October 29 (SeeNews) - Fitch Ratings said it has assigned final long-term foreign-currency (FC) issuer default rating (IDR) and senior unsecured rating of 'BB-', with a negative outlook, to Turkish confectionery producer Ulker Biskuvi Sanayi [IST:ULKER].
The rating follows the placement of $650 million (554 million euro) senior unsecured notes, due in 2025, that will refinance the company's syndicated loan due in November 2020, as well as the receipt of final documentation with terms and conditions that are aligned with Fitch's expectations, the ratings agency said in a statement on Wednesday.
Fitch added it has also assigned Ulker a final long-term local-currency (LC) IDR of 'BB' with negative outlook and simultaneously withdrawn the rating for commercial reasons.
Fitch also said in the statement:
"The LC IDR is premised on Ulker being ring-fenced from the rest of the Yildiz group, to which it belongs. It assumes that Ulker's cash flows will not be used to service the substantial debt of its ultimate parent Yildiz Holding A.S. or its sister companies and that Ulker's transactions with related parties will remain at arm's length and will not jeopardise its credit profile.
The LC IDR reflects Ulker's strong market position in the Turkish confectionery market and a growing international presence as well as the company's ability to drive EBITDA margin improvements and generate positive free cash flow (FCF).
The Negative Outlook on the LC IDR reflects uncertainty around the level of cash outlay for potential M&A. We view the possibility that Ulker may acquire related-party entities that are ultimately owned by shareholder Yildiz Holding A.S. (Yildiz) as increasingly likely over the next two to three years. This could prevent funds from operations (FFO) net leverage falling below 4x, despite EBITDA growth, limited capex needs and moderate dividends.
Ulker's 'BB-' FC IDR is constrained by Turkey's Country Ceiling of 'BB-' as we expect the company's hard-currency debt service ratio to remain insufficient to allow it to be above the Country Ceiling in 2020-2023. Therefore, the Outlook on the FC IDR is aligned with that on Turkey's sovereign rating.
The Long-Term LC IDR was withdrawn for commercial reasons.
KEY RATING DRIVERS
Largest Confectionery Producer in Turkey: Ulker's ratings benefit from the company's strong position as the largest confectionery producer in Turkey with a 37.8% market share in total confectionery market at end-June 2020. Ulker has leading market shares in chocolate and biscuits but is behind Eti, its largest competitor, in the cake category.
Limited Threat from International Confectioners: Market shares of international confectionery producers, such as Nestle SA (A+/ Stable), Mondelez International Inc. and Ferrero, in Turkey are substantially smaller than those of Ulker and Eti, despite their portfolios of global brands and strong innovation capabilities. This is because of consumer loyalty to local brands and Ulker's adequate pace of product innovation, which we believe effectively addresses consumer needs in Turkey. Synergy products, which are produced under Godiva and McVitie brands and sold by Ulker in countries where it has a presence, also enhance the competitiveness of its product offer.
Expected Stable Market Position: We see limited threat from new market entrants promoting healthy-snacking as this trend has a limited influence on consumers in Turkey relative to developed markets. Therefore, we assume that Ulker's market position is not going to change over the next five years.
Growing Foreign Operations: Over the past five years, Ulker has grown its exports and increased its presence outside Turkey through acquisitions in Egypt, Saudi Arabia, Kazakhstan and UAE. In 2019 foreign operations accounted for 39% of its revenue and 48% of its EBITDA. Geographic diversification improves Ulker's growth and profitability profile and also lowers FX risks due to hard currency- denominated exports and sales in Saudi riyal and United Arab Emirates dirham, which are pegged to the US dollar.
