Fitch Affirms Avon's IDRs at 'BBB-/F3'; Outlook Revised to Negative

Fitch Ratings has affirmed Avon Products, Inc.'s (Avon) and its subsidiary's rating as follows:

Avon Products, Inc:

--Long-term Issuer Default Rating (IDR) at 'BBB-';

--Short-term IDR at 'F3';

--Commercial Paper program at 'F3';

--Bank credit facility at 'BBB-';

--Bank Term Loan at 'BBB-';

--Senior unsecured notes at 'BBB-'.

Avon Capital Corporation:

--Short-term IDR at 'F3';

--Commercial Paper program at 'F3'

The Rating Outlook for Avon and Avon Capital Corporation has been revised to Negative from Stable.

Outlook:

The Negative Outlook reflects that Avon's turnaround will take more time than Fitch initially expected, the company continues to lose representatives, and profitability may be pressured versus prior years leading to a transition period that is likely to extend well past 2012. Liquidity and credit protection measures could deteriorate given the current trajectory. The extended time frame is based on stepped up competition in Avon's significant growth markets of Brazil, Russia, Turkey and Colombia compounded by executional missteps in several countries. All of this is taking place with sudden deceleration in Europe since May accompanied by a general global slowdown.

The direct selling model appears healthy in many international markets. Increase in active representatives or marked increases in average order size, drive growth. In the past, representative growth for Avon increased during economic downturns due to a larger pool of individuals seeking earnings opportunities although average order size tended to be smaller.

Avon's overall representative growth has a negative trend-line, declining in each of the past three quarters. In Europe (25% of Avon's first half revenues) where the regional unemployment rate is over 11%, the number of Avon's active representatives has declined three quarters in a row. Only the Latin American region has managed to show flat or modestly positive representative growth in the past three quarters. However, Fitch is concerned about the first sign of decline in active representatives in the second quarter in Brazil (Avon's largest single market), after years of good to stellar increases in this metric. Russia and the UK also are experiencing declines in representatives. These three markets had been strong contributors to revenue growth, profits or cash flow to the consolidated enterprise.

Avon's operational challenges were reflected in a 53% decline in adjusted operating profits in the first half of 2012 to $288 million from $614 million last year. Operating margins for the first half is approximately 6%. Management had previously guided to a tough second quarter. However, in the earnings discussion on Aug. 1, 2012 it was noted that there are plans to reduce excess inventory in Brazil, which will have a negative impact on the operating margin in the second half of this year.

Fitch expects that given the current trajectory and momentum in Avon's operations, the potential for a downgrade has increased. Fitch views as positive management's clear signal to address the dividend to be in line with its peer group and to fund the payments from internally generated cash flow rather than borrowing. However, if profitability continues be pressured the company's core cash generation will also suffer. The company cited in its recent earnings discussion that fixing Avon will take time. If the fix extends well into 2013 on much lower profits, the company's current liquidity and credit protection measures could become constrained despite the potential dividend cut.

Rating:

Avon's rating reflects the continued trends in Avon's generation of negative free cash flow (cash flow from operations minus capital expenditures and dividends) during the past two years and through the first half of 2012 and increase in leverage (total debt to operating EBITDA) to 3.4X for the last 12 months ended June 30, 2012 (LTM) from the 2.3x seen at year end. The rating also encompasses operational and executional challenges that management is focused on such as increased competition, representative compensation, and inventory management. Fitch expects that margins could be materially lower than 2011, leverage could increase to near 4x, and FCF is likely to remain negative with lower profitability in 2012.

Financial Performance:

For the first half of 2012 Avon's operating performance deteriorated substantially. Sales declined 10% due mainly to negative translation effects. Fitch notes that there was sequential improvement in operating margins in the second quarter but it remains well below the prior period. Higher inflation for labor and materials in the supply chain, lower sales and increased investments in the selling organization among others led to adjusted operating margin declining more than 50% as discussed previously. Debt increased $225 million from year end to $3.5 billion and leverage to 3.4x from 2.3x at year end as the company's $41 million in cash flow from operations had to be supplemented with debt to fund $88 million in capex and $199 million in dividends. Fitch does not expect year end debt levels to increase materially given Avon's decision to not permanently reinvest this year's overseas profits.

Liquidity and Debt:

Much of Avon's solid liquidity of almost $2 billion is derived from maintaining more than $1.3 billion in cash and $670 million availability on the revolver (after excluding $330 million in commercial paper). Approximately $228 million of cash is trapped in Venezuela. Therefore, the company can access about $1 billion though there may be added cash costs based on the amounts and tax differentials between the source country and U.S. rates. Avon has already indicated in its recent filing that in 2012 it will not indefinitely reinvest any current year earnings of its foreign subsidiaries.

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. Avon's $1 billion revolver terminates in November 2013 as well. Fitch expects that these will be refinanced or renegotiated.

What could trigger a rating action:

Future developments, that may individually or collectively lead to a negative rating action include:

Lack of material improvement from recent earnings trends, and debt at current or higher levels, putting pressure on leverage and covenant compliance. Fitch notes that the leverage covenant in the $550 million term loan and $535 million in privately placed notes tighten after March 31, 2013 from 4x to 3.75x for the remainder of 2013. The term loan tightens further to 3.5x after 2013.

Future developments, that may nonetheless potentially lead to a positive rating action include:

The Outlook could return to Stable if earnings and cash flow rebound or show positive traction to stabilization and growth during 2013. Stabilization or growth in active representatives is also critical.

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. 11, 2012).

Applicable Criteria and Related Research:

Corporate Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684460

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