United Natural Foods, Inc.
New Coverage: Amid Headwinds, United Natural Targets 2x-2.5x Leverage Ratio After Consummation of Supervalu Acquisition; Company Likely Not Restricted From Prepaying Term Loan
Tue 01/08/2019 15:24 PM
Relevant Documents:
United Natural Debt Documents
On Oct. 22, 2018, United Natural Foods Inc. announced the closing of its acquisition of Supervalu in a deal valued at approximately $2.9 billion. Combined last-12-month EBITDA of $747 million at the time of the merger implied leverage of 4.7x, according to a presentation announcing the deal. Despite a number of headwinds, the company continues to discuss the benefits of the deal and says it remains dedicated to “reducing outstanding debt and delevering our balance sheet.” The company’s goal is to reduce its leverage to be between 2.5x and 2x.
When the company announced that it would be acquiring Supervalu, it had projected “Year One” adjusted EBITDA between $655 million and $675 million and net sales between $24.2 billion and $24.8 billion. In December, the company projected fiscal 2019 EBITDA between $650 million and $665 million and net sales between $21.5 billion and $22 billion, suggesting a leverage ratio of between about 5.07x and 5.19x.
This article analyzes United Natural’s ability to improve its balance sheet, including by prepaying the term loans and reducing debt through asset sales.
United Natural is likely not currently restricted from prepaying the term loans; to the extent such prepayments of the term loan B tranche are funded with lower-priced term loans within the first year after closing, the company would likely be subject to a 1% prepayment penalty.
The company is generally permitted to consummate asset sales, subject to certain conditions, including that proceeds in excess of $10 million (or, for sales of Supervalu’s retail business, $5 million) be used to prepay the terms loan or, other than proceeds from sales of Supervalu’s retail business, to reinvest in the business.
Under the company’s term loan and ABL facility, it is likely currently permitted to increase commitments under the ABL Facility by $500 million and to incur $656.25 million of debt that is pari to the Term Loan and $75 million of additional debt secured by general liens.
It is likely restricted from making more than $25 million of restricted payments and is restricted from transferring IP to unrestricted subsidiaries.
On Oct. 22, 2018, United Natural Foods Inc. (“United Natural”) announced the closing of its acquisition of Supervalu in a deal valued at approximately $2.9 billion. In order to fund the acquisition, United Natural entered into a new $2.1 billion asset-based revolving credit facility (the “ABL Facility”) and a $1.9 billion senior secured first lien term loan facility (the “Term Loan”) consisting of a $1.8 billion term loan B tranche and a $150 million 364-day term loan B-2 tranche.
United Natural’s capital structure as of Oct. 27, reflecting the consummation of the Supervalu acquisition, including the redemption of Supervalu’s outstanding debt, is illustrated below for reference.
As illustrated above, the term loan B facility’s maturity date springs from Oct. 22, 2025, to Dec. 31, 2024, if, by such date, United Natural has not extended the termination date of its contract with Whole Foods to Oct. 23, 2025, or later.
In a supplemental presentation to investors discussing the benefits of the acquisition on Sept. 20, United Natural included the following slide that provided financial projections for the 2019 fiscal year:
Management also provided a walk to “Normalized LTM Adjusted EBITDA” of $904 million:
In a presentation accompanying the company’s first-quarter earnings release on Dec. 6, it included the following revised projections:
On its 2019 first-quarter earnings call, management discussed a number of secular and industry-wide headwinds, including:
The company also cited higher-than-expected acquisition financing costs:
Despite these headwinds, management stated that:
In this article, we analyze the company’s ability to improve its balance sheet, including by prepaying the term loans and reducing debt through asset sales. We also briefly discuss the company’s ability to incur debt and liens and make restricted payments and investments under the Term Loan and ABL Facility.
As illustrated below, on the basis of the company’s projected fiscal year 2019 projected EBITDA of between $650 million and $665 million, we calculate its leverage ratio, assuming constant outstanding debt and unrestricted cash, to be between 5.07x and 5.19x.
As shown above, the company also projected “Normalized LTM Adjusted EBITDA,” after certain synergies including year four run-rate cost synergies of $185 million, of $904 million. However, holding debt and cash constant, even at that level of EBITDA, the company would still need to reduce debt to hit its 2x to 2.5x leverage target.
The ABL Facility restricts United Natural from prepaying Junior Debt unless availability under the ABL Facility is at least 10% of the aggregate borrowing base and, unless availability is at least 15% of the borrowing base, compliance with a 1x FCCR.
