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TEXT-S&P cuts Alliance One International snr unsecured notes
July 24, 2012 / 8:16 PM / in 5 years

TEXT-S&P cuts Alliance One International snr unsecured notes

Overview
     -- U.S.-based Alliance One International's operating margins
improved over the past year as a result of a reduced tobacco leaf oversupply and
the company's recent operating initiatives. 
     -- We are affirming our 'B' corporate credit rating and our 'BB-' secured 
debt rating.
     -- We are lowering our debt issue rating on the company's unsecured notes 
based on our expectation for weaker recovery prospects in the event of a 
payment default, primarily as a result the company's recently upsized accounts 
receivable securitization. 
     -- We are revising our outlook to stable from negative, given our 
expectation that more-favorable industry conditions and enhanced profitability 
should lead to improved credit measures over the next year.

Rating Action
On July 24, 2012, Standard & Poor's Ratings Services affirmed the 'B' 
corporate credit rating on Morrisville, N.C.-based Alliance One International 
Inc. (AOI), and revised its outlook on the company to stable from negative. We 
also affirmed our 'BB-' rating on the company's senior secured debt. The 
recovery rating on AOI's secured debt remains '1', indicating our expectation 
for very high recovery (90% to 100%) in the event of a payment default.

At the same time, we lowered our rating on the company's senior unsecured 
notes to 'B-' from 'B', and revised the recovery rating to '5' from '4', 
indicating our expectation of modest (10% to 30%) recovery for noteholders in 
the event of a payment default. 

Our rating on the company's $115 million convertible notes due 2014 remains 
'CCC+', with a recovery rating of '6', indicating our expectation of 
negligible (0% to 10%) recovery in the event of a payment default.
Rationale
The lowering of the issue-level rating on the company's $635 million unsecured 
notes due 2016 primarily reflects our view that recovery prospects will be 
weaker in the event of a payment default under our simulated default scenario, 
based on higher senior secured priority claims following the company's upsized 
accounts receivable securitization program, which was increased to $250 
million from $125 million. (For more information, see our recovery report on 
AOI, to be published on RatingsDirect following the release of this report.)

Our affirmation of the 'B' corporate credit rating and outlook revision to 
stable reflects our expectation that the tobacco leaf company's operating 
performance will continue to improve in fiscal 2013 (ended March 31) and that 
the company will achieve sales growth and maintain EBITDA margins such that 
leverage strengthens closer to the 6x area (adjusted for committed 
inventories) by the end of the fiscal year, compared to about 6.8x at the 
fiscal year ended March 31, 2012. 

The ratings on AOI reflect Standard & Poor's view that the company will 
maintain a "weak" business risk profile, reflecting highly competitive global 
competition, susceptibility to supply and demand imbalances that can be tied 
to external factors such as weather and political unrest, risk of further 
shifting towards direct leaf sourcing, and its exposure to foreign currency 
volatility. We also believe the company will continue to maintain a "highly 
leveraged" financial risk profile, based on our view that the company's 
financial policy will remain aggressive, cash flows will continue to be 
volatile, and key credit metrics will be indicative of the company's financial 
profile through the end of fiscal 2013; this includes the ratio of total debt 
to EBITDA remaining above 5x and funds from operations (FFO) to total debt 
remaining below 12%. 

Key assumptions in Standard & Poor's fiscal 2013 forecast include:
     -- Sales increase at a low- to mid-single-digit percentage rate, based on 
new processing contracts, moderate volume growth, and our expectation for 
prices paid to AOI by its customers to increase.
     -- Adjusted EBITDA margin stabilizes at around 8%, but potentially 
improves to 9%, reflecting ongoing improvement in operating efficiency through 
its recent restructuring plans, and improved operating leverage achieved with 
growing sales, which we believe could offset some shift to value products. In 
recent years, margins had been pressured as a result of the more difficult 
cost environment, foreign exchange rate volatility, higher levels of leaf 
directly procured, and greater supply of burley and flue-cured tobacco, which 
placed downward pressure on prices paid to farmers for green tobacco, and 
prices paid to AOI by its customers. 
     -- We estimate the ratio of total debt to EBITDA will be reduced closer 
to 6x by the end of fiscal 2013, compared with leverage of about 6.8x for the 
fiscal year ended March 31, 2012. This is based on our expectation for higher 
EBITDA attributed to prospects for improved operating performance and lower 
debt levels. Based on our expectation that industry oversupply will continue 
to be worked down, we expect a more favorable working capital environment 
through the reduction of inventory, which we believe will help the company 
boost cash flow and reduce debt levels through the end of fiscal 2013. We also 
project EBITDA coverage of interest expense will remain thin, but increase 
closer to the 2x area, compared with interest coverage of about 1.6x through 
the fiscal year ended March 31, 2012.
     -- We forecast cash flow generation will be positive in fiscal 2013, 
based on our expectation that the company will further reduce inventory levels 
over the next year. We expect capital spending related to ongoing 
infrastructure initiatives will remain elevated in fiscal 2013 (about $75 
million) but then become more maintenance-oriented over the next several 
years, ranging between $15 million and $25 million. 
     -- Although we recognize the potential for volatility of foreign exchange 
rates and its potential impact to AOI's profitability, we assume foreign 
exchange movements are modest over the next year; margins could benefit 
somewhat if the U.S. dollar continues to show further strength, which would 
translate to potentially lower leaf input costs in key regions such as Brazil. 
The company also hedges some of its currency related exposure.

