TEXT-S&P cuts Alliance One International snr unsecured notes
Overview -- U.S.-based Alliance One International's operating margins improved over the past year as a result of a reduced tobacco leaf oversupply and the company's recent operating initiatives. -- We are affirming our 'B' corporate credit rating and our 'BB-' secured debt rating. -- We are lowering our debt issue rating on the company's unsecured notes based on our expectation for weaker recovery prospects in the event of a payment default, primarily as a result the company's recently upsized accounts receivable securitization. -- We are revising our outlook to stable from negative, given our expectation that more-favorable industry conditions and enhanced profitability should lead to improved credit measures over the next year. Rating Action On July 24, 2012, Standard & Poor's Ratings Services affirmed the 'B' corporate credit rating on Morrisville, N.C.-based Alliance One International Inc. (AOI), and revised its outlook on the company to stable from negative. We also affirmed our 'BB-' rating on the company's senior secured debt. The recovery rating on AOI's secured debt remains '1', indicating our expectation for very high recovery (90% to 100%) in the event of a payment default. At the same time, we lowered our rating on the company's senior unsecured notes to 'B-' from 'B', and revised the recovery rating to '5' from '4', indicating our expectation of modest (10% to 30%) recovery for noteholders in the event of a payment default. Our rating on the company's $115 million convertible notes due 2014 remains 'CCC+', with a recovery rating of '6', indicating our expectation of negligible (0% to 10%) recovery in the event of a payment default. Rationale The lowering of the issue-level rating on the company's $635 million unsecured notes due 2016 primarily reflects our view that recovery prospects will be weaker in the event of a payment default under our simulated default scenario, based on higher senior secured priority claims following the company's upsized accounts receivable securitization program, which was increased to $250 million from $125 million. (For more information, see our recovery report on AOI, to be published on RatingsDirect following the release of this report.) Our affirmation of the 'B' corporate credit rating and outlook revision to stable reflects our expectation that the tobacco leaf company's operating performance will continue to improve in fiscal 2013 (ended March 31) and that the company will achieve sales growth and maintain EBITDA margins such that leverage strengthens closer to the 6x area (adjusted for committed inventories) by the end of the fiscal year, compared to about 6.8x at the fiscal year ended March 31, 2012. The ratings on AOI reflect Standard & Poor's view that the company will maintain a "weak" business risk profile, reflecting highly competitive global competition, susceptibility to supply and demand imbalances that can be tied to external factors such as weather and political unrest, risk of further shifting towards direct leaf sourcing, and its exposure to foreign currency volatility. We also believe the company will continue to maintain a "highly leveraged" financial risk profile, based on our view that the company's financial policy will remain aggressive, cash flows will continue to be volatile, and key credit metrics will be indicative of the company's financial profile through the end of fiscal 2013; this includes the ratio of total debt to EBITDA remaining above 5x and funds from operations (FFO) to total debt remaining below 12%. Key assumptions in Standard & Poor's fiscal 2013 forecast include: -- Sales increase at a low- to mid-single-digit percentage rate, based on new processing contracts, moderate volume growth, and our expectation for prices paid to AOI by its customers to increase. -- Adjusted EBITDA margin stabilizes at around 8%, but potentially improves to 9%, reflecting ongoing improvement in operating efficiency through its recent restructuring plans, and improved operating leverage achieved with growing sales, which we believe could offset some shift to value products. In recent years, margins had been pressured as a result of the more difficult cost environment, foreign exchange rate volatility, higher levels of leaf directly procured, and greater supply of burley and flue-cured tobacco, which placed downward pressure on prices paid to farmers for green tobacco, and prices paid to AOI by its customers. -- We estimate the ratio of total debt to EBITDA will be reduced closer to 6x by the end of fiscal 2013, compared with leverage of about 6.8x for the fiscal year ended March 31, 2012. This is based on our expectation for higher EBITDA attributed to prospects for improved operating performance and lower debt levels. Based on our expectation that industry oversupply will continue to be worked down, we expect a more favorable working capital environment through the reduction of inventory, which we believe will help the company boost cash flow and reduce debt levels through the end of fiscal 2013. We also project EBITDA coverage of interest expense will remain thin, but increase closer to the 2x area, compared with interest coverage of about 1.6x through the fiscal year ended March 31, 2012. -- We forecast cash flow generation will