“Junior Debt” is defined as payment subordinated debt, debt that is junior in priority to the liens securing the ABL Facility or unsecured debt, in all cases, in excess of $75 million.
Because the term loans are secured by a junior lien on the liens securing the ABL Facility, the ABL Facility’s prepayment covenant likely restricts United Natural from prepaying the term loans.
Nevertheless, in its 10-Q for its first quarter, the company disclosed that the total borrowing base was $2.088 billion and that:
Although the Term Loan includes a 1% call protection premium if United Natural prepays the term loan B tranche with the proceeds of lower-priced term loans in the first year after closing where the primary purpose of such prepayment is to reduce interest expense, it does not require a prepayment premium if such prepayment is funded with cash or draws on the revolver or proceeds of any other non-term loan debt.
As such, United Natural is likely not currently restricted from prepaying the term loans; to the extent such prepayments of the term loan B tranche are funded with lower-priced term loans within the first year after closing, the company would likely be subject to a 1% prepayment penalty.
Note that as long as any term loans B-2 are outstanding, voluntary prepayments will be used to repay the term loans B-2 ahead of the term loans B.
As part of the Supervalu acquisition, United Natural has discussed its intention to sell Supervalu’s retail businesses:
The Term Loan and ABL Facility also explicitly permit the sale of Supervalu’s retail, tobacco and other non-wholesale businesses (such sales, “Permitted Supervalu Retail Asset Sales”) as long as, under the Term Loan, proceeds are subject to the mandatory prepayment requirements, unless the proceeds are used to reduce outstanding pension liabilities.
While the ABL Facility does not require United Natural to repay outstanding revolver borrowings with asset sale proceeds, the Term Loan does.
Under the Term Loan, United Natural is required to use 100% of proceeds from any General Asset Sales in excess of $10 million in any fiscal year and from any Permitted Supervalu Retail Asset Sales in excess of $5 million in any fiscal year to either repay the term loans (and, if required, other pari debt) or, in the case of proceeds from General Asset Sales, reinvest in the business.
As long as any term loans B-2 are outstanding, United Natural may use proceeds from asset sales solely to repay the term loans B-2 or to ratably repay the term loans B and B-2.
The following table illustrates the permitted debt and liens, restricted payments and investments baskets under the Term Loan and ABL Facility.
Although the ABL Facility provides United Natural with significant capacity to incur secured debt and to make restricted payments and investments, the Term Loan is generally more restrictive.
Under the Term Loan and ABL Facility, the company is likely permitted to increase commitments under the ABL Facility by $500 million (the ABL Facility permits $600 million of commitments increases; pursuant to the First Amendment in October, United Natural increased revolving commitments by $100 million) and to incur $656.25 million of debt that is pari to the Term Loan and $75 million of additional debt secured by general liens.
As illustrated above, the Term Loan likely restricts United Natural from making more than $25 million of restricted payments, given that it is unable to meet the leverage tests required to access the Available Amount and the Leverage-Based Restricted Payments baskets.
Although the company can likely make at least $340 million of investments in unrestricted subsidiaries, the ABL Facility restricts the company from transferring IP to any unrestricted subsidiary.
United Natural Debt Documents
Executive Summary
On Oct. 22, 2018, United Natural Foods Inc. announced the closing of its acquisition of Supervalu in a deal valued at approximately $2.9 billion. Combined last-12-month EBITDA of $747 million at the time of the merger implied leverage of 4.7x, according to a presentation announcing the deal. Despite a number of headwinds, the company continues to discuss the benefits of the deal and says it remains dedicated to “reducing outstanding debt and delevering our balance sheet.” The company’s goal is to reduce its leverage to be between 2.5x and 2x.
When the company announced that it would be acquiring Supervalu, it had projected “Year One” adjusted EBITDA between $655 million and $675 million and net sales between $24.2 billion and $24.8 billion. In December, the company projected fiscal 2019 EBITDA between $650 million and $665 million and net sales between $21.5 billion and $22 billion, suggesting a leverage ratio of between about 5.07x and 5.19x.
This article analyzes United Natural’s ability to improve its balance sheet, including by prepaying the term loans and reducing debt through asset sales.
United Natural is likely not currently restricted from prepaying the term loans; to the extent such prepayments of the term loan B tranche are funded with lower-priced term loans within the first year after closing, the company would likely be subject to a 1% prepayment penalty.
The company is generally permitted to consummate asset sales, subject to certain conditions, including that proceeds in excess of $10 million (or, for sales of Supervalu’s retail business, $5 million) be used to prepay the terms loan or, other than proceeds from sales of Supervalu’s retail business, to reinvest in the business.
