Fitch Rates Flowers' $300M Sr. Unsecured Notes 'BBB'; Outlook Negative

CHICAGO--()--Fitch Ratings has assigned a 'BBB' rating to Flowers Foods', Inc. (Flowers; FLO) new $300million senior unsecured notes due Oct. 1, 2026. Net proceeds will be used to repay outstanding debt and for general corporate purposes. The notes rank equally with all of Flowers' existing and future senior unsecured debt and include standard protection for bondholders including a Change of Control Triggering Event provision.

Fitch's current Negative Outlook on Flowers' Long-Term Issuer Default Rating (IDR) reflects the possibility recent weakness in the company's organic revenue growth could continue and that EBITDA margins could remain pressured absent meaningful cost savings. Moreover, Flowers has demonstrated a willingness to deploy more of its cash flow towards share repurchases, in lieu of debt reduction following its acquisitions of Dave's Killer Bread and Alpine Valley, which took leverage to 3.2 times (x) from 2.7x. Ratings could be downgraded if organic revenue growth remains negative and total debt/EBITDA and if total adjusted debt/EBITDA exceeds the low 2.0x and 3.0x range, respectively. The Outlook could stabilize if volume trends improve and leverage remains near current levels.

KEY RATING DRIVERS

Sustainability of Market Share:

Flowers' ratings reflect its position as the second largest producer of baked goods in the U.S., behind Grupo Bimbo, S.A.B. de C.V. ('BBB'/Outlook Stable), with annual revenue of $3.8 billion in 2015. Flowers has a strong portfolio of brands including Nature's Own (the nation's leading brand of loaf bread, generating over $1 billion of retail sales annually), Wonder, Tastykake, and Mrs. Freshley's. Contiguous geographic expansion and bolt-on acquisitions have enabled the company to grow sales and increase market share in a mature, highly competitive, and consolidating industry. Flowers' geographic footprint reaches about 85% of the U.S. population, and its share in branded fresh packaged breads has steadily increased to 14.9% in 2015 from 10.7% in 2011, despite periods of promotional intensity in the industry.

Organic Sales Growth and Volume Trends:

Flowers' organic revenue has grown in the low single-digit range in most years due mainly to volume growth from geographic expansion. During 2015, consolidated organic sales increased 1.2% with volumes up 1%. However, during the first half of 2016, overall organic growth has been flat to slightly negative due to weak fresh packaged bread category trends and a high level of promotional activity by competitors. Flowers' volumes in traditional loaf bread, which represents approximately a third of revenue, have recently underperformed the category, declining 5.5% in the quarter ended July 16, 2016 and 2.5% in the quarter ended April 23, 2016.

Flowers revised its long-term annual organic growth rate goal down to 2%-4% from 3%-5% due to weak volume trends for the fresh packaged breads category. Fitch is concerned that volume trends, especially in the traditional loaf bread category, could remain weak and therefore views the low point of this range as achievable at best. Promotional activity is expected to limit ongoing pricing.

Execution of Margin Expansion Strategy:

Flowers is targeting 200 basis points of EBITDA margin expansion to the 12%-14% range over the next five years driven by cost reductions, reduced returns/stale product, and increased operating efficiency. However, absent improved organic revenue trends and meaningful cost savings from Flowers' recently initiated comprehensive business and operational review, Project Centennial, margins could remain under pressure. In addition, a portion of the cost savings may need to be redeployed towards lowering retail price points in the price elastic bread category to preserve volumes given that Flowers price gap to peers has increased.

Fitch expects modest margin contraction for 2016 due to cost associated with recent acquisitions and the conversion of the company's Tuscaloosa plant to organic production and only slight margin expansion for 2017. Nonetheless, Fitch views the low end of Flowers' EBITDA margin goal as achievable over the long term given potential cost synergies from past acquisitions and mix benefits from growth in higher margin branded organic bread sales.

