Fitch Ratings has placed the ratings for Campbell Soup Company, including the Long-Term Issuer Default Ratings (IDR) of 'BBB' and Short-Term IDR of 'F2', on Rating Watch Negative (RWN).
On Aug. 7, 2023, Campbell signed a definitive agreement to acquire Sovos Brands, Inc. for $2.7 billion, reflecting a multiple of approximately 20x Sovos' LTM EBITDA of around $135 million. The transaction is expected to close by the end of calendar 2023, subject to regulatory approvals and other customary closing conditions.
The RWN reflects the potential for leverage to be sustained above Campbell's ratings sensitivities within 12 to 24 months post the close of the transaction, which could lead to a Negative Rating Outlook or a one-notch downgrade. However, Fitch could affirm the ratings on increased visibility for EBITDA leverage to return to under 3.5x within 12 to 24 months, from a projected pro forma leverage of 4x at transaction close. The RWN may take over six months to resolve.
Key Rating Drivers
Sovos Expands Premium Strategy: Campbell's announced an agreement to acquire Sovos Brands (NASDAQ: SOVO) for $2.7 billion or $23.00 per share (a 28% premium to its closing price on Aug. 4, 2023 of $18.02). The acquisition includes Sovos' existing net debt of approximately $315 million. Sovos generated LTM (ended July 1, 2023) revenue of approximately $940 million and EBITDA of around $138 million. Close to 70% of its revenue comes from its Rao's brand, which is the market leader in the premium pasta sauce category. Campbell does not currently compete in the premium segment, and the acquisition would complement its presence in the mainstream category where it has a leading position with Prego. Sovos also has a presence in frozen Italian food products with Michael Angelo's, which accounted for 10% of 2022 revenue with the remaining 20% coming from noosa, a premium yogurt brand.
Sovos Revenue/Margin Expectations: Sovos' net sales grew at a CAGR of 29% between 2019-2022, driven by over 30% CAGR in Rao's, with mid-single digits growth in noosa and low single digit growth for Michael Angelo's. Campbell views the company as having significant runway, particularly with Rao's, given the potential for increased household penetration, increased brand awareness, and new adjacencies. Fitch expects Sovos could grow in the high-single digits over the next 24-36 months, adding about 1% annually to Campbell's total top line growth after year one. However, Rao's already has a dominant share in the ultra-premium pasta category has seen outsized growth over the last few years and increased household penetration and new adjacencies could be challenging to achieve, which would limit revenue upside.
Sovos' LTM EBITDA margin of around 14.5% is significantly lower than Campbell's at just over 19% and would be a drag on Campbell's margins in the near term. Campbell expects to realize about $50 million in synergies including distribution, sales & marketing optimization, back-office consolidation, procurement savings, network optimization and elimination of public company costs.
Elevated Leverage, Reduced FCF: Campbell plans to finance the acquisition through the issuance of new debt. Fitch projects EBITDA leverage to be approximately 4x at transaction close, versus Campbell's EBITDA leverage of around 2.6x for fiscal 2023 (ended July). Campbell has publicly articulated its focus on reaching its target leverage ratio of approximately 3x by the end of year three, while investing in key growth and productivity initiatives in its core business, maintaining a competitive dividend, and continuing anti-dilutive share repurchases.
Fitch expects FCF (post dividends) generation could be materially lower than Campbell's current run rate of around $300 million to $350 million annually given a higher interest burden, higher capex and working capital to support its ongoing investments in the business, and any cash charges related to merger integration. This could limit the potential for debt paydown and therefore, leverage could be sustained above 3.5x beyond the 12-24 months post-merger close.
Campbell's Standalone Drivers
Stable Revenue Base: Fitch expects organic sales growth of 8%-9% in fiscal 2023 based on volume declines of 4% and pricing increases in the low teens. Fitch expects Campbell's medium-term organic sales will be flat to modestly positive going forward. This is relative to management's expectations of driving organic sales growth of approximately 2% for the total company, given projected average category growth rate of 1% in its meals and beverages business and approximately 3% growth in its snack business.
EBITDA Expected to Trend Around $1.7-$1.8 Billion: Fitch expects EBITDA to increase in the mid-single digit range in fiscal 2023 after declining about 4% to $1.65 billion in fiscal 2022 (from normalizing volume levels post pandemic fueled demand and inflationary pressures). This EBITDA level is essentially in line with pre-pandemic levels with EBITDA margin decline of around 150 bps to the low 19% offset by higher top line. Fitch expects EBITDA to grow modestly with EBITDA margins relatively stable, as Fitch expects targeted cost savings to help offset cost inflation and increased promotional spending and investments in the business.
In December 2021, the company shared its targets of driving 2% organic sales growth, 4%-6% EBIT growth, and 6%-8% adjusted Earnings Per Share (EPS) growth between fiscal 2022 and fiscal 2025. Campbell expects to expand profit margins in the Snacks business through better plant performance, further manufacturing and logistics network optimization, route to market enhancements, and overall improved revenue management.
Derivation Summary
Campbell's (BBB/RWN) ratings reflect its strong brands, significant market share in several product categories, solid profit margins and consistent FCF generation. Fitch expects EBITDA leverage to be in the mid-2x in fiscal 2023 (ended July). Fitch expects organic sales to be flat to modestly positive over the medium with EBITDA sustained at around $1.7 billion to $1.8 billion for the standalone business over the medium term. The RWN reflects the potential increase for a sustained increase in leverage, pro forma for the Sovos transaction.
