-- Global cosmetics company Avon Products Inc.'s operating results
continue to be weak and credit metrics have deteriorated over the past year.
-- We are lowering our corporate credit rating on Avon to 'BBB' from
-- The outlook is negative, reflecting our concern that weak operating
results may persist in light of continued operating disruptions in Avon's
major markets. These may be further exacerbated by the uncertainty caused by a
longer-term company strategy that is on hold until a new CEO is placed, and by
potential management distractions from the ongoing SEC investigation.
On March 16, 2012, Standard & Poor's Ratings Services lowered its corporate
credit rating on Avon Products Inc. to 'BBB' from 'BBB+'. The rating outlook
is negative. At the same time, we lowered our ratings on the company's senior
unsecured notes to 'BBB' from 'BBB+'.
The 'A-2' short-term rating remains unchanged. We believe the company's strong
liquidity and good access to capital markets support the short-term rating.
Today's rating action reflects the company's weak operating results, and
credit metrics deterioration amid persistent soft global economic conditions
and continued operating disruptions in Brazil. Brazil is a key market for the
company. Service delays related to the implementation of Enterprise Resource
Planning systems pressured sales and profitability in Brazil.
The rating action also reflects our expectations for some margin erosion in
2012 due to higher operating expenses related to increased investment in the
company's "representative value proposition" (RVP) broad-based recruitment and
reward platform, rising commodity costs, and expenses related to the ongoing
investigation under the Foreign Corrupt Practices Act (FCPA), all will
contribute to lower margins and earnings. We believe an operating turnaround
could be more difficult to manage than previously expected.
In December the company announced that it is seeking to replace its CEO, and
longer-term company strategy will depend on the new CEO. Without a clear
longer-term strategy in place, we are uncertain about the company's ability to
execute an operating turnaround over the next year.
The SEC's formal investigation related to the company's possible violations of
the FCPA and Regulation FD adds additional risk. The bribery investigation and
potential disclosure violation could be a distraction for management and could
lead to fines and other regulatory action against the company.
Our ratings on U.S.-based cosmetics company Avon Products incorporates our
view that the company's business risk profile continues to be "satisfactory"
and its financial risk profile as "intermediate", as our criteria define these
terms. Avon has sustained its good market share in the direct sales channel.
It has also sustained a broad international presence, with more than 75% of
the company's revenue generated outside North America. Additionally, the Avon
brand continues to exhibit brand strength. However, we believe the risks of
direct sales distribution and near-term operating difficulties, especially in
its Brazil, Russia, and North American businesses, somewhat offset the
Avon's intermediate financial risk profile is supported by its continuing
strong liquidity and credit measures, which, despite the deterioration, remain
in line with the indicative financial ratios for the "intermediate"
descriptor. This includes adjusted leverage from 2x to 3x. Credit metrics have
weakened as a result of declining profitability and higher debt levels. The
ratio of total debt to EBITDA for fiscal year 2011 increased to about 2.7x.
This compares with 2.6x leverage in the prior year and historical levels of
1.7x, with the leverage increase primarily attributable to the debt-funded
acquisition of Silpada Designs Inc. in July 2010. We believe credit measures
could further deteriorate if the company is not able to improve operating
results over the next year.
Avon's operating performance has declined significantly since 2009, despite
various restructuring programs that generated significant annual cost savings.
The company's EBITDA margin has been on a declining trend and is below its
peers, contracting about 60 basis points from the prior year, to about 13% at
fiscal 2011, and nearly 300 basis points since 2008.
Our assumptions for Avon over the next year include the following:
-- Low-single-digit revenue growth, as we expect softness will persist in
some of its key markets.
-- EBITDA margin between 12% and 13%, as margin pressure from higher
commodity costs, labor costs, and operating expenses related to investment
-- Flat capital expenditures of about $275 million.
-- Dividends of about $400 million to be funded with cash flow generation.
Under these base case assumptions, we expect the company's credit metrics will
remain near its current levels, which includes adjusted leverage in the
high-2x area in fiscal 2012. We forecast the ratio of funds from operations to
total adjusted debt will be about 30%, and free operating cash flow to be $400
million to $500 million over the next year.
Avon continues to have large scale and geographic diversity, which can
generally compensate for regional weaknesses. Its diverse operating base also
helps offset the impact of foreign currency fluctuations in regional markets.
Developing markets remain a significant portion of the company's sales, and we
expect them to continue to be an important component of Avon's long-term
Avon has "strong" liquidity (as defined in our liquidity criteria), with
sources of cash that are likely to exceed uses for the next 12 to 24 months.
We expect the company's substantial cash balances, cash flow generation, and
access to capital markets to be more than adequate to support its operating
needs and debt maturities over the next couple years. The next debt maturity
is in 2013.
Our view of the company's liquidity profile incorporates the following
-- We expect coverage of uses of cash to exceed 1.5x in the next year and
1.0x in the next 24 months.
-- Cash sources include existing cash balances of $1.3 billion (of which
a significant portion is held overseas) and a $1 billion commercial paper
program backed by a $1 billion revolving credit facility that is due in 2013.
At the end of fiscal year 2011, there was nothing outstanding on the revolving
credit facility and $709 million outstanding under the commercial paper
-- We expect cash uses to include some investment in working capital,
about $275 million in capital spending, and about $400 million in dividends.
-- We expect net sources of cash would be positive even with a 30% drop
-- The company has a minimum interest coverage covenant, which we expect
the company will maintain sufficient covenant cushion on.
-- We expect Avon could likely absorb low-probability shocks based on its
positive cash flow and current cash balances.
Our rating outlook on Avon is negative, given the continued operating issues
in Brazil and softness in other key markets, including Russia. Furthermore, we
are uncertain as to whether the company will be able to execute an operating
turnaround and improve credit metrics over the next year, given the lack of
clear strategy without a new CEO in place and the ongoing SEC investigation,
which could be a further distraction and adds some risk to the company's
reputation. We also expect higher investment spending on representatives,
rising commodity costs, and global economic conditions will continue to affect
the company's sales base and margins. We would contemplate lowering the rating
if the company is not able to improve its operating results, or if the bribery
and FD regulation investigations lead to additional costs and result in
further deterioration of credit metrics, such that leverage increases to above
3x. Leverage could rise to this level if debt increased 11% to $4.4 billion,
or if EBITDA fell 10% (assuming debt levels remain unchanged). If we lower the
long-term rating to 'BBB-', we would lower the short-term rating to 'A-3'
based on our criteria.
Alternatively, we could consider a stable outlook if the company is able to
resolve some its operating issues in its key markets and stabilize its
operating results, such that leverage is lowered and sustained near 2.5x. This
could occur if EBITDA increases 8% (assuming debt levels remain unchanged).
Downgraded; Short-Term Rating Unchanged
Avon Products Inc.
Corporate credit rating BBB/Negative/A-2 BBB+/Negative/A-2
Senior unsecured BBB BBB+
Avon Capital Corp.
Commercial paper A-2