OREANDA-NEWS. August 03, 2015. Fitch Ratings has affirmed UK-based Premier Foods plc's Long-term Issuer Default Rating (IDR) at 'B' with a Negative Outlook. Fitch has also affirmed Premier Foods Finance plc's senior secured rating at 'B' with a Recovery Rating of 'RR4'/32%.

The Negative Outlook reflects the recent weak financial performance posted by the company with contracting revenues and profit as the UK packaged food trading environment remains extremely challenging and prone to promotions. We expect funds from operations (FFO) to remain under pressure, especially from fiscal year ending April 2017 (FY17), due to a step-up of pension contributions. Consequently, on an FFO basis, Fitch does not expect the company to achieve any material deleveraging over the rating horizon. If FFO adjusted net leverage remains above 6.0x when pension payments resume, as currently forecast, this will likely erode the group's financial flexibility and could result in a downgrade.

The 'B' IDR continues to reflect Premier Foods' robust market position, its continued innovation and marketing efforts, some benefits from the currently lower input costs environment, a strong operating margin and adequate liquidity, offset by the above mentioned weaknesses.

KEY RATING DRIVERS
No Material Deleveraging Expected
Our expectation of weak operating performance resulting in the inability to improve FFO does not allow for material deleveraging prospects over the rating horizon. While management remains focused on paying down debt, Fitch expects that FFO adjusted net leverage will likely rise above 6.7x-6.5x for at least FY17 and FY18 when pension contributions increase after the agreed contribution holiday elapses. This would be incompatible with Premier Foods' 'B' IDR. The expected elevated leverage is due to high interest costs and pension contribution payments which will put pressure on FFO generation. However, Fitch expects Premier Foods to generate neutral to positive FCF thanks to no disbursements for tax, cautious capex spending and a strong EBITDA margin.

Reliant on Challenging UK Market
Premier Foods operates mainly in the UK and a significant portion of its turnover is from the "big-four retailers" in the UK - Tesco (BB+/Negative), Asda, J Sainsbury's and Morrisons. The shift in consumer shopping behaviour from these traditional big retailers to hard discounters, online and convenience stores has gathered pace in the UK, and is strongly affecting Premier Foods' performance.

Although Fitch acknowledges the company's efforts in adapting to this challenging environment, for example by launching products tailored for the faster growing hard discount channel, Premier Foods' planned recovery is hampered by its mainly UK presence. In addition to these new shopping behaviours, including people eating out more often, the UK market is currently subject to deflation and strong competitive pressures leading to a high level of promotions.

Leading UK Ambient Food Producer
The ratings continue to support Premier Foods' position as one of the UK's largest ambient food producers, with a 4.7% market share in the fragmented and competitive GBP28bn UK ambient grocery market. Premier Foods manufactures, distributes and sells a wide range of branded and non-branded food products, across five categories with leading and strongly established brands.

The company benefits from its diversity and scale in terms of manufacturing, logistics and procurement in the UK. However, despite its ability to grow the categories in which it operates, Premier Foods mainly competes in very mature segments such as ambient desserts and ambient cakes. This limits its growth prospects and requires high marketing and innovation spending.

International Diversification Possibly Distracting
While the company's decision to expand outside the UK in Australia, the US and China could provide some diversification, international business is unlikely to contribute meaningfully in the short term given the small proportion (estimated less than 5%) of group profits and could actually be more of a distraction to management.

Good Operating Margins
Premier Foods reported a weak financial performance for the 52 weeks ending 4 April 2015 with a 4.5% decrease in sales and a decline in trading profit and margin (of -6.4% and -30 bps, respectively). Premier Foods should be able to maintain its EBITDA margin above 18% in FY16 thanks to its important market shares, as well as Fitch's expectation of benefits from lower input costs and cost-saving initiatives. This should enable sufficient flexibility to fund marketing and innovation spending.

Senior Secured Notes' Rating
The 'B'/'RR4' senior secured rating reflects Fitch's expectations that the enterprise value of the company and the resulting recovery of its creditors (including the pension trustees) would be maximised in a restructuring scenario (going-concern approach) rather than a liquidation due to the asset-light nature of the business as well as the strength of its brands.

Furthermore, a default scenario would likely be triggered by unsustainable financial leverage, possibly as a result of weak consumer spending affecting sales and profits or punitive pension deficit contributions. As such, Fitch has applied a 30% discount to EBITDA and a distressed EV/EBITDA multiple of 5.0x reflecting the challenging market conditions in the UK and the reliance on a single country partially offset by a portfolio of strong names. This results in average recoveries (31%-50%), albeit at the low end (32%) for senior secured noteholders in the event of default.

KEY ASSUMPTIONS
- Low single digit revenue decrease due to negative market factors with a shift towards discounters and convenience channels and strong competitive pressure leading to high levels of promotions negatively affecting the company's revenue generation
- Slight improvement in profit margin with lower input costs and operating efficiencies offsetting high marketing spending
- Neutral to slightly positive FCF generation despite high interest costs and pension payments thanks to relatively limited working capital outflow and capex spending
- With respect to pension schemes, cash contributions (from FY17) and sharing of security with lenders to remain in line with April 2014 agreements, irrespective of the evolution of the plan's deficit

RATING SENSITIVITIES
Negative (downgrade to B-): Future developments that could lead to a negative rating action include:
- Failure to stabilise performance with continued revenue decline and margin deterioration with EBITDA falling below 18%.
- Neutral to negative FCF on a sustained basis due to profitability erosion, higher or unexpected capex and increases in pension contribution or funding costs.
- FFO adjusted net leverage remaining around 6.0x by FY17 (pension deficit contributions are deducted from FFO).
- FFO fixed charge coverage below 1.8x on a sustained basis.

Positive (revision of the Outlook to Stable): Future developments that could lead to a positive rating action include:
- Evidence of a recovery of financial performance with the reversal of organic revenue decline and the ability to maintain EBITDA margin above 18% after having sufficiently invested in advertising and promotions to protect its market position and drive growth.
- FFO adjusted net leverage trending towards 5.5x (pension deficit contributions are deducted from FFO).
- FFO fixed charge coverage above 1.8x on a sustained basis.
- FCF margin sustainably in positive territory (FY14/15: -4%) after adequate capital investments.

ADEQUATE LIQUIDITY
Premier Foods' liquidity is adequately supported by a GBP272m revolving credit facility (RCF) due in March 2019 (currently GBP159m estimated available), with appropriate covenant headroom. Premier Foods' liquidity also benefits from a lack of material short-term debt maturities over the next four years, apart from the negotiated pension deficit contributions and a GBP80m securitisation facility due in December 2016. The company's liquidity profile is also supported by the expected ability to generate neutral to positive FCF over the rating horizon.