Kraft Heinz's 'BBB'/Stable ratings reflect the company's significant scale, with 2022 revenue of $26.5 billion, strong EBITDA margins and good cash flow generation. KHC has focused on debt reduction and tighter leverage metrics and delivered strong results that support its market leading position in the U.S. packaged food space. Fitch expects KHC to generate at least flat organic sales growth and EBITDA around the $6 billion range over the medium term while sustaining EBITDA leverage under 3.5x.
Conagra Brands' 'BBB-'/Stable ratings reflect its leading position in the U.S. packaged food space and well-diversified brand portfolio. Conagra is the fourth largest U.S. packaged foods company and the portfolio benefits from its concentration in the frozen and refrigerated as well as snacking domain. Fitch expects Conagra to generate low single digit organic sales growth and EBITDA of around $2.3 billion to $2.4 billion over the medium term with EBITDA leverage remaining relatively stable in the mid to high 3x.
Key Assumptions
Fiscal 2023 organic revenue is expected to increase by 8%-9% based on volume declines of 4% and pricing increases in the low teens. Fitch expects Campbell's medium-term organic sales will be flat to modestly positive going forward.
Fitch expects EBITDA to increase in the mid-single digit range in fiscal 2023 to $1.7 billion to $1.8 billion after declining about 4% to $1.65 billion in fiscal 2022 (from normalizing volume levels post pandemic fueled demand and inflationary pressures). This is essentially in line with pre-pandemic levels with EBITDA margin decline of around 150 bps to the low 19% offset by higher top line. Fitch expects EBITDA to grow modestly with EBITDA margins relatively stable, as Fitch expects targeted cost savings to help offset cost inflation and increased promotional spending and investments in the business.
FCF (after dividends) is projected to remain between $300 million to $350 million over the medium term. EBITDA leverage (total debt/EBITDA) is expected to be around 2.6x in fiscal 2023 and around 3x thereafter.
Campbell's debt generally has fixed interest rate structures besides its commercial paper borrowings and its $500 million DDTL (SOFR + 1.225%) due to mature in November 2025, and as such, the recent rise in interest rates is expected to have modest impact on Campbell's interest expense.
Fitch's Rating Case for Combined Campbell/Sovos Entity
Total revenue is expected to increase to $9.9 billion in fiscal 2024, assuming the transaction closes at calendar year end, and $10.4 billion in fiscal 2025 primarily as a result of the incremental revenue from the acquisition of Sovos Brands, with flat to modestly positive revenue growth in the base business.
EBITDA is expected to increase to around $2 billion over the medium term versus a pro forma EBITDA of $1.9 billion on an LTM basis.
Fitch expects FCF (post dividends) generation could be materially lower than Campbell's current run rate of around $300 million to $350 million given a higher interest burden, higher capex and working capital to support its ongoing investments in the business, and any cash charges related to merger integration. This could limit the potential for debt paydown and therefore, leverage could be sustained above 3.5x beyond the 12-24 months post-merger close.
RATING SENSITIVITIES
Sensitivities related to Sovos acquisition:
Fitch anticipates resolving the RWN following the conclusion of the regulatory review process. The transaction could lead to a Negative Outlook or one-notch downgrade of Campbell in the event Fitch projects EBITDA leverage could sustain above 3.5x beyond a 12 to 24-month window following transaction close. Final ratings will depend on several factors including receiving regulatory approvals, operating trends at both Campbell and Sovos, more details around FCF generation and capital allocation priorities, and potential for deleveraging.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
An upgrade to 'BBB+' would require management achieving its growth targets of 2% organic sales growth, 4%-6% EBIT growth, and strong FCF generation on a standalone basis (and projected sales and EBITDA contribution for Sovos at transaction close), along with a demonstrated commitment to maintaining EBITDA leverage under 3.0x.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Organic revenue declines in the high margin U.S. soup business that are not offset by growth in Campbell's snacks portfolio, and/or margin compression due to the need for increased investment such that EBITDA trends below $1.5 billion in its core business and EBITDA leverage is sustained above 3.5x.
Debt financed acquisitions such as Sovos or shareholder friendly activities that lead to EBITDA leverage sustained above 3.5x 12-24 months after transaction close.
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
Adequate Liquidity: Campbell had total liquidity of around $1.8 billion, as of April 30, 2023, primarily consisting of $223 million in cash and $1.6 billion available on its senior unsecured $1.85 billion revolving credit facility with $1 million of standby LOC. The revolver backstops the company's CP program, under which there were $249 million of borrowings as of April 30, 2023.
On Nov. 15, 2022, Campbell entered into a $500 million delayed draw term loan (DDTL) due November 2025, which the company used to refinance the $566 million of notes due March 2023. The company's total debt stood at close to $4.8 billion at quarter end, and the next debt maturity is $1.150 billion of notes due in March 2025.
Based on Fitch's assessment of Campbell's financial flexibility, financial structure, and operating environment, the higher of the two short-term options (F2/F3) 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.
Issuer Profile
Campbell manufactures and markets branded food and beverage products, primarily in the U.S., where it generated over 90% of total net revenue in FY 2022. The company segments its business into Meals and Beverages (about 54% of revenue in FY 2022) and Snacks (about 46% of revenue).
Summary of Financial Adjustments
Fitch adjusts Campbell's EBITDA for stock-based compensation, restructuring expenses, implementation costs & other related costs, and the impact of any discontinued operations.
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
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, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.
SOVOS BRANDS, INC. 