Country Ceiling Constraint: Ulker's FC IDR is constrained by the Country Ceiling of Turkey where 52% of the company's 2019 EBITDA was generated. EBITDA from countries with higher Country Ceilings - Saudi Arabia (A+) and Kazakhstan (BBB+) - is not sufficient to cover the company's hard-currency interest payments, although the coverage ratio increased substantially in 1H20. Considering the enlarged bond placement of USD650 million and related interest costs, we now project that growth in profits generated in Saudi Arabia and Kazakhstan will not be sufficient to support an increase in the coverage ratio above 1x and therefore the Country Ceiling is unlikely to be changed in 2022-2023.
Limited Disruptions from Pandemic: Global lockdowns and social-distancing measures to fight the spread of coronavirus so far have had limited impact on Ulker's sales due to the company's low presence in on-trade channels. We estimate that reduction in revenue due to decreased gifting activity and lost sales to schools (around 1% of 2019 revenue) were more than offset by growth in at-home snacking.
Positive FCF: The ratings are supported by Ulker's ability to generate FCF, which we expect to be sustained over 2020-2022 as the company has completed its investment cycle and now has low capex needs. This is despite our assumption that Ulker will resume dividend payments from 2021 after paying no dividends in 2019 and 2020. We forecast dividends not to exceed 20% of Ulker's consolidated net income in 2021-2023.
Substantial Cash Adjustment: Fitch adjusted Ulker's reported cash by excluding investments in traded equity, fixed income and alternative investments. The adjustment of TRY3.1 billion in 2019 resulted in a substantial 2.6x increase in Ulker's FFO net leverage. We believe that such investments are likely to be liquidated only to fund potential M&A but their value could also be subject to market fluctuations and we therefore do not assume them as a funding source for debt repayment.
EBITDA Growth Supports Leverage: Ulker's strong ability to grow sales and drive EBITDA margin improvements through supply-chain efficiencies supports deleveraging capacity. This in turn builds up headroom for M&A, which we expect would mostly be directed for acquisitions of related-party entities that are ultimately owned by Yildiz. The 'BB-' IDR is premised on these transactions not causing FFO net leverage to exceed 4.5x (2020: 4.1x) over the next two to three years. We also assume no major FX shocks as Ulker's debt is almost fully denominated in hard currencies (1H20: 94% of total).
Eurobond in Line with IDR: Ulker's senior unsecured Eurobond is rated in line with the 'BB-' FC IDR. As with the syndicated loan, which is the other major funding source of Ulker, Eurobond is not guaranteed by subsidiaries. However, prior-ranking debt, represented by debt at subsidiaries, accounted for only around 0.5x of consolidated EBITDA at end-June 2020, which supports the alignment of the instrument rating with the FC IDR.
Related-Party Transactions: Ulker has an ESG Relevance Score of '4' for Group Structure as its operations are characterised by a relevant degree of interconnection with companies that are ultimately owned by its shareholder Yildiz. These related-party transactions are mostly in the company's ordinary course of business, including sales to modern and traditional retail and procurement of chocolate dough. Additionally, Ulker pays royalties to Yildiz, which owns the brands under which Ulker markets its products. We assume these transactions will continue to be conducted at arm's length and will not result in significant cash leakage outside Ulker's consolidated scope of activities.
The rating is premised on Ulker being ring-fenced from the rest of Yildiz group and we assume that Ulker's cash flows will not be used to service the substantial debt of Yildiz nor of Ulker's sister companies. However, we include in our calculation of leverage metrics the guarantees Ulker provides for obligations of Yildiz and Önem Gida San. ve Tic. A.S., which increase FFO net leverage by about 0.8x
DERIVATION SUMMARY
Ulker is firmly positioned across Fitch-rated confectionery and baked goods manufacturers as a medium-sized company with average profitability and innovation capability. Ulker's organic growth potential and ability to achieve consistent EBITDA margin improvements differentiate the company favourably from peers.
Ulker compares well against Argentinean confectionery producer Arcor S.A.I.C. (FC IDR: B/Stable, LC IDR: B+/Negative) due to similar operational scales, strength of local brands and geographic diversification. Both companies generate about 35%-40% of revenue outside their domestic markets. Ulker's rating is higher than Arcor's due to stronger EBITDA margins, positive FCF, lower net leverage and more manageable FX risks.
