Investor confidence in Avon pushes CDS lower

Thu Jul 18, 2013 3:53pm EDT

NEW YORK, July 18 (IFR) - The credit default swap (CDS) spreads of Avon Products dropped a further 8bp to 190bp on Thursday and are now down 25% on the month, as the turnaround in the beauty products company continues to instill confidence in investors.

Avon, one of the largest direct-selling companies in the world, has overall seen its CDS narrow from around 600bp in August 2012, a sharp reversal since CEO Sheri McCoy took over in April last year.

McCoy established an initiative to save USD400m of costs by 2015 and turn around the company's underperforming North American business, and the revamp has changed the view of Avon in the synthetic CDS market. CDS is a kind of insurance investors buy to guard against the company defaulting on its outstanding debt.

The company, downgraded by Fitch in February to speculative-grade BB+ from investment-grade BBB-, looked to be headed to full junk status the same month when S&P said it could also downgrade Avon, in part due to a whopping 443bp CDS spread that dwarfed those of its comparable peers in the sector.

S&P still has a negative outlook to Avon due to the company's high leverage and debt levels, but the compression in its CDS spreads of late reflects investor belief that changes in the international company, a US household name founded in the 19th century, are for the better.

Earlier this month, Avon announced a definitive agreement to sell off its Silpada Designs jewelry business in an all-cash deal for USD85m. CDS spreads dropped 25bp to 225 within five days of that announcement.

Since then, spreads have narrowed an additional 25bp to bring the company's synthetic levels close to tights on the year ahead of Avon's release of second-quarter results on August 1.

In other changes, Avon's decision to shore up cash by slashing the dividend 75% (from USD400m in 2012 to USD100m in 2013) will take it into positive free cash flow this year.

Moreover, it undertook an ambitious refinancing in March that meaningfully decreased its leverage amid a significant paydown of USD1.9bn in debt, while removing a large chunk of refinancing risk over the next few years. It successfully refinanced a USD1bn 2017 credit facility and is committed to maintaining its investment grade ratings as per negative maintenance covenants in its term loan.

Although CDS spreads have widened from around 150bp in May due to troubles in the broader market, market opinion on Avon remains positive - and most participants think operating and margin performance will continue to improve and stabilize.

Anticipation is also high that Avon will continue to deleverage from more than 3.5x to 2.4x. This could prompt both an upgrade back to investment grade by Fitch and remove S&P's negative outlook.

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