Sept 27 -
Summary analysis -- The Estee Lauder Cos. Inc. -------------------- 27-Sep-2012
CREDIT RATING: A/Stable/A-1 Country: United States
State/Province: New York
Primary SIC: Toilet
Mult. CUSIP6: 29736R
Mult. CUSIP6: 518439
Credit Rating History:
Local currency Foreign currency
07-Mar-2007 A/A-1 A/A-1
27-Jun-2000 A+/A-1 A+/A-1
The ratings on New York City-based skincare, makeup, and fragrance provider The Estee Lauder Cos. Inc. reflect Standard & Poor's Ratings Services' view that its business risk profile continues to be "strong," highlighted by its enduring significant position in the prestige segment of the cosmetics industry; good geographic, channel, and product diversity; and well-recognized brands. The ratings also reflect our "modest" financial risk assessment of Estee Lauder, supported by its ongoing strong cash flow generation and relatively steady credit metrics. We expect Estee Lauder to sustain its credit measures commensurate with indicative ratios for the "modest" financial risk descriptor--which include adjusted leverage in the low- to mid-1x area--as a result of continued profitability and cost-saving initiatives. While we expect Estee Lauder to maintain its historically conservative financial policies, we believe there is a degree of uncertainty regarding financial policies that could be prompted by a change in the Lauder family's ownership stake that limits upside to the rating.
Estee Lauder has demonstrated its ability to generate strong cash flow and maintain steady financial metrics. For the fiscal year ending June 30, 2012, funds from operations (FFO) totaled about $1.4 billion and free cash flow was close to $615 million, up from $1.2 billion and $610 mllion, respectively, in the prior year. The ratio of total debt to EBITDA was flat with the prior year, at about 1.4x, and FFO to total debt was about 53%, compared with 52% in the prior year. The company's EBITDA margins for the same periods improved to 19.7% from 18.6% due to cost-saving initiatives, product mix shift, and higher pricing.
Despite weak global macroeconomic conditions, including U.S. unemployment of about 8%, weak consumer spending, and decelerating growth in emerging markets, we expect positive operating performance over the next year. Our assumptions for Estee Lauder over the next year include the following:
-- Mid-single-digit revenue growth. We expect Estee Lauder's portfolio of prestige brands will help sustain sales escalation over the next year, despite weak global economic conditions. We believe good performance in emerging markets, new product introductions, and continued high levels of brand reinvestment will drive sales growth, although these could be tempered by some softness in Europe. We believe skincare, particularly in China, will continue to be Estee Lauder's fastest growing product category.
-- EBITDA margins near 20%. In response to the weak global retail environment, Estee Lauder has implemented cost-reduction initiatives that we expect to result in $760 million to $785 million of savings through fiscal 2013. We forecast these gains, as well as price increases, will offset input costs.
-- Capital expenditures of about $500 million.
-- Dividends of about $200 million.
-- Share repurchases of about $500 million.
Under these base-case assumptions, we expect the company will be able to maintain a modest financial risk profile and steady credit metrics over the next year, unless the company's financial policy becomes aggressive. We forecast the company's leverage will be near 1.3x in fiscal 2013 and FFO to total debt will remain over 55% over the same period. Our free operating cash flow forecast for fiscal 2013 is about $775 million.
Estee Lauder maintains solid shares in several core categories of the prestige cosmetics market (makeup and fragrances), despite its inherent vulnerability to changing consumer preferences and a highly competitive operating environment. The company has a relatively strong portfolio of brands, in which the brands are marketed to appeal to a varied spectrum of consumers. The branding is further reinforced by the distribution channel associated with each brand. Distribution channels include department stores, company-operated freestanding retail stores, independent salons and spas, and e-commerce. Estee Lauder devotes substantial efforts to new-product development and line extensions, a key to generating consumer excitement and maintaining brand relevance in the marketplace. Estee Lauder expects to increase its presence in key international and domestic markets by focusing on major brands, including Estee Lauder, Clinique, and M.A.C.
We believe Estee Lauder will continue to invest in increasing its sales outside of the U.S. We expect growth in emerging regions, especially China (where demand for skincare products is strong), to continue to outpace growth in developed markets, such as the U.S. and Europe. About 63% of total fiscal 2012 sales come from outside the U.S., compared with 51% in fiscal 2005. Conditions in the mature U.S. cosmetics industry have been difficult in the past few years because of increasingly intense competition, retailer consolidation and inventory destocking initiatives, and a weaker economy that has contributed to lower store traffic, especially at department stores. The company has weathered the storm and the North American low-growth department store channel remains a key part of Estee Lauder's business.
We believe Estee Lauder has "strong" liquidity, with sources of cash likely to substantially exceed uses for the next 24 months. We expect the company's substantial cash balances, good cash flow generation, and access to capital markets to be more than adequate to support its operating needs and manageable debt maturities over the next couple years.
Our view of the company's liquidity profile incorporates the following expectations:
-- We expect coverage of uses of cash to exceed 1.5x for the next 24 months.
-- Cash sources include existing cash balances of about $1.3 billion, a $750 million commercial paper program backed by a $1 billion revolving credit facility due 2015, and expected internal cash flow generation. At June 30, 2012, the company had $200 million of commercial paper outstanding and nothing outstanding under its revolving credit facility.
-- We expect cash uses to include some investment in working capital, about $500 million in capital spending, about $200 million in dividends, and $500 million in share repurchases.
-- We expect net sources of cash would remain positive, even with a 30% drop in EBITDA.
-- We believe it is likely that Estee Lauder could absorb, without refinancing, low-probability shocks, based on its positive cash flow and current cash balances.
-- In our assessment, the company has well-established and solid relationships with banks and a generally high standing in the credit markets.
The outlook is stable. We expect Estee Lauder to sustain its strong market positions, to continue generating good cash flows, and that credit metrics will remain in line with the indicative ratios for the "modest" financial risk descriptor. We anticipate the company will maintain FFO to total debt of at least 50% over the next one to two years.
We could lower the rating if the company's financial profile and credit measures were to weaken over this outlook period, such that total debt to EBITDA increases to about 2.5x. This could occur if the company were to increase debt by funding a dividend or share repurchases, both of which we view as unlikely. Based on the company's current level of EBITDA and debt, the company would need to add about $2.2 billion of debt for leverage to rise to 2.5x.
An upgrade over the next one to two years is also unlikely given the competitive nature of the cosmetics industry and the company's need to invest in growth overseas, and a degree of uncertainty regarding financial policies that could be prompted by a change in the Lauder family's ownership stake.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008