Moody's raises Krispy Kreme liquidity rating

by Josh Sosland
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NEW YORK — Moody’s Investors Servie on May 8 raised the speculative grade liquidity rating of Krispy Kreme Doughnuts Corp. to SGL-3 from SGL-4. The update reflected a recent credit agreement that eased liquidity tightness but was accompanied by several caveats about the company’s outlook.

With the adjustment, Krispy Kreme’s corporate family rating was affirmed at Caa1 with a B3 for senior secured credit facilities. The rating outlook remained negative.

Explaining the liquidity upgrade, Moody’s said Krispy Kreme "modestly improved (its) liquidity position with an April 2009 amendment to its financial covenant. Under terms of the amendment, the interest coverage covenant has been relaxed over the next two fiscal years. Additionally, the company has prepaid $20 million of term debt from cash and reduced its secured $30 million revolving credit facility commitment to $25 million.

Moody’s said other contributing factors were Krispy Kreme’s "manageable amortization schedule" and a "modest" cash balance of $17 million after the debt paydown.

On the other hand, Moody’s said the rating optimism was "tempered" by "weakening free cash flow generation" forecast over the next 12 months and reduced availability under the revolving credit facility.

Other aspects of Krispy Kreme’s prospects prompt a cautionary view, Moody’s said.

"Most of Krispy Kreme's operations likely remain under pressure," the agency said. "To this point, we note that any decline in operating performance and cash flow generation in conjunction with scheduled covenant step downs could erode the newly afforded covenant cushion. If this occurs, both the company’s SGL and long-term rating could be pressured downward."

Summarizing the broader picture at Krispy Kreme, Moody’s said the Caa1 rating (credit defined by the agency as of "poor standing and subject to very high credit risk") and negative outlook reflect weak credit metrics, a narrow product line and weak sales trends because of slumping customer traffic.

Because of a high fixed cost structure, these challenges may result in further operating margin deterioration, offsetting possible gains from commodity and transportation cost reductions. An effort to move toward more of a franchisee-based operation from a company-based operation have not helped Krispy Kreme’s financial picture, in part because certain large franchisees, especially those not in the Southeast, are struggling.

Moody’s said the picture for Krispy Kreme is not entirely negative. The company benefits from strong brand recognition, geographic diversification and "some success" in resolving legacy litigation and material weaknesses issues that had been a weight on Krispy Kreme’s credit ratings.

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