be positive in fiscal 2013, based on our expectation that the company will further reduce inventory levels over the next year. We expect capital spending related to ongoing infrastructure initiatives will remain elevated in fiscal 2013 (about $75 million) but then become more maintenance-oriented over the next several years, ranging between $15 million and $25 million. -- Although we recognize the potential for volatility of foreign exchange rates and its potential impact to AOI's profitability, we assume foreign exchange movements are modest over the next year; margins could benefit somewhat if the U.S. dollar continues to show further strength, which would translate to potentially lower leaf input costs in key regions such as Brazil. The company also hedges some of its currency related exposure. Our view that the company will continue to maintain a weak business risk profile is based on our expectation that there will continue to be variability in operating performance over time and the business environment in which AOI operates will remain difficult, marked by global competition, political unrest in certain leaf-tobacco producing countries, and exposure to foreign currency volatility (particularly when the U.S. dollar weakens, which unfavorably affects expenses denominated in foreign currencies). In addition, we expect cigarette consumption will continue to decline in most mature markets (including the U.S. and Western Europe), although we also believe these declines will be offset by more favorable prospects in growth markets such as China. We believe the negative financial impact of manufacturers' shifts towards direct sourcing of tobacco leaf in 2010 is mostly behind AOI. Notable shifts towards vertical integration include Japan Tobacco Inc.'s (JTI) acquisition of selected leaf merchants and Philip Morris International's (PMI) purchase of assets from AOI and Universal Corp. Such actions have contributed to more processing-oriented relationships between AOI and these key customers in selected markets such as Brazil. We expect AOI will continue to take steps to broaden its customer base and pursue other partnerships and growth opportunities in light of recent industry developments. For example, in January 2012 AOI's Brazilian subsidiary entered into a joint venture with China Tobacco Internacional do Brasil. We still expect customer concentration will also remain a risk factor; AOI's top three customers each accounted for more than 10% of sales in fiscal 2012. As a result, we will continue to assess the effect on AOI's business from its largest customers in light of recent actions, its ability to replace lost business, and the company's ongoing restructuring efforts to address the changing landscape. At the same time, the company benefits from its position as one of the two leading independent leaf-tobacco merchants, its sourcing diversification, and solid, longstanding customer relationships with the leading cigarette manufacturers. Operating performance improved over the past year as industry oversupply was worked down. Through the fiscal year ended March 31, 2012, sales increased 2.7%, largely from higher processing sales (new long-term processing arrangements in Brazil. These new sales offset a decline in quantities sold, mainly resulting from PMI's prior-year purchase of AOI's tobacco suppliers in Brazil and slightly lower average selling prices attributed to lower green leaf costs that were passed on to AOI's customers. While we believe operating results will improve further in fiscal 2013, we expect performance will remain volatile over the next several years, and believe the company remains sensitive to external market forces beyond its control. Liquidity We believe liquidity has improved over the past several quarters as a result of improved cash flow generation and recently amended covenants, although we currently classify liquidity as "less than adequate" in accordance with key quantitative measures (see "Methodology And Assumptions: Liquidity Descriptors for Global Corporate Issuers," Sept. 28, 2011). We will reassess this descriptor if performance exceeds our expectations and we believe covenant cushion will be maintained at 15% or more over the subsequent four-quarter period. Our view is based on the following: -- We believe AOI covenant headroom could again fall below 15% and closer to the 10% area by the back half of fiscal 2013, most notably on the company's new minimum EBITDA covenant, which was added in conjunction with the most recent amendment. We estimate covenant cushion under its remaining covenants will be sufficient and close to 15% or more, given our expectation for further improvement in performance, positive cash flow generation, and lower debt levels by the end of fiscal 2013. -- We estimate that if EBITDA declines more than 15% from current levels over the next year and cash flow generation is weaker than expected, the company could be in violation of its financial covenants, as amended. -- There is some seasonality in the business with several peak working capital usage periods, and quarterly performance can also be influenced by timing of payments. In June 2012 AOI entered into the most recent (fifth) amendment to its credit agreement. Under the amended terms the lenders agreed to extend the maturity date on its