Fitch Affirms Tyson's IDR at 'BBB/F2'; Outlook Stable

CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) of Tyson Foods, Inc. (Tyson; NYSE: TSN) at 'BBB/F2' and the IDR of its wholly-owned subsidiary - The Hillshire Brands Co. (Hillshire) - at 'BBB'. The Rating Outlook is Stable.

Tyson's ratings recognize structural improvement in the company's business and significant debt reduction since the 2014 acquisition of Hillshire. However, ratings incorporate Fitch's view that the current prolonged period of favorable industry fundamentals is not sustainable and that operating margins and EBITDA will revert to a more normalized level over the intermediate term.

Fitch expects operating margins to approximate 6% (translating to segment-level operating margins at the low end of Tyson's current normalized ranges), and for EBITDA to be around $3 billion in most years such that total adjusted debt/EBITDA is sustained around 2.0x. This compares to an LTM EBITDA of $3.5 billion and operating margin of 7.3%. Fitch also anticipates Tyson will remain acquisitive and that leverage could periodically spike above 2.0x to finance potential transactions.

KEY RATING DRIVERS

Significant Scale, Increased Diversification

Tyson's ratings benefit from its significant scale, with LTM sales of $38.2 billion and EBITDA of $3.5 billion, leading position in U.S. protein, and product diversification that includes a growing portfolio of branded packaged food products. Tyson is one of the world's leading food companies with No. 1 and No. 2 share in large and growing protein categories such as frozen breakfast and smoked sausage under the Jimmy Dean and Hillshire brands.

Fitch believes Tyson is making progress towards its goal of transitioning from a commodity meat and poultry processor to a protein-centric packaged foods company. However, sales and earnings remain subject to periodic volatility caused by changes in input costs and prices due to supply/demand dynamics of commodity products.

Tyson's vulnerability to these risks is partially mitigated by diversification in chicken, beef, pork, and prepared foods, operating efficiency, and a conservative balance sheet. For the nine months ended July 2, 2016, segment contribution to sales and operating earnings was as follows: chicken (28% and 48%), beef (39% and 9%), pork (13% and 19%), prepared foods (19% and 27%), and other which consists mainly of foreign operations (1% and negative 3%).

Structural Changes, Prepared Volume Weakness

Structural changes have enhanced Tyson's margins and are providing increased earnings stability. Changes implemented over the past several years include improved operating efficiency and closure of inefficient processing facilities. Moreover, within the chicken segment specifically, Tyson has diversified its pricing to include more short-term and fewer fixed-price customer contracts, instituted a more disciplined risk management strategy, and uses a buy versus grow strategy in chicken when appropriate.

Tyson has also increased its percentage of value-added and prepared food products, particularly its 2014 $8.6 billion acquisition of Hillshire, which offer higher margins and more stable cash flow than commodity proteins due to less price volatility. Fitch estimates Tyson's sales dollar mix of value-added and prepared foods to commodity proteins was about 40%/60% in fiscal 2015 and views volume growth in prepared foods as a key rating driver.

Value-added and branded packaged foods are susceptible to volume pressures as consumer preferences change. Prepared foods volume rose 1.9% in the third quarter ended July 2, 2016 but was down 2.1% in the nine-months ended July 2, 2016 due in part to Tyson reducing volume in lower margin categories at retail and slower than planned price reduction reflected on retail shelves. Fitch views 1%-2% volume growth as achievable over the long term with continued innovation and marketing support but anticipates that volumes will be negative in fiscal 2016.

Momentum Continues, Modest Volatility Possible Longer-Term

Tyson's strong operating performance, which began in fiscal 2010, should continue through fiscal 2017 due to the continuation of favorable industry fundamentals related to low grain costs, ample livestock supply, and steady global demand which partially offset the negative impact of increased industry supply on selling prices. Results will also benefit from the realization of a targeted $700 million of annual synergies related to the Hillshire acquisition by the end of fiscal 2017 and continued operating efficiency. Synergies are being sourced from operational improvements, manufacturing, procurement, logistics, and organizational duplication and have exceeded $400 million since August 2014 and should be sustainable over the long term.

This year Tyson raised its normalized margin in chicken to 9%-11% from 7%-9%, after increasing it from 5%-7% at the end of fiscal 2014. In 2015, the company raised its prepared foods normalized margin to 10%-12% from 4%-6% due mainly to the integration of Hillshire but lowered beef to 1.5%-3% from 2.5%-4.5%. Normalized margin expectations for pork have been maintained at 6%-8% since 2010.

For the nine months ended July 2, 2016, each of Tyson's core segments performed within or above their normalized range. As mentioned, Tyson's EBITDA for the LTM period ended July 2, 2016 was $3.5 billion, reflecting in part abnormally strong industry fundamentals driven by low grain costs, ample livestock supply, and steady global demand. The company's consolidated operating margin was 7.3%.

