TEXT-S&P revises Avery Dennison outlook to stable from positive

Tue Dec 11, 2012 2:21pm EST

Related Topics

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. Use the Ratings search box located in the left 
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