Our view that the company will continue to maintain a weak business risk 
profile is based on our expectation that there will continue to be variability 
in operating performance over time and the business environment in which AOI 
operates will remain difficult, marked by global competition, political unrest 
in certain leaf-tobacco producing countries, and exposure to foreign currency 
volatility (particularly when the U.S. dollar weakens, which unfavorably 
affects expenses denominated in foreign currencies). In addition, we expect 
cigarette consumption will continue to decline in most mature markets 
(including the U.S. and Western Europe), although we also believe these 
declines will be offset by more favorable prospects in growth markets such as 
China. 

We believe the negative financial impact of manufacturers' shifts towards 
direct sourcing of tobacco leaf in 2010 is mostly behind AOI. Notable shifts 
towards vertical integration include Japan Tobacco Inc.'s (JTI) acquisition of 
selected leaf merchants and Philip Morris International's (PMI) purchase of 
assets from AOI and Universal Corp. Such actions have contributed to more 
processing-oriented relationships between AOI and these key customers in 
selected markets such as Brazil. We expect AOI will continue to take steps to 
broaden its customer base and pursue other partnerships and growth 
opportunities in light of recent industry developments. For example, in 
January 2012 AOI's Brazilian subsidiary entered into a joint venture with 
China Tobacco Internacional do Brasil. 

We still expect customer concentration will also remain a risk factor; AOI's 
top three customers each accounted for more than 10% of sales in fiscal 2012. 
As a result, we will continue to assess the effect on AOI's business from its 
largest customers in light of recent actions, its ability to replace lost 
business, and the company's ongoing restructuring efforts to address the 
changing landscape. 

At the same time, the company benefits from its position as one of the two 
leading independent leaf-tobacco merchants, its sourcing diversification, and 
solid, longstanding customer relationships with the leading cigarette 
manufacturers.

Operating performance improved over the past year as industry oversupply was 
worked down. Through the fiscal year ended March 31, 2012, sales increased 
2.7%, largely from higher processing sales (new long-term processing 
arrangements in Brazil. These new sales offset a decline in quantities sold, 
mainly resulting from PMI's prior-year purchase of AOI's tobacco suppliers in 
Brazil and slightly lower average selling prices attributed to lower green 
leaf costs that were passed on to AOI's customers. While we believe operating 
results will improve further in fiscal 2013, we expect performance will remain 
volatile over the next several years, and believe the company remains 
sensitive to external market forces beyond its control. 

Liquidity
We believe liquidity has improved over the past several quarters as a result 
of improved cash flow generation and recently amended covenants, although we 
currently classify liquidity as "less than adequate" in accordance with key 
quantitative measures (see "Methodology And Assumptions: Liquidity Descriptors 
for Global Corporate Issuers," Sept. 28, 2011). We will reassess this 
descriptor if performance exceeds our expectations and we believe covenant 
cushion will be maintained at 15% or more over the subsequent four-quarter 
period. Our view is based on the following:
     -- We believe AOI covenant headroom could again fall below 15% and closer 
to the 10% area by the back half of fiscal 2013, most notably on the company's 
new minimum EBITDA covenant, which was added in conjunction with the most 
recent amendment. We estimate covenant cushion under its remaining covenants 
will be sufficient and close to 15% or more, given our expectation for further 
improvement in performance, positive cash flow generation, and lower debt 
levels by the end of fiscal 2013.
     -- We estimate that if EBITDA declines more than 15% from current levels 
over the next year and cash flow generation is weaker than expected, the 
company could be in violation of its financial covenants, as amended.
     -- There is some seasonality in the business with several peak working 
capital usage periods, and quarterly performance can also be influenced by 
timing of payments. 

In June 2012 AOI entered into the most recent (fifth) amendment to its credit 
agreement. Under the amended terms the lenders agreed to extend the maturity 
date on its revolving credit facility by one year to April 15, 2014. At the 
same time, the maximum amount under the revolver was reduced to $250 million 
from $290 million; we continue to view the revolver (which was undrawn as of 
March 31, 2012) as a key liquidity source, most notably if global credit 
conditions tighten and there is less availability under its seasonal lines of 
credit. As discussed above, financial covenants were modified to provide the 
company additional covenant cushion. However, a new financial covenant was 
added, requiring the maintenance of minimum EBITDA of $166 million; this 
requirement increases to $200 million by the end of fiscal 2013.

