Standard & Poor's affirms BBB- rating on Flower Foods following announcement of company's plan to issue US$400M of senior unsecured notes; outlook stable

Nevin Barich

NEW YORK , April 3, 2012 (press release) – Overview

-- Flowers Foods Inc. is issuing $400 million of senior unsecured notes due 2022. Proceeds for the issuance will be used for debt repayment and general corporate purposes, which could include acquisitions.

-- We have affirmed the corporate credit rating at 'BBB-'. We have assigned a 'BBB-' issue-level rating to the new senior unsecured notes.

-- The outlook is stable, reflecting our belief that the company will sustain adequate liquidity and maintain credit metrics close to ranges indicative of an intermediate financial risk profile over the next 12 months.

Rating Action

On March 30, 2012, Standard & Poor's Ratings Services affirmed at 'BBB-' its corporate credit rating on Thomasville, Ga.-based Flowers Foods Inc. following the company's announcement that it plans to issue $400 million of senior unsecured notes. At the same time we assigned a 'BBB-' issue-level rating to the proposed $400 million senior unsecured notes due 2022. The outlook is stable. Pro forma for the notes issuance, we estimate that adjusted total debt outstanding (including operating lease adjustments and pension expenses) is
about $1 billion.

Rationale

The rating affirmation reflects our belief that Flowers' credit measures will remain indicative of those for an "intermediate" financial risk profile despite the increase in long-term debt. Pro forma for the note issuance we estimate adjusted debt to EBITDA will increase to slightly below 3x, as compared with about 2.2x actual for the 12 months ended Dec. 31, 2011. We
estimate funds from operations (FFO) to adjusted debt will decline to the mid 20% area as compared with about 30% for the same period. These ratios are near or below our indicative ratios for an intermediate financial risk descriptor, which includes leverage between 2x and 3x, and FFO to adjusted debt between 30% to 45%. We anticipate that credit measures will remain near current levels through fiscal year-end 2012 yet then improve back to within these indicative ratio ranges through acquisition-related synergies and EBITDA expansion during
the next year.

We view Flowers' financial risk profile as "intermediate" and the business risk profile as "satisfactory" (as defined in our criteria). Key credit factors considered in our view of the satisfactory business risk assessment include Flowers' narrow product portfolio, leading market positions in the southern United States within the highly competitive fresh-baked goods industry, exposure to volatile commodity costs, moderate customer concentration, and geographic diversity within the U.S. yet a lack of international diversification.

Flowers' fresh-packaged bakery products are marketed predominantly in the southern and mid-Atlantic areas of the U.S. Its snack and frozen products are distributed nationally through direct delivery to warehouses. It is our opinion that, relative to the overall packaged foods industry, the company's products are narrowly focused within, bread, rolls, buns, and snack cakes. Flowers has expanded its DSD system into adjoining territories through modest-sized acquisitions (such as Tasty Baking Co. in 2011) and building new manufacturing facilities. Including Tasty's markets, Flowers' fresh bakery products reached 61% of the U.S. population in 2011 and its goal is to reach 75% of the population by 2016 through acquisitions and organic growth. Although the company has expanded into the northeastern U.S., the company's geographic footprint is limited to domestic markets.

Branded product and private label retail sales made up about 51% and 18%, respectively, of consolidated sales in fiscal 2011 while food service and other nonretail establishments constituted 31% of sales. The company's "Nature's Own" brand is a leader in the U.S. soft variety bread category. Fresh bakery is a consolidating industry, and branded competitors include Bimbo Bakeries USA (Grupo Bimbo S.A.B. de C.V. rating is BBB/Negative/--), Pepperidge Farm (owned by Campbell Soup Co., A-/Stable/A-2), and Hostess Brands. We believe customer concentration is moderate, as Flowers' top 10 customers accounted for 45.6% of 2011 sales, with Wal-Mart and Sam's Club together constituting 21.6% of sales.