Under the company’s term loan and ABL facility, it is likely currently permitted to increase commitments under the ABL Facility by $500 million and to incur $656.25 million of debt that is pari to the Term Loan and $75 million of additional debt secured by general liens.
It is likely restricted from making more than $25 million of restricted payments and is restricted from transferring IP to unrestricted subsidiaries.
Background
On Oct. 22, 2018, United Natural Foods Inc. (“United Natural”) announced the closing of its acquisition of Supervalu in a deal valued at approximately $2.9 billion. In order to fund the acquisition, United Natural entered into a new $2.1 billion asset-based revolving credit facility (the “ABL Facility”) and a $1.9 billion senior secured first lien term loan facility (the “Term Loan”) consisting of a $1.8 billion term loan B tranche and a $150 million 364-day term loan B-2 tranche.
United Natural’s capital structure as of Oct. 27, reflecting the consummation of the Supervalu acquisition, including the redemption of Supervalu’s outstanding debt, is illustrated below for reference.
As illustrated above, the term loan B facility’s maturity date springs from Oct. 22, 2025, to Dec. 31, 2024, if, by such date, United Natural has not extended the termination date of its contract with Whole Foods to Oct. 23, 2025, or later.
In a supplemental presentation to investors discussing the benefits of the acquisition on Sept. 20, United Natural included the following slide that provided financial projections for the 2019 fiscal year:
Management also provided a walk to “Normalized LTM Adjusted EBITDA” of $904 million:
In a presentation accompanying the company’s first-quarter earnings release on Dec. 6, it included the following revised projections:
On its 2019 first-quarter earnings call, management discussed a number of secular and industry-wide headwinds, including:
- Weakness at Supervalu: “[Supervalu’s] performance, where trends have weakened, caus[ed] us to reset near-term expectations. … The integration work at Unified Grocers and Associated Grocers Florida had softer product margins across certain center store categories.”
- Challenges in the retail market: “[T]he macroeconomic environment of retail continues to be challenging, more and more retailers competing for their share of the consumers' dollar. Products are now available in more and more outlets, including online.”
- Labor costs: “[L]ike many distribution companies, we continue to be challenged with higher labor costs and productivity issues related to serving this busy holiday season and the addition of temporary labor where needed.”
- Fuel costs: “For the quarter, total legacy UNFI fuel costs increased 10 basis points as a percentage of net sales in comparison to Q1 of fiscal '18 and represented 54 basis points of distribution net sales. Our diesel fuel cost per gallon increased approximately 21% in Q1 versus Q1 last year.”
The company also cited higher-than-expected acquisition financing costs:
“As many of you are aware, the final interest rate and fees we paid on our term loan refinancing were significantly higher than we had originally expected for several reasons, which include the state of the term loan market, SUPERVALU's Q2 results and the unexpected financing costs we incurred. … [W]e now expect our fiscal 2019 adjusted interest expense to be between $181 million and $191 million, which is approximately $38 million higher on a comparable basis than the $185 million to $190 million we estimated back in September for the full first fiscal year of the combined companies.”
Despite these headwinds, management stated that:
“We remain dedicated to reducing outstanding debt and delevering our balance sheet. We will forgo M&A opportunities in the near term and have no plans for dividends or share buybacks until we hit our target leverage of 2.0 to 2.5x. Our team is focused on efficient management of our working capital and capital spend, with focusing - with a focus on maximizing free cash flow while making the necessary investments to drive our business results.”
In this article, we analyze the company’s ability to improve its balance sheet, including by prepaying the term loans and reducing debt through asset sales. We also briefly discuss the company’s ability to incur debt and liens and make restricted payments and investments under the Term Loan and ABL Facility.
Current Leverage Ratio and Required Debt Reduction
As illustrated below, on the basis of the company’s projected fiscal year 2019 projected EBITDA of between $650 million and $665 million, we calculate its leverage ratio, assuming constant outstanding debt and unrestricted cash, to be between 5.07x and 5.19x.
As shown above, the company also projected “Normalized LTM Adjusted EBITDA,” after certain synergies including year four run-rate cost synergies of $185 million, of $904 million. However, holding debt and cash constant, even at that level of EBITDA, the company would still need to reduce debt to hit its 2x to 2.5x leverage target.
Prepayment of the Term Loans
The ABL Facility restricts United Natural from prepaying Junior Debt unless availability under the ABL Facility is at least 10% of the aggregate borrowing base and, unless availability is at least 15% of the borrowing base, compliance with a 1x FCCR.
