Flowers ratings reflect good portfolio, supply chain focus

CHICAGO — Fitch Ratings on July 18 affirmed its long-term issuer default rating of “BBB” on Flowers Foods, Inc. while maintaining its “stable” outlook for the Thomasville, Ga.-based baker of Nature’s Own, Dave’s Killer Bread, Canyon Bakehouse and Wonder bread brands. The “BBB” investment grade represents medium class companies that are satisfactory at the moment.

Fitch said its ratings reflect Flowers “good competitive position as a retail packaged bakery product producer with a strong branded portfolio” but are “constrained by the lack of diversification and material scale from a revenue and EBITDA perspective relative to its larger direct peer and other packaged food companies.”

The ratings agency said it expects Flowers Foods will take a measured approach to capital allocation regarding opportunistic bolt-on mergers and acquisitions and share repurchases within the context of the company maintaining long-term total debt/operating EBITDA below the low 2x range, and gross lease-adjusted debt to EBITDAR below the low 3x range.

Among the key rating drivers identified by Fitch were Flowers Foods’ strong performance during the pandemic, a good portfolio with differentiated brands, a portfolio and supply chain optimization focus and disciplined capital allocation.

“The pandemic accelerated Flowers’ shift to higher-margin, value-added branded retail bread products that has resulted in share gains from higher food-at-home consumption trends and boosted margins,” Fitch said. “A key enabler is Flowers’ ability to leverage the significant flexibility within its direct-store-delivery distribution system and bakery production network to retail fresh packaged bakery production, shifting away from lower margin non-retail sales. Net sales in 2021, increased by around 5% over a two-year period, with EBITDA in the low $500 million range during the last two years compared to EBITDA of $422 million in fiscal 2019.”

Fitch noted that Flowers Foods is focused on several strategic initiatives around its products portfolio, ERP upgrades and digital strategy initiatives, including e-commerce, autonomous planning, and bakery operations to revamp core business processes, simplify operations and enhance digital capabilities. The company also is pursuing several near-term initiatives, primarily across operational efficiencies and procurement, to generate an incremental $25 million to $35 million cost savings for 2022 that is back-half weighted, the ratings agency pointed out.

“The longer-term portfolio strategy is expected to result in a shift of the sales mix to a greater percentage of branded retail supported by share gains in underdeveloped geographies and segments combined with the selective exit of low to no margin businesses,” Fitch said. “Flowers expects these strategic initiatives should result in improved price realization and operational efficiencies that drives meaningful margin improvement during the next couple of years. Fitch’s forecast assumes modest improvement in margins given the uncertainty in the operating environment including inflation, demand elasticity, the potential for demand reversion and the promotional environment.

“Flowers has also experienced past margin pressures despite strategic cost initiatives intended to improve profitability. Fitch believes if these types of headwinds were to increase materially over the course of the next 12 to 24 months, Flowers’ initiatives should position the company well to help mitigate potential headwinds.”

Fitch said it expects Flowers Foods will take a “measured and disciplined approach” to long-term capital allocation including bolt-on acquisitions. This approach could increase leverage levels modestly with recovery within 18 months, similar to past acquisitions of DKB or Canyon, Fitch said, adding that Flowers Foods is currently holding “higher than normal” cash levels that could be used for acquisitions and/or share repurchases.

Fitch noted that its ratings on Flowers Foods are in line with that of Grupo Bimbo, SAB de CV (BBB/stable).

“Bimbo’s ratings incorporate its solid position as a global leading producer of baked goods that leverages an extensive distribution network, with operations in Mexico, the US, Canada, Latin America, Europe and, to a lesser extent, Asia and Africa,” Fitch said. “This reflects much greater geographical diversification than Flowers. Consequently, Bimbo has substantially larger scale than Flowers, demonstrated by revenue and EBITDA of more than four times Flowers. Bimbo has similar EBITDA margins of around 12% and gross leverage of around 2x.”