Effective hedging programs, price increases, manufacturing efficiencies, and new product introductions have helped the company maintain relatively stable operating margins in the 11% to 12% range for the past few years despite operating in a volatile commodity sector with high promotional activity. For the year ended Dec. 31, 2011, sales grew 7.8%, including 3.7% from pricing and mix, and 5% from the Tasty acquisition, partially offset by a 0.9% volume decline. Adjusted EBITDA in 2011 was essentially flat over the prior year period as margins of about 11.6% declined by about 90 basis points largely due to higher input costs. We expect EBITDA margins to remain near current levels as the company has hedged most of its 2012 commodity exposure, including ingredients, packaging, and natural gas.

On a pro forma basis for the senior note issuance and potential acquisitions, we estimate credit measures will weaken. We estimate pro forma lease- and pension-adjusted total debt to EBITDA will be just below 3x for the 12 months ended Dec. 31, 2011, compared with actual leverage of about 2.2x for the same period and about 1.3x for the prior year. The increase in actual leverage at year end was primarily related to the Tasty acquisition on May 25, 2011. We estimate the ratio of funds from operations (FFO) to total debt will decline to the mid 20% area on a pro forma basis, compared with 30% at year end. We do not anticipate that the company will continue to buyback shares until credit measures improve. Flowers had about 7 million shares remaining under its share-authorization program, which we anticipate will resume in the intermediate term.

We expect Flowers' credit measures to weaken following this transaction and metrics to remain at these weaker levels through 2012, but for measures to modestly improve in 2013 as the company continues to expand its products into new geographies. Our base case scenario assumptions include:

-- Low double-digit revenue growth, driven by acquisitions and further penetration of existing products in new regional markets;
-- Maintenance of at least 11% EBITDA margins because of increased sales of branded products in new markets and because any acquisitions made will have
EBITDA margins near the company's current levels;

-- Positive free operating cash flow after capital expenditures of at least $150 million, with capital expenditures not substantially greater than $85 million; and

Based on our forecast, we estimate that by the end of 2012, leverage will remain just below 3x, and FFO to total debt will increase slightly to about 27%, with improvement to more than 30% in 2013.

Liquidity

We believe Flowers has adequate liquidity, and that sources of cash are likely to exceed uses for the next 12 months. Our view of the company's liquidity profile incorporates the following expectations:

-- We expect liquidity sources (including cash, discretionary cash flow, and availability under its $500 million revolving credit facility) to exceed uses by 1.2x over the next 12 months.

-- We expect liquidity sources to continue exceeding uses, even if EBITDA declines by 15%.

-- Cash sources include cash balances of about $8 million as of Dec. 31, 2011, and cash flow (reported free operating cash flow totaled about $55 million in the 12 months ended Dec. 31, 2011).

-- As of Dec. 31, 2011, Flowers had $260.3 million (including $14.7 million for letters of credit outstanding), available under its $500 million revolver due 2016. With a strong cushion, the company was in compliance with covenants. Financial covenants under the agreement include a minimum interest coverage and maximum leverage ratio, which do not become more restrictive over time.

Outlook

Our rating outlook on Flowers is stable. We expect Flowers to use proceeds from the senior notes issuance to pay down a portion of existing debt and for potential acquisitions in order to improve credit measures to those commensurate with an intermediate financial risk profile during the next year. This includes leverage improving to the 2.5x area and FFO to debt over 30% by the end of 2013. We could consider an outlook revision to negative, or a downgrade, if adjusted leverage is well above 2.5x at fiscal year end 2013 or if FFO to debt does not improve as expected. Relative to our pro forma credit metrics as of the 12 months ended Dec. 31, 2011, we estimate this could occur if sales decline by a low single-digit percentage, or if adjusted EBITDA margins decline by more than 100 basis points. An upgrade is unlikely given that pro forma for this transaction, credit measures are at the weaker end of our intermediate indicative ratio assessment. For an upgrade, Flowers would need to improve and sustain leverage near or below 2.0x and FFO to total debt of over 40%.

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