OREANDA-NEWS. Fitch Ratings views the announced intention to merge Land O' Lakes, Inc. (LOL) and United Suppliers, Inc. (United) as neutral to modestly positive to LOL's current ratings. LOL's long-term Issuer Default Ratings (IDR) are 'BBB-'. The Rating Outlook is Stable. See the full list of ratings at the end of this press release.

Fitch anticipates that the merger will be a two-step process, first combining the two companies' seed and crop protection businesses, and later bringing in the crop nutrient business when sales restrictions are released over the next few years. Owner/member votes, which are scheduled for August 2015, are required for both companies. Fitch expects the transaction to close shortly thereafter in October 2015.

LOL's ratings factor in equity financing for the transaction, with no material incremental long-term debt or cash payments. Transaction risks include United's higher member payout structure and higher combined seasonal working capital borrowings, partially offset by anticipated cost synergies, particularly in procurement. These risks will be potentially offset by revenue synergies from cross-selling crop inputs and crop nutrients. Fitch does not anticipate that the acquisition will be dilutive or impact the payout to existing LOL equity holders who will continue to be paid based upon their business generated with the co-op.

The combined company will have increased scale and the ability to provide customers with expanded product offerings, including enhanced agricultural services and technologies. These benefits are important in an industry that has seen rapid consolidation of suppliers, retailers and growers. In 2014, LOL's WinField division generated $4.9 billion in seed and crop protection product sales and United generated $2.6 billion in crop protection, seed and crop nutrient sales.

The ratings continue to reflect LOL's significant scale as the second-largest U.S. agricultural cooperative (co-op), consistent EBITDA growth and reasonable credit metrics. The company's operations are diversified versus its agricultural peers. LOL's competitive market positioning is balanced with its low-single-digit EBITDA margins of approximately 3%, which Fitch estimates will improve moderately when combined with United's higher margins, as well as stand-alone supply chain efficiency and favorable product mix in dairy and feed.

As a co-op, high cash patronage payments of its net profits to grower/owners leave LOL reliant on external sources of liquidity, particularly during near- to intermediate-term periods of heightened capex. Fitch treats the patronage payouts, estimated to continue at 60% of the prior year's net income, as dividends. LOL's debt agreements contain credit enhancing restrictions that subordinate the majority of patronage payments to debt payments. However, there is a 20% allowed patronage distribution to preserve the co-op's tax status. Member/owners have incentive to maintain a relatively conservative capital structure to maintain the financial health of the co-op.

LOL's leverage (total debt to EBITDA) was 2.6x, total adjusted debt to EBITDAR was 3.6x and operating EBITDA/gross interest expense was 6.6x for 2014. Fitch's expects total debt/EBITDA will be approximately flat in 2015 and then improve by approximately one turn to the 1.5x range in 2016, assuming the co-op's next significant maturity, a $155 million private placement, is repaid with cash on hand.

LOL's liquidity is ample at approximately $860 million at March 31, 2015. Seasonal working capital needs are highest during the first and third quarters and trough-to-peak liquidity varies by approximately $900 million. Fitch estimates that annual free cash flow (FCF; cash flow from operations less capex and dividends) will continue to be relatively flat on average, with FCF margins of +1% to -1%. Given the lack of materially positive FCF during most years, LOL has historically relied on asset sales proceeds to reduce debt.

LOL is a Minnesota-based co-op originally incorporated to meet the needs of dairy farmers in the Midwest. The company has expanded through mergers, acquisitions and joint ventures to a revenue base of $15 billion and EBITDA per Fitch's calculation of approximately $440 million in 2014. Dairy members supply LOL's Dairy segment with milk, cream, cheese and butter. Ag members purchase agricultural products, primarily feed, seed and crop protection products. United, headquartered in Iowa, comprises 600 agricultural dealer/owners that operate approximately 2,800 retail locations in the U.S. and Canada.

RATING SENSITIVITIES
A negative rating action could occur if there is a sustained weakness or operating profit decline in one of LOL's key business segments, if total debt to EBITDA is consistently greater than 3x, and FCF after patronage dividends remains negative for multiple years. A Board commitment to a patronage payout materially above 60%, which is currently factored into Fitch's base case projections, could also support a negative rating action.

A positive rating action could occur if LOL diversifies its portfolio towards higher growth and higher margin categories, if leverage is sustained below 2x, and the company consistently generates positive FCF. Fitch does not expect a positive rating action in the near term due to the low-growth and low-margin structure of its business segments.

Fitch currently rates LOL as follows:

Land O' Lakes, Inc. (LOL)
--Long-term IDR 'BBB-';
--Senior secured credit facility 'BBB-';
--Senior secured term loan 'BBB-';
--Senior secured private placement notes 'BBB-';
--Senior unsecured notes 'BBB-';

Land O' Lakes Capital Trust I
--Long-term IDR 'BBB-'
--Junior subordinated capital securities 'BB.'

The Rating Outlook is Stable.