TEXT-S&P revises Avery Dennison outlook to stable from positive
Overview -- Stable operating trends at Pasadena, Calif.-based Avery Dennison continue to support credit quality and our expectations for the current ratings. -- We are revising the outlook to stable from positive to reflect our expectation that the company is unlikely to materially improve its financial profile in the near term. -- We affirmed all ratings on the company, including the 'BBB' corporate credit rating -- The stable outlook indicates our expectation of gradually improving operating trends, adequate liquidity, good free flow generation, and financial policies that support a financial profile consistent with the current ratings. Rating Action On Dec. 11, 2012, Standard & Poor's Ratings Services revised its outlook on Avery Dennison to stable from positive. We affirmed all other ratings, including the 'BBB' corporate credit rating. Rationale The outlook revision reflects our expectation that Avery is unlikely to improve its financial profile to a level that would warrant a higher rating during the next several quarters. Despite initiatives to increase revenues and improve profitability, we do not expect the financial profile to materially improve in the near term, in part, due to the continuation of challenging business conditions. Nevertheless, we expect modestly improving operating trends and good free cash flow generation to be supported by various cost reduction initiatives, modest volume improvements in its core businesses, growth in emerging markets, and effective management of raw material costs. Overall, we expect Avery Dennison to maintain its financial profile and sustain the key ratio of funds from operations (FFO)-to-total adjusted debt in the mid-30% area, which is consistent with its current rating. During October 2012, the proposed sale of office and consumer products to 3M was terminated due to regulatory approval issues. However, the company has restarted the sale process and have several interested buyers, both strategic and financial, which we believe will materialize into a sale of the business in the next few quarters. Standard & Poor's continues to regard the planned sale as a slight net negative to the business profile, although, following the sale we would still assess Avery's business profile as "satisfactory", consistent with the current business risk profile. The ratings on Avery reflect our view of the company's satisfactory business risk profile and intermediate financial risk profile. Avery's key business strengths include a leading global market position in pressure-sensitive materials and retail tag and labeling systems, well-established brands, and broad geographic diversity. Sales of pressure-sensitive materials are somewhat dependent on the level of general economic activity, but have been fairly resilient in the past recession. Given its leadership position in the pressure sensitive materials segments, the company has had a good track of passing through higher raw material costs to customers, albeit with a time lag. While the RBIS segment has improved from its low point in 2009, and is poised for gradual growth in sales volume and operating profitability over the next few years, earnings are more volatile as compared with the pressure sensitive materials segment. Recent industry dynamics of more selling seasons, faster response times, and getting more in-store productivity bodes well for Avery's RBIS business longer term. However, demand for price marking and brand identification products are closely tied to retailer and apparel end markets, and consumer spending patterns. Standard & Poor's Ratings Services views the U.S. apparel and retail sectors as highly competitive and subject to fashion risk and consumer spending patterns. Weak discretionary consumer spending (mostly due to high unemployment) and rising raw material costs are key hurdles facing these sectors. Avery's office and consumer products unit, now under consideration for sale, is a leading producer of printable media. This segment has faced stiff competition in its less-differentiated product categories, and shrinking demand, particularly in its largest mailing label category. This has resulted in declining volumes and earnings and margin erosion for the past several years. However, the office and consumer products segment is a relatively stable business and a sale will reduce Avery's business diversity and expose it increasingly to the volatile retail branding and information solutions segment. International opportunities are a key component of the company's growth strategy. Pro forma for the anticipated divestiture of the office and consumer products segment, Avery derives about 73% of its 2011 sales from outside the U.S., and it continues to grow in emerging markets, which account for about 40% of sales. Emerging markets across Asia-Pacific (particularly China), Latin America, and Eastern Europe continue to shift to pressure-sensitive materials for various labeling, packaging, and decorating needs, and per capita consumption is still much less than in the mature U.S. and European markets. A critical underpinning to the ratings is our belief in the company's cash-generating ability and management's track record of, and current commitment to, preserving credit quality. We consider an average ratio of FFO-to-total adjusted debt of approximately 35% to be consistent with the current rating. Based on our scenario forecasts (with the anticipated sale of the office and consumer products business), we expect FFO-to-total adjusted debt will be in the mid-30 % area for the next few years. We adjust debt to include about $244 million of underfunded postretirement obligations and about $183 million of capitalized operating leases. We also expect Avery to pursue acquisitions and any share repurchases prudently, with a view on retaining a financial profile consistent with current ratings. Liquidity We view Avery's liquidity as adequate supported by relatively predictable free cash generation. As of Sept. 30, 2012, the company had a cash balance of $191 million and about $362 million available under its revolving credit facility. However, Avery has historically had, and continues to have, a high proportion of short-term debt, including CP outstanding and short-term borrowings under its $675 million revolving credit facility maturing in 2016, which also backstops the CP program. Our liquidity assessment reflects the following factors and assumptions: -- We expect sources of cash to exceed 1.2x of cash usage during the next 12 to 18 months; and -- We expect sources to remain positive even in the unlikely event of a 20% EBITDA decline. Based on our 2013 scenario forecasts (assuming the sale of the office and consumer products business), we expect capital expenditures of about $155 million and free operating cash flow of about $250 million to $300 million. In 2013, we expect Avery to make larger pension contributions (domestic and international) mainly from the proceeds from the anticipated sale of its office and consumer products business. In addition, we believe that Avery will use discretionary cash flows (after dividends) primarily for share repurchases. Debt maturities are manageable, and we expect the company will refinance its upcoming $250 million notes due in 2013 in February 2013. Outlook The stable outlook incorporates Avery's good cash generating ability and management's commitment to maintaining a financial risk profile consistent with the current ratings while pursuing a disciplined growth strategy and shareholder rewards. We could revise the outlook to negative if volumes decline while margins compress. In such a scenario, challenging operating conditions would lower operating margins (before depreciation and amortization) by 200 basis points from current levels and result in FFO-to-total adjusted debt weakening to about 30%. We could also consider an outlook revision to negative if management's financial policies unexpectedly become more aggressive so that FFO-to-total adjusted debt slips to about 30% with no near-term prospects for improvement. In our view, a departure from moderate financial policies would include increases in debt to fund large acquisitions or potential shareholder rewards with low prospects to quickly pay down additional debt. We could raise the ratings modestly during the next few years if earnings and cash flow strengthen without a commensurate increase in debt, and if Avery maintains FFO-to-total adjusted debt within the 35% to 40% through the business cycle. Related Criteria And Research -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- Key Credit Factors: Methodology And Assumptions On Risks In The Packaging Industry, Dec. 4, 2008 Ratings List Ratings Affirmed; Outlook Revised To From Avery Dennison Corp. Corporate Credit Rating BBB/Stable/A-2 BBB/Positive/A-2 Ratings Affirmed Avery Dennison Corp. Senior Unsecured BBB Short-Term Debt A-2 Commercial Paper A-2 ADOP Co. Senior Unsecured BBB 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. 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