CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed Brown-Forman Corporation's (Brown-Forman) ratings at 'A'/'F1' and revised the Outlook to Negative from Stable on the announcement of Brown-Forman's acquisition of The BenRiach Distillery Company Limited for approximately BP285 million or approximately $400 million.
Fitch views the acquisition of the BenRiach Distillery Company as highly complementary and fills a gap in Brown-Forman's aged spirits portfolio by adding super-premium Scotch whisky brands to the company's existing premium-to-super-premium whiskey portfolio. Additionally, the new brands will replace a portion of the cash flow associated with the divestiture of Southern Comfort and Tuaca with more margin accretive cash flows. Over the long term, Fitch expects good growth potential for these Scotch whisky brands, as Brown-Forman invests behind the brands and leverages its global distribution network.
The Outlook revision to Negative reflects the continued erosion of Brown-Forman's credit profile driven primarily by an aggressive financial policy towards debt-funded share repurchases and expectations that Brown-Forman will fully complete its $1 billion share repurchase program in fiscal 2017 combined with the increased debt associated with the acquisition of The BenRiach Distillery Company. As a result, Fitch believes leverage will increase to 1.6x for FY2016 and approximately 2.1x in FY2017 before moderating in FY2018 to slightly less than 2x due to growth in EBITDA. This compares to debt/EBITDA in the 1x-1.1x range during the last few years.
KEY RATING DRIVERS
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 Tennessee Fire.
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, Finlandia Vodka, Canadian Mist and El Jimador Tequila have experienced further volume pressure during FY2016. The El Jimador brand family declined in Mexico as the company continues brand repositioning at a more premium price point through multi-year price increases.
Brown-Forman's spirits portfolio primarily competes in the premium and super premium categories and skews toward American whiskeys. 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 American whiskey.
As such, Brown-Forman has experienced strong category momentum for Jack Daniel's Tennessee Honey and the higher-priced Woodford Reserve family with depletion volume growth at 10% and 27%, respectively, during the first nine months of fiscal 2016 (ended Jan. 31, 2016). The Jack Daniel's Tennessee Fire line extension experienced strong underlying net sales growth, contributing over 1% of overall underlying sales growth during the same time period. Industry demand trends should remain strong for the foreseeable future which, when coupled with Brown-Forman's portfolio, would allow the company to grow at above-average rates for the next several years.
Operating Performance In-line with Expectations
Sales, net of excise taxes, decreased 2% to $3.15 billion for the first nine months of FY2016. Sales growth on an underlying basis was 5% with growth in volume of 1%, price/mix of 4%, and foreign exchange impact of 8%. Growth in the U.S. and Europe, which represents over 70% of net sales, was 7% and 5%, respectively, on an underlying basis. Fitch expects underlying revenue growth of approximately 5%-6% in FY2016 and FY2017 and foreign currency pressure of 7% and 4% in FY2016 and FY2017.
Operating income increased 2% to $807 million for the first nine months of FY2016, pressured by foreign currency of 5%. Underlying operating income continues to benefit from positive volume and price/mix, growing by 7% during the same period. Currency headwinds in the high single digits are expected to impact the full-year results for FY 2016. Fitch expects currency headwinds will continue to weigh on the results in FY2017, although to a lesser extent than in FY2016. Fitch expects EBITDA growth to be up 1% in FY2016 and up approximately 3% in FY2017 due primarily to the brand portfolio restructurings, improvements in gross profit margin, a decline in SG&A expense and organic growth in the rest of the portfolio.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for Brown-Forman in 2016 include:
--Net revenue down 1% in FY2016, flat-to-slightly negative in FY2017, and growing low-to-mid-single digits in FY2018. Underlying revenue growth is expected in the 55-6% range over the forecast period.
--EBITDA margins increasing in FY2017 to approximately 37.5%, and 40bps in FY2018 driven by improved gross margins on the brands in the portfolio.
--Capital expenditures of $130 million in FY2016, growing to over $200 million in FY2017 to support additional capex related to the BenRiach acquisition and distillery buildout for Slane Castle.
--Free cash flow (FCF) margins growing from 4.5% in FY2016 to approximately 6.5% in FY2017 with margins in the high single digits in FY2018 as capital spending declines.
--Total Debt/EBITDA of 1.6x in FY2016 increasing to approximately 2.1x in FY2017 assuming Brown-Forman completes its $1 billion share authorization. Leverage moderates to less than 2x as a result of EBITDA growth in FY2018 and beyond.
RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to a positive rating action include:
Positive rating actions are not anticipated in the intermediate term given the expected increase in leverage and the Negative Outlook. Over the longer term, a positive rating action would be based on continued strong operating performance driven by the Jack Daniel's Brand Family combined with:
--Decreased leverage such that total debt-to-operating EBITDