(The following statement was released by the rating agency)
Oct 1 - Overview
-- Increased working capital requirements and various acquisitions and capital investments have left Land O'Lakes' debt levels higher than we anticipated.
-- Land O' Lakes might not reduce the acquisition-related debt enough to improve debt leverage during our outlook period, meaning credit measures may remain weaker than expected beyond fiscal 2013.
-- We are affirming our Land O'Lakes ratings, including the 'BBB-'corporate credit rating, and revising the outlook to negative from stable.
Rating Action On Oct. 1, 2012, Standard Poor's Ratings Service affirmed its ratings on Arden Hills, Minn.-based Land O'Lakes Inc., including the 'BBB-' corporate credit rating, and revised the outlook to negative from stable. Land O'Lakes had reported debt outstanding of $1.4 billion as of June 30, 2012.
Rationale
The negative outlook reflects our estimate that the company may not reduce its debt balances enough to allow currently weaker-than-expected credit measures to improve to levels that support the ratings. This includes an average adjusted debt to EBITDA ratio of about 3x through its seasonal working capital cycle, and a funds from operations (FFO) to average debt ratio of about 30%. We believe deleveraging may be delayed in part because the company is not likely to fully realize normalized EBITDA contribution from recent investments and acquisitions until beyond fiscal 2013. We currently project average adjusted debt to EBITDA to stay near 3.5x and FFO to average debt of about 25% by fiscal year-end 2012, compared with respective pro forma ratios of about 3.7x and 25% for the 12 months ended June 30, 2012. Although historically the company has paid down its working capital lines by fiscal year end, resulting in better year-end credit measures than our average debt-based target ratios, it is unclear if Land O'Lakes will be able to reduce its higher debt balances over the next year, given recent increases in investments.
The ratings on Land O'Lakes reflect our view that the company has a "satisfactory" business risk profile and "significant" financial risk profile.
Key credit factors in our assessment of the business risk profile include the company's diverse portfolio of businesses, strong brand awareness, and leading market positions, which we believe help offset some of the earnings volatility inherent to the company's agricultural commodity businesses (particularly industrial dairy and eggs).
The company's business risk profile reflects the importance of its feed and crop input distribution network to member farmers, the strength and leading market shares of many of its brands, its diverse product line, and an experienced management team. Although the inherent seasonality of many of the cooperative's commodity-based agriculture businesses and its low margins remain important risk factors in our analysis, we believe the company's demonstrated earnings stability in recent years largely mitigates these risks (adjusted EBITDA averaged about $400 million over the past three fiscal years, with an average margin of about 3.6%). Moreover, despite competitive pressure from larger seed manufacturers like Monsanto Co. (A+/Stable/A-1) in Land O'Lakes' key crop inputs business segment, we believe the company has been able to successfully defend, if not grow, its share in this market segment in part because we believe Land O'Lakes has flexibility in providing a wider product portfolio than other seed and crop protectant manufacturers.
Land O' Lakes' first-half earnings were modestly weaker than expected, reflecting a significant decline in operating profits in the dairy foods segment (primarily because of lower prices) and losses in the Layers segment (its egg business; due to higher feed costs). However, better-than-expected performance in the crop inputs segment (in part because of lower aggregate seed supplies) and stable performance in the feed segment largely offset the dairy foods shortfall. We believe dairy product performance will rebound significantly in the second half, primarily because of higher milk prices and in part because of recent acquisitions. We believe ongoing growth in the crop input divisions and a fairly stable performance in the feed division will offset the recent earnings volatility in the company's dairy business and the continued underperformance in its Layers division. Additionally, the company's recently completed acquisitions and strategic investments should lead to ongoing EBITDA growth.
We believe fiscal 2012 EBITDA will increase by close to 10% year over year, totaling about $430 million. Our current base-case forecast for 2012 includes the following assumptions:
-- Another favorable year in the company's key crop segment, given year-to-date performance.
-- A second-half rebound in the company's dairy division, in part because we expect milk prices to rebound in the second half of 2012.
