Rating Action Overview

• Triton Water Holdings Inc. experienced a difficult fiscal 2022 as operational challenges primarily related to the separation from its former parent Nestle persisted and input cost inflation pressured margins.
• We expect S&P Global Ratings-adjusted leverage of about 10x for the full-year 2022, though more recent performance points to adjusted leverage closer to 8x.
• We expect the company to strengthen credit metrics significantly in 2023, including adjusted leverage slightly below 7x as three rounds of price increases take full effect and certain one-time expenses are lapped.
• We affirmed our 'B' issuer credit rating on Triton. At the same time, we affirmed our 'B' issue-level rating on the company's $2.8 billion senior secured first-lien term loan due 2028 and our 'CCC+' issue-level rating on its $770 million senior unsecured notes due 2029. The recovery ratings on the debt are '3' and '6', respectively.
• The outlook remains negative since we need more evidence that the company has reached an operating performance inflection point. We could lower the rating over the next few quarters if Triton cannot successfully strengthen profitability and credit measures in line with our forecast.

Rating Action Rationale

Triton's credit metrics remained weak during 2022.  Higher raw material, fuel, and freight costs pressured gross margin performance last year. Moreover, since the leveraged buyout (LBO), Triton has incurred a host of costs associated with its IT cutover from the former parent, as well as significant management, restructuring, and legal expenses that pressured EBITDA performance. We expect a number of these other operating expenses to moderate in 2023 as one-time costs start to fall off. We believe that higher advertising and promotion (A&P) spend will persist as Triton operates the business for growth. We recognize that operating performance will likely hit a trough in the first quarter of 2022, and two rounds of significant price increases bolstered EBITDA in the second and third quarter of 2022. It is our understanding that a third round of pricing also took effect in the fourth quarter. Additionally, we expect that some input cost inflation, particularly polyethylene terephthalate resin (the main input in plastic bottles), may have peaked in mid-2022. Our base-case forecast for 2023 includes modest recapture of the gross margin lost in 2022, and we also believe that the magnitude of other separation-related operating costs will be lower next year. These factors should be a tailwind for EBITDA performance.

The challenging macroeconomic outlook for 2023 could slow the path to deleveraging.  Waning macroeconomic momentum and the increasing likelihood of a shallow recession with weaker consumers in 2023 present downside risk to our expectation for volume growth next year. As such, increased promotional activity could slow progress from price increases that Triton implemented over the last few quarters. S&P Global Ratings economists currently expect a shallow recession in the first half of 2023, and the risk of consumers opting for private-label and tap water alternatives is higher. Transition away from the Nestle-branded packaging on the company's Pure Life brand (19% of sales in U.S. retail) further exacerbates private-label risk. Supply chain disruptions, resulting from challenges in the company's transition to a new enterprise resource planning (ERP) system, negatively impacted fill rates in 2022, which could influence customer relationships and order behavior from its retailing partners--especially given the recent propensity for destocking among the largest players. 

Financial policy under the ownership of One Rock Capital Partners is highly aggressive.  Despite already high S&P Global Ratings-adjusted leverage at the close of the LBO transaction, Triton executed a debt-funded shareholder distribution at the end of 2021 and a sale leaseback transaction of owned properties that resulted in incrementally higher lease liabilities and rent expense. We cannot rule out the possibility of future debt-funded mergers and acquisitions (M&A) or dividends, which could result in elevated leverage for a longer period of time.

Outlook

The negative outlook reflects the potential for a lower rating over the next few quarters if Triton is unable to meaningfully improve profitability.

Downside scenario

We could lower our ratings if the company does not delever in line with our expectations, and S&P Global Ratings-adjusted leverage is sustained above 7x. This could happen if:

• Operational challenges relating to its IT cutover process persist;
• Increasing competition from private-label rivals or the loss of major customers result in lower demand for the company's products; or
• The company's financial policy becomes more aggressive, with significant debt-financed shareholder distributions or acquisitions.

Upside scenario

We could revise our outlook to stable if the company improves operating performance, such that adjusted leverage is sustained below 7x and we forecast materially positive free operating cash flow (FOCF). This could happen if:

• The company successfully recaptures gross margin with pricing momentum and moderating inflationary pressures.
• Demand for the company's products remains satisfactory and volumes grow; and
• Separation-related costs decrease as expected and Triton fully realizes cost savings.

Company Description

Stamford, Conn.-based Triton, formerly known as Nestle Waters North America, is the resulting entity from Nestle's separation of its North American water business. Through various brands, Triton is the No. 1 player in the U.S. bottled water market and has the No. 2 position in beverage delivery services. The company produces and sells six regional spring water brands that include Poland Spring, Deer Park, Ice Mountain, Ozarka, Zephyrhills, Arrowhead, and two national water brands that include Pure Life (a value brand) and Splash. It sells through retail channels, which represent about 75% of its total sales and the ReadyRefresh channel, which represents about 25% of its total sales. The company operates primarily in the U.S. (97% of revenue) and Canada (3%).

Our Base-Case Scenario

• S&P Global economists assume a shallow recession in the first half of 2023 with GDP declining 0.1% in 2023 and rebounding to 1.4% growth in 2023.
• We expect about 14% revenue growth in 2022 primarily due to three rounds of pricing taken last year and our expectation for roughly flat volumes. In 2023, we forecast a low-single-digit percent increase in volumes, primarily driven by category growth, and a high-single-digit boost from pricing, resulting in approximately 10% revenue growth.
• S&P Global Ratings-adjusted EBITDA margin expands about 300 basis points in 2023, driven by pricing, moderating input cost inflation, and lapping significant one-time costs associated with the separation from Nestle.
• FOCF is a deficit of about $55 million in 2023 due to elevated working capital uses and large capital expenditure (capex) requirements, but we expect it to turn positive in 2024 as IT-related capex lessens.
• We do not assume any acquisitions or dividends in 2023 or 2024, but we cannot rule out the possibility of debt-financed M&A or shareholder distributions in the future, given Triton's historical financial policy.