Longer-term, Fitch views EBITDA of around $3 billion and an operating margin around 6% as more reflective of a normalized level of profitability for Tyson. Fitch also expects performance in chicken and prepared foods to drive future growth, given they are Tyson's highest-margin segments.

Disciplined Financial Strategy

Tyson maintains a conservative financial strategy, targeting net debt-to EBITDA of 1.5x-2.0x over time (which approximates gross debt to EBITDA in the high-1x-low-2x range assuming cash of $200 million-$300 million). The company also strives to maintain overall liquidity in the $1.2 billion-$1.5 billion range. Fitch believes Tyson's conservative stance is due to potential operating earnings volatility.

For the LTM ended July 2, 2016, total debt-to-EBITDA was 1.8x, down from 4.3x at the end of fiscal 2014 following the acquisition of Hillshire, and FCF was $1.8 billion. Cash flow is benefiting from favorable operating fundamentals and significant synergy capture which has allowed Tyson to reduce debt by roughly $2 billion to $6.2 billion since the end of fiscal 2014.

Fitch expects leverage to approximate 2x over the forecast horizon. FCF is projected to approximate $1 billion or more annually during this time period and to be deployed mainly towards share repurchases, absent acquisitions.

Tyson remains open to strategic M&A, particularly of companies with value-added and branded protein-related products, even though organic growth continues to be an important driver of sales and operating earnings. The company has completed tuck-in acquisitions to enhance its existing portfolio, is proving its ability to integrate large purchases, and has demonstrated a willingness to utilize equity to finance sizeable deals.

Fitch views debt capacity at the current rating level, based on a projected $3.5 billion of EBITDA in fiscal 2016 and total debt-to-EBITDA of no more than 2.5x, as at least $2.5 billion depending on EBITDA contribution of any acquired entity.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Tyson's fiscal years include:

-Consolidated revenue declines about 10% in 2016 to about $37 billion due mainly to lower sales prices and divestiture of non-core businesses; declines moderate to the low single digits in 2017 as pressures on pricing, particularly in beef ease, and then revenue grows at a low-single-digit rate in 2018;

-Consolidated volumes are relatively flat, excluding the impact of divestitures, in 2016, but vary among the segments; volumes increase at a low-single-digit rate in 2017 and 2018;

-Consolidated EBITDA of about $3.6 billion in 2016, $3.3 billion in 2017, and $3 billion in 2018 as fundamentals revert to a more normalized level and Fitch's view of a normalized 6% EBIT margin;

--FCF approximating $1 billion or more annually, the majority of which is deployed towards share repurchases;

-Total debt-to-EBITDA of approximately 2x over the medium term.

RATING SENSITIVITIES

Positive Triggers: Continued progress transitioning towards a protein-centric packaged foods company as exhibited by reduced variability in operating earnings and better than expected volume trends in prepared foods. The ability to sustain normalized consolidated EBIT margins above the 6%-7% range while maintaining total debt-to-EBITDA below 2x, and an FCF margin of 2.5% (more than $1 billion annually) would be key indicators of continued progress.

Negative Triggers: A sustained period of total debt-to-EBITDA above 2.5x due to sluggish earnings growth or a change in financial policy would result in a negative rating action. Worsening industry fundamentals caused by meaningfully higher feed costs or a prolonged protein supply/demand imbalance would be leading indicators of a potential downturn in earnings. A sustained loss of market share in branded packaged meats would be of concern.

LIQUIDITY

Fitch views Tyson's liquidity as ample. Liquidity is supported by good FCF generation, a $1.25 billion unsecured revolver that can be upsized by $500 million, and the maintenance of moderate cash balances. At July 2, 2016, Tyson had $1.3 billion of liquidity consisting of $197 million of cash and $1.1 billion available under its revolver.

Tyson's revolver matures on Sept. 25, 2019. The facility subjects the firm to a maximum debt-to-capitalization ratio of 60% and a minimum interest expense coverage ratio of 3.75x for which the company has significant cushion. After repaying its $638 million of 6.6% notes due April 2016, upcoming maturities include $88 million of amortizing notes due July 2017 and $120 million of 7% notes due May 2018.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

Tyson Foods, Inc. (Parent)

--Long-Term Issuer Default Rating (IDR) at 'BBB';

--Unsecured bank credit facilities at 'BBB';

--Senior unsecured notes at 'BBB';

--Short-Term IDR at 'F2'.

The Hillshire Brands Co.

--Long-Term IDR at 'BBB';

--Senior unsecured notes at 'BBB'.

The Rating Outlook is Stable.

Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:

--Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation expense as reported in financials.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013523

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