NEW YORK — Amid a Department of Labor investigation into the company, the credit rating of Hearthside Food Solutions’ parent company has been downgraded by Moody’s Investors Service.
The ratings agency on May 18 cut the corporate family rating of H-Food Holdings, LLC to Caa1 from B3 and downgraded the company’s senior secured first lien revolving credit and senior secured first lien term loans to B3 from B2. Neither of the ratings are investment grade. Caa ratings at Moody’s are “judged to be of poor standing and are subject to very high credit risk.” B ratings at Moody’s are considered speculative.
Moody’s attributed the downgrade to poor operating performance in fiscal 2022 and to a concern that a modest improvement in the next 12 to 18 months will not materially reduce leverage and restore positive cash flow. Moody’s is projecting Hearthside’s debt-to-EBITDA at about 9 times in 2023. The multiple was 11 times at the end of 2022. Hearthside may be challenged in “addressing” loan maturities in November 2024 and May 2025, the agency said.
Labor issues were front and center in Hearthside’s difficulties in 2022, with baking operations most severely affected, Moody’s said.
“During fiscal 2022, Hearthside experienced inflationary headwinds as well as labor and supply chain issues,” Moody’s said. “Management has been able to partially address the inflation headwinds through price increases for its customers. Hearthside’s labor issues have improved as management implemented wage increases that helped reduce employee turnover. The company’s bakery operations experienced the biggest impact from labor, as employees in this segment require a longer timeframe for training, and as such, Hearthside did not have enough experienced bakers to operate its bakeries at an efficient capacity. Lastly, supply chain issues have begun to normalize which should help improve the EBITDA margin and reduce the free cash flow deficit, as the company no longer needs to hold excess inventory to address supply chain challenges.”
Hearthside was featured prominently in a New York Times article in late February alleging that the company and many other employers were using underage migrant children at their plants. Moody’s said the situation poses particular risks for Hearthside.
“As a co-manufacturer for private label and branded food providers, product quality is a key attribute that retail and foodservice partners look for when choosing a supplier,” Moody’s said. “As a result, product quality and reputational risk are important for Hearthside to sustain its customer base and revenue. Human capital risk is evidenced by the company’s current Department of Labor investigation regarding alleged employees working at its plants under the age of 18. Although this investigation is ongoing, it illustrates the human capital risk that the company faces.”
The ratings agency noted some improvement in Hearthside’s operating performance. In the fourth quarter, the company’s EBITDA margin improved 180 basis points. While positive cash flow is likely for Hearthside in 2023, Moody’s said cash flow will be weak or negative in 2024 due to a rising interest burden.