Fitch 2009 U.S. Commodity Food Outlook: Liquidity and Leverage Will Be the Focus

CHICAGO--(BUSINESS WIRE)--Despite declining energy and agricultural ingredient costs, high financial leverage and weak cash flow generation continue to wreak havoc on the commodity food industry. Liquidity and debt reduction should take priority over share repurchases and acquisitions in 2009, regardless of significant stock price declines and additional assets coming to market. The well-anticipated bankruptcy filing by poultry processor Pilgrim's Pride Corp. (Pilgrim's) and the potential inability of fresh produce manufacturer Dole Food Co. (Dole) to refinance significant near-term maturities illustrate the challenges faced by a low-margin highly levered food company in a difficult operating environment.

Equity issuances, convertible debt offerings and asset sales enabled many commodity food companies to pay down debt or support near-term liquidity in 2008. Tyson Foods, Inc. (Tyson), Pilgrim's, Smithfield Foods, Inc. (Smithfield), Dean Foods Co. (Dean) and Chiquita Brands International, Inc. (Chiquita) all issued equity, convertible notes or both. Large divestitures included Smithfield's beef operation and Del Monte Foods Co.'s (Del Monte) StarKist seafood business. Although Del Monte is not a pure play commodity food company and the divestiture of its seafood operation further reduces its exposure to low-margin commodity food products, more than half its revenue comes from processed fruits and vegetables. Fitch anticipates continued stock market weakness, a poor credit environment and higher risk premiums will limit these activities for high-yield commodity food companies in 2009.

A conservative financial strategy and significant exposure to higher margin packaged or pet food should continue to benefit firms such as Hormel Foods Co. (Hormel) and Del Monte, both of which have a Stable Rating Outlook. The Outlooks for Dole and Tyson, however, remain Negative. Dole's liquidity will continue to gradually improve as the company closes a number of smaller asset sales announced at the end of September. The company's ratings, however, are likely to be downgraded if management does not provide additional visibility in the near term around plans for its significant upcoming maturities. A cash infusion or additional equity by owner David H. Murdock, who has substantial wealth, would be viewed positively.

Tyson is currently benefiting from the diversification provided by its pork and beef business but continued deterioration in the profitability of its core chicken business is a concern. Ratings could be downgraded if the company's acquisition strategy becomes increasingly aggressive, leverage increases more than anticipated or liquidity becomes an issue. Tyson's nearest material maturity is in early 2010.

CREDIT OUTLOOK REMAINS NEGATIVE DESPITE DECLINING COMMODITY PRICES

Although costs have declined, 2009 is projected to be another difficult year for most of the commodity food industry. Until core operating margins show meaningful improvement and leverage declines, credit profiles will remain weak. On latest 12-month basis, Pilgrim's, Smithfield, Tyson, Dole and Chiquita are all currently generating negative free cash flow. Fitch expects the protein processors to benefit the most from declining commodity prices; however, continued weak chicken prices and hedging losses could mask much of the benefit in the near term.

The price of corn and soybean meal, two primary ingredients in animal feed for the protein industry, has declined approximately 40%-50% since peaking at over $7.00 per bushel and $400 per short ton during the summer of 2008. On Oct. 31, 2008, spot prices were approximately $3.66 per bushel and $278 per short ton, respectively. As of Nov. 10, 2008, the USDA expects corn prices to average $4.00-$4.80 per bushel and soybean meal prices to average $255 and $315 per short ton during 2008/2009. Corn and soybean meal futures indicate prices will average near the low end of this range.

Declining raw milk prices should continue to benefit the operating earnings and cash flow generation of Dean. After peaking at over $24/hundredweight (cwt) in mid-2007, the USDA has forecast the Class 1 All milk price of $16.50-$17.40/cwt in 2009, down from the $18.45/cwt estimate for 2008. Dean used its approximately $400 million of equity offering proceeds during the first quarter of 2008 to reduce debt and plans to use discretionary cash flow to continue deleveraging its balance sheet in 2009.

Improved performance in the banana operations of Dole and Chiquita combined with the dramatic pullback in shipping fuel prices should benefit cash flow in 2009. Bunker fuel, as measured by the Rotterdam Netherlands index, has declined 55% from a peak of $761/metric ton on July 15, 2008 to $343/metric ton at Oct. 31, 2008. However, operating costs for these companies remain challenged by European Union's (EU) Euro176 per metric ton tariff on bananas sourced from Latin America.

Negotiations regarding a reduction in the tariff collapsed along with the Doha Round of global trade discussions this past summer and the European Commission (EC) has appealed the WTO's ruling that its tariff violates trade rules. The timing of a resolution remains uncertain; however, Fitch continues to expect a change in the regime and notes that a material immediate reduction in banana tariffs would be extremely beneficial for the operating earnings and cash flow of these companies.

