OREANDA-NEWS. April 13, 2016. Fitch Ratings has affirmed Land O' Lakes, Inc.'s (LOL) Long-term Issuer Default Rating (IDR) and unsecured debt ratings at 'BBB-'. Fitch has upgraded LOL's preferred stock rating to 'BB' from 'BB-' and the junior subordinated capital securities to 'BB+' from 'BB'. Additionally, LOL increased its preferred stock by \\$115 million to \\$315 million. The Rating Outlook is Stable. A full list of ratings is provided at the end of this release.

The preferred stock ranks junior to the senior debt and capital securities. Fitch grants 50% equity credit to LOL's preferred shares after considering the junior ranking, perpetuity, the option to defer dividends, and the cumulative coupon deferral. On or after July 16, 2025, the preferred stock will be redeemable at the option of the company. Proceeds from the offering will be used to refinance certain existing debt, to provide general working capital, or for other general corporate purposes.

KEY RATING DRIVERS

Significant Scale, Strong Brands: LOL's ratings reflect the significant scale as the second largest U.S. agricultural cooperative (co-op) that has expanded through mergers, acquisitions and joint ventures with sales of approximately \\$13 billion in 2015. The co-op's long history since 1921, long-term relationships with its grower/owners, as well as strong brands including Land O' Lakes, Purina Animal Nutrition and WinField Solutions, support the ratings. 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.

Diversified Operations: LOL's operations are more diversified versus its agricultural peers. The recent United Suppliers Inc. (United) transaction, which generated \\$2.6 billion in revenues in 2014, is a two-step merger process that has increased LOL's scale and exposure to the more profitable Crop Inputs segment. After merging United's seed and crop protection business in October 2015, the second phase merges United's remaining crop nutrient operations and is expected to complete in October 2017. For 2015, Dairy Foods, Feed, and Crop Inputs accounted for 26%, 26% and 42% of EBITDA respectively. Fitch expects once United's crop nutrients business is merged, the Crop Inputs segment should generate close to 60% of LOL's overall EBITDA.

Low Margins: LOL's competitive market positioning is balanced against its exposure to volatile commodity products with low single digit EBITDA margins. EBITDA margins were 3.8% in 2015 compared to 3% in 2014 driven by margin increases in the Dairy and Feed segments. Fitch's forecast has margins remaining relatively stable in 2016 given the likely required investments to defend LOL's market share. Consequently, Fitch expects the majority of synergy benefits from the United merger of approximately \\$50 million in the first year will be reinvested into the business. Some margin upside exists depending on the extent LOL can leverage margin management initiatives and favorable product mix in Dairy to mitigate expected margin pressure in Feed.

Retained Earnings, Board Policies Provide Flexibility: Co-ops generally distribute the majority of their earnings back to members which can constrain financial flexibility resulting in low free cash flow (FCF) generation. LOL's board has a current cash target for distribution of 60% of prior year's net earnings with the remainder retained by the company as either permanent or member equity. LOL retains permanent equity through both its non-member business earnings and LOL's by-laws that allow the company to retain up to 25% of earnings from its member business. The current holdback percentage for the dairy business is 10% and the Agriculture business is 25%. In 2017, the holdback percentage for the Agriculture business is being lowered to 10%. The holdback percentage and cash target for distribution is subject to annual board review.

Consequently, Fitch believes these sources of permanent retained earnings and the current 60% cash distribution of prior year's earnings provide sufficient flexibility to maintain adequate capital to finance its business. Fitch treats the cash patronage pay-outs as dividends and our forecast expects the cash patronage pay-outs will continue at 60% of prior year's net income. As part of LOL's merger with United, LOL transitioned from its current Agriculture member equity program to a new three-tiered base capital plan to better align the Ag Services cash patronage payments between the two co-ops. However, the increase in the Ag Services cash patronage payment does not affect the overall cash paid out to co-op members due to the 60% cash cap of prior year's net income.

Credit Enhancements: LOL's debt agreements contain credit enhancing restrictions that subordinate the majority of patronage payments to debt payments with an allowed 20% cash patronage distribution to preserve the co-op's tax status. LOL's effective income tax rate is substantially lower than the statutory federal and state income tax rates as a result of the tax deductibility of qualified patronage distributions made from net income.