In addition to its revolver, AOI had $119.7 million in cash and about $266.6 
million available under seasonally adjusted uncommitted lines of credit. The 
company uses its available lines of credit to fund its capital expenditures 
and its seasonal working capital requirements. Committed inventories (in 
excess of short-term lines of credit) and advances on tobacco purchases 
represent some additional sources of liquidity and financial flexibility. AOI 
also maintains accounts receivable securitization facilities, the first of 
which was recently upsized to $250 million (from $125 million), with $182 
million of receivables outstanding as of March 31, 2012. The company also has 
a $35 million uncommitted accounts receivable securitization program. 

AOI generated positive free operating cash flow in fiscal 2012 (as reported, 
inclusive of cash from the increase in sale of trade receivables), and we 
believe cash flow generation will remain positive in fiscal 2013, based on our 
expectation that the company will further reduce inventory levels over the 
next year. We expect capital spending related to ongoing infrastructure 
initiatives will remain elevated in fiscal 2013 but then become more 
maintenance-oriented over the next several years. Committed inventories in 
excess of short-term lines of credits and advances on tobacco purchases 
represent some additional sources of liquidity and financial flexibility.

Recovery analysis
AOI's senior secured debt is rated 'BB-' (two notches higher than the 'B' 
corporate credit rating); the recovery rating is '1', indicating our 
expectation for very high recovery (90% to 100%) in the event of a payment 
default. The company's senior unsecured notes are rated 'B-', with a recovery 
rating of '5', indicating our expectation of modest (10% to 30%) recovery for 
noteholders in the event of a payment default. Our rating on the company's 
$115 million convertible notes due 2014 is 'CCC+', with a recovery rating of 
'6', indicating our expectation of negligible (0% to 10%) recovery in the 
event of a payment default. For the complete recovery analysis, see our 
recovery report on Alliance One International, to be published following the 
release of this report on RatingsDirect. 

Outlook
The outlook is stable, reflecting our opinion that industry conditions are 
improving and that credit measures should continue to improve in fiscal 2013, 
but remain indicative of a highly leveraged financial risk profile. Because of 
the seasonality of the company's operations (especially working capital needs 
during the harvest) and the timing of shipments to customers, there can be 
volatility in operating performance and credit metrics from quarter to 
quarter. We forecast leverage to decline closer to the 6x area in fiscal 2013 
(from 6.8x currently) based on our expectation for moderate sales growth and 
stable operating margins. We forecast lower working capital needs in 2013 
(mainly through lower inventory levels by the end of the year) to lead to 
improved cash flow generation. We would consider a lower rating if operating 
performance falls below our expectations such that credit metrics weaken 
and/or AOI is unable to maintain adequate covenant cushion of 10% or more. 

Although less likely given our expectation that leverage will remain high over 
the next year, we could consider raising the rating in the event that covenant 
cushion is maintained in the 15% area or higher, cash flow generation improves 
further, and debt levels are reduced such that leverage declines closer to the 
5x area. We estimate debt levels would need to be reduced by about $300 
million or EBITDA would need to increase 35% for leverage to approach the 5x 
level, which could occur with sustained sales growth, restoration of EBITDA 
margins of about 10% or more, and positive cash flow generation.

Related Criteria And Research
     -- Methodology And Assumptions: Liquidity Descriptors For Global 
Corporate Issuers, Sept. 28, 2011
     -- Key Credit Factors: Criteria For Rating The Global Branded Nondurable 
Consumer Products Industry, April 28, 2011
     -- Criteria Guidelines For Recovery Ratings On Global Industrials 
Issuers' Speculative-Grade Debt, Aug. 10, 2009
     -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009
     -- Corporate Ratings Criteria 2008, April 15, 2008
     -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008
     -- Analyzing Agricultural Inventories, Jan. 3, 2005

Ratings List


Ratings Affirmed; Outlook Action
                                        To                 From
Alliance One International Inc.
 Corporate Credit Rating                B/Stable/--        B/Negative/--

Ratings Affirmed

Alliance One International Inc.
 Senior Secured                         BB-                
  Recovery Rating                       1         
 Subordinated                           CCC+               
  Recovery Rating                       6          

Intabex Netherlands B.V.
 Senior Secured                         BB-                
  Recovery Rating                       1           

Downgraded
                                        To                 From
Alliance One International Inc.
 Senior Unsecured
  Local Currency                        B-                 B 
  Recovery Rating                       5                  4

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