The Long and Short

Campbell, in the soup with S&P, still looks good

Meredith Contente | August 11, 2023

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Campbell Soup (CPB) has announced a $2.7 billion acquisition of Sovos Brands, which houses the premium growth brand Rao’s, prompting a downgrade by S&P. But the downgrade does not detract from CPB’s strong cash flow and ability to reduce debt. CPB’s new issuance will likely provide an attractive buying opportunity as the deal is expected to come with some concession to secondaries. And CPB should continue to trade well relative to peers.

CPB’s strategic deal is expected to add to the company’s Meals & Beverages division, which includes the well-known Prego brand. The Sovos deal is the next step in CPB’s transformation following its successful acquisition of Snyder’s-Lance in 2018, which added a host of growth brands to its Snacks division. The deal will be funded with new debt and is expected to close by year-end 2023.

Following the Sovos announcement, S&P downgraded CPB to low BBB noting that leverage would exceed its threshold for the mid-BBB ratings and that CPB would not bring leverage back to its target range until three years post close. The downgrade was a bit of surprise given that S&P had previously allowed for 36 months to delever in the packaged food sector. The new ratings profile does not detract from CPB’s transformation progress and management has noted that debt reduction will remain a capital priority given their strong cash flow generation. As such, CPB’s new issuance will likely provide an attractive buying opportunity as the deal is expected to come with some concession to secondaries. CPB should continue to trade through peer Conagra Brands (CAG – Baa3/BBB-/BBB-) given its strong margin and cash flow profile and collapse closer to Kraft Heinz (KHC – Baa2/BBB/BBB) as it delevers.

Exhibit 1. Packaged Food BBB Curve

Source: Bloomberg TRACE, Santander US Capital Markets

Terms of the Acquisition

CPB will acquire Sovos Brands for $23 per share in cash, which translates to an enterprise value of roughly $27 billion. The purchase price represents a 14.6x adjusted EBITDA multiple, which includes annual run rate synergies of approximately $50 million. Sovos Brands posted annual adjusted sales of $837 million in calendar 2022. The flagship Rao’s brand accounted for 69% of net sales and was a large growth driver for the company, as organic net sales of Rao’s was up 34.9% from the year-ago period.

CPB plans to finance the acquisition with new debt, which is expected to bring net leverage to the 4.0x area. This is above management’s target range of 3.0x and over a turn higher than current net leverage of 2.8x. Management anticipates hitting its 3.0x leverage target by the end of the third year post close. CPB reiterated its capital allocation priorities of reinvestment in the business, maintaining a competitive dividend, and focus on reaching its leverage target. The deal is expected to close by the end of calendar 2023 and is subject to stockholder and regulatory approvals. Both Boards of Directors have already approved the transaction and there should be no issues receiving regulatory approval.

Leverage Target is Achievable

Pro forma estimates for the combined entity put total debt at $8.24 billion and EBITDA of $1.89 billion at the time of closing. That would indicate net leverage of 4.0x, which is what CPB management has been guiding to. Assuming annual run rate synergies of $50 million (beginning in year two), coupled with gross margin expansion as supply chain restraints begin to ease and the mid-point of management’s 4-6% EBIT growth rate, CPB should be able to delever roughly a third of a turn per year. This would assume debt reduction of $350-$400 million per year, which will be covered by free cash flow generation after dividends (Exhibit 2). The dividend currently consumes roughly $450 million annually, leaving enough room to repay debt while reinvesting in the business.

Exhibit 2. CPB Pro Forma Estimates

Source: Company Reports, Santander US Capital Markets, Bloomberg

Additionally, CPB has some levers to pull if cash flow generation were to stall or the economy enters into a recessionary period. Along with the Rao’s brand, CPB will be acquiring the Noosa yogurt brand with Sovos acquisition. Street estimates have CPB fetching roughly $240 million should it pursue a divestiture of the brand. CPB pursued divestitures post the Snyder’s-Lance acquisition in an effort to repay debt quickly and return leverage to its target.

Rating Agencies All Take a Different Approach

All three rating agencies took a different approach to the acquisition announcement. S&P took the most negative stance by immediately downgrading the rating by one notch to Baa3. The agency noted that they do not forecast the company to restore leverage to the low-3x area until at least fiscal 2026. While the agency noted that the acquisition will add a higher-growth, super-premium asset to the portfolio, higher interest costs associated with funding the deal coupled with capital investments will keep leverage above its target range for three years post close. S&P believes that integration risk is low and that synergies are conservatively estimated at $50 million. S&P’s stable outlook reflects its expectation that CPB will delever while successfully integrating the acquisition and maintaining stable operating performance.

Moody’s approach was the most positive as the agency reaffirmed the current Baa2 ratings while revising the company’s outlook to stable from positive. Moody’s noted that while the transaction will result in credit metrics that are weak for the current rating, the agency expects debt repayment to allow for CPB to reduce leverage to levels more appropriate for the rating within 12-24 months post close. Moody’s also believes that management will prioritize debt reduction over shareholder distributions, until net leverage reaches the company’s target range of 3.0x. Additionally, CPB is expected to finance the deal while preserving liquidity and meeting upcoming debt maturities. CPB has $1.65 billion of debt maturing in 2025 which consists of two bonds totaling $1.15 billion and a $500 million term loan. The term loan carries no pre-payment penalties, meaning that the company could begin to repay debt in 2024 by chipping away at the term loan.

Fitch placed CPB’s BBB rating on review for a downgrade given the higher leverage and noted that it could lead to either a negative rating outlook or a one-notch downgrade. Fitch noted that they could affirm the ratings if CPB were to decrease net leverage below 3.5x within 12-24 months post close. That said, the review for downgrade make take over six months to resolve. Fitch anticipates EBITDA to grow modestly as cost savings are expected to help offset continued cost inflation. Share buybacks are expected to be limited to anti-dilutive purchases until CPB hits its leverage target.

Meredith Contente
meredith.contente@santander.us
1 (646) 776-7753

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