-- U.S.-based Avon's operating performance continues to be weaker than
expected and credit metrics remain weak.
-- We are revising the 'BBB-' rating outlook on Avon to negative from
-- The negative outlook reflects our expectation that the company's
operating performance will continue to be weak and leverage will be above
3.5x, unless the company reduces debt levels.
As Standard & Poor's Ratings Services previously announced, on Nov. 1, 2012,
we affirmed our 'BBB-' corporate credit rating on New York City-based Avon
Products Inc. and revised the rating outlook to negative from stable.
In addition, we affirmed our 'BBB-' issue-level ratings on the Avon's senior
unsecured debt and 'A-3' commercial paper rating.
The negative outlook reflects Avon's continuing poor operating results and
weak credit metrics. We estimate adjusted leverage continues to be above 3.5x
as of the recent September quarter compared with 2.5x in the September 2011
quarter. We have also revised our financial risk profile to "significant" from
"intermediate," supported by weaker credit metrics and our change in our
assessment of the company's liquidity to "adequate" from "strong." Financial
ratios indicative of a significant financial risk profile include ratios of
adjusted total debt to EBITDA between 3x and 4x, funds from operations (FFO)
to total debt between 20% and 30%, and adjusted total debt to capital between
45% and 50%. Avon's credit metrics are weaker mainly because of declining
profitability and higher debt. Its ratio of total debt to EBITDA for the
September 2012 quarter remained elevated above 3.5x, an increase from 2.7x at
2011 year-end and historical levels of 1.7x. We attribute the increase
primarily to the debt-funded acquisition of Silpada Designs Inc. in July 2010.
Though we had expected leverage to increase above 3.5x, we now expect it will
be difficult for the company to materially lower leverage through improved
operating results, as slow operating turnaround and weak operating performance
could persist into next year (though we believe the company could lower
leverage by reducing debt). Additionally, although the company has reduced its
outstanding commercial paper and cut its dividend by about 75%, the company's
cash flow generation has decreased and the company has financial covenants,
with cushion estimated to be below 30%. The company also has about $375
million of debt maturing in 2013, which we expect the company will address.
Our Avon ratings also reflect our view that the company's business risk
profile will remain "satisfactory." Avon continues to sustain its good market
share in the direct sales channel. It has also sustained a broad international
presence, generating more than 75% of the company's revenue outside North
America. Additionally, the Avon brand continues to exhibit brand strength. Our
assessment of the business risk also includes the inherent risks of operating
with channel concentration as a direct sales company (including potential
difficulties with its sales force and participation in the highly competitive
Our assumptions for Avon include a slow operating turnaround. Although the
company has resolved the issues related to the Enterprise Resource Planning
systems implementation in key-market Brazil, operating improvement continues
to be slow, and sales and profitability remain pressured. The company
continues to face soft overall top-line growth against foreign exchange
headwinds and margin pressure from higher input costs, increased investment in
its "representative value proposition" (RVP; a broad-based recruitment and
reward platform), and other expenses (such as for the ongoing investigation
under the Foreign Corrupt Practices Act ). We expect the company will
need to make investments to improve operating efficiencies, and it may take
time before the company begins to benefit from the new management's operating
Our assumptions over the next year include the following:
-- Weak sales growth, which could include mid- to high-single digit
percentage sales declines for this year, as we expect negative foreign
exchange and softness to continue in some of its key markets.
-- Margin pressure persists from higher commodity costs, labor costs, and
operating expenses related to continued investment spending in its sales
-- Relatively flat capital expenditures of about $260 million to $280
million for this year and possibly increasing beyond 2012, as the company may
make investments as part of its operating turnaround strategy.
-- Dividends cut to about $100 million.
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 declining and is below its peers',
contracting about 500 basis points since 2008 to about 10%.
Avon continues to have large scale and geographic diversity, which can
generally compensate for regional weaknesses, if the company is operating
efficiently. Its diverse operating base also helps offset the effect 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 important to Avon's long-term growth strategy.
Avon currently has adequate liquidity, with sources of cash that are likely to
exceed uses for the next 12 months. We expect the company's substantial cash
balances, cash flow generation, and access to capital markets will support its
operating needs and debt maturities over the next couple of years. The next
debt maturity is about $375 million in 2013.
Our view of the company's liquidity profile incorporates the following
-- We expect cash sources to cover uses of cash by at least 1.2x in the
next 12 months.
-- We expect net sources would be positive, even with a 15% drop in
-- Cash sources include existing cash balances of $1.1 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.
On Sept. 30, 2012, there was nothing outstanding on the revolving credit
facility and about $69 million outstanding under the commercial paper program.
The company has indicated it does not plan to reinvest its 2012 foreign
earnings. The company may further reduce its reliance on its outstanding
commercial paper by year end.
-- We expect cash uses to include some investment in working capital,
about $260 million to $280 million in capital spending, and about $100 million
-- The company has leverage and interest coverage covenants on the new
$550 million term loan, as well as a minimum interest coverage covenant on its
private placement notes. The company currently has about 20% cushion on its
tightest covenant and we expect the company would remain compliant even with a
15% drop in EBITDA.
The outlook is negative. Operating performance has been poor and we expect
progress towards stabilizing the business to be slow over the next 2 years.
We would consider lowering the rating if credit metrics do not begin to
improve, including leverage decreasing to about 3.5x by year end and towards
the low 3x area over the next year. The company could possibly achieve this
through debt reduction and we would also expect some progress towards improved
operating results, including increased profitability, next year. If we lower
the long-term rating to speculative grade, we would lower the short-term
rating to 'B'.
Although unlikely in the next 12 to 18 months, we could consider revising the
outlook to stable if the company improves operating results, particularly in
Brazil, and increases profitability, leading to improved credit metrics on a
sustained basis, including leverage in the low 3x area.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
Ratings affirmed; Outlook Revised
Avon Products Inc.
Corporate credit rating BBB-/Negative/A-3 BBB-/Stable/A-3
Avon Products Inc.
Senior unsecured BBB-
Commercial paper A-3
Complete ratings information is available to subscribers of RatingsDirect on
the Global Credit Portal at www.globalcreditportal.com. All ratings affected
by this rating action can be found on Standard & Poor's public Web site at
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