Fitch Affirms Ocean Spray's IDR at 'BBB-'; Outlook Revised to Positive

CHICAGO--()--Fitch Ratings has affirmed Ocean Spray Cranberries, Inc.'s (Ocean Spray) Issuer Default Rating (IDR) at 'BBB-'. The Rating Outlook has been revised to Positive from Stable. A full list of rating actions follows at the end of this release.

The Outlook revision to Positive reflects Ocean Spray's lower than expected leverage for fiscal 2016, a reduction in cash distribution to its members, improved alignment of grower-owner payment schedules to pool earnings, a decline in capital spending and stable profitability supported by a strengthening in gross margins. Consequently, Fitch believes Ocean Spray will generate cash flow that can be used for debt reduction to further strengthen the credit profile over the rating horizon.

KEY RATING DRIVERS

Strong Market Position

Ocean Spray's credit ratings reflect its dominant share in the shelf stable cranberry juice and dried cranberry segments. Importantly, Ocean Spray's strong focus on innovation in their beverage and snack portfolio partially mitigates its relatively narrow product line that is mainly dependent on a single fruit. Ocean Spray's market position with its premium, highly-recognizable brand has generated a good level of consistent profitability for a consumer goods company. Consequently, Ocean Spray has not experienced the market share and volume erosion that has occurred in the shelf stable juice segment during the past several years due to competition, shift in consumer preferences and consolidation within the supermarket chains. Nevertheless, larger, well-capitalized beverage companies remain a material threat given their resources and a wider variety of alternative beverage options.

Market Leadership, Brand Equity

Ocean Spray is a marketing cooperative wholly owned by approximately 800 cranberry and 40 grapefruit growers. Approximately 60% of the world-wide cranberry crop is received, processed, and marketed through Ocean Spray resulting in over $1.7 billion in net sales. Ocean Spray also has a material presence in the grapefruit industry. The cooperative provides a stable organizational structure for cranberry grower-owners that enhances grower profitability by using Ocean Spray's marketing/advertising, new product development/innovation and demand planning. Through the cooperative agreement, Ocean Spray has generated material profitable returns for its grower-owners during the past several years.

Operating Challenges: Concentrate Imbalance & High Sugar Content

Fitch believes Ocean Spray will continue leveraging innovation efforts into new products and categories to stem ongoing competitive intrusions. This growth should also help mitigate operating challenges from cranberry concentrate supply-demand imbalances caused by recent cranberry supply increases. This is critical for Ocean Spray to absorb the excess concentrate supply to generate healthy long-term returns for its member-growers.

One recent innovation is PACT cranberry extract water, which targets consumers seeking healthier beverages that are fresh, natural and aligned closely to current health and wellness trends. Fitch believes consumer adoption of these types of brands could take longer to materialize due to the more complex health benefit message. Therefore, investment behind these brands is key to generating consumer interest. Fitch also expects Ocean Spray to make modest investments in minority interests or M&A of smaller beverage companies to increase its opportunity to leverage alternative uses for cranberries.

Fitch anticipates that Ocean Spray will also address public concerns over high sugar content in its products through public relations campaigns and adaptation of their product portfolio. Over the past several years, the company has been successful at reducing sugar content within its beverages, and current innovation is largely focused on low/no sugar brand extensions.

Ratings Constrained by Financial Flexibility

Ocean Spray's financial flexibility is a factor that constrains its ratings. Like other cooperatives, Ocean Spray pays out a high percentage of its patron earnings through cash payments to its grower-owners leaving the company significantly more reliant on external sources of liquidity particularly in times of high investment periods. In addition, the high member cash payments can hinder the company's ability to deleverage following increases in debt. As such, Ocean Spray's narrow product focus and high cash patronage payments are major elements in limiting the IDR to the 'BBB' category. Fitch believes Ocean Spray needs to demonstrate a track record for reducing debt and increasing the level of growers' equity to ensure appropriate flexibility to support upward rating movement. Ocean Spray has demonstrated progress in these areas to improve its financial profile.

Earlier in 2016, Ocean Spray management and the board of directors extended the allocated retained equity holding period for its growers from six years to eight years, which is a key step toward increasing grower equity over the longer-term to the mid 30% range. When combined with increases in the equity quota levels given the larger cranberry harvests and the decline in capital spending, Fitch expects Ocean Spray will generate excess cash flows that will be used for debt reduction. Grower equity as a percentage of total capitalization had weakened to approximately 24% in fiscal 2014 following increased borrowings from higher capital investments and increases in working capital from elevated crop inventories. Fitch expects grower equity as percentage of total capitalization will approach the upper 20% range for fiscal year 2016.

