Nov 9 - Fitch Ratings has affirmed Diageo plc's (Diageo) Long-Term Issuer
Default Rating (IDR) and senior unsecured rating at 'A-' and Short-Term IDR at
'F2'. The Outlook on the Long-term IDR is Stable.
Diageo's subsidiaries Diageo Finance BV, Diageo Finance plc, Diageo Capital plc
and Diageo Investment Corporation's senior unsecured ratings are also affirmed
The affirmation follows Diageo's announcement that it will be buying between
25.1% and 53.4% of leading Indian spirits-maker United Spirits Limited (USL) for
a maximum net cash disbursement - including USL's net debt - of GBP1.8bn.
As a result of Diageo's healthy and predictable free cash flow generation (FCF;
GBP0.8bn in 2012 excluding one-off working capital changes), Fitch calculates
that the company should be in a position to see only a marginal increase in
leverage following completion of the transaction.
Diageo's lease adjusted net debt/funds from operations (FFO), pro-forma for the
annualisation of USL's cash flow and post-transaction debt of approximately
GBP0.6bn, is expected to increase marginally towards 3.0x from its YE12 level of
2.7x. This also includes other M&A activity already completed by Diageo during
FY13 (see "Fitch: Diageo's Ypioca acquisition within its 'A-' rating headroom",
dated 28 May 2012 at www.fitchratings.com). This calculation reflects both the
scenario in which Diageo would be successful in its tender offer to acquire 26%
of USL on the market, as well as the scenario in which, with a more limited
degree of ownership, it may not be able to consolidate USL.
The increased leverage in FY13 will cause a tightening of Diageo's financial
flexibility although it remains compatible with its current 'A-' rating. In
Fitch's opinion Diageo could remain in acquisitive mode during 2013. However the
agency projects that, in the absence of other acquisitions, credit metrics will
recover in FY14, enabling Diageo's financial flexibility to improve.
By gaining management control of USL, which enjoys a 41% share of the Indian
spirits market through leading regional positions in the important local whisky
category, the transaction will provide Diageo with a unique position in a market
characterised by growing consumption, premiumisation trends and high barriers to
entry. This is an important step for Diageo in the direction of increasing
exposure to developing markets.
The agreements with the current majority shareholders of USL ensure that Diageo
will, for an initial four year period, achieve a good degree of control even if
it does not achieve 50% ownership.
However, these benefits are contrasted by the high multiple paid and by Fitch's
expectation that, in the light of the significant minorities, profit upstreaming
to Diageo will be limited. In addition, there could be further disbursements in
future in order to increase ownership of the company towards 100% although there
is currently a remote possibility of this happening.
WHAT COULD TRIGGER A RATING ACTION?
Negative: Future developments that may, individually or collectively, lead to a
negative rating action include:
- FFO adjusted net leverage on a permanent basis above 3.0x - either as a result
of shareholder distributions / acquisitions / business weakness
- Fixed charge cover ratio below 6.0 x
- Organic revenue and profit growth negative or expected to be negative for
three successive six month periods
- Permanent EBITDA margin erosion by more than 150 - 200bp
- Free cash flow turning below GBP300m
- Materially adverse regulatory changes causing declines in global spirits
Positive: Provided that acquisition appetite and opportunities have abated,
upward rating pressure could materialise in the event of:
- FFO adjusted net leverage on a permanent basis below 2.5x
- Fixed charge cover ratio above 8.0 x
- Continuation of consistently positive, at least low-mid single digit organic
revenue and profit growth
- Free cash flow moving well above GBP600m - GBP700m