TEXT - S&P cuts Brown-Forman to 'A-'

Wed Nov 28, 2012 5:32pm EST

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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
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