Leverage Expected to Decrease over Rating Horizon

Estimated leverage (adjusted for cranberry COGS) for the LTM ended May 28, 2016 was 2.3x down from 2.8x at the end of fiscal 2015. Fitch expects Ocean Spray's leverage will end fiscal 2016 in the mid 2x range with expectations that leverage will continue to trend downwards over Fitch's forecast horizon. The extension of the equity period results in a lower cash payment to members providing additional cash flow to pay down Ocean Spray's revolver borrowings. Ocean Spray's upcoming maturities during fiscal 2016 and fiscal 2017 should be relatively modest following the refinancing of term notes due in fiscal 2016.

KEY ASSUMPTIONS

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

--In fiscal 2016, Fitch expects Ocean Spray will increase revenue in the low single digits;

--Cranberry COGS adjustment in the mid-single digit of revenue for imputed cost of cranberries;

--EBITDA margins (without cranberry COGS adjustment) in the low 20% range for fiscal 2016 and 2017;

--In fiscal 2016 and beyond, Ocean Spray is expected to derive cash flow benefits from adjusting grow-owner payment schedules to better align grower advances to pool earnings;

--Leverage (total debt-to-adjusted operating EBITDA) will decrease to approximately 2.6x at the end of fiscal 2016 and continue to trend down in fiscal 2017 and beyond.

RATING SENSITIVITIES

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

--Increase in grower equity approaching the 30% range of total capitalization;

--Total debt-to-adjusted operating EBITDA sustained below the 3.0x range due to operating income growth and/or debt reduction;

--Demonstrated ability to generate discretionary cash flow to reduce debt;

--Expectations for stable revenue trends with low single-digit revenue growth driven by innovation;

--Per barrel patronage rates reflecting healthy operating conditions for Ocean Spray and its member-owners;

--EBITDA margins (absent COGS adjustments) sustained at least in the low 20% range.

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

--Total debt-to-adjusted operating EBITDA sustained above mid 3x range due to materially lower than expected operating income, or unanticipated debt-financed acquisitions;

--Negative cash deficit over multiyear period driven by higher capital investment and working capital requirements funded by debt;

--Revenue weaker than expectations;

--EBITDA margins (absent COGS adjustments) sustained below 20%;

--Grower equity as a percent of total capitalization declines to the lower 20% range;

--Lack of appropriate level of external liquidity with sufficient covenant capacity in the event of a material revolver draw-down.

--Persistent industry oversupply that causes per barrel patronage rates to fall significantly into the $20 per barrel range or less for a sustained period of time.

LIQUIDITY

Ocean Spray's liquidity is supported by its good cash flow generation and subordinated grower payments. Fitch believes the subordinated nature of Ocean Spray's patronage payments to any loan agreements or preferred stock distribution provides additional protection and credit enhancing restrictions in the unlikely event of an unforeseen drop in profitability and cash flow. The board of directors for Ocean Spray must approve each patronage payment allowing the payment to be withheld or adjusted for business needs.

Ocean Spray has an $820 million credit agreement including a $300 million revolving commitment with a $100 million accordion that matures in 2020. Fitch believes Ocean Spray maintains an appropriate level of external liquidity with sufficient covenant cushion for debt to consolidated capitalization and consolidated shareholders' equity. This also provides Ocean Spray with sufficient cushion if capital market access becomes limited.

FULL LIST OF RATING ACTIONS

Fitch has affirmed Ocean Spray's ratings as follows:

--Long-term IDR at 'BBB-';

--$150 million 6.25% series A preferred stock at 'BB'.

The Rating Outlook has been revised to Positive from Stable.

Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:

--Fitch gives Ocean Spray's subordinated debt and preferred stock each 50% equity treatment based on methodology outlined in Fitch's hybrid debt criteria report. Key attributes for both instruments include the ability to defer coupon payments for up to five years. Other factors that support 50% equity treatment include the cumulative nature of the preferred stock dividend and for the subordinated debt, no cross default or cross acceleration triggers are present in the event of default on Ocean Spray's senior debt.

--Cranberry COGS adjustment in the mid-single digit of revenue for imputed cost of cranberries to determine an adjusted leverage.

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

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Additional Disclosures

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1009286

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Contacts

Fitch Ratings
Primary Analyst
William Densmore
Senior Director
+1-312-368-3125
Fitch Ratings, Inc.
70 W. Madison St.
Chicago, IL 60602
or
Secondary Analyst
Carla Norfleet Taylor, CFA
Senior Director
+1-312-368-3195
or
Committee Chairperson
Michael Weaver
Managing Director
+1-312-368-3156
or
Media Relations:
Alyssa Castelli, New York, +1 212-908-0540
Email: alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
William Densmore
Senior Director
+1-312-368-3125
Fitch Ratings, Inc.
70 W. Madison St.
Chicago, IL 60602
or
Secondary Analyst
Carla Norfleet Taylor, CFA
Senior Director
+1-312-368-3195
or
Committee Chairperson
Michael Weaver
Managing Director
+1-312-368-3156
or
Media Relations:
Alyssa Castelli, New York, +1 212-908-0540
Email: alyssa.castelli@fitchratings.com