TEXT-S&P raises Shearer's Foods corp credit rating to 'B'

Mon Nov 12, 2012 3:46pm EST

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Overview
     -- U.S.-based Shearer's Foods LLC has modestly improved operating 
performance and completed a recapitalization after being purchased by 
financial sponsors Wind Point Partners (WPP) and Ontario Teachers' Pension 
Plan Board (OTPP) (not rated). 
     -- Following the acquisition, Shearer's repaid its term loan and its 
subordinated debt (unrated) balances totaling about $169 million and converted 
to a limited liability company, named Shearer's Foods LLC.
     -- We are raising our corporate credit rating on Shearer's to 'B' from 
'CCC+' and removing all ratings from CreditWatch.
     -- The outlook is stable, reflecting our expectation that Shearer's will 
maintain adequate liquidity, will deleverage, and will improve free operating 
cash flow through EBITDA expansion and reduced capital expenditures.

Rating Action
On Nov. 12, 2012, Standard & Poor's Ratings Services raised its corporate 
credit rating on Masillon, Ohio-based Shearer's Foods to 'B' from 'CCC+'. At 
the same time, the 'B' issue level ratings on the company's $210 million 
senior secured notes due 2019 remain unchanged after being upsized to $235 
million. We are also withdrawing the ratings on the company's existing $119 
million senior secured term loan and $20 million revolving credit facility 
upon their repayment following the close of the company's new $235 million 
senior notes and $50 million asset-based revolving facility (ABL; not rated). 
Proceeds from the note issuance, along with approximately $149 million in 
preferred stock and $3 million in common stock, were used to fund the purchase 
of the company, repay about $169 million of existing debt, fund about $21.6 
million in operating lease buyouts, and pay for fees and expenses.  

The outlook is stable. We estimate following this transaction about $451 
million in adjusted debt will be outstanding (including $149 million in 
preferred stock). 

Rationale
The upgrade primarily reflects Shearer's modestly improved operating 
performance and improved liquidity profile following its recapitalization and 
purchase by WPP and OTPP. We estimate that the financial sponsors and 
management have contributed roughly $149 million new preferred stock as part 
of this transaction. We treat the Class A preferred stock as 100% debt-like 
under our hybrid criteria. Although we recognize that the preferred stock 
provides the company with some financial flexibility, such as no mandatory 
redemption or cash dividends, we treat the preferred units as 100% debt in our 
financial ratios based on our belief that the preferred units are unlikely to 
become a permanent part of the company's capital structure given the 
incentives and motivations of the preferred shareholders to seek a return on 
their investment. The preferred stock has a payment-in-kind dividend that, in 
our view, represents a growing liability.

Following this transaction, we believe that Shearer's will have an improved 
and adequate liquidity profile. The company's new asset-based revolver and 
senior secured notes will not have maintenance financial covenants. Therefore, 
we no longer believe that there is risk of a financial cushion covenant 
violation, and we revised our liquidity assessment to adequate. Still, we 
believe leverage will be increasing with new debt and preferred stock raised 
to fund the acquisition, and that Shearers financial profile will remain 
highly leveraged. We estimate key credit measures will remain at levels 
indicative of a highly leveraged financial profile, including leverage over 5x 
and funds from operations (FFO) to total debt below 12%. We estimate the 
company's fiscal 2012 pro forma lease-adjusted debt (including $149 million of 
preferred stock) would be $457 million as compared with $259 million at June 
30, 2012, and that lease-adjusted leverage for the fiscal year ended Sept. 30, 
2012 will be very high, at roughly 8.3x (5.6x, excluding the preferred stock). 
We also estimate that FFO to total debt will remain under 12% in fiscal 2012. 

Our ratings on Shearer's also reflect our view of the company's "vulnerable" 
business risk profile. Key credit factors considered in Shearer's business 
risk profile reflects the company's narrow product focus, relatively high 
customer concentration, and exposure to volatile commodity costs. We believe 
Shearer's is vulnerable to changes in consumer tastes, given its narrow 
product focus primarily on chips and other savory and salty snacks. Shearer's 
also has relatively high customer concentration, with its top two customers 
accounting for about 48% of fiscal 2012 estimated net sales. Given the 
company's small size, we believe that a change in one of its key customers' 
strategies could significantly affect its financial performance. The company 
is also exposed to volatile commodity costs. Shearer's commodity exposure 
(e.g., cooking oils and potatoes) is concentrated in the private-label and 
branded food business segments, as co-packing has pass-through pricing. We 
believe that rising commodity costs could pressure operating performance, and 
that margin preservation will depend on Shearer's ability to pass along price 
increases, mainly to its retail customers.