Ulker is also rated higher than Russia's largest confectionery producer JSC Holding Company United Confectioners (B/Stable) as it benefits from larger market shares in its domestic market, better geographic diversification and the resulting larger business scale. United Confectioners has weaker financial transparency and opaque related-party transactions, which constrain its rating, despite its more conservative leverage.
Ulker is rated lower than Mexico-based Grupo Bimbo, S.A.B. de C.V. (BBB/Stable), the world's largest baked goods producer with about a 3% market share, due primarily to its smaller scale and geographic footprint.
Ulker has a substantially weaker business profile than Mondelez International, Inc. (BBB/Stable), one of the largest confectionery producers globally with strong local and global brands and diversified operations by product and geography. In addition, Ulker's profitability, FCF generation and financial flexibility are weaker than Mondelez's. This explains its lower rating, despite a more conservative capital structure.
Ulker's FC IDR of 'BB-' is constrained by Turkey's Country Ceiling of 'BB-'.
No parent-subsidiary linkage or operating environment aspects were applied to Ulker's rating. We could consider linking Ulker's rating to Yildiz's credit profile in case of a weakening of the current ringfencing.
KEY ASSUMPTIONS
Fitch's Key Assumptions Within Our Rating Case for the Issuer
- Low single-digit sales volumes growth and price/mix changes above inflation contributing to revenue CAGR of 13% over 2020-2023
- Gradual improvement in EBITDA margin over 2020-2023 with dilution from potential acquisition of related-party distributers
- Capex below TRY150 million in 2020 and at around TRY200 million-TRY250 million a year over 2021-2023
- Dividends no higher than 20% of consolidated net income over 2021-2023
- Short-term investments and receivables from Yildiz on balance sheet and to be liquidated only to fund bolt-on M&A
- No non-trade outflows to related parties
- No additional guarantees provided for obligations of third parties
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- Upgrade of Turkey's Country Ceiling
- Annual EBITDA from Saudi Arabia and Kazakhstan sufficiently exceeding annual hard-currency interest payments or Fitch-projected hard currency debt service ratio exceeding 1x over the next three to four years
Factors that could, individually or collectively, lead to a revision of Outlook to Stable:
- A revision of Turkey's Outlook to Stable
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- Downgrade of Turkey's Country Ceiling below 'BB-'
- Increased competition, eroding Ulker's market share in Turkey or internationally
- Deterioration in FCF profile on a sustained basis
- FFO net leverage consistently above 4.5x
- Larger-than-assumed M&A, investments in high-risk securities affecting our restricted cash calculation or related-party transactions leading to significant cash leakage outside Ulker's scope of consolidation
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 [...].
LIQUIDITY AND DEBT STRUCTURE
Ample Liquidity after Bond Placement: Pro-forma for the recent bond placement and refinancing of the syndicated loan due in November 2020, Ulker has ample liquidity without any significant maturities until 2023 when another syndicated loan is due. We project Ulker's cash balances and operating cash flow to be sufficient to cover capex, dividends, potential M&A and other debt maturities.
SUMMARY OF FINANCIAL ADJUSTMENTS
We have reclassified TRY3.1 billion of cash invested in liquid mutual funds at end-2019 as restricted cash. We believe that such investments are likely to be liquidated only to fund potential M&A but their value could also be subject to market fluctuations and we therefore do not assume them as a source of debt repayment.
We have added guarantees provided by Ulker's subsidiaries for debt of Yildiz and obligations of Onem to off-balance-sheet debt.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG CONSIDERATIONS
Group Structure: ESG Relevance Score '4'
Ulker has an ESG Relevance Score of '4' for Group Structure due to the complexity of the structure of the wider Yildiz group and material related-party transactions. This ESG score currently has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit [...]."
($ = 0.8534 euro)