Fitch Ratings has affirmed the ratings of Tyson Foods, Inc. and The Hillshire Brands Co, including the Long-Term Issuer Default Rating (IDR) at 'BBB' and Tyson's Short-Term IDR at 'F2'. The Rating Outlook has been revised to Stable from Negative.

The Outlook revision to Stable reflects the material improvement in Tyson's credit profile supported by greater than expected EBITDA driven by strong operating performance in the Beef segment combined with debt repayment. Consequently, leverage (total debt-to-EBITDA) is expected to decline to around 2.3x for FY'21 (ending Oct. 2, 2021), compared with leverage that peaked at over 3x during the height of the coronavirus pandemic and around 2.6x for FY20.

Tyson's 'BBB' ratings balance its significant scale, product diversification with leading market share positions in beef, chicken, pork, and prepared foods, operating efficiency, and consistent financial policy with its exposure to the low-margin volatile commodity protein business.

 

 

KEY RATING DRIVERS

 

Coronavirus Pandemic Disruptions: Tyson experienced significant business disruption to processing operations from the coronavirus pandemic due to reduced foodservice demand, lower production volumes including some temporary closures, increased operating costs including additional payments to frontline workers, unfavorable price/mix and plant inefficiencies. Tyson incurred incremental expenses related to the coronavirus pandemic totaling approximately $540 million in FY'20.

Tyson's exposure to the foodservice channel is roughly 40% in Prepared Foods and slightly higher in Chicken. The Beef and Pork segments have materially less foodservice exposure. Chicken and the Prepared Foods segments were most adversely affected with adjusted operating margins of 1.1% and 9.0% respectively in FY'20 compared to 4.9% and 10.7% in FY'19. Within the Beef and Pork segments, volume and cost pressures were offset by increased cut-out processing margins. Beef and Pork segment adjusted margins were 10.1% and 11.1% in FY'20 respectively compared to 6.8% and 5.4% in FY'19.

Margin Outlook Mixed: Fitch's margin assumptions for Beef are expected to remain very strong in FY21, approaching 12% (1H21 at 12.1%) with good underlying fundamentals supported by a stable cattle supply and strong global demand. Prepared Foods margins are expected to be modestly lower than FY'20, reflecting higher cost inflation. Fitch expects Pork margins materially lower than FY'20 and lower than 1H21 margins of 6.3% given operational inefficiencies, elevated labor costs and hog costs. Chicken margins are expected to remain materially below historical levels and in the low-single digits due to higher feed ingredient costs, grow-out expenses, outside meat purchases, production inefficiencies and coronavirus expenses.

Fitch anticipates the Beef segment should generate roughly two-thirds of Tyson's operating income in FY'21 which compares to slightly more than one-third in FY'19. In FY'22, Fitch expects Beef margins will moderate from FY'21 levels while margins in the other three segments improve as operating conditions normalize.

Leverage Moderating: Tyson's leverage (net debt to EBITDA) increased above management's long-term targeted range of 2.0x (equivalent to gross debt to EBITDA in the 2.1x-2.2x range, based on Fitch adjustments) due to several past acquisitions. Consequently, leverage at the end of fiscal 2019 was 2.9x and peaked at over 3x during the height of the pandemic before ending fiscal 2020 at 2.6x following approximately $600 million in gross debt repayment and Fitch adjusted EBITDA of $4.4 billion.

During the first half of fiscal 2021, Tyson further repaid approximately $1 billion in debt. For fiscal 2021, Fitch projects gross leverage of 2.3x which assumes Tyson repays the $500 million notes due August 2021 with cash on hand and EBITDA, based on Fitch adjustments, of approximately $4.4 billion. Gross leverage could decrease to the low 2x range in fiscal 2022 to the extent Tyson uses excess cash for debt reduction with net leverage of 2x or less.

