Flowers Foods (FLO) Ratings Affirmed by Fitch Following Move to Acquire Dave's Killer Bread

Fitch Ratings has affirmed the long-term Issuer Default Rating (IDR) at 'BBB' for Flowers Foods (NYSE: FLO) (Flowers) upon its recent announcement that it will acquire Dave's Killer Bread (DKB) primarily with debt for $275 million. The Rating Outlook is Stable. A full list of ratings follows at the end of this release.

KEY RATING DRIVERS

DKB Acquisition Opens New Category:
The purchase of DKB, a private-held company specializing in the manufacture of organic bread, would expand Flowers' category offering into fast-growing organic bread products as well as increasing its reach into the Pacific Northwest and Canada. Fitch recognizes the potential to broaden the sales territory for the DKB brand through Flowers' distribution channel. The new business conforms to the company's business development strategy that targets bolt-on acquisitions to build density in expansion markets.

Leverage to Remain Consistent with Rating:
Fitch sees leverage rising from debt funding required to complete the transaction (anticipated in the third quarter of the current fiscal year), yet stay consistent with the current rating category. At the end of fiscal 2015, gross leverage (total debt to EBITDA) and adjusted leverage (total adjusted debt to EBITDAR) may increase to 2x and 3x, respectively, from 1.5x and 2.5x for the latest 12-month as of July 18, 2015, in Fitch's estimation. However, Fitch anticipates adjusted leverage to return to a historical run rate of the mid-2x range in the medium term from some debt reduction along with margin expansion from incremental earnings generated by the higher-margin organic breads business and continued operational efficiency gains.

Leading Position in Consolidating Industry:
Flowers' ratings reflect its leading position as the second largest producer of baked goods in the U.S., with annual revenue of $3.7 billion, good margins for the industry, as well as a history of successful acquisition integration and adjacent geographic expansion. Flowers is a low-cost operator in a highly mature industry. The company has steadily increased its market share as it acts as a consolidator in an industry with low single-digit annual volume declines over the past few years.

Larger Scale:
Acquisitions over the past few years have greatly enhanced Flowers' geographic footprint, which now reaches approximately 81% of the U.S. population with fresh bakery foods through its DSD system. Margins should improve as the company builds greater density in expansion markets it has recently entered through its DSD system. The former Hostess bread brands, including Wonder, and the Tastykake brand from Tasty Baking have enabled Flowers to bring a broader product selection into new and existing markets. The Wonder brand in particular is complementary to Flowers' core brands, anchored by approximately $1.1 billion annual revenue at retail from Nature's Own. Flowers' long-term goal is to reach 90% of the U.S. population, which Fitch assumes will be achieved at a measured pace.

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

--Organic sales (price/mix, and volume) over the forecast period grow in the low single digit range annually, mostly driven by expansion markets, as core markets remain competitive;
--Continued focus on debt reduction with free cash flow (FCF) as Flowers integrates DKB. As leverage declines to a more normal run rate, Fitch believes that the company may resume bolt-on acquisitions in the $100 million to $200 million range given importance to its operating strategy;
--Fitch sees modest margin expansion as the promotional environment rationalizes coupled to benefits derived from the higher-margin DKB purchase and ongoing cost effectiveness efforts;
--Average annual FCF over forecast period at least $100 million annually with periodic volatility due to commodity hedging;
--Total adjusted debt-to-EBITDAR rising to 3x following the mostly debt-financed acquisition of DKB and returning to the mid-2x range over the intermediate term.

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

--A positive rating action could occur if Flowers demonstrates a commitment to maintain leverage (total adjusted debt-to-operating EBITDAR) in the low 2x range while generating material FCF. Fitch believes this is unlikely in the near to intermediate term due to the company's bolt-on acquisition strategy that periodically increases leverage.

Future developments that may, individually or collectively, lead to a negative rating action include:

--A prolonged and significant drop in earnings and FCF, potentially due to a secular shift away from bakery products, a sizeable acquisition or series of acquisitions or change in financial strategy that results in total adjusted debt/EBITDAR to remain in the low-3x range or higher for an extended period.

LIQUIDITY
Flowers typically holds minimal cash on its balance sheet. The company derives immediate liquidity mainly from internally generated cash flow and full availability under its $200 million accounts receivable securitization facility. Flowers also had availability of $484.3 million, net of $15.7 million standby letters of credit, under its $500 million revolver (maturing in February 2019) on July 18, 2015.

Long-term debt maturities are manageable and primarily consist of term loan amortization. Annual maturities as of July 18, 2015 are $17.1 million in 2015, $73.2 million in 2016, and $122.0 million in 2017, with the majority due to amortization of Flowers' term loan of $15 million in fiscal 2015, $67.5 million in 2016, and $112.5 million in 2017. The company may also make voluntary prepayments without penalty. The company's credit agreements have a maximum leverage covenant of 3.5x and a minimum interest coverage of 4.5x. Including incremental debt from the purchase of DKB, Fitch sees limited cushion under the financial covenants over the near term.

FULL LIST OF RATING ACTIONS

Fitch affirms Flowers's rating with a Stable Outlook as follows:

--Issuer Default Rating (IDR) at 'BBB';
--Senior unsecured revolving credit facility at 'BBB';
--Senior unsecured term loan at 'BBB';
--Senior unsecured notes at 'BBB'.

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