Fitch Ratings has assigned a 'BBB-' rating to Avon Products, Inc. (Avon) new $500 million three-year term loan maturing in June 2015. Fitch expects that much of the proceeds will be used to reduce commercial paper (CP) balances totaling $754 million at March 31, 2012.
Avon's CP program is for a cumulative face amount not to exceed $1 billion and with maturities not to exceed 270 days from the date of issue. CP is typically not redeemable prior to maturity and is not subject to voluntary prepayment. In its last quarterly filing Avon had cited that demand for its CP had declined. Fitch expects that leverage may be temporarily higher than normal at quarter end given that the facility funded on June 29 and CP maturities may potentially extend past that date. Cash balances could also be temporarily higher than Avon's $1 billion to $1.2 billion normal range.
The term loan can be increased to a maximum of $750 million prior to Aug. 2, 2012 and can be prepaid without premium or penalty. Pricing is based on the company's ratings and would be L + 2.25% at current ratings levels. If Avon raises at least $500 million of new debt, then 50% of the net cash proceeds must be applied to the term loan.
Terms and conditions are essentially similar to the existing $1 billion three-year revolving credit facility maturing in November 2013 except for the addition of a leverage covenant. Leverage on a last twelve months basis must be no more than 4 times (x) through March 31, 2013, 3.75x for the following three quarters ending Dec. 31, 2013 and 3.5x thereafter. Leverage should be reasonably close to Fitch's calculation which was 2.7x at March 31, 2012. Except for a potential temporary increase at June 30, 2012, leverage near 4x would be of concern.
Fitch rates Avon as follows:
Avon Products, Inc. (Avon)
--Long-term Issuer Default Rating (IDR) 'BBB-';
--Bank credit facility 'BBB-';
--Senior unsecured notes 'BBB-';
--Short-term IDR 'F3';
--Commercial Paper 'F3'.
Avon Capital Corporation with a guarantee from Avon
--Short-term IDR 'F3';
--Commercial Paper 'F3'.
The Rating Outlook is Stable.
The ratings reflect the continued trends in Avon's generation of negative free cash flow (FCF, cash flow from operations minus capital expenditures and dividends) during the past two years and through the first quarter of 2012, as well as Avon's increase in leverage. The ratings also encompass operational and business model challenges to improve service levels in Brazil, manage price gaps in several categories, address working capital issues, and increase representative compensation to stem volume and market-share declines given heightened levels of competition. Fitch expects that these factors increase the probability that margins could be materially lower than 2011, leverage will increase to the 3x range, and that FCF is likely to remain negative with lower profitability during 2012.
Rating Movements:
Downgrade/Negative Outlook: Fitch would consider a Negative Outlook or downgrade for Avon if the company maintains the $400 million dividend beyond 2012 without generating meaningful free cash flow or with no clear and credible plan for a turnaround. Given the poor first quarter and guidance for more of the same in the second, it is likely that FFO will be less than $1 billion during 2012. Additionally, a significant decrease in working capital usage and/or material increases in margins could take longer to realize which could put pressure on generating free cash flow and the rating. Meaningful positive surprises from working capital improvement and profitability increases clearly provide more room for discretionary activities.
Another factor to be considered in a potential Negative Outlook or downgrade is the impact on Avon's covenants if material declines in profitability continue. Avon's $1 billion credit agreement and the $535 million in privately placed notes require interest coverage of at least 4x. At the end of 2011 it was approximately 9x but after the poor first quarter it was 6.9x. Fitch will be monitoring this covenant closely although it is likely that lenders will work with a borrower through short term issues via amendments.
Upgrade: An upgrade is not likely in the short term. However, Fitch would consider an upgrade if Avon generates and is able to sustain FCF in the $100 million range, and management is committed to maintaining leverage under 2.5x while maintaining a stable operating and business profile. Resolution of the Foreign Corrupt Practices Act issue given the high cost of the investigation (near the $100 million range) has also been a drag on cash flow and would also be viewed positively. The ongoing cost of compliance would remain but is likely to be lower.
Financial Performance:
For the first quarter ended March 31, 2012, Avon's operating performance deteriorated substantially. Commodity and wage inflation pressured margins by 220 basis points (bps), in addition to 170bps of additional spending against the representatives and brochures, and 220bps in other items including negative mix and additional bad debt expense. As a result, the EBIT margin (excluding restructuring charges) declined by 610 bps to 4.3%.
Debt increased from year end by $74 million to $3.4 billion to partially fund $178 million in negative FCF in the first quarter. Avon used some of its cash on hand to fund the remainder. Fitch does not expect debt levels to increase materially given Avon's intention to repatriate international cash balances if needed. LTM Leverage (Debt/EBITDA) increased to 2.7x from 2.3x at Dec. 31, 2011 with the decline in profitability during the first quarter.
Liquidity:
Much of Avon's healthy liquidity is derived from maintaining more than $1 billion in cash. Avon's liquidity of almost $1.5 billion at the quarter-end, however, is down from almost $2.5 billion at the end of 2010. Debt maturities are very modest in 2012 at just $17 million; however, $250 million 4.8% notes are due in March 2013 and $125 million 4.625% notes are due in May 2013. The $1 billion revolver terminates in November 2013 as well. Fitch expects that these will be refinanced or renegotiated.
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' (Aug. 12, 2011)
--'Fitch Downgrades Avon's IDR to 'BBB-/F3'; Outlook Stable (May 8, 2012);
--'FBT and Consumer - FCF Efficiency Leaders and Laggards (July 28, 2011);
--'Foreign Corrupt Practices Act - No Minor Matter' (June 1, 2010).
Applicable Criteria and Related Research:
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229
FBT and Consumer -- FCF Efficiency Leaders and Laggards
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=638784
Foreign Corrupt Practices Act -- No Minor Matter
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=526965
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