OREANDA-NEWS. S&P Global Ratings today revised its outlook on Ridgefield, Conn.-based The Chefs' Warehouse Inc. (Chefs') to stable from positive and affirmed its 'B' corporate credit rating on the company.

At the same time, we affirmed our 'B' issue-level rating on the company's $280 million senior secured first-lien term loan and $50 million senior secured first-lien delayed-draw term loan. The recovery rating on the senior secured facilities is '3', reflecting our expectation for meaningful (50% to 70%, at the high end of the range) recovery in the event of a default. Debt outstanding as of June 24, 2016, was about $346 million.

"Our outlook revision to stable from positive primarily reflects Chefs' inability to manage the effects of protein deflation at its Del Monte Capital Meat Co., which it acquired in April 2015," said S&P Global Ratings credit analyst Gerald Phelan. We believe the inability to manage input costs occurred in part because Chefs' was in the process of implementing an enterprise resource planning (ERP) system at Del Monte, which caused disruptions. Although the ERP implementation is now complete, the profit outlook for the second half of 2016 remains weak, which we believe could signal the risk of lingering operating challenges at Del Monte, clearly weakening trends in the restaurant sector generally (including modestly lower same store sales), and some trouble passing on inflation at the company's premium meat company, Allen Brothers. As a result, we believe Chef's ability to strengthen its credit ratios materially over the next year have weakened. We now forecast debt to EBITDA in the low-6x area over the next 12 months, slightly weaker that our pro forma estimate in the high-5x area as of June 24, 2016. Nevertheless, we believe the company will maintain adequate liquidity over the next year.

Our ratings reflect Chefs' narrow business focus as a foodservice distributor primarily serving higher-end independent restaurants and specialty shops; its comparatively small scale versus larger peers in the industry; high financial leverage; and an aggressive growth strategy. We also consider input cost volatility and the potential for the large broad line competitors (including Sysco Corp., U. S. Foods Inc., and Performance Food Group Co.) to expand into Chefs' niche core customer space as key risks to the company's good position in the segment. The large broad liners have much greater scale and financial resources than Chefs' and could likely absorb more input cost volatility while being very competitive on price.

The stable outlook incorporates our expectation that profitability will stabilize over the next 12 months. We forecast adjusted EBITDA margin in the 6%-6.5% range and debt to EBITDA in the low-6x area over the next year.

We could lower our ratings if Chefs' continues to struggle to manage profitability in light of input cost volatility, if Del Monte faces further operating inefficiencies potentially due to lingering information technology (IT) problems, or if industry conditions deteriorate further, which could lead to escalating price competition. We could lower the ratings if we forecast that debt to EBITDA will approach 8x, which compared to our 2016 forecast could occur if EBITDA falls by 20% or debt increases by over $100 million.

Although unlikely over the next year, we could raise our ratings if Chefs' is able to strengthen profitability to previously projected levels, including adjusted EBITDA margin over 7%, which could result from an improved ability to manage input cost fluctuations (mainly proteins); if the company profitably gains new customers; and if it utilizes the majority of free cash flow for debt reduction. We could raise the ratings if we believe Chefs' will strengthen and sustain debt to EBITDA at 5x or below, which compared to our 2016 forecast could result if EBITDA increases by 25% or debt is reduced by $100 million.