TEXT - S&P cuts Brown-Forman to 'A-'
Overview -- Brown-Forman announced on Nov. 27, 2012, a special dividend of $4 per share of its Class A and Class B common stock to be paid on Dec. 27, 2012. -- We believe the dividend may amount to approximately $850 million and will be largely debt-financed, which will weaken credit measures and displays a more aggressive financial policy than we previously factored into the rating. -- We are lowering the corporate credit rating to 'A-' and short-term commercial paper rating to 'A-2'. -- The outlook is negative, reflecting our concerns that the company may not improve cash flow metrics to levels that support the company's modest financial risk profile until after the fiscal year ending April 2014. Rating Action On Nov. 28, 2012, Standard & Poor's Ratings Services lowered its ratings on Louisville, Ky.-based Brown Forman Corp, including its long-term corporate credit rating to 'A-' and its short-term commercial paper rating to 'A-2' (from 'A' and 'A-1', respectively). The outlook is negative. Brown-Forman had reported debt totaling about $511 million as of July 31, 2012. We estimate this transaction will more than double the company's debt outstanding to roughly $1.25 billion. Rationale The downgrade reflects the higher than anticipated debt balances the company will likely incur to fund its recently announced special dividend, which we believe will lead to weaker than expected credit measures beyond fiscal 2014. Based on the company's reported shares outstanding as of July 31, 2012, we estimate the special dividend will total approximately $850 million, which we believe will be funded with debt, resulting in a pro forma leverage ratio (debt to EBITDA) of 1.8x and a ratio of funds from operations (FFO) to debt of 42% (compared with respective ratios of 0.8x and 89.5% for the 12 months ended July 31, 2012). These pro forma ratios are close to the indicative ratio ranges for a "modest" financial risk profile, which include debt leverage of 1.5x-2.0x and FFO to debt of 45%-60%. However, given the company's share repurchase activity and history of periodic special dividends, our prior 'A' corporate credit rating was underpinned by the maintenance of key credit measures consistent with indicative ratio ranges for a "minimal" financial risk profile, including average debt leverage of less than 1.5x and FFO to average total debt greater than 60%. Although the company may lower its debt leverage to below 1.5x over the next two years, we do not believe the company will improve its FFO to debt ratio to over 60% by then. We believe that global economic conditions will stagnate through fiscal year-end 2013, which we reflect in our forecast assumptions as follows: -- We expect the company's fiscal 2013 and 2014 net sales (excluding excise taxes) to increase in the low- to mid-single-digit percentage area. -- We believe the adjusted EBITDA margin will remain pressured by the same factors the company experienced during fiscal 2012, including the negative impact from foreign exchange rates. -- We expect capital expenditures to increase to $110 million as the company expands its production capacity for Jack Daniel's, as well as for Sonoma-Cutrer. -- Discretionary cash flows exceed $150 million in 2014 after dividends of between $200 million and $250 million. -- Additional debt totaling $850 million is incurred to fund the company's special dividend. -- Regular dividends will increase with profitability. -- We haven't incorporated acquisitions into our forecast, nor any share repurchases in fiscal 2013. Based on the above assumptions we believe Brown-Forman will increase adjusted EBITDA by low- to mid-single-digit rates in fiscal 2013 and 2014, resulting in average debt to EBIDA of about 1.7x and FFO to average debt of close to 40%. We believe debt leverage may approach 1.5x by fiscal year-end 2014 but FFO to average debt will remain below 45% during that time if the company elects to repurchase shares in 2014 and refinances its $250 million bonds maturing 2014. The company may resume share repurchases in fiscal 2014, and we believe it will fund such potential buybacks with discretionary cash flow. Although the size of any share repurchase program would be contingent upon future board approval, we believe such repurchases will be similar in size to those in fiscal 2012. During fiscal 2012 the company repurchased about $220 million in stock. Our opinion of the company's business risk profile is "satisfactory." Key credit factors in the company's business risk profile include its good position in the global distilled spirits industry, geographic diversification, and relatively stable cash flow characteristics, tempered by a somewhat narrow product portfolio. The company is one of the largest U.S. suppliers of distilled spirits, but we believe it has a relatively small share of the still-fragmented global spirits industry. Although several of the company's key alcoholic beverage markets are somewhat mature, we believe that its brand positioning and global market penetration should continue to generate moderate earnings growth over time, despite the lingering weak global economy's effect on demand for premium-priced products. Brown-Forman is geographically diversified, and international sales continued to account for more than half of total revenues in fiscal 2012. Still, we believe product concentration risk exists, with Jack Daniel's (the company's leading premium brand) continuing to account for a majority of Brown-Forman's fiscal year 2012 gross sales and profitability. Liquidity We believe Brown-Forman's liquidity is "adequate," as defined in our criteria. Our view of the company's liquidity profile incorporates the following expectations: -- We expect liquidity sources (including FFO and availability under its $800 million revolving credit facility due 2016) to exceed uses by 1.2x over the next 12 months. -- We expect liquidity sources to continue to exceed uses, even if EBITDA were to decline by 15%. -- We believe Brown-Forman has solid relationships with its banks and a generally satisfactory standing in the credit markets Liquidity sources include over $500 million of FFO and close to full availability on the company's $800 million revolving credit facility maturing in 2017. The company's current cash balances are not included as a source of liquidity reflecting our assumption that available domestic cash will be negligible following the company's special dividend payment. Still, our projected sources should adequately cover projected capital expenditures of more than $100 million seasonal working capital requirements, and annual dividend payments of more than $200 million. There is currently ample cushion under its bank maintenance financial covenant. Brown-Forman has $3 million of debt maturing in fiscal 2013 and $253 million due in fiscal 2014. Outlook The negative outlook reflects our concerns that the company may not improve its cash flow metrics to levels that support the modest financial risk profile until after fiscal 2014 (ending April 30, 2014). Specifically, we are uncertain whether the company will increase its FFO to average debt ratio to over 50% by fiscal year-end 2014. We believe doing so largely hinges on operating performance exceeding our expectations and on whether the company elects to repay its $250 million bonds maturing in fiscal 2014 or instead applies discretionary cash flows to share repurchases or other shareholder-friendly initiatives. We could lower the ratings if the company is unable to improve its FFO to average debt to over 50%. We believe this could occur if the company does not repay upcoming debt maturities while annual sales growth remains in the low-single-digit area and adjusted EBITDA margins remain flat from current levels. We would consider revising the outlook to stable if the company improves debt leverage near or below 1.5x while improving FFO to debt to more than 50%. For this to occur the company would have to make debt repayments, and its operating performance would have to exceed our expectations, including annual sales growth of close to 5% and a 100 basis point adjusted EBITDA margin expansion. Related Research And Criteria -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 Ratings List Downgraded To From Brown-Forman Corp. Corporate credit rating A-/Negative/A-2 A/Stable/A-1 Senior unsecured 5.0% notes due 2014 A- A 2.5% notes due 2016 A- A Commercial paper A-2 A-1