low-cost operator in a highly mature industry. The company has steadily increased its market share as it acts as a consolidator in an industry with low single-digit annual volume declines over the past few years.

Leverage Declining as Anticipated:

The Stable Outlook factors in Flowers' demonstrated progress paying down debt following several acquisitions. Flowers' credit protection measures are in line with Fitch's expectations following the $355 million debt-financed asset purchase of certain fresh bakery brands and related facilities from Old HB, Inc., formerly Hostess Brands, Inc., (Hostess) in July 2013. The Hostess acquisition followed several other acquisitions. Flowers purchased Tasty Baking Company (Tasty Baking) in May 2011 for $172 million, Lepage Bakeries, Inc. in July 2012 for $382 million, and the Sara Lee bread, buns and roll brand in California in February 2013 for $42.5 million net.

Total debt declined to $763.4 million at the end of 2014, down $160.4 million from $923.8 million at the end of 2013. For the latest 12 months ended Jan. 3, 2015, total adjusted debt-to-EBITDAR was 2.7x, total debt to EBITDA was 1.7x, funds from operations (FFO) adjusted leverage was 3.6x and operating EBITDA to interest expense was 15.9x. Fitch focuses on EBITDAR as the primary measure of leverage for Flowers due to the company's significant rental expense, which adds approximately 1x to total debt-to-EBITDA.

Modest Additional Debt Reduction with FCF:

Fitch estimates that Flowers' total adjusted debt-to-EBITDAR will fall to approximately the mid-2x range by the end of 2015 through modest additional debt reduction using free cash flow (FCF; cash flow from operations less capital expenditures and dividends). Fitch expects Flowers FCF could fall below $100 million in 2015 primarily due to higher capex and dividends, and average almost $100 million annually thereafter as the company continues to grow its revenue base. These FCF estimates incorporate moderate periodic volatility due to the timing of Flowers' commodity hedging on cash flow.

Larger Scale:

Recent acquisitions have greatly enhanced Flowers' geographic footprint, which now reaches approximately 81% of the U.S. population with fresh bakery foods through its DSD system. Margins should improve as the company builds greater density in expansion markets it has recently entered through its DSD system. The former Hostess bread brands, including Wonder, and the Tastykake brand from Tasty Baking enable Flowers to bring a broader product selection into new and existing markets. The Wonder brand in particular is complementary to Flowers' core brands, which are anchored by approximately $1.1 billion annual revenue at retail from Nature's Own. Flowers' goal is to reach 90% of the U.S. population over the long term which Fitch assumes will be achieved at a measured pace.

Liquidity and Debt Structure:

Flowers typically carries very little cash on its balance sheet. Much of the company's immediate liquidity is derived from internally generated cash flow and access to its $500 million revolver which matures in February 2019. Total revolver availability was $430.6 million, net of $53 million of revolver borrowings and $16.4 million standby letters of credit at Jan. 3, 2015. The company also had full availability under its $200 million accounts receivable securitization.

Long-term debt maturities are manageable and primarily consist of term loan amortization. Annual maturities are $35.1 million in 2015 and $74.9 million in 2016. Flowers' $300 million term loan entered into in July 2013 has amortization of $30 million in fiscal 2015, $67.5 million in 2016, $112.5 million in 2017 and $60 million in 2018. The company may also make voluntary prepayments without penalty. The company's credit agreements have a maximum leverage covenant of 3.5x and a minimum interest coverage of 4.5x. Fitch expects significant room will remain under these covenants.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

--Organic sales (price, volume and mix) over the forecast period grow in the low single digit range annually, mostly due to expansion markets, as core markets remain very competitive and the promotional environment may not abate materially in the near-to-intermediate term.

--Working capital is estimated as a modest usage, with periodic volatility due to hedging.

--Continued focus on debt reduction with FCF in the absence of bolt-on acquisitions. However, Fitch estimates that bolt-ons in the $100 million to $200 million range could resume in the near- term as modest acquisitions in adjacent expansion markets are part of the company's strategy.

--Fitch believes some modest margin pressure could occur due to the ongoing competitive environment with heightened promotions. This could be somewhat offset as the company builds density in expansion markets and focuses on generating operating efficiencies. Margins grow modestly in outer years of forecast.

--Average annual FCF over forecast period approaches $100 million annually.

--Total adjusted debt-to-EBITDAR in the mid-2x range over the intermediate term.

RATING SENSITIVITIES

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

--A positive rating action could occur if Flowers demonstrates a commitment to maintain leverage (total adjusted debt-to-operating EBITDAR) in the low 2x range while generating material FCF. Fitch believes this is unlikely in the near to intermediate term due to the company's bolt-on acquisition strategy that periodically increases leverage.

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

--A prolonged and significant drop in earnings and FCF, potentially due to a secular shift away from bakery products, a sizeable acquisition or series of acquisitions or change in financial strategy that results in total adjusted debt/EBITDAR to remain in the low-3x range or higher for an extended period.

Fitch affirms Flowers' ratings as follows:

--Issuer Default Rating (IDR) at 'BBB';

--Senior unsecured revolving credit facility at 'BBB';

--Senior unsecured term loan at 'BBB';

--Senior unsecured notes at 'BBB'.

The Rating Outlook is Stable.

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

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 2014).

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=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=981825

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Contacts

Fitch Ratings
Primary Analyst:
Judi Rossetti, CFA, CPA, +1-312-368-2077
Senior Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst:
Grace Barnett, +1-212-908-0718
Director
or
Committee Chairperson:
Monica Aggarwal, CFA, +1-212-908-0282
Managing Director
or
Alyssa Castelli, +1-212-908-0540
Media Relations, New York
alyssa.castelli@fitchratings.com
or
Elizabeth Fogerty, +1-212-908-0526
Media Relations, New York
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst:
Judi Rossetti, CFA, CPA, +1-312-368-2077
Senior Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst:
Grace Barnett, +1-212-908-0718
Director
or
Committee Chairperson:
Monica Aggarwal, CFA, +1-212-908-0282
Managing Director
or
Alyssa Castelli, +1-212-908-0540
Media Relations, New York
alyssa.castelli@fitchratings.com
or
Elizabeth Fogerty, +1-212-908-0526
Media Relations, New York
elizabeth.fogerty@fitchratings.com