Dole's appeal of the Euro 45.6 million (approximately $58 million) banana price-fixing fine charged by the EC will delay the need to make any payments. However, due to high leverage and a string of near-term maturities, liquidity and refinancing risk remains a major concern. Dole has $350 million of 8 5/8% notes due May 1, 2009, followed by $400 million of 7 1/4% notes due June 15, 2010 and $200 million of 8 7/8% notes due March 15, 2011. Due to progress made on an additional $145 million in near-term asset sales, Fitch estimates that Dole's liquidity has improved since the end of second-quarter 2008. At June 14, the company had $166 million available on its $350 million asset-based revolver expiring in 2011 and $77 million in cash.

STRUCTURAL CHANGES IN THE PROTEIN INDUSTRY CONTINUE

Change is no stranger to the meat and poultry industry, given its long history of large acquisitions and divestitures. However, due to the U.S. Department of Justice's anti-trust lawsuit filed in late October, Brazilian-based JBS S.A.'s acquisition of National Beef Packing Co., LLC does not appear likely. If successful, the U.S. could risk becoming less competitive in the global beef industry. Fitch anticipates that the bankruptcy filing of Pilgrim's - the largest chicken processor in the world with approximately $8.6 billion in sales, $1.5 billion in debt, $185 million of EBITDA and leverage of 8.0 times (x) at the latest 12-month period ending June 28, 2008 - will be the most significant change faced by the industry in 2009.

Pilgrim's has exhibited a long list of warning signals; including high leverage, four consecutive quarters of losses, entering of a 30-day interest payment grace period ending Dec. 3, 2008 on its unsecured notes and retaining investment advisors to examine refinancing or recapitalization options. In addition, the company has lost 100% of its equity value. Recent actions by the company's lenders including granting of a temporary fixed-charge coverage covenant waiver expiring Nov. 26, 2008 and the forced hiring of a restructuring chief indicate that they are more interested in cutting potential losses versus continuing to work with the company. Fitch believes bondholders could be more apt to work with the company as it restructures its balance sheet. Bondholder losses may accelerate if Pilgrim's is forced into chapter 7 liquidation.

With the elimination of capacity, Fitch believes the bankruptcy of Pilgrim's will be longer term positive for Tyson and the viable remaining players in the poultry industry. A considerable reduction in production will help support higher pricing for the entire industry. Difficult credit conditions, levered balance sheets, uncertain operating conditions and a strengthening dollar is expected to limit the number of potential buyers.

Fitch also continues to believe higher than normal grain costs is a structural change for the protein industry and that input costs for commodity food companies are not sustainable at pre-2006 levels. Despite the current global macroeconomic slowdown, longer term secular demand for agricultural grains remains strong and should outweigh ancillary factors such as the impact of a strengthening dollar. Efforts by protein processors to modify customer contracts by shifting more commodity risk to customers are evidence of this change.

NEAR-TERM MARKET PRICES FOR THE PROTEIN INDUSTRY RAISING CONCERN

Commodity food companies have historically had less pricing power than their branded packaged food companies. Conventional wisdom, however, would suggest an improved ability to raise prices given the rapid escalation of agricultural commodity prices during the first half of 2008, significant operating losses and announcements regarding supply cuts.

As of Oct. 17, 2008, the USDA is forecasting live hog prices of $50-$55/cwt for 2008/2009, up an average of 7% from $49/cwt estimate for 2007/2008. Broilers prices are projected to range 81-88 cents/lb, an average increase of 7% from the 79 cents/lb forecast for the previous year. Finally, choice steers are expected to be $94-$102/lb, up approximately 4% from approximately $94/lb. Consumer price inflation for these proteins is projected to be 5%-6%, versus an estimated 3%-4% in 2008. Recent market pricing trends, however, are signaling less of an increase in 2009. Industry profitability could remain under pressure even though year-over-year costs for feed grains have declined.

As of Nov. 12, Georgia Dock skinless boneless breast meat prices were $1.10/lb; levels not seen since January 2006 when reduced international demand for leg quarters caused a significant oversupply of U.S. chicken. Leg quarter prices are down over 35% to 36 cents/lb in the last month due to inventory buildup caused by lower imports by Russia - the largest importer of U.S. chicken. A general slowdown in foodservice demand could escalate this buildup. If chicken prices remain depressed, consumer substitution into other proteins could further negatively affect prices. However, reduced egg sets for chicken, the removal of chicken production capacity by Pilgrim's and production cuts by hog and turkey producers should support all protein prices in 2009.

The following is a list of Fitch-rated issuers and their current Issuer Default Ratings (IDR):

--Tyson Foods, Inc. ('BB+'; Outlook Negative);

--Hormel Foods Corp. ('A'; Outlook Stable);

--Dole Food Co. Inc. ('B-'; Watch Negative);

--Del Monte Foods Co. ('BB'; Outlook Stable).

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.