Significant Scale, Protein Diversification: Tyson's ratings benefit from its significant scale, with approximately $43 billion in net sales and $4.4 billion of operating EBITDA in FY'20, leading positions in U.S. protein, and product diversification that includes a growing portfolio of branded packaged food and value-added products with number one and two shares in large and growing protein categories. These benefits are balanced by its exposure to the low-margin volatile commodity protein businesses, which are subject to periodic volatility caused by changes in input costs and protein prices due to supply/demand dynamics of commodity products.

Material FCF Generation: Tyson's operations generate considerable FCF, averaging $1.3 billion annually during the past four years including $2.1 billion in FY'20, providing good support to its credit profile. Fitch's forecast assumes reduced FCF in FY'21 of around $500 million based on capital spending of approximately $1.3 billion given higher working capital usage with FCF reverting back to historical levels in the outer years of the forecast of at least $1 billion. Fitch's forecast assumes capital spending approaching $1.6 billion in FY'22 reflecting increased investments for capacity expansion and automation projects.

Acquisitive Strategy, Shifting Mix: Strategic M&A has been at the cornerstone of Tyson's diversification strategy during the past several years, shifting its business mix to higher margin businesses with complementary value-added and branded protein-related products. The acquisition of Keystone Foods during 2018 complemented Tyson's existing portfolio, further improved scale and increased exposure to higher margin proteins with access to key higher growth international markets that is expected to serve as a platform for bolt-on acquisitions.

In recent years Tyson has exited several non-core assets. Earlier this month it announced a definitive agreement to sell its pet treats business for approximately $1.2 billion. The sale is expected to be completed before 2021 fiscal year end.

 

 

DERIVATION SUMMARY

 

Tyson's 'BBB' ratings balance its significant scale, product diversification with leading market share positions in chicken, beef, pork, and prepared foods, operating efficiency, and consistent financial policy with its exposure to the low-margin volatile commodity protein business. Tyson's operating strategy entails transitioning from a commodity meat and poultry processor to a higher margin protein-focused packaged food firm via organic growth and acquisitions.

The U.S. protein industry is fairly concentrated among a few large participants including Tyson; Smithfield Foods, Inc. (BBB/Stable); JBS S.A. (BB+/Stable); Pilgrim's Pride Corporation (BB+/Stable); Cargill Incorporated (A/Stable); Hormel Foods Corporation; Sanderson Farms, Inc., Perdue Farms; and National Beef Packing Company.

Tyson is well positioned relative to peers. Its ratings are similar to Smithfield, which benefits from a one-notch upgrade from its standalone credit profile because it is 100% owned by WH Group Limited (BBB+/Stable). Tyson has a stronger business profile than Smithfield, with greater scale and protein diversification, and relatively similar expectations for long-term financial leverage.

Tyson's ratings are higher than JBS due to JBS's higher leverage, historical acquisitive nature and corporate-governance issues. JBS's ratings integrate its weak governance and ongoing litigation issues related to corruption investigations and uncertainty regarding potential fines, which could damage the company's credit profile and access to capital market. JBS has a similar business profile as Tyson, with comparable scale, market position and protein diversification. JBS is the parent of Pilgrim's Pride. Tyson is rated lower than Cargill, which is significantly larger, generates over $100 billion of revenue, is highly diversified and has readily marketable inventory-adjusted leverage of less than 1.0x.

Tyson's ratings relative to Fitch publicly rated investment-grade packaged food companies -- such as Mondelez International, Inc. (BBB/Stable); and Conagra Brands, Inc. (BBB-/Stable) -- consider relative profitability, earnings volatility, leverage and scale.

Based on our assessment of Tyson's financial flexibility/financial structure/operating environment, the higher of the two short-term options for the current rating profile has been assigned at 'F2'. Any material weakening in financial flexibility, financial structure or operating environment conditions could lead to the assignment of the lower of the two short-term rating options for the current long-term profile.