-- Improved feed segment performance, which more than offsets weakness in the Layers segment.
-- Negative free cash flows, stemming from working capital outflows and higher capital expenditures, will not allow the company to fully repay its short-term borrowings, a significant portion of which it drew earlier this year to finance various capital investments and acquisitions.
Based on the above base-case assumptions, we believe the company's debt levels will grow by more than $300 million year over year, which would result in weaker-than-expected credit measures in fiscal 2012, including a pro forma average adjusted debt to EBITDA closer to 3.5x and FFO to average debt of about 25%, compared with respective pro forma ratios of about 3.7x and 25% for the 12 months ended June 30, 2012. These ratios are at the weaker end of indicative ratio ranges for an intermediate financial risk profile (which include a debt leverage of 2x-3x and FFO to debt of 30%-45%), and are now closer to ranges for a "significant" financial risk profile (which includes leverage of 3x-4x and FFO to debt between 20%-30%).
Liquidity
We believe Land O'Lakes has "adequate" liquidity (as defined in our liquidity criteria) to meet its needs over the next year. Our view of liquidity incorporates the following expectations:
-- We expect liquidity sources (including cash, FFO, and revolving credit availability) will exceed uses by 1.25x over the next year.
-- We expect liquidity sources would continue to exceed uses even if EBITDA were to decline by 15%.
-- Although compliance with financial maintenance covenants may not always retain a 15% EBITDA cushion following its peak working capital borrowings at the end of the first quarter and into the second quarter, covenant cushion is well above 15% in other quarters.
-- In our assessment, the company has sound relationships with its banks, and a generally satisfactory standing in the credit markets.
-- Also, we believe the company will continue to adopt generally prudent financial risk management practices.
Estimated cash sources include about $350 million in FFO, and over $750 million of excess cash and available borrowings under the company's $475 million revolving credit facility and upsized $500 million accounts receivable facility (both of which mature in 2016) at the beginning of the company's seasonal working capital cycle in January. The company historically has repaid its outstanding short-term working capital borrowings by its Dec. 31 fiscal year end. However, we believe this trend may not continue in 2012 because of recent acquisitions that the company funded with short-term working capital borrowings.
Outlook
The negative outlook reflects our opinion that EBITDA contribution from the company's various acquisitions and capital investments may not sufficiently lead to better credit measures over our outlook horizon. We would consider lowering the ratings if current growth expectations do not materialize and the company does not pay down a portion of its acquisition-related short-term debt. We believe this would prevent credit measures from improving to closer to our prior expectations, and result in an average debt to EBITDA ratio of more than 3.5x and FFO to average debt remaining near 25% until fiscal year-end 2013. We estimate this could occur if pricing and margin growth in the company's dairy and Layers businesses significantly underperforms our current expectations and only grows by low-single-digit percentages for the remainder of 2012 and beyond.
We would consider an outlook revision to stable if Land O'Lakes is able to improve its average debt to EBITDA levels closer to 3x and FFO to debt near 30% by fiscal year end 2013. We believe this could occur under several scenarios, including if lower raw material cost inflation in 2013 results in lower average outstanding debt balances, if there's better-than-expected EBITDA contribution from the company's recent acquisitions, or if there's continued stable performance in the company's crop input and feed segments coupled with a significant double-digit rebound in either the dairy or Layers segment.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Standard & Poor's Ratings--And Their Role In The Financial Markets, April 15, 2008
-- Our Rating Process, April 15, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
Ratings List Ratings affirmed; Outlook revised To From Land O'Lakes Inc. Corporate credit rating BBB-/Negative/-- BBB-/Stable/-- Ratings affirmed Land O'Lakes Inc. Senior secured BBB
Land O'Lakes Capital Trust I
Preferred stock BB
Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at
. All ratings affected by this rating action can be found on Standard & Poor's public Web site at . Use the Ratings search box located in the left column. (New York Ratings Team)
((e-mail: pam.niimi@thomsonreuters.com; Reuters Messaging: pam.niimi.reuters.com@reuters.net; Tel:1-646-223-6330;))