We expect Shearer's credit metrics will continue to remain near pro forma 2012 
levels in fiscal 2013 and will modestly improve as EBITDA grows thereafter. 
Our forecast assumptions include:

     -- Mid to high single digit revenue growth in 2013 driven by volume 
increases for existing customers in most product lines;
     -- The company's EBITDA margin will remain in the high single to low 
double digits, reflecting slightly lower commodity costs and improved 
operating efficiencies and scale, with cost-reduction actions taken and 
improved volumes and some lease expense savings associated with some operating 
lease buyouts; 
     -- Capital expenditures that will be roughly $23 million, $14 million of 
which are expected to support growth plans; as a result of the company's 
continued growth in investments, we estimate that free operating cash flow 
will be modestly negative for fiscal 2013 but positive by 2014 after the 
company decreases its growth capital expenditures;
     -- No debt reduction given the company's lack of debt amortization in its 
capital structure; and
     -- No discretionary dividends to shareholders. 

We believe that the company will remain highly leveraged over the 
near-to-intermediate term given its lack of pre-payable debt and payment in 
kind dividend accretion on its sizable preferred stock (for which we assign 
100% debt treatment when calculating financial ratios). As a result, we 
believe that the majority of the company's deleveraging will be dependent upon 
EBITDA growth. Our forecast assumptions yield leverage of about 8x and FFO to 
total debt of under 10% by the end of fiscal 2013 (5x area and about 12%, 
respectively, excluding preferred stock), which are in line with our highly 
leveraged indicative ratios.

Liquidity
We view Shearer's Foods LLC's liquidity as "adequate." We expect sources of 
liquidity over the next 12 months will exceed its uses by more than 1.2x, and 
that next sources will be positive, even with a 15% drop in EBITDA. Our view 
of liquidity is also based on the following information and assumptions:

     -- We expect funds from operations and availability under the company's 
$50 million ABL will be sufficient to cover cash uses, including working 
capital and operational needs.
     -- We believe the company will have an adequate financial covenant 
cushion based on our belief that the only financial maintenance covenant, a 
springing fixed coverage covenant of 1x on the company's ABL facility, will 
not trigger because we do not anticipate that excess availability wil fall 
below $5 million at any time or that average excess availability will fall 
below $7.5 million over any five-business-day period. 
     -- The company has a manageable debt maturity schedule, including no near 
term debt maturities until 2017, when its ABL facility matures, and no debt 
amortization requirements on its senior secured notes maturing 2019. 
     -- We believe the company has sound relationships with its banks. 

Recovery analysis

The issue-level rating on the company's $235 million senior secured notes is 
'B'. The recovery rating is '4', indicating our expectation for average (30% 
to 50%) recovery for lenders in the event of a payment default.  

Standard & Poor's simulated default scenario assumes a loss of revenues for 
Shearer's due to increased competitive pressures from both name brand and 
private label products, as well as the loss of one or more key customers. At 
the same time, the company experiences an increase in raw material costs, 
which negatively impacts margins and profitability. In addition, difficulties 
could result from product safety or recall issues. Such factors lead to a 
default occurring in 2015.Standard & Poor's believes that if the company were 
to default, the business model would continue to be viable driven by the 
continued demand for Shearer's products, such as kettle chips, and its 
manufacturing scale. As a result, lenders would achieve a greater recovery 
value through a reorganization process rather than through liquidation. 
Therefore, in evaluating the recovery prospects for debt holders, we used an 
enterprise value methodology under our distressed case scenario to determine 
emergence enterprise value. To value the reorganized enterprise, we apply a 5x 
EBITDA multiple to our estimated emergence-level EBITDA of approximately $29 
million to arrive at a gross enterprise value of about $144 million.

Outlook

The outlook is stable, reflecting our expectation that Shearer's will maintain 
adequate liquidity and improve free operating cash flow through EBITDA 
expansion and reduced capital expenditures. We could consider a downgrade if 
the company's operating performance deteriorates, leading to sustained 
negative free cash flows or to constrained liquidity, possibly leading to a 
"less than adequate" liquidity descriptor. We believe this could result from 
higher input costs that the company is unable to offset, a loss of key 
customers, or a change in financial policy whereby the company makes large 
leveraged dividends or debt-financed acquisitions, reducing its revolver 
availability. Given the company's very high debt leverage, it is unlikely that 
we would consider an upgrade in the next 12 months.  

Related Criteria And Research
     -- Key Credit Factors: Criteria For Rating The Global Branded Nondurable 
Consumer Products Industry, April 28, 2011 
     -- Corporate Ratings Criteria 2008, April 15, 2008
     -- Methodology And Assumptions: Liquidity Descriptors For Global 
Corporate Issuers, Sept. 28, 2011 
     -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 
2012
     -- Hybrid Capital Handbook: September. 2008 Edition, Sept. 15, 2008
     -- 2008 Corporate Criteria: Ratios and Adjustments, April 15, 2008. 

Alternate contact information for Jean Stout: (1) 917- 572-7609
Ratings List
Upgraded
                         To        From
Shearer's Foods LLC
Chip Finance Corp.        
  Corporate credit rating    B/Stable    CCC+/Watch Pos

Unchanged Ratings

Shearer's Foods LLC
  Senior secured debt        B
    Recovery rating            4

Withdrawn
                         To        From
Shearer's Foods LLC
  Senior secured term loan    NR        CCC+
   Recovery rating            NR        3
  Revolving credit facility    NR        CCC+
   Recovery rating            NR        3


Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.
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