TEXT-S&P revises Avon rating outlook to negative

Mon Nov 5, 2012 10:15am EST

Overview
     -- U.S.-based Avon's operating performance continues to be weaker than 
expected and credit metrics remain weak.
     -- We are revising the 'BBB-' rating outlook on Avon to negative from 
stable.
     -- The negative outlook reflects our expectation that the company's 
operating performance will continue to be weak and leverage will be above 
3.5x, unless the company reduces debt levels.

Rating Action
As Standard & Poor's Ratings Services previously announced, on Nov. 1, 2012, 
we affirmed our 'BBB-' corporate credit rating on New York City-based Avon 
Products Inc. and revised the rating outlook to negative from stable.
 
In addition, we affirmed our 'BBB-' issue-level ratings on the Avon's senior 
unsecured debt and 'A-3' commercial paper rating.

Rationale
The negative outlook reflects Avon's continuing poor operating results and 
weak credit metrics.  We estimate adjusted leverage continues to be above 3.5x 
as of the recent September quarter compared with 2.5x in the September 2011 
quarter. We have also revised our financial risk profile to "significant" from 
"intermediate," supported by weaker credit metrics and our change in our 
assessment of the company's liquidity to "adequate" from "strong." Financial 
ratios indicative of a significant financial risk profile include ratios of 
adjusted total debt to EBITDA between 3x and 4x, funds from operations (FFO) 
to total debt between 20% and 30%, and adjusted total debt to capital between 
45% and 50%. Avon's credit metrics are weaker mainly because of declining 
profitability and higher debt. Its ratio of total debt to EBITDA for the 
September 2012 quarter remained elevated above 3.5x, an increase from 2.7x at 
2011 year-end and historical levels of 1.7x. We attribute the increase 
primarily to the debt-funded acquisition of Silpada Designs Inc. in July 2010. 
Though we had expected leverage to increase above 3.5x, we now expect it will 
be difficult for the company to materially lower leverage through improved 
operating results, as slow operating turnaround and weak operating performance 
could persist into next year (though we believe the company could lower 
leverage by reducing debt). Additionally, although the company has reduced its 
outstanding commercial paper and cut its dividend by about 75%, the company's 
cash flow generation has decreased and the company has financial covenants, 
with cushion estimated to be below 30%. The company also has about $375 
million of debt maturing in 2013, which we expect the company will address.

Our Avon ratings also reflect our view that the company's business risk 
profile will remain "satisfactory."  Avon continues to sustain its good market 
share in the direct sales channel. It has also sustained a broad international 
presence, generating more than 75% of the company's revenue outside North 
America. Additionally, the Avon brand continues to exhibit brand strength. Our 
assessment of the business risk also includes the inherent risks of operating 
with channel concentration as a direct sales company (including potential 
difficulties with its sales force and participation in the highly competitive 
cosmetic industry).  

Our assumptions for Avon include a slow operating turnaround. Although the 
company has resolved the issues related to the Enterprise Resource Planning 
systems implementation in key-market Brazil, operating improvement continues 
to be slow, and sales and profitability remain pressured. The company 
continues to face soft overall top-line growth against foreign exchange 
headwinds and margin pressure from higher input costs, increased investment in 
its "representative value proposition" (RVP; a broad-based recruitment and 
reward platform), and other expenses (such as for the ongoing investigation 
under the Foreign Corrupt Practices Act ). We expect the company will 
need to make investments to improve operating efficiencies, and it may take 
time before the company begins to benefit from the new management's operating 
turnaround strategy.

Our assumptions over the next year include the following:

     -- Weak sales growth, which could include mid- to high-single digit 
percentage sales declines for this year, as we expect negative foreign 
exchange and softness to continue in some of its key markets.
     -- Margin pressure persists from higher commodity costs, labor costs, and 
operating expenses related to continued investment spending in its sales 
representatives.
     -- Relatively flat capital expenditures of about $260 million to $280 
million for this year and possibly increasing beyond 2012, as the company may 
make investments as part of its operating turnaround strategy.
     -- Dividends cut to about $100 million.
 
Avon's operating performance has declined significantly since 2009, despite 
various restructuring programs that generated significant annual cost savings. 
The company's EBITDA margin has been declining and is below its peers', 
contracting about 500 basis points since 2008 to about 10%.

Avon continues to have large scale and geographic diversity, which can 
generally compensate for regional weaknesses, if the company is operating 
efficiently. Its diverse operating base also helps offset the effect of 
foreign currency fluctuations in regional markets. Developing markets remain a 
significant portion of the company's sales, and we expect them to continue to 
be important to Avon's long-term growth strategy.

Liquidity
Avon currently has adequate liquidity, with sources of cash that are likely to 
exceed uses for the next 12 months. We expect the company's substantial cash 
balances, cash flow generation, and access to capital markets will support its 
operating needs and debt maturities over the next couple of years. The next 
debt maturity is about $375 million in 2013.

Our view of the company's liquidity profile incorporates the following 
expectation:

     -- We expect cash sources to cover uses of cash by at least 1.2x in the 
next 12 months.
     -- We expect net sources would be positive, even with a 15% drop in 
EBITDA.
     -- Cash sources include existing cash balances of $1.1 billion (of which 
a significant portion is held overseas) and a $1 billion commercial paper 
program backed by a $1 billion revolving credit facility that is due in 2013. 
On Sept. 30, 2012, there was nothing outstanding on the revolving credit 
facility and about $69 million outstanding under the commercial paper program. 
The company has indicated it does not plan to reinvest its 2012 foreign 
earnings. The company may further reduce its reliance on its outstanding 
commercial paper by year end.
     -- We expect cash uses to include some investment in working capital, 
about $260 million to $280 million in capital spending, and about $100 million 
in dividends.
     -- The company has leverage and interest coverage covenants on the new 
$550 million term loan, as well as a minimum interest coverage covenant on its 
private placement notes. The company currently has about 20% cushion on its 
tightest covenant and we expect the company would remain compliant even with a 
15% drop in EBITDA.

Outlook
The outlook is negative. Operating performance has been poor and we expect 
progress towards stabilizing the business to be slow over the next 2 years.  
We would consider lowering the rating if credit metrics do not begin to 
improve, including leverage decreasing to about 3.5x by year end and towards 
the low 3x area over the next year. The company could possibly achieve this 
through debt reduction and we would also expect some progress towards improved 
operating results, including increased profitability, next year. If we lower 
the long-term rating to speculative grade, we would lower the short-term 
rating to 'B'.
 
Although unlikely in the next 12 to 18 months, we could consider revising the 
outlook to stable if the company improves operating results, particularly in 
Brazil, and increases profitability, leading to improved credit metrics on a 
sustained basis, including leverage in the low 3x area.
 
Related Criteria And Research
     -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
     -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011

Ratings List
Ratings affirmed; Outlook Revised
                          To                   From
Avon Products Inc.
 Corporate credit rating  BBB-/Negative/A-3    BBB-/Stable/A-3

Ratings Affirmed
Avon Products Inc.
 Senior unsecured         BBB-
 Commercial paper         A-3


Complete ratings information is available to subscribers of RatingsDirect on 
the Global Credit Portal at www.globalcreditportal.com. All ratings affected 
by this rating action can be found on Standard & Poor's public Web site at 
www.standardandpoors.com. Use the Ratings search box located in the left 
column.
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