Good FCF, Increased Share Repurchases:

Flowers generates good free cash flow (FCF), which Fitch projects will approximate $95 million in 2016 and $80 million in 2017. However, as evidenced by a $120 million accelerated share repurchase program in the first quarter of 2016, Flowers has demonstrated a willingness to deploy more of its cash flow towards share buybacks in lieu of debt reduction.

Fitch projects total debt/EBITDA and total adjusted debt/EBITDA will remain in the low 2.0x and 3.0x range, respectively, in 2016 and 2017, as limited debt reduction is anticipated. Flowers' leverage increased during 2015 due to the acquisition of organic bread producers Dave's Killer Bread ($275 million or 1.7x revenue) and Alpine Valley ($120 million or 1.3x revenue). Total debt/EBITDA increased to 2.2x for the year ended Jan. 2, 2016, from 1.7x in the prior year period, and total adjusted debt/EBITDAR rose to 3.2x from 2.7x.

KEY ASSUMPTIONS

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

--Organic sales growth of 2% annually, excluding acquisitions;

--EBITDA margin approximates 11.6% in 2016 and 11.7% in 2017;

--FCF approximates $95 million in 2016 and $80 million in 2017;

--Total/EBITDA and total adjusted debt/EBITDA will remain in the low 2.0x and 3.0x range, respectively, in 2016 and 2017.

RATING SENSITIVITIES

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

--Consistently positive low-single digit volumes and organic revenue growth at the high end of the targeted 2%-4% range that lead to market share gains;

--Meaningful margin expansion with the company achieving the higher end of its 12%-14% EBITDA margin goal;

--Total debt/EBITDA and total adjusted debt-to-operating EBITDAR maintained in the mid-1.0x and mid-2.0x range, respectively.

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

--Consistently negative volumes and weaker than expected organic revenue growth due to a consumer shift away from bakery products or a loss of market share;

--Continued margin contraction due weak top line growth and an absence of meanings cost reductions;

--Total debt/EBITDA and total adjusted debt/EBITDAR sustained above the low 2.0x and low 3.0x, due to operational weakness or heightened share repurchase activity.

LIQUIDITY

Flowers' liquidity remains adequate. Liquidity is supported by internally generated cash flow and availability under a $500 million revolver, which can be upsized to $700 million and matures in April 2020, and a $200 million accounts receivable (A/R) securitization facility that expires August 2017. As of July 16, 2016, Flowers had $452 million available on its revolver excluding letters of credit and $6 million available under its A/R facility. The company typically maintains minimal cash on its balance sheet. Aggregate maturities of debt at July 16, 2016 totalled $327 million in 2017 and $85 million in 2018.

FULL LIST OF RATING ACTIONS

Fitch currently rates Flowers Foods, Inc. as follows:

--IDR 'BBB';

--Senior unsecured revolving credit facility 'BBB';

--Senior unsecured term loan 'BBB';

--Senior unsecured notes 'BBB'.

The Rating Outlook is Negative.

Date of Relevant Rating Committee: Aug. 12, 2016

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:

--Historical and projected EBITDA is adjusted to add back non-cash stock based compensation expense as reported in financials.

--Fitch views operating leases as debt-like obligations so capitalizes gross rent expense using a multiple of 8x.

Additional information is available on 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/site/re/869362

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Contacts

Fitch Ratings
Primary Analyst
Carla Norfleet Taylor, CFA
Senior Director
+1-312-368-3195
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Monica Aggarwal, CFA
Managing Director
+1-212-908-2082
or
Committee Chairperson
Eric Ause
Senior Director
+1-312-606-2302
or
Media Relations:
Alyssa Castelli, +1-212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Carla Norfleet Taylor, CFA
Senior Director
+1-312-368-3195
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Monica Aggarwal, CFA
Managing Director
+1-212-908-2082
or
Committee Chairperson
Eric Ause
Senior Director
+1-312-606-2302
or
Media Relations:
Alyssa Castelli, +1-212-908-0540
alyssa.castelli@fitchratings.com