TEXT - Fitch cuts Avon Products issuer default ratings
Feb 26 - Fitch Ratings has downgraded Avon Products, Inc.'s (Avon) and its subsidiary's rating as follows: Avon Products, Inc: --Long-term Issuer Default Rating (IDR) to 'BB+' from 'BBB-'; --Short-term IDR to 'B' from 'F3'; --Commercial Paper program to 'B' from F3'; --Bank credit facility to 'BB+' from 'BBB-'; --Bank Term Loan to 'BB+' from 'BBB-'; --Senior unsecured notes to 'BB+' from 'BBB-'. Avon Capital Corporation: --Short-term IDR to 'B' from 'F3'; --Commercial Paper program to 'B' from 'F3' The Rating Outlook for Avon and Avon Capital Corporation has been revised to Stable from Negative. KEY RATING DRIVERS: The downgrade of Avon's ratings is due to a confluence of factors which are not representative of an investment-grade profile. These factors include the combination of a continued decline in U.S. revenues, lack of sustainable operating income growth in key international markets, and weakened credit protection measures. The likely need to use a substantial portion of offshore cash balances to repurchase debt and substantial levels of restructuring which could continue in the near term also triggered the downgrade. Fitch recognizes that while there were some early signs of stabilization in Avon's Latin American and European segments which generate almost 90% of operating earnings before corporate overhead, it is too early to ascertain its sustainability. The emerging markets have proven to be a strong base of operations for the direct-selling distribution model; however, the level of competition has increased with marketers such as L'Oreal accelerating their investments in the region. Both Natura Cosmeticos S.A. and Avon have commented about the high level of competition in Brazil in the past several years. Given the increased presence of large multinational beauty care companies and further maturation of the emerging markets, Fitch believes that Avon is likely to find it more difficult to return to sustainable growth and that longer-term operating margin expansion may be limited. Additional factors such as lost market share and the need for additional investments to improve Avon's operations are also part of the consideration in the downgrade. Avon has lost market share in growth markets such as Brazil and China. Further, the U.S., a major market representing 18% of 2012's revenues, is continuing to decline at a rapid pace in both representative count and volume. Avon may need to keep representative incentives high in the U.S. and Brazil and spend additional capital to stabilize the U.S and Asia Pacific segments. The performance of these segments has been a drag on the company's performance for a number of years. Fitch does not see a meaningful turnaround in the near term. The Stable Outlook is due to Avon's adequate liquidity and its plan to address its capital structure, which should allow management more time to execute its strategic goals. Fitch is encouraged by a number of the company's recent announcements or results. First, Avon cut its dividend by almost 75%, a deeper level than Fitch expected. While 2012's free cash flow (FCF) remained negative at $2 million, reducing the dividend outlay by $300 million should result in positive FCF in 2013 even if the company's financial performance were to remain flat. Nonetheless, FCF is benefitting from the dividend cut and working capital improvements, while cash flow from operations continued a four-year decline from $782 million to $556 million at the end of 2012. Second, the company was able to reduce debt by more than $110 million year over year given $337 million of FCF in the fourth quarter. Financial Performance: Consolidated revenues were essentially flat at $10.7 billion excluding a 5% drag from negative foreign exchange. Sales in Latin America increased 5% on a constant currency basis while sales in North America, Asia Pacific, and EMEA (Europe, Middle East, and Africa) declined 8%, 5%, and 1%, respectively. Consolidated adjusted EBIT margins (excluding impairments and restructuring charges) increased almost sequentially during the year from 3.8% to 9.2%. After years of leverage creep to a peak of approximately 3.5x in mid-2012, Avon's leverage tracked down modestly to 3.2x. Liquidity and Financial Flexibility: Avon announced that it has notified the holders of its $535 million privately placed notes that it will redeem those notes and make a required make-whole premium of approximately $65 million by the end of March 2013. The company cited that it is able to fund the redemption from cash on hand overseas. The company is also renegotiating its $1 billion revolving credit which is scheduled to mature in November 2013. Fitch expects that the company will be able to secure a new credit agreement. The public debt markets are also quite liquid and Avon should be able to refinance its near-term debt maturities. The company has $250 million 4.8% notes due March 1, 2013, $125 million 4.625% notes due May 13, 2013 and a 5.75%, $500 million notes due March 1, 2014. There is also a $137 million amortization on the term loan due this year. RATINGS SENSITIVITIES: Positive: Future developments that may, individually or collectively, lead to a positive rating action include: Although a positive rating action is not likely in the next 18 months, leverage in the low- to mid-2x range due to a restoration of consistent growth in Avon's major markets, a meaningful increase in operating earnings and cash flow, or greater than expected debt reduction, could lead to consideration of an upgrade. Generating FCF in excess of $200 million annually would also be viewed positively. Negative: Future developments that may, individually or collectively, lead to a negative rating action: Leverage maintained over 3x and diminishing FCF due to further deterioration of its base business, indicated by declining sales and margins in key geographical segments, or increased debt levels could result in a downgrade. Declining volumes and sales representative count in the key market of Latin America and Europe would also be viewed negatively.
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