Dec 5 - Fitch Ratings has affirmed the ratings for Arrow Electronics, Inc.
(Arrow) as follows:
--Issuer Default Rating (IDR) at 'BBB-';
--Senior unsecured notes at 'BBB-';
--Senior unsecured bank credit facility at 'BBB-'.
The Rating Outlook is Stable.
Fitch's stable outlook for IT distributors in 2013 reflects the companies'
strong liquidity and countercyclical cash flows, which help offset Fitch's
expectations for a difficult competitive environment and softening end market
demand. Fitch's base scenario is for flat to modestly negative revenue change in
2013, although risk is weighted to the downside with the potential for a
cyclical decline pending global economic conditions. Fitch views a reasonable
stress scenario for the distributors at this point in time as consisting of a
double digit decline in 2013 continuing through part of 2014. Under both
scenarios, Fitch would expect significant margin compression but for EBITDA
margins to remain positive across the sector. FCF generation would likely be
significantly positive, given the expected resulting decline in working-capital
balances under such a scenario.
Fitch believes Arrow Electronics, Inc. would maintain its investment-grade
ratings under such a scenario. This assumes cash generated from working-capital
declines does not go to shareholders or aggressive acquisitions that would
ultimately result in higher leverage once growth returns and working capital
would be expected to increase. Fitch would be concerned if revenues declined
from a loss of market share, either to other distributors or suppliers
increasingly going direct to market.
The ratings and Outlook incorporate the above considerations as well as the
--Fitch expects flat to mid-single digit organic revenue declines in 2013 as
Arrow manages choppy end market demand and macroeconomic concerns. Fitch would
expect EBITDA margins (currently 4.7% for the LTM ending Sept. 29, 2012) to
continue to compress given slowing end market demand. In a stress scenario,
Fitch would expect EBITDA margins to decline to levels near the trough of the
last downturn, roughly 3%, or moderately lower if revenue declines are more
severe. In a flat revenue environment, Fitch estimates Arrow would generate
approximately $500 million in annual free cash flow. In a stress scenario, Fitch
would expect working capital cash inflows to roughly offset lower EBITDA levels
and free cash flow to be near $500 million.
--The ratings incorporate expectations that Arrow would maintain leverage (total
debt to total operating EBITDA) of 2.5 times (x) or below (3.0x when adjusted
operating leases) given Arrow's business model and credit profile. Fitch
estimates leverage at 2.0x (approximately 2.4x adjusted) and interest coverage
(EBITDA to total interest expense) at 9.0x as of Sept. 29, 2012.
--Fitch expects uses of cash flow and excess cash will principally go to fund
organic growth, working capital needs, potential small acquisitions, and share
repurchases. Arrow has roughly $124 million in remaining share repurchase
authorization and has repurchased $223 million in the LTM period. Fitch believes
Arrow has headroom for a moderate amount of share repurchases given the cash
generative nature of the business model. However, aggressive
shareholder-friendly actions in the face of increasing macroeconomic uncertainty
could pressure ratings if such action would be expected to lead to additional
higher leverage once revenue growth returns. Fitch believes Arrow could
potentially pursue debt-financed acquisitions resulting in higher than expected
leverage if opportunities arise going forward. Such a scenario could pressure
ratings if Fitch did not reasonably expect that Arrow would reduce leverage
closer to historical levels in the short-run through the use of free cash flow
for debt reduction and EBITDA growth.
Fitch believes Arrow's diversification efforts into areas like software and
network security as well as services like IT asset disposition and reverse
logistics are important developments for Arrow's credit profile. Fitch would
expect demand for these services to be less volatile than traditional hardware
and components businesses. As these services grow to comprise a greater portion
of Arrow's business through organic growth and additional acquisitions, Fitch
believes the resulting diversification of revenue streams would help solidify
Arrow's rating in the investment-grade category.
Credit strengths include the company's leading market positions in both
component and enterprise computing distribution worldwide; the ability to
generate cash from operations in a normal revenue growth environment, as well as
achieve significant free cash flow in a downturn from reduced working capital;
and a highly diversified supplier and customer base.
Credit concerns include Arrow's thin operating margins, which are typical of the
IT distribution market; significant investment levels required to increase share
in the faster-growing Asia-Pacific region, including potentially debt-financed
acquisitions; integration risk stemming from Arrow's acquisition growth
strategy; Arrow's exposure to the cyclical demand patterns and cash flows
associated with the semiconductor and networking sectors; and the potential for
future partially debt-financed share-repurchase programs.
As of Sept. 29, 2012, financial flexibility was solid with $359 million in cash
and $1.1 billion available from a $1.2 billion senior unsecured revolving credit
facility which expires in August 2016. Arrow has roughly $540 million available
under a three-year $775 million accounts receivable securitization (ARS)
facility maturing in December 2014. Fitch expects Arrow to produce strong free
cash flow, with minimal working capital requirements. Fitch estimates that Arrow
has produced average annual free cash flow in excess of $400 million over past
five years. Arrow's next scheduled maturity is $332 million of notes due in 2013
which Fitch expects to be refinanced in the coming months.
Total debt as of Sept. 29, 2012 was $1.9 billion and consisted primarily of:
--$94 million drawn on the company's $1.2 billion revolving credit facility
expiring August 2016;
--$235 million drawn on the company's $750 million A/R securitization facility
expiring December 2014;
--$332 million 6.875% notes due 2013;
--$250 million of 3.375% notes due 2015;
--$200 million 6.875% senior debentures due 2018;
--$300 million 6% notes due 2020;
--$200 million 7.5% senior debentures due 2027; and
--$250 million of 5.125% notes due 2021.
WHAT COULD TRIGGER A RATING ACTION
Negative: Future developments that may, individually or collectively, lead to
negative rating action include:
--Revenue declines that signal a loss of market share, either to other
distributors or suppliers increasingly going direct to market;
--Severe operating margin compression resulting from intense competition;
--Significant debt-financed acquisitions and/or share repurchases, particularly
if funded from cash generated from working capital declines.
Positive: Upside movement in the ratings is limited given Arrow's the razor-thin
operating margin profile with significant cyclical demand exposure. Significant
sustained improvement in credit metrics paired with a long-term strategic
business rationale and demonstrated commitment from management to maintain a
higher rating would be necessary.
Additional information is available at 'www.fitchratings.com'. The ratings above
were unsolicited and have been provided by Fitch as a service to investors.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology', dated Aug. 8, 2012;
--'Evaluating Corporate Governance', dated Dec. 13, 2011;
--'Rating Technology Companies', dated Aug. 9, 2012.
Applicable Criteria and Related Research:
Corporate Rating Methodology
Evaluating Corporate Governance
Rating Technology Companies