TEXT-Fitch raises H.J. Heinz ratings
July 23 - Fitch Ratings has upgraded the following long-term ratings of H.J. Heinz Company (Heinz) and its subsidiaries: H.J. Heinz Co. --Long-term Issuer Default Rating (IDR) to 'BBB+' from 'BBB'; --Bank facilities to 'BBB+' from 'BBB'; --Senior unsecured debt to 'BBB+' from 'BBB'. H.J. Heinz Finance Co. (HFC) --Long-term IDR to 'BBB+' from 'BBB'; --Bank facilities to 'BBB+' from 'BBB'; --Senior unsecured debt to 'BBB+' from 'BBB'; --Series B Preferred Stock to 'BBB-' from 'BB+'. H.J. Heinz Finance UK Plc. --Long-term IDR 'BBB+' to from 'BBB'; --Senior unsecured debt to 'BBB+' from 'BBB'. Concurrently, Fitch has affirmed the following short-term ratings: H.J. Heinz Co. --Short-term IDR at 'F2'; --Commercial paper (CP) at 'F2'. H.J. Heinz Finance Co. (HFC) --Short-term IDR at 'F2'; --Commercial paper at 'F2'. The Rating Outlook is Stable. The upgrade reflects Fitch's view that Heinz is likely to maintain its consistent, conservative financial strategy, generate meaningful free cash flow (FCF) and keep leverage (total debt to operating EBITDA) relatively steady in the mid 2x range. Heinz's strategies that support the upgrade include its commitment to minimal share repurchases and use of overseas cash to fund acquisitions. Credit positives include the company's solid cash flow generation, substantial liquidity, diversification across product lines and geography, as well as leading market positions in major product categories. The company has generated more than $450 million of average annual free cash flow during the past five years, despite a $540 million pension contribution in fiscal 2010. Heinz's well-funded pension plan minimizes the likelihood of large pension contributions in the near term. Heinz generates approximately two-thirds of its sales outside the U.S., including approximately 21% of sales from emerging markets in fiscal 2012. Emerging markets are expected to remain the company's growth driver, rising to approximately 30% of sales in fiscal 2016 from 9% in fiscal 2005. Heinz's emerging markets exposure is well balanced geographically and provides a stronger growth platform than many of its U.S.-based peers. Incorporated in the rating is the company's slow growth in developed markets, particularly North American Consumer Products (NACP), which generates the company's highest operating margins. NACP's fiscal 2012 organic sales increased 0.5% and reported operating income fell 2.5%. The company also has high exposure to Europe, at 30% of sales. However, Heinz's has generated good results in this region despite the economic turmoil, with 4.3% organic sales growth in fiscal 2012 and a 4.8% increase in operating income. Given the company's significant Non-U.S. exposure, currency fluctuations periodically impact earnings and are expected to be a headwind this year. Heinz's major product categories include its namesake ketchup, as well as condiments and sauces, frozen food, soup, beans, infant food and other processed foods. Ketchup, condiments and sauces comprise approximately 45% of sales. EBITDA margins have remained in the high teens over the past several years, and are near the top tier for the packaged food industry, despite commodity inflation which peaked at approximately 12% in fiscal 2009 and remained in the 5-7% range in fiscal 2010 through 2012. Heinz expects moderate inflation this year of 4%, driven by potatoes, beans, meat and packaging. While inflation will not be as much as an issue in the near term, Heinz plans to reinvest approximately $120 million in fiscal 2013 in incremental advertising, systems, sales and innovation resources. The company's internally generated liquidity is substantial. Cash and cash equivalents were $1.3 billion at the fiscal 2012 year end and are expected to grow. Cash provided by operating activities was $1.49 billion for the year, down from $1.58 billion in the prior year primarily due to the $122 million cash impact of spending on productivity initiatives. Heinz generated $455 million in free cash flow (after dividends and capital expenditures) in fiscal 2012. Based on the company's current guidance, Fitch expects free cash flow in fiscal 2013 should be in a similar range, including $80 million cash costs related to the 2012 restructuring program. Heinz's cash flow priorities include growing its dividend, engaging in bolt-on acquisitions, debt reduction, and balancing share repurchases against option exercises. Fitch expects Heinz's Fiscal 2013 organic sales growth of 4%+ to be mostly offset by modest U.S. divestitures and currency headwinds. Gross margins, excluding fiscal 2012 productivity charges, are expected to grow slightly, driven by productivity savings and pricing to offset commodity inflation. At April 29, 2012, there were no borrowings on Heinz and HFC's $1.5 billion committed revolving credit facility expiring in June 2016. Heinz did not have any CP. In addition, Heinz had $500 million of short-term foreign credit lines available. Except for the $1.1 billion due in fiscal 2014, upcoming debt maturities over the next four years are modest at $200 million or less. Heinz is likely to refinance most of its medium-term debt maturities. For fiscal 2012, Heinz's total debt-to-operating EBITDA was 2.6 times (x), funds from operations (FFO) adjusted leverage was 3.8x, and operating EBITDA-to-gross interest expense was 7.0x. At the April 29, 2012 fiscal year end, Heinz's total debt was $5.3 billion. Fitch includes the face amount of the company's $931 million 7.125% notes due 2039 in total debt. What could trigger a rating action? Future developments that may, individually or collectively, lead to a positive rating action include: A further ratings upgrade in the near to intermediate term is unlikely but could occur if Heinz commits to maintain leverage (total debt to operating EBITDA) in the low 2x range while generating consistency or growth in FCF. Future developments that may, individually or collectively, lead to a negative rating action include: If Heinz engaged in a significant debt financed acquisition or share repurchase program, or operating earnings and margins came under severe pressure, resulting in a sustained period of leverage greater than 3.0x and weakening FCF.
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