Fitch Ratings – Milan – 15 Jan 2025: Fitch Ratings has assigned Dutch dairy company Royal FrieslandCampina NV’s (RFC) new EUR300 million perpetual subordinated hybrid securities a final debt rating of ‘BBB-‘.
The securities qualify for 50% equity credit. The hybrids are rated two notches below RFC’s ‘BBB+’ Issuer Default Rating (IDR) to reflect their deep subordination.
The IDR reflects RFC’s large scale and strong position in the global dairy market, with a good product mix and balanced geographic footprint across developed and emerging markets, in combination with low leverage. This is balanced against low profitability and its exposure to commoditised dairy products.
The rating also reflects Fitch’s expectation that it will maintain a conservative financial and dividend policy, and a limited acquisitions strategy.
Friesland Campina Ingredients predicts the key functional food trends for 2025
The Stable Outlook reflects our expectation that EBITDA net leverage will return to below Fitch’s negative sensitivity of 1.5x in 2025 from a stretched 1.9x at end-2023, on the back of operating profit margin recovery.
Key Rating Drivers
Rating Reflects Deep Subordination: The notes’ two-notch differential with RFC’s IDR reflects their deep subordination and, consequently, lower recovery prospects than senior obligations in a liquidation or bankruptcy. In the capital structure, the notes only rank senior to the claims of equity shareholders and equally with RFC’s member bonds and cooperative loan.
50% Equity Credit: The securities qualify for 50% equity credit as they meet Fitch’s criteria with regard to deep subordination, perpetual nature, full discretion to defer coupons for at least five years, an absence of covenants, and limited events of default.
These are key equity-like characteristics, affording RFC greater financial flexibility. Equity credit is limited to 50%, given the notes’ cumulative interest coupon, a feature that is more debt-like in nature.
Effective Maturity Date: The notes are perpetual but Fitch deems the effective maturity to be in 25.25 years from their issue or 20 years from the first coupon reset date, in accordance with Fitch’s hybrid criteria.
From this date, the coupon step-up is within Fitch’s aggregate threshold rate of 100bp in the next five years, but the issuer will no longer be subject to replacement language expressing the intent to redeem the instrument at its call date with the proceeds of a similar instrument or with equity. Under our criteria, the equity credit of 50% would change to 0% five years before the effective maturity date.
Cumulative Coupon Limits Equity Treatment: Interest coupon deferrals are cumulative and compounding, which results in 50%/50% equity and debt treatment of the hybrid notes by Fitch. Despite the 50% equity treatment, Fitch includes the full coupon payment in its interest or fixed charge coverage ratios.
The company is obliged to make a mandatory settlement of deferred interest payments under certain circumstances, including the declaration of a cash dividend or supplementary cash payments, which are dividend-like in nature.
Derivation Summary
The dairy market is inherently volatile as raw milk prices and selling prices for dairy commodity products are largely outside producers’ control. Market volatility leads to instability in dairy companies’ profits and working capital.
RFC’s high share of value-added products in sales helps the company achieve greater control over selling prices and stronger profit margins than some of its closest peers, but does not fully isolate it from the sector’s high risks.
RFC is not fully comparable with other rated peers operating in the dairy market, such as Nestle SA (A+/Stable), but is similar in its business model to Fonterra Co-operative Group Limited (A/Stable) and Dairy Farmers of America, Inc. (DFA; BBB/Stable).
RFC’s credit profile is characterised by higher volatility than Nestle’s, due to its substantially higher exposure to commoditised products and more limited diversification across product categories and geographies.
Furthermore, RFC’s scale in the global food sector is substantially smaller than Nestle’s. At the same time, RFC has more conservative financial leverage, which helps balance its higher operating risks.
Similar to RFC, the operations of Fonterra and DFA are concentrated on dairy products produced under a cooperative set-up.
he companies have similar business scales. However, Fonterra’s and DFA’s ratings benefit from a stronger mechanism of subordination of milk payments to the companies’ principal and interest obligations (and other costs), as specified in their by-laws.
This allows them to operate under higher leverage than RFC. RFC’s stronger profitability and geographic diversification than DFA’s contribute to its higher rating.
Key Assumptions
– Revenue increase of 1.2% in 2024 and 2% in 2025, driven mainly by more premium products and distribution expansion in Asia, and specialised nutrition. This is followed by low single-digit revenue growth in 2026 and 2027
– Increase of EBITDA margin in 2024 to 6.2%, due mainly to normalising milk prices after abnormally high prices in 2022-2023. This is followed by mid-cycle EBITDA margins at 6.5% through to 2027
– Trade working capital remaining at about 10% of sales to 2027
– Capex of EUR450 million a year to 2027
– No supplementary cash payment made in 2024 over the 2023 results, before gradually increasing toward EUR53 million in 2027
– No M&As to 2027
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
-Evidence that the earning profile is subject to sustained increased volatility or adverse trends linked to regulatory pressure or consumer demand trends affecting supply and demand for dairy products
-Inability to support stable operating profit, and negative free cash flow (FCF) margins in the low single digits for more than two years, driven by weak operating performance and an aggressive financial policy
-EBITDA net leverage consistently above 1.5x
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
-Increased scale in profitable and stable businesses enhancing product and geographic diversification and reducing the proportion of sales from the more volatile trading division
-Further improvement in product or geographic diversification or a leaner cost structure supporting operating profit, and FCF margins consistently above 2%
-EBITDA net leverage below 0.5x on a sustained basis
Liquidity and Debt Structure
We forecast at end-2024 RFC will have an adequate liquidity headroom with estimated EUR450 million of Fitch-defined readily available cash and access to an undrawn EUR1 billion credit facility maturing in October 2029. We restrict year-end cash by EUR12 million to reflect the cash held in Nigeria.
RFC has shown the ability to refinance its debt on a timely basis, given its historically good access to debt capital markets. In January 2024 it refinanced EUR493 million of its EUR615 million debt maturing in that year with new debt. We expect the remaining maturing debt will be repaid from RFC’s internal cash generation.
Issuer Profile
RFC is the eighth-largest dairy company globally. It is wholly owned by the dairy co-operative Zuivelcoöperatie FrieslandCampina, which has 14,634 member dairy farmers and 9,417 member dairy farms in the Netherlands, Germany and Belgium.
Date of Relevant Committee
08 March 2024
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.
MACROECONOMIC ASSUMPTIONS AND SECTOR FORECASTS
Fitch’s macroeconomic forecasts, commodity price assumptions, default rate forecasts, sector key performance indicators and sector-level forecasts are among the data items included.
ESG Considerations
RFC has an ESG Relevance Score of ‘4’ for GHG Emissions & Air Quality, due to increasing attention from governments and consumers on the environmental impact of the emissions of dairy cattle, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.
The highest level of ESG credit relevance is a score of ‘3’, unless otherwise disclosed in this section. A score of ‘3’ 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. Fitch’s ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch’s ESG Relevance Scores
