NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings for Avon Products, Inc. (Avon). In addition, Fitch has removed the ratings from Negative Watch. The ratings were placed on Rating Watch Negative on Nov. 4, 2013 following the uncertainty over the potential size of the monetary penalties the company faced related to Foreign Corrupt Practices Act (FCPA) violations. The Rating Outlook is Negative.
Fitch affirms Avon's ratings as follows:
--Long-term Issuer Default Rating (IDR) at 'BB';
--Bank credit facility at 'BB';
--Bank Term Loan at 'BB';
--Senior unsecured notes at 'BB';
--Short term IDR at 'B';
--Commercial Paper at 'B'.
Fitch has also affirmed Avon's subsidiary's Avon Capital Corporation ratings as follows:
Avon Capital Corporation (ACC):
--Short-term IDR at 'B';
--Commercial Paper at 'B'
Commercial paper issuances by ACC are fully guaranteed by Avon.
KEY RATING DRIVERS
NEGATIVE WATCH REMOVED AFTER FCPA OUTCOME
Fitch placed Avon on Negative Watch after text in the company's Sept. 30, 2013 10-Q SEC filing stated that not only could the company's financial condition be affected, but its ongoing business could be materially adversely impacted. The publicly announced outcome, discussed below, has no material impact to Avon's ongoing business.
Avon recently announced that it has reached an understanding on settlement terms with the Department of Justice and the staff of the Securities and Exchange Commission. Avon is to pay $135 million in aggregate fines, enter into a deferred prosecution agreement (DPA), and agree to a government compliance monitor for 18 months with self-monitoring for an additional 18 months. Avon currently has comfortable liquidity although the payment will depress FCF when paid.
NEGATIVE OUTLOOK ON FURTHER BUSINESS MODEL RISKS
The Negative Outlook is due to intensifying business model risk not only in North America and Asia Pacific but also in Europe and the company's Latin American stronghold. Model risks are reflected in negative volume and active representative declines over the past three quarters. Fitch had expected soft results in North America and Asia Pacific to continue. This played a key part in the downgrade to 'BB' in November 2013. However, declining active rep growth and volumes throughout the rest of the world since 3Q'13 was worse than Fitch anticipated.
Management is working on solidifying markets with some stabilization expected in the second half of this year. Nonetheless, visibility to sustained stability and overall growth remains unclear.
If sales and, in particular, the number of active representatives and volumes remain negative, currently good credit protection measures could be negatively impacted in the medium term. The Rating Outlook could be revised to Stable if solid signs of stabilization in key markets materialize over the next several quarters.
SLOW TURNAROUND, DECLINING OPERATING CASH FLOWS
The turnaround in Avon's operations is clearly taking longer than management or Fitch has expected. In the interim, the company needs to continue investing in restructuring efforts, product launches, improved business processes and its representatives. These are future draws on internally generated liquidity from operating cash flow which has declined sequentially from $782 million in 2009 to $544 million through the latest 12 months (LTM).
Fitch notes that the company is able to maintain a flat 10% adjusted EBITDA margin quarter over quarter despite an 11% revenue decline in 1Q'14 to $2.1 billion. The benefits of the company's cost cutting, disposition and market exits has been promising. However, a lengthy turnaround increases the potential of further market share losses, sales deleveraging and a heightened risk that adequate credit protection measures that exist today, could weaken.
METRICS AND LIQUIDITY GOOD IN THE NEAR TERM
Avon's credit protection measures improved since the company cut its dividend by 75% in 4Q'12, used a portion of its cash balances to reduce overall debt levels, and refinanced near-term maturities. Leverage (debt/EBITDA) declined to approximately 2.9x for the LTM ended March 31, 2014 from 3.5x at year end 2012. Long-term debt maturities through 2015 are modest. Term loan amortization of $13 million is due in 2014 and the remaining $39 million is due in 2015.
FCF for the LTM was $246 million, a positive turnaround from several years of marginal or negative results. The improvement in FCF was supported by the dividend cut from roughly $400 million to $100 million annually.
Liquidity has declined moderately from $2.1 billion last year to $1.8 billion but remains adequate. Cash balances were almost $800 million at quarter end. There is ample ability to fund the $135 million FCPA payment. The company has solid financial flexibility with its covenants. The company states that if they were to fully draw the $1 billion revolving credit facility, which matures in March 2017, Avon would remain in compliance with its covenants. The company's near term liquidity is a positive though it is noted that the leverage covenant tightens from 3.75x to 3.5x after Sept. 30, 2014.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--An upgrade is not likely in the next 12 - 18 months due to the slow pace of turnaround and accelerating negative operating trends in most markets. However, if there is a significant turnaround in the business model and FCF absent the FCPA payment can be maintained over the $200 million level an upgrade could be considered.
--Stabilizing the Outlook as mentioned above is dependent on Avon's ability to achieve flat to positive consolidated volume and active representative growth over several quarters. The company has some cushion here given comparatively easy comps. Avon should also maintain FCF of at least $100 million in 2014 taking into account the FCPA payment.
Negative: Future developments that may, individually or collectively, lead to a negative rating action:
--Avon's credit protection measures including leverage and liquidity are ample in the near term. However, if sales declines accelerate -- which would be exemplified by active representative and volume declines, margin compression, increases in leverage over 4x and modest or negative FCF - then along with the rating, credit protection measures in the medium term are likely to feel the impact.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 2013)
Applicable Criteria and Related Research:
Corporate Rating Methodology -- Effective 12 August 2011 to 8 August 2012