NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the Issuer Default Rating (IDR) for Avnet, Inc. (Avnet) at 'BBB-' with a Stable Outlook.
KEY RATING DRIVERS
The ratings and Outlook incorporate the following considerations:
--Avnet maintains a leading market position in both segments of its business. The growth in scale and breadth of its business over the years has enabled Avnet to increase its importance and value in the global supply chain. Fitch believes this should serve to boost the relative permanence of its value-added distribution model.
--Avnet has maintained a reasonably conservative balance sheet and approach to capital allocation with leverage (total debt to total operating EBITDA) currently at 2.1x based on Fitch's estimates. Further, the company has consistently produced positive free cash flow (FCF) across the cycle, aided in part by the countercyclical nature of its working capital cash flow.
--Avnet's credit strengths are balanced by the relative low margins and high capital intensity of the distributor model, as well as the inherent volatility in the markets it serves. The company's acquisition growth strategy is also a potential source of event risk for bondholders. Some larger acquisitions, such as Avnet's 2010 purchase of Bell Microproducts, can lead to execution risk in integration which is complicated by the relative low margin nature of the business.
--Fitch expects low to mid-single digit organic revenue growth in 2014 as Avnet manages modestly improving end market demand despite continuing macroeconomic concerns. Fitch would expect EBITDA margins (currently 3.8% for the latest 12 months [LTM] ending Sept. 28, 2013) to stabilize near the 4% level as the company adjusts to a slow end-market environment. In a flat revenue environment, Fitch estimates Avnet would generate approximately $500 million in annual FCF.
--In a stress scenario, Fitch would expect revenue declines and EBITDA margins to reflect trough levels of the last downturn in 2009, or roughly 10% revenue declines and 3% EBITDA margins. In a stress scenario, Fitch would expect working capital cash inflows to largely offset lower EBITDA levels and FCF to fall only modestly from normalized levels, if at all.
--The ratings incorporate expectations that Avnet will maintain leverage of 2.5x or below (3x when adjusted operating leases) on a normalized basis given Avnet's business model and credit profile. Fitch estimates leverage at 2.1x (approximately 2.6x adjusted) and interest coverage (EBITDA to total interest expense) at 9x as of Sept. 28, 2013.
--Avnet's recent decision to implement a quarterly dividend does not impact the ratings but does reduce financial flexibility. This could pressure the investment grade rating in a stressed environment, particularly if share repurchase activity exceeds FCF generation before changes in working capital.
--Fitch expects uses of cash flow and excess cash will principally fund organic growth, working capital needs, potential modest acquisitions and share repurchases. Avnet has roughly $224 million in remaining share repurchase authorization and has repurchased $79 million in the LTM period. Fitch believes Avnet has headroom for a moderate amount of share repurchases given the cash generative nature of the business model. However, aggressive shareholder-friendly actions in the face of increasing macroeconomic uncertainty could pressure ratings if such action would be expected to lead to higher leverage once revenue growth returns.
--Fitch believes Avnet could potentially pursue debt-financed acquisitions resulting in higher than expected leverage if opportunities arise going forward. Such a scenario could pressure ratings if Fitch did not reasonably expect that Avnet would reduce leverage closer to historical levels in the short-run.
Fitch believes Avnet's diversification efforts into areas like software, network security, cloud-based services and reverse logistics are important developments for the company's credit profile. Fitch would expect demand for these products and services to be less volatile than the traditional hardware and components businesses. As these areas of focus grow to comprise a greater portion of Avnet's business through organic growth and additional acquisitions, Fitch believes the resulting diversification of revenue streams would help solidify Avnet's rating in the investment-grade category.
Credit strengths include Avnet's leading market positions in both component and enterprise computing distribution worldwide; the ability to generate cash from operations in a normal growth environment, as well as achieve significant FCF in a downturn from reduced working capital; a highly diversified customer base and well-diversified supplier base with only IBM representing greater than 10% of revenue over the past several years.
Credit concerns include Avnet's thin operating margins, which are typical of the IT distribution market; significant investment levels required to increase share in the faster-growing Asia-Pacific region, including potentially debt-financed acquisitions; integration risk stemming from Avnet's acquisition growth strategy; Avnet's exposure to the cyclical demand patterns and cash flows associated with the semiconductor and networking sectors; and the potential for future debt-financed share-repurchase programs.
Total liquidity as of Sept. 28, 2013 was solid and consisted principally of $866 million of cash and cash equivalents; $998 million of available borrowing capacity under Avnet's $1 billion senior unsecured bank credit facility expiring November 2016; and $472 million available under an $800 million A/R securitization facility expiring August 2014.
Total debt as of Sept. 28, 2013 was $2.1 billion and consisted principally of the following:
--$328 million drawn on the company's $800 million A/R securitization facility expiring August 2014;
--$300 million 5.875% senior notes due March 2014;
--$250 million 6% senior notes due September 2015;
--$300 million 6.625% senior notes due September 2016;
--$300 million 5.875% senior notes due June 2020; and
--$350 million 4.875% senior notes due December 2022.
Fitch has affirmed the following ratings for Avnet:
--Issuer Default Rating (IDR) at 'BBB-';
--$1 billion senior unsecured revolving credit facility at 'BBB-';
--Senior unsecured debt at 'BBB-'.
The Rating Outlook is Stable.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
--Revenue declines that signal a loss of market share, either to other distributors or suppliers increasingly going direct to market;
--Severe operating margin compression resulting from intense competition or supplier price pressures;
--Significant debt-financed acquisitions and/or share repurchases, particularly if funded from cash generated from working capital declines.
Positive: Upside movement in the ratings is limited given Avnet's razor-thin operating margin profile with significant cyclical demand exposure. Significant sustained improvement in credit metrics paired with a long-term strategic business rationale and demonstrated commitment from management to maintain a higher rating would be necessary.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology', dated Aug. 5, 2013.
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage