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June 6 (The following statement was released by the rating agency)
Fitch Ratings has affirmed Germany-based consumer goods and industrial adhesives company Henkel AG & Co. KGaA's (Henkel) Long-term Issuer Default Rating (IDR) and senior unsecured rating at 'A' and Short-term IDR at 'F1'. The rating of the company's EUR1.3bn hybrid bond, due 2104 has also been affirmed at 'BBB+'. The Outlook on the Long-term IDR is Stable.
The affirmation reflects the further strengthening of Henkel's credit metrics during 2013 and following the EUR1.3bn acquisition spending announced over the past weeks, the confirmation of Fitch's expectations that the company is deploying its rating headroom towards acquisitions aimed at complementing organic growth in order to reach its 2016 targets. Henkel benefits from a diversified business portfolio and healthy profitability and cash flow generation. However, Henkel is smaller and lacks the same degree of geographic diversification and profit contribution from the faster-growing developing markets relative to some large chemical or fast-moving consumer goods companies rated in the 'A' category.
Headroom for M&A Appetite
Fitch expects Henkel to continue making acquisitions in order to complement management's ability to reach its 2016 revenue targets. Management had stated Henkel could spend EUR3.5bn to EUR4bn on acquisitions over 2013 to 2016. The group benefits from low leverage and high liquid resources, including EUR2.4bn of financial investments at YE13. Fitch believes Henkel has enough headroom in its 'A' rating - to which management has reiterated its commitment - to support this acquisition policy.
Solid Debt Protection Measures
Henkel's hybrid- and lease-adjusted net debt/EBITDAR further reduced to 0.8x in FY13 (1.1x on net adjusted funds from operations (FFO) basis), mainly thanks to higher EBITDA generation and working capital improvement leading to enhanced free cash flow (FCF) generation and a reduction in net debt.
Assuming M&A activity referred to by management is spread out over 2014 to 2016 Fitch believes Henkel should be able to maintain its hybrid- and lease-adjusted FFO net leverage below 1.5x over to FY16, thanks to a further increase in EBITDA and a cash conversion ratio (measured as FCF to EBITDAR) sustainably above 35%.
Healthy Organic Revenue Growth
Despite weaker growth in developing markets, Henkel was able to deliver 2013 organic sales growth of 3.5%, mainly fuelled by healthy volume performance (+2.7%) but with a sharp reduction of the contribution of pricing (+0.8% vs 2012's +3.1%) reflecting a strong competitive environment negatively impacting Henkel's pricing power. Organic profit grew by 7.8% due to continued cost rationalisation. From 2014-2015 onwards, as cost rationalisation programmes finish and the company re-invests their benefits increasingly into advertisement and promotion activity, we expect organic profit growth to moderate to a pace closer to organic revenue growth.
Continuous Improvement in Profitability
From 2008 to 2013 Henkel improved its pre-exceptionals EBIT margin to 15.4% from 10.3%, with all divisions contributing. In 1Q14 the EBIT margin further improved to 15.8% (1Q13: 14.9%). Henkel's consolidated EBIT margin and its margin in home and personal care are now more aligned with major industry peers such as Unilever and Procter & Gamble.
The company achieved these improvements thanks to a successful implementation of cost restructuring measures and efficiency gains, as well as a portfolio optimisation strategy. As in FY12, the year-on-year increase of pre-exceptionals EBIT margin was particularly significant in the Adhesive Technology division (+180bps) where Henkel pursued its portfolio shift towards higher-margin products from commodity-like products.
Improving Emerging Markets Exposure
Henkel is working to further increase its already healthy exposure to fast-growing-emerging markets towards 50% (44% of FY13 sales). Fitch views this strategy as beneficial for Henkel as it offers sales growth opportunities and enables it to benefit from more economies of scale in these regions. However, we note that Henkel is far from being a global player, as most of its emerging market strength is in Eastern Europe and the company still generates two-thirds of its profits in the mature world.
Strong in Adhesives and Laundry
Henkel's Adhesive Technologies business is the global leader in the growing adhesives, sealants and surface treatments market with a global share of approximately 25%. However, its presence in this business exposes it to some volatility, as the industry is reliant on cyclical sectors such as automotive and construction. The group also holds leading positions in the western European laundry and home care market, with a number 5 position.
Weaker Personal Care Business
Henkel's personal care operations, ranking below the top ten global players, remain small relative to competitors such as L'Oreal, Unilever or Procter & Gamble that enjoy wide portfolios of brands and presence across several categories.
Positive: Further developments that could lead to a positive rating action include:
--Expanded scale and geographic reach in different product areas together with the ability to maintain sustained profitability in line with major industry peers.
This should be accompanied by management's commitment to financial ratios commensurate with a higher rating
Negative: Further developments that could lead to a negative rating action include:
Significant deterioration in profitability and cash flow generation due to adverse operating performance or a more aggressive financial policy leading to:
--FFO fixed charge cover below 8x on a continuing basis.
--Hybrid- and lease-adjusted FFO net leverage above 2.0x on a continuing basis.