 

 

KEY ASSUMPTIONS

 

Fitch's Key Assumptions Within Our Rating Case for the Issuer
--For FY'21, Beef margin assumptions are expected to be very strong above FY'20, approaching 12%; Prepared Foods margins are expected to remain relatively flat to FY'20 in the upper 8% range; Pork margins are expected materially lower than FY'20 and lower than 1H'21 margins of approximately 6%; chicken margins are expected in the low-single digits. For FY'22, Fitch assumes a moderation in Beef segment margins partially offset by margin improvements in Chicken, Prepared Foods and Pork segments reflecting recovery in food service sector and operating improvement in the Chicken segment.

--EBITDA (including stock-based compensation) of approximately $4.4 billion in FY'21 and $4.2 billion in FY'22;

--Over the medium term to long term, Fitch's forecast assumes Beef margins normalize to the 6% range, Chicken margins improve to the 4% range, Prepared Foods margins increase to the 10% range and Pork margins increase to the 6% range that results in EBITDA of approximately $4.2 billion to $4.3 billion;
--Capital spending of approximately $1.3 billion in FY'21 and approaching $1.6 billion in FY'22;
--FCF of around $500 million in FY'21 increasing to an average of around $1 billion annually over the remainder of the forecast period;
--Further debt reduction in FY'21 and FY'22 using excess cash on hand that is expected to be supplemented with proceeds from the divesture of the Pet Treats business. Debt remaining flat beyond FY'22 with an increase in capital allocation toward share repurchases and bolt-on M/A in the outer years of the forecast.
--Leverage around 2.3x in FY'21 and in the lower 2x range in FY'22.

 

 

RATING SENSITIVITIES

 

Factors that could, individually or collectively, lead to positive rating action/upgrade:

--An upgrade to a 'BBB+' would require the company to achieve strong operating performance as characterized by consolidated sales and operating income growth or market share gains in line with or better than Fitch's projections, FCF margin consistently over 2.5%, combined with gross debt/EBITDA sustained under 2x.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

--Sluggish sales and operating earnings pressure with meaningfully weaker FCF, a change in financial policy or material M&A that results in a sustained period of gross debt/EBITDA above 2.5x. Worsening of industry fundamentals caused by higher input costs, prolonged protein supply/demand imbalance, trade policy issues or a loss of market share would be leading indicators of a potential downturn in earnings.

 

 

BEST/WORST CASE RATING SCENARIO

 

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

 

 

LIQUIDITY AND DEBT STRUCTURE

 

Comfortable Liquidity: Tyson's liquidity is supported by good FCF generation, a $1.75 billion revolving facility and cash balances. At the end of the second quarter of FY'21, Tyson's liquidity was $2.6 billion with $877 million in cash and cash equivalents and full availability under the company's $1.75 billion revolving credit facility. There was no commercial paper outstanding. Fitch projects Tyson's FCF in FY'21 will be around $500 million compared to almost $2.1 billion in FY'20. The lower FCF is driven primarily from working capital changes and increased capital spending. Fitch projects FCF normalizing over the forecast period at around roughly $1 billion.

At the end of the second quarter FY'20, Tyson entered into a $1.5 billion two-year term loan agreement to supplement liquidity and improve financial flexibility during the coronavirus pandemic. During the second quarter FY'21, Tyson fully repaid the $1.5 billion term loan using excess cash and proceeds from a new $500 million term loan facility due March 2023.

 

Tyson's revolver matures on March 14, 2023. The facility subjects the firm to a maximum debt-to-capitalization ratio of 60% and a minimum interest expense coverage ratio of 3.50x for which Tyson has significant cushion under the covenants. Bond, and term loan maturities include approximately $500 million in FY'21, $1 billion in FY'22 and $900 million in FY'23. Fitch's forecast assumes Tyson's $500 million notes maturity in FY'21 will be repaid with cash on hand. In FY'22, further debt reduction could occur to the extent Tyson uses excess cash to repay maturing debt.