Credit Metrics Stable: For 2015, LOL's leverage (total debt to EBITDA) was 2.5x, total adjusted debt to EBITDAR was 3.5x and operating EBITDA/gross interest expense was 9.0x. Fitch expects total debt/EBITDA will be approximately flat to down slightly in 2016 assuming the majority of LOL's \\$155 million notes maturity at the end of 2016 is effectively refinanced. LOL's rent expense is significant at approximately \\$110 million annually, but more than 40% is comprised of inventory storage fees for its dairy and crop inputs business that are very short-term and cancellable at any time.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for LOL include:

--Approximately 7% increase in sales in 2016 driven mainly by increased revenue related to United and an approximate mid-single digit increase in the feed segment offset by high-single digit declines in the dairy segment due to lower prices. In 2017, revenue growth is expected in the high single digits driven by organic growth, commodity price increases and the second phase closure of the United merger.

--Margins remain relatively stable in 2016 given the likely required investments to defend LOL's market share. Consequently, Fitch expects the majority of synergy benefits from the United merger of approximately \\$50 million in the first year will be reinvested into the business. Fitch expects margins will remain stable in 2017.

--Over Fitch's forecast period, cash pay-out to members remains at the targeted 60% of prior year net income with FCF of approximately \\$150 million in 2016 and a FCF margin in the range of 1% of sales driven by working capital benefits from inventories and improved efficiencies from the United merger. In 2017, Fitch expects FCF will be close to \\$100 million depending on additional working capital benefits.

--Total debt/EBITDA approximately flat to down slightly in 2016 assuming the majority of LOL's \\$155 million notes maturity at the end of 2016 is effectively refinanced. Leverage in 2017 is expected to decrease modestly driven primarily by increased EBITDA.

RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to a negative action include:

--Sustained weakness or operating profit decline in at least one of LOL's key business segments;
--Leverage (total debt to EBITDA) moving toward 3x;
--FCF (cash flow from operations less capex and dividends) after patronage dividends remains negative for multiple years;
--A Board commitment to a higher cash patronage payout that creates a sustained FCF deficit.

Positive: 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. However, future developments that may, individually or collectively, lead to a positive action include:

--LOL diversifies its portfolio towards higher growth and higher margin categories;
--Leverage is sustained below 2x;
--LOL consistently generates positive FCF.

LIQUIDITY

LOL's liquidity is ample at approximately \\$1.5 billion as of Dec. 31, 2015. Liquidity includes \\$341 million cash and cash equivalents, which varies seasonally, \\$550 million available on its \\$575 million senior unsecured revolver and full availability on its \\$700 million receivables facility. Seasonal working capital needs are highest during the first and third quarters and trough to peak liquidity varies by approximately \\$900 million. Fitch forecasts FCF of approximately \\$150 million for 2016 driven by working capital benefits from inventories and improved efficiencies from the United merger. Historically, annual FCF margins ranged between +1% to -1%.

LOL's capital structure consists of a \\$575 million unsecured credit facility due March 2020, \\$150 million senior unsecured term loan due August 2021, \\$325 million in 6.24%-6.77% senior unsecured private placement notes due 2016 through 2021 including \\$155 million due in December 2016, \\$300 million 6.00% unsecured notes due August 2022 and a \\$700 million receivables securitization facility due March 2020. There are also \\$200 million junior subordinated capital securities due in March 2028 at Land O' Lakes Capital Trust I and \\$315 million of preferred stock (including the newly issued \\$115 million) at LOL.

In October 2015, LOL requested and was granted a release of security of substantially all of the material assets of LOL and its wholly owned domestic subsidiaries for the revolving credit facility, term loans and private placement notes. The release of security is conditional based on maintaining investment grade ratings from two nationally recognized rating agencies. The release of collateral was a factor in the rating upgrade for the junior debt.

FULL LIST OF RATING ACTIONS

Fitch affirms the ratings for LOL and its subsidiary, Land O'Lakes Capital Trust as follows:

LOL
--Long-term Issuer Default Rating (IDR) at 'BBB-';
--Senior unsecured credit facility at 'BBB-';
--Senior unsecured term loan at 'BBB-';
--Senior unsecured private placement notes at 'BBB-';
--Senior unsecured notes at 'BBB-'.

Fitch upgrades the ratings for LOL and its subsidiary, Land O'Lakes Capital Trust as follows:

LOL
--Preferred stock to 'BB' from 'BB-'.

Land O' Lakes Capital Trust I
--Junior subordinated capital securities to 'BB+' from 'BB'.

Fitch withdraws the following ratings at Land O Lakes Capital Trust I:

Land O' Lakes Capital Trust I
--Long-term Issuer Default Rating (IDR) 'BBB-'.

The Rating Outlook is Stable.