RIO DE JANEIRO & SAO PAULO--(BUSINESS WIRE)--Fitch Ratings has affirmed the following ratings of Natura Cosmeticos S.A. (Natura):
--Long-term foreign currency Issuer Default Rating (IDR) at 'BBB';
--Long-term local currency IDR at 'BBB';
--Long-term national scale rating at 'AAA(bra)';
--Fifth senior unsecured debentures issuance at 'AAA(bra)'.
The Rating Outlook is Stable.
KEY RATING DRIVERS
Natura's 'BBB' ratings reflect its very solid capital structure, robust operational cash flow generation and track record of a sound business model. The company has a leading market position in the Cosmetics, Fragrances and Toilette (CF&T) sector in Brazil. This position is a result of Natura's strong brand recognition, high business scale and distinguished direct sales structure in the country.
Natura's conservative financial profile is a key pillar supporting the company's challenging scenario over the next two years. The company's current business profile is pressured by a more competitive business environment, which has been leading the company to seek alternatives to switch its business model, basically underpinned by a direct sales structure. Natura's ability to carry over this change without further deterioration in its EBITDA margins to below 18% on a recurring basis, while maintaining its strong credit metrics will be key to avoiding a negative rating action in the medium term.
Natura's ratings headroom is low and Fitch expects the company to conservatively manage its financial flexibility by reducing dividend payouts, if necessary, in order to avoid deterioration in its credit profile, with net leverage ratios going beyond 2.0x, on a sustainable basis.
The company's ratings are also constrained by its still limited geographic diversification, with almost all of its cash flow generation derived from Brazil despite the solid growth and improving profitability of the international operations.
Highly Competitive Market
Natura's main challenge is to continue to conduct its activities on a profitable basis while preserving its strong market position in Brazil, within the context of increasing competition and lower market growth rates. Natura's market share in the Brazilian market declined to 20.7% in 2013 from 24.1% in 2010 according to Sipatesp. Competitive threats in direct sales have intensified as a result of a new relevant entrant, O Boticario, and a recovery of Natura's main competitor, Avon Products, Inc. (IDR 'BB'/Negative Outlook). Competition has also increased from retailers and drugstores, which have been receiving strong support and incentives from global consumer companies. There is a new business dynamic in the CF&T market in Brazil, with competitive threats coming from drugstores and supermarkets and from the new 'beauty specialty store chains' and e-commerce, which have as their competitive advantage better payment plans for consumers (installments). As of June 30 2014, Natura had 1.7 million sales consultants. The company's ability to reach consumers through these sales reps is considered an important competitive advantage.
New Business Strategy; Further Deterioration in EBITDA Margin Expected
The structural change in the competitive environment is leading Natura to alter its business strategy. The company is moving to a multi-market, multi-channel and multi-categories strategy. Under this new business model, the company is expected to enhance its portfolio of products and brands and aims to enter into the home & fashion segment, to leverage its distribution platform, and seek opportunities to further develop its internet platform (Rede Natura). Nevertheless, Fitch expects that these new strategies should only be in place from 2017 on.
In the meantime, Natura continues to aim at strengthening its innovation pipeline to occupy new categories in the CF&T market in an effort to be more competitive at the retail level. The company has also increased sales terms and promotional items throughout the sales cycle in order to boost their consultants' productivity.
Fitch believes that the company might be able to capture benefits from the internal actions to reduce costs, but at the same time, stronger marketing initiatives, higher R&D expenses and a lower product mix should drive margins down. Fitch's base case considers EBITDA margins of around 20%, which represents a significant drop from historical margins in the range of 23%-25%. The new EBITDA margin level is still well positioned within global players.
Very Robust and Resilient Cash Flow from Operations
Natura has historically reported sound operational performance. The current scenario should result in lower revenue growth and operating margins in the medium term, but should still generate robust operating cash flows. Natura's competitive advantages and consumer sector fundamentals support the company's business resilience.
During the last 12 months (LTM) ended June 30, 2014, Natura's net revenues and EBITDA generation reached BRL7.3 billion and BRL1.6 billion, respectively, which compares positively with the BRL6.3 billion and BRL1.5 billion posted in 2012. Funds from operations (FFO) and cash flow from operations (CFFO) remained robust at BRL1.1 billion and BRL935 million, respectively. The lower profitability and larger working capital requirements (higher inventories and accounts receivables terms) have been pressuring CFFO and Fitch does not expect any relevant improvement in the medium term. For 2014 and 2015, Fitch expects Natura to generate around BRL900 million of CFFO.
Natura's free cash flow (FCF) generation has been pressured by its aggressive dividend payouts. Yet, Fitch considers Natura to have adequate financial flexibility to reduce these payments if needed. During the LTM ended June 30, 2014, FCF was negative at BRL405 million, resulting from capex in the period of BRL473 million and BRL867 million of dividend distributions. Going forward, FCF should continue to be negative as Natura should maintain its aggressive dividend payout above 90% of its net profit. From 2010 to 2013, total dividend disbursements reached BRL3.1 billion while FCF was negative by BRL736 million.
Fitch does not expect a larger capex volume to support Natura's new strategy. Over the last three years, Natura invested heavily in its production facilities and logistics, and the expected growth did not materialize. Currently, the company's utilization rate within its industrial facilities is 65% and for its logistic network, 55%.
Leveraging Trending Up; Still Conservative
Fitch expects net leverage ratios to stay around 1.5x, which remains consistent with the 'BBB' rating category. The lower operating cash flow generation should result in a moderate leverage increase. Shareholder-friendly policy will likely be maintained as the company seems comfortable with a net leverage level of around 1.0x-1.5x, which is still conservative. As of June 2014 (LTM), the company reported net leverage of 1.3x. From 2010 to 2013, Natura reported, on average, a total leverage ratio of 1.2x and a net leverage ratio of 0.5x.
Natura has a track record of strong liquidity. As of June 30, 2014, cash and marketable securities totaled BRL1.4 billion. This compares with BRL3.6 billion of total debt, of which BRL808 million is short term. The cash/short-term debt ratio is healthy, at approximately 1.8x, and when incorporating CFFO, Natura's cash plus CFFO/short-term debt ratio strengthens to 3.0x.
Challenge to Increase Geographic Diversification
Natura's operating cash flow generation is still concentrated in Brazil, which represents approximately 94% of its consolidated EBITDA. International operations, which are concentrated in other Latin American countries, are still in a ramp-up curve, and over the last quarters have shown an improvement that has resulted in positive EBITDA. Fitch does not expect relevant cash flow from these operations in the medium term, but it should benefit consolidated operating margins and stop consuming resources from the Brazilian operations. Fitch views as positive the company's goal to achieve broader geographic diversification as well as the fact that these activities have been developed with low capital allocation.
RATING SENSITIVITIES
Negative rating actions could be triggered by a severe reduction in operating cash flow generation that could lead to a worsening of the company's credit metrics to net leverage ratio above 2.0x, on a recurring basis. The company's EBITDA margins declining to below 18%, a significant deterioration of its brands' reputation, and/or of its leading market position may also lead to a negative rating action. A relevant leveraging transaction or one that illustrates a departure from Natura's traditional commitment to its conservative financial strategy may also trigger a downgrade.
An upgrade is unlikely in the medium term, given the current challenging competitive scenario and the company's ongoing strategy to boost revenue, while maintain market-share and profitability.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=884974
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