Standard & Poor's raises ratings on Brasil Foods to BB+ from BBB-, saying full integration of BRF and Sadia enhances company's business profile; outlook stable

Nevin Barich

NEW YORK , April 5, 2012 (press release) – Overview

-- The full integration of Brazil-based branded food producer BRF and Sadia enhances the company's business profile, resulting in leading shares in the domestic branded food markets and cost efficiencies.

-- BRF has maintained resilient profitability and moderate financial policies, and it has decreased its leverage.

-- We are raising our ratings on BRF to 'BBB-' from 'BB+' on the global scale and assigning a 'brAAA' Brazilian national scale corporate credit rating.

-- The outlook is stable, reflecting our expectation that BRF will maintain adequate liquidity and gradually reduce its debt in the next several years.

Rating Action

On April 4, 2012, Standard & Poor's Ratings Services raised its ratings on BRF Brasil Foods S.A. to 'BBB-' from 'BB+'. At the same time, we assigned our 'brAAA' Brazilian national scale corporate credit rating to the company. We also raised our ratings on the 2020 and 2017 bonds of subsidiaries BFF International Ltd. and Sadia Overseas Ltd., respectively. Total rated debt is $1 billion. The outlooks are stable.

Rationale

The upgrade reflects our view that BRF's business profile has improved following the full integration of Sadia and BRF. Due to its strong branded portfolio, efficient hedging strategy, and leading market positions in most of the segments in which it operates in Brazil, BRF has been able to pass on raw material price increases to end products, resulting in resilient cash flows and higher margins, which are consistently above 10%. The higher cash flows have contributed to a gradual reduction in debt, which we expect to be flat for next couple of years despite the company's growth strategy.

We assess BRF's financial profile as intermediate. Its gross adjusted debt to EBITDA is below 3x and funds from operations (FFO) to debt is above 30%. Expected higher capital expenditures for the next several years could pressure cash flows and lead to slightly negative free operating and discretionary cash flows. As a result, we shouldn't see a decrease in total debt. On the other hand, we expect a gradual deleveraging as revenues and EBITDA rise. In our base-case scenario, we are projecting internal growth at 7% to 9% per year and EBITDA margins of about 13%. As a result, total debt to EBITDA should improve to 2x by 2014-2015. We did not consider the possibility of major acquisitions in our scenarios, but we believe that BRF will maintain a conservative approach to its debt profile while considering merger and acquisition (M&A) opportunities. Also, we expect the company to be willing to adjust expenditures, such as capital expenditures and dividends, to maintain a total debt to EBITDA below 3x.

In our view, the regulatory restrictions under which the merger of Perdigao and Sadia occurred to form BRF will not significantly affect sales, cash generation, and debt. We believe the sale of brands and assets, and the suspension of some of BRF's strong brands (such as Batavo and Perdigao) in specific subsegments that total Brazilian reais (R$) 3 billion in revenues will be offset by internal growth of existing brands and, in part, by the exchanged asset Quickfood S.A. in Argentina. Previously, Marfrig S.A. owned Quickfood.

Still, we believe BRF will recover the sales from divested assets in six months to one year, and we expect the assets exchange will occur in mid-2012.

Liquidity

We view BRF's liquidity as adequate. Cash on hand totaled R$2.8 billion in December 2011, with expected FFO generation of more than R$2.5 billion for 2012, which compares favorably with short-term debt of R$3.7 billion (including derivatives). It's important to highlight that a majority of short-term maturities are rural and Banco Nacional de Desenvolvimento Economico e Social (BNDES) loans, which are always rolled over and renewed at favorable interest rates. We expect cash sources to exceed cash uses by more than 1.2x in the next 12 to 18 months, even if EBITDA were to decline 15%. We expect capital expenditures of R$2 billion to R$2.5 billion in the next couple of years, which, coupled with dividend distributions of 35% of net income, will result in negative discretionary cash generation. Importantly, the company has a discretionary profile of investments that's flexible to market conditions, and the company has adequate funding terms. We estimate maintenance capital expenditures of about R$900 million. BRF has adequate access to credit and capital markets and has no financial covenants on its debt agreements.

Outlook

The stable outlook reflects our expectation that BRF will maintain its financial discipline, even if M&A transactions occur, and will continue to pass on raw material price hikes to end customers. We expect BRF to keep total adjusted debt to EBITDA of less than 3x and FFO to total debt close to 30%, generate double-digit margins on a rotating 12-month basis, and have adequate liquidity. A negative rating action could occur if BRF assumes a more aggressive growth strategy, increasing debt to EBITDA consistently above 3x and FFO to debt to about 20%, or weakening its liquidity. A positive rating action would occur if margins grew consistently above 15% and if BRF lowered its debt-to-EBITDA ratio to less than 2x, which could happen with the increase of processed branded products in its portfolio, mainly from its operations in the external market.

Related Criteria And Research

-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Criteria For Rating The Global Branded Nondurable Consumer Products Industry, April 28, 2011 -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- Corporate Ratings Criteria 2008, April 15, 2008 Ratings List Upgraded To From BRF Brasil Foods S.A. Corporate Credit Rating BBB-/Stable/-- BB+/Positive/-- Sadia S.A. Corporate Credit Rating BBB-/Stable/-- BB+/Positive/-- Senior Unsecured BBB- BB+ Sadia Overseas Ltd. Senior Unsecured BBB- BB+ BFF International LTD Senior Unsecured BBB- BB+ New Rating BRF Brasil Foods S.A. Corporate Credit Rating National Scale brAAA/Stable/--

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