revolving credit facility by one year to April 15, 2014. At the same time, the maximum amount under the revolver was reduced to $250 million from $290 million; we continue to view the revolver (which was undrawn as of March 31, 2012) as a key liquidity source, most notably if global credit conditions tighten and there is less availability under its seasonal lines of credit. As discussed above, financial covenants were modified to provide the company additional covenant cushion. However, a new financial covenant was added, requiring the maintenance of minimum EBITDA of $166 million; this requirement increases to $200 million by the end of fiscal 2013. In addition to its revolver, AOI had $119.7 million in cash and about $266.6 million available under seasonally adjusted uncommitted lines of credit. The company uses its available lines of credit to fund its capital expenditures and its seasonal working capital requirements. Committed inventories (in excess of short-term lines of credit) and advances on tobacco purchases represent some additional sources of liquidity and financial flexibility. AOI also maintains accounts receivable securitization facilities, the first of which was recently upsized to $250 million (from $125 million), with $182 million of receivables outstanding as of March 31, 2012. The company also has a $35 million uncommitted accounts receivable securitization program. AOI generated positive free operating cash flow in fiscal 2012 (as reported, inclusive of cash from the increase in sale of trade receivables), and we believe cash flow generation will remain positive in fiscal 2013, based on our expectation that the company will further reduce inventory levels over the next year. We expect capital spending related to ongoing infrastructure initiatives will remain elevated in fiscal 2013 but then become more maintenance-oriented over the next several years. Committed inventories in excess of short-term lines of credits and advances on tobacco purchases represent some additional sources of liquidity and financial flexibility. Recovery analysis AOI's senior secured debt is rated 'BB-' (two notches higher than the 'B' corporate credit rating); the recovery rating is '1', indicating our expectation for very high recovery (90% to 100%) in the event of a payment default. The company's senior unsecured notes are rated 'B-', with a recovery rating of '5', indicating our expectation of modest (10% to 30%) recovery for noteholders in the event of a payment default. Our rating on the company's $115 million convertible notes due 2014 is 'CCC+', with a recovery rating of '6', indicating our expectation of negligible (0% to 10%) recovery in the event of a payment default. For the complete recovery analysis, see our recovery report on Alliance One International, to be published following the release of this report on RatingsDirect. Outlook The outlook is stable, reflecting our opinion that industry conditions are improving and that credit measures should continue to improve in fiscal 2013, but remain indicative of a highly leveraged financial risk profile. Because of the seasonality of the company's operations (especially working capital needs during the harvest) and the timing of shipments to customers, there can be volatility in operating performance and credit metrics from quarter to quarter. We forecast leverage to decline closer to the 6x area in fiscal 2013 (from 6.8x currently) based on our expectation for moderate sales growth and stable operating margins. We forecast lower working capital needs in 2013 (mainly through lower inventory levels by the end of the year) to lead to improved cash flow generation. We would consider a lower rating if operating performance falls below our expectations such that credit metrics weaken and/or AOI is unable to maintain adequate covenant cushion of 10% or more. Although less likely given our expectation that leverage will remain high over the next year, we could consider raising the rating in the event that covenant cushion is maintained in the 15% area or higher, cash flow generation improves further, and debt levels are reduced such that leverage declines closer to the 5x area. We estimate debt levels would need to be reduced by about $300 million or EBITDA would need to increase 35% for leverage to approach the 5x level, which could occur with sustained sales growth, restoration of EBITDA margins of about 10% or more, and positive cash flow generation. Related Criteria And Research -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Criteria For Rating The Global Branded Nondurable Consumer Products Industry, April 28, 2011 -- Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- Corporate Ratings Criteria 2008, April 15, 2008 -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 -- Analyzing Agricultural Inventories, Jan. 3, 2005 Ratings List Ratings Affirmed; Outlook Action To From Alliance One International Inc. Corporate Credit Rating B/Stable/-- B/Negative/-- Ratings Affirmed Alliance One International Inc. Senior Secured BB- Recovery Rating 1 Subordinated CCC+ Recovery Rating 6 Intabex Netherlands B.V. Senior Secured BB- Recovery Rating 1 Downgraded To From Alliance One International Inc. Senior Unsecured Local Currency B- B Recovery Rating 5 4
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