CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the Issuer Default Rating (IDR) and the debt ratings of Brown-Forman Corporation at 'A+'. A full list of rating actions follows at the end of this press release. The Rating Outlook is Stable.
KEY RATING DRIVERS
New Share Repurchase Exhausts Ratings Flexibility:
Brown-Forman's new $1 billion debt-financed share repurchase program, if fully executed, is viewed as a credit negative and will severely reduce flexibility in the company's ratings. Leverage is expected to eventually rise to the high end of Fitch's expectations. On an funds from operations (FFO) basis, FFO adjusted leverage and FFO fixed charge coverage are expected to be approximately 1.7x and 15x at the end of the company's 2015 fiscal year (FY) in April. Fitch now expects FFO leverage to approximate 2.5x for FY2016.
Longer term, Fitch expects leverage will remain toward the upper end of rating expectations with the increased focus on shareholder returns. Consequently, beyond FY2016, Fitch is anticipating share repurchases are anticipated to pace with free cash flow (FCF), thus any improvement in leverage metrics will be driven by EBITDA growth.
Strong Anchor Brand, Favorable Demand Trends:
Brown-Forman's ratings are supported by the sizeable operating earnings and consistent cash flow generation that is derived from the strong and competitive brand portfolio of one of the largest worldwide spirits companies. Major contributors to Brown-Forman's operating earnings are its Jack Daniel's franchise, which is the fourth-largest premium spirits brand and the largest selling American whiskey brand in the world including its highly successful line extensions, Tennessee Honey, and ready-to-drink beverages. The Jack Daniel's family represents on an annual basis approximately half of the depletions of the company's major brands. Brown-Forman's other major brands are Finlandia Vodka, Southern Comfort Liqueur, Canadian Mist and El Jimador Tequila which have experienced some volume pressure during FY2015.
Brown-Forman's spirits portfolio primarily competes in the super premium to premium category and skews toward whiskeys, liqueurs and bourbons. Fitch views this as a competitive strength, because the aging process and inventory investments required are a barrier to entry providing an impediment particularly for value competition. Brown-Forman spirits have taken share from beer and clear spirits with the favorable demand trends driven by flavored and higher-end whiskey and bourbon products.
As such, Brown-Forman has experienced strong category momentum for Jack Daniel's Tennessee Honey which has continued to grow depletion volume above 30% during fiscal 2015 to more than 1 million cases. Industry demand trends should remain strong for the foreseeable future that when coupled with Brown-Forman's portfolio would allow the company to grow at above average rates for the next several years.
Debt Structure and Liquidity:
Brown-Forman maintains a very manageable maturity profile with approximately $250 million coming due in 2016 and $250 million in 2018. The company has an undrawn $800 million five-year credit facility that matures in November 2018, which can be expanded by $400 million. The credit facility is primarily used to support the company's $1 billion commercial paper program. Commercial paper borrowings averaged $153 million during the quarter ending Jan. 31, 2015. The credit facility includes an interest coverage financial maintenance covenant of 3.0x.
Brown-Forman cash balances, stable FCF generation and undrawn credit facility provide good liquidity. As of Jan. 31, 2015, Brown-Forman had $250 million of cash, with $187 million being held by foreign subsidiaries whose earnings Brown-Forman expects to reinvest indefinitely outside the U.S. FCF for the past 12 months was $250 million. Fitch expects FCF in fiscal 2015 to decline moderately to less than $200 million due to higher levels of working capital, negative effects from foreign exchange and increased dividends. FCF is expected to be at least $200 million in FY2016 before increasing in the following years through organic growth and as capital spending ramps down following capacity investments to maintenance levels of approximately $80 million by fiscal 2018.
In October 2014, Brown-Forman had authorized a new stock repurchase program of up to $250 million. As of Jan. 31, 2015, Brown-Forman had repurchased shares totaling $66 million. Share repurchases totaled $288 million the last 12 months as Brown-Forman completed the previous $250 million share repurchase program authorized in 2013 during 2014. Fitch expects Brown-Forman to begin the new $1 billion share program once the 2014 repurchase program is completed. The existing buyback authorization had $108 million remaining as of market close on March 24, 2015.
Fitch believes Brown-Forman could participate in industry consolidation with bolt-on sized acquisitions. However, the sizable $1 billion share repurchase program would seem to indicate the company does not view a near-term acquisition as probable. The company's acquisition strategy is to acquire brands opportunistically with growth potential and are complementary to its current portfolio. Acquisitions that could improve the portfolio would include Scotch, Irish whiskey, Vodka or a local brand.
Operating Performance In-line with Expectations:
Sales, net of excise taxes, increased 3% to $2.4 billion for the nine months ended Jan. 31, 2015. Sales growth on an underlying basis was 5% with growth in volume of 2% and price/mix of 3%. Growth in the U.S. and Europe, which represents approximately 75% of net sales, was 7% and 5% respectively on an underlying basis. The Jack Daniel's franchise experienced 5% net depletion volume growth and was the primary contributor to overall sales growth, aided by Brown-Forman's super/ultra-premium whiskey brands that grew underlying net sales by double digits including 32% by Woodford Reserve, a super-premium bourbon brand. El Jimador, Southern Comfort Canadian Mist and Finlandia all experienced declines in the low-, mid-, mid- and high- single digits respectively. The weak volume performance varied depending on the brand and represents an area the company must improve on to maintain longer-term expected growth rates.
Underlying operating income, excluding currency, increased 7% to $795 million and continued to benefit from volume and distribution changes in France. EBITDA margins for the past nine months increased modestly to 34.2%. Currency headwinds of middle-single-digits for fiscal year 2015 are much greater than initial expectations (negligible). Fitch expects currency headwinds will weigh on the results in FY2016.
KEY ASSUMPTIONS
Additional key assumptions within Fitch's rating case for the issuer include:
--Reported revenue and operating income growth in the lower-single digits for FY2016;
--Increased debt of approximately $800 million in FY2016 to fund the $1 billion share repurchase program. As a result, Fitch forecasts FFO leverage would increase to approximately 2.5x and adjusted debt to EBITDAR of 1.8x, which is at the upper end of leverage expectations. Expected improvement in leverage following FY2016 would be due to EBITDA growth;
--After FY2016, share repurchase activity would pace with FCF generation;
--EBITDA margin of approximately 34%;
--FCF of at least $200 million for FY2016 with FCF margin of 7%.
RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to a positive rating action include:
--An upgrade is unlikely given higher than expected leverage for FY2016 and Brown-Forman's dependence on the Jack Daniel's franchise.
Future developments that may, individually or collectively, lead to a negative rating action include:
--Increased leverage such that total adjusted debt-to-operating EBITDAR exceeds 2.0x or FFO adjusted leverage exceeds 2.5x on a sustained basis;
--A material leveraging transaction;
--Sustained FCF margin declining to less than 5%;
--A significant and sustained loss of market share for the Jack Daniel's brand.
Fitch has affirmed the following ratings:
--Long-term Issuer Default rating (IDR) at 'A+';
--Senior unsecured notes at 'A+';
--Bank credit facility at 'A+';
--Short-term IDR at 'F1';
--Commercial paper at 'F1'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014);
--'Alcoholic Beverages: Ratings Navigator Companion Report' (Nov. 14, 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
Alcoholic Beverages: Ratings Navigator Companion
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=803928
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=981937
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