Based on our forecast, we assume the following key metrics:

• S&P Global Ratings-adjusted leverage declines to about 6.9x in 2023 and 6.6x in 2024;
• Adjusted funds from operations (FFO) to debt around 9% in 2023 and 2024;
• EBITDA interest coverage around 2.5x in 2023 and 2024.

Liquidity

We continue to assess Triton's liquidity as adequate and expect the company's sources of liquidity will exceed uses by more than 2.1x over the next 12 months. We expect liquidity sources will continue to exceed uses even if EBITDA declines 30%, and the company would maintain sufficient cushion to its financial covenants. While the company quantitatively qualifies for a higher assessment, we do not believe it possesses the characteristics necessary to warrant a higher assessment. We believe the bank relationships are sound, but not well-established or solid. We do not believe the company has the likely ability to absorb high-impact, low-probability events without refinancing. The company has generally prudent risk management to maintain adequate liquidity.

Principal liquidity sources: 

• Cash and cash equivalents of $259 million;
• $329 million of availability net of letters of credit under the asset-based lending (ABL) facility; and
• Annual cash FFO $260 million-$270 million.

Principal liquidity uses: 

• Annual scheduled debt amortization of $28 million;
• Working capital outflows (not seasonal) of around $90 million
• Intrayear peak-to-trough seasonal working capital uses of around $25 million;
• Capex of about $260 million over the next 12 months, followed by $160 million over the subsequent 12 months.

Covenants

The ABL has a springing minimum fixed-charge covenant of 1.0x if excess availability on the ABL falls below the greater of 10% of the max borrowing amount and $25 million. The ABL remains unutilized, and we do not expect the covenant to spring. If it springs, we believe Triton has adequate cushion.

Issue Ratings - Recovery Analysis

Key analytical factors

The debt capital structure consists of:

• $350 million ABL due 2026 (not rated);
• $2.8 billion first-lien term loan maturing in 2028 (rated);
• $770 million ($713 million outstanding) of senior unsecured notes due 2029 (rated).

Security and guarantee package: 

Triton Water Holdings Inc. is the borrower of the ABL and senior secured first-lien term loan. The first-lien term loan is guaranteed jointly and severally by Triton Water Intermediate Inc. and each existing and newly acquired or created wholly owned domestic subsidiary of the borrower. The term loan facility is secured by a first lien on substantially all assets of the company and the guarantors.

Insolvency regime: 

Triton is a Delaware company headquartered in Stamford, Conn. In the event of an insolvency proceeding, we anticipate the company would file for bankruptcy protection under the auspices of the U.S. federal bankruptcy court system and would not involve other foreign jurisdictions.

We believe Triton's creditors would receive maximum recovery in a payment default scenario if the company reorganizes rather than liquidates. This is because of its leading position in the U.S. bottled water market, portfolio of satisfactory brands, national spring site footprint, established distribution network, and longstanding customer relationships. Therefore, in evaluating the recovery prospects for debtholders, we assume the company continues as a going concern and arrive at our emergence enterprise value (EV) by applying a multiple to our assumed emergence EBITDA.

Simulated default assumptions

Our simulated default scenario contemplates a default occurring in 2026 due to a protracted economic downturn, increasing competition from private-label rivals, loss of key customers, or volatile input costs. These factors lead to significant EBITDA and cash flow deterioration, causing a payment default.

Valuation

• Debt service: $246 million (default year interest plus amortization)
• Minimum capex: $89 million
• Default EBITDA proxy: $335 million
• Cyclicality adjustment: $0 million (0%)
• Preliminary emergence EBITDA: $335 million
• Operational adjustment: $17 million (-5%)
• Emergence EBITDA: $318 million

We estimate a $1.9 billion gross emergence EV, which incorporates a 6.0x multiple of emergence EBITDA. This multiple is consistent with the multiples we use for other U.S.-based branded nondurables issuers.

Simplified waterfall

• Emergence EBITDA: $318 million
• EBITDA multiple: 6.0x
• Gross recovery value: $1,909 million
• Net recovery value (after 5% administrative expenses): $1,814 million
• Valuation split (obligor/nonobligor): 100%/0%
• Estimated priority claims (receivables facility): $195 million
• Collateral value for secured debt: $1,618 million
• Estimated senior secured claims: $2,755 million
• --Recovery range: 50%-70% (rounded estimate: 55%)
• Total unsecured claims: $1,905 million
• Value available to unsecured claims: $0
• --Recovery range: 0%-10% (rounded estimate: 0%)

Ratings Score Snapshot

Issuer Credit Rating: B/Negative/--

Business risk: Fair

• Industry risk: Low
• Country risk: Very low
• Competitive position: Fair

Financial risk: Highly leveraged

• Cash flow/leverage: Highly leveraged

Anchor: b

Modifiers

• Diversification/portfolio effect: Neutral (no impact)
• Capital structure: Neutral (no impact)
• Liquidity: Adequate (no impact)
• Financial policy: FS-6 (no additional impact)
• Management and governance: Fair (no impact)
• Comparable rating analysis: Neutral (no impact)

ESG Credit Indicators: E-,2 S-2, G-3

Related Criteria

• General Criteria: Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• General Criteria: Group Rating Methodology, July 1, 2019
• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
• Criteria | Corporates | General: Recovery Rating Criteria For Speculative-Grade Corporate Issuers, Dec. 7, 2016
• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
• General Criteria: Methodology: Industry Risk, Nov. 19, 2013
• Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013
• General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013
• General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011

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