“Junior Debt” is defined as payment subordinated debt, debt that is junior in priority to the liens securing the ABL Facility or unsecured debt, in all cases, in excess of $75 million.
Because the term loans are secured by a junior lien on the liens securing the ABL Facility, the ABL Facility’s prepayment covenant likely restricts United Natural from prepaying the term loans.
Nevertheless, in its 10-Q for its first quarter, the company disclosed that the total borrowing base was $2.088 billion and that:
“[Our] resulting remaining availability under the ABL Credit Facility was $682.4 million as of October 27, 2018.”
Because the company’s availability under the ABL Facility exceeds 15% of the borrowing base, the ABL Facility likely does not restrict the company from prepaying the term loans.Although the Term Loan includes a 1% call protection premium if United Natural prepays the term loan B tranche with the proceeds of lower-priced term loans in the first year after closing where the primary purpose of such prepayment is to reduce interest expense, it does not require a prepayment premium if such prepayment is funded with cash or draws on the revolver or proceeds of any other non-term loan debt.
As such, United Natural is likely not currently restricted from prepaying the term loans; to the extent such prepayments of the term loan B tranche are funded with lower-priced term loans within the first year after closing, the company would likely be subject to a 1% prepayment penalty.
Note that as long as any term loans B-2 are outstanding, voluntary prepayments will be used to repay the term loans B-2 ahead of the term loans B.
Asset Sales
As part of the Supervalu acquisition, United Natural has discussed its intention to sell Supervalu’s retail businesses:
“We believe SUPERVALU's core distribution business is strong. Combined with UNFI's core distribution business, the resulting combination is powerful. … Running retail banners just is not our core business, and we have been clear since announcements regarding our plans to divest.”
On United Natural’s first-quarter earnings call, in response to a question regarding whether the company would consider selling non-retail assets, management responded:“Yes. So obviously, we are looking at, for example, real estate. We acquired quite a bit of real estate with SUPERVALU, not to mention some other assets that we own. And so I think the point that I was trying to make is, where we can create value and it's in the best interest of the company long term, then we will look to sell those assets in order to pay down the debt sooner.”
As illustrated in the Term Loan Summary and ABL Summary, the Term Loan and ABL Facility generally permit asset sales, including sale-and-leaseback transactions, as long as such sales are consummated at fair market value, 75% of the consideration consists of cash and equivalent and, under the Term Loan, proceeds are subject to the mandatory prepayment requirements (such asset sales, “General Asset Sales”). Under the ABL Facility, if the sold assets account for 5% or more of the borrowing base assets, United Natural must deliver an updated borrowing base certificate.The Term Loan and ABL Facility also explicitly permit the sale of Supervalu’s retail, tobacco and other non-wholesale businesses (such sales, “Permitted Supervalu Retail Asset Sales”) as long as, under the Term Loan, proceeds are subject to the mandatory prepayment requirements, unless the proceeds are used to reduce outstanding pension liabilities.
While the ABL Facility does not require United Natural to repay outstanding revolver borrowings with asset sale proceeds, the Term Loan does.
Under the Term Loan, United Natural is required to use 100% of proceeds from any General Asset Sales in excess of $10 million in any fiscal year and from any Permitted Supervalu Retail Asset Sales in excess of $5 million in any fiscal year to either repay the term loans (and, if required, other pari debt) or, in the case of proceeds from General Asset Sales, reinvest in the business.
As long as any term loans B-2 are outstanding, United Natural may use proceeds from asset sales solely to repay the term loans B-2 or to ratably repay the term loans B and B-2.
Negative Covenants
The following table illustrates the permitted debt and liens, restricted payments and investments baskets under the Term Loan and ABL Facility.
Although the ABL Facility provides United Natural with significant capacity to incur secured debt and to make restricted payments and investments, the Term Loan is generally more restrictive.
Under the Term Loan and ABL Facility, the company is likely permitted to increase commitments under the ABL Facility by $500 million (the ABL Facility permits $600 million of commitments increases; pursuant to the First Amendment in October, United Natural increased revolving commitments by $100 million) and to incur $656.25 million of debt that is pari to the Term Loan and $75 million of additional debt secured by general liens.
As illustrated above, the Term Loan likely restricts United Natural from making more than $25 million of restricted payments, given that it is unable to meet the leverage tests required to access the Available Amount and the Leverage-Based Restricted Payments baskets.
Although the company can likely make at least $340 million of investments in unrestricted subsidiaries, the ABL Facility restricts the company from transferring IP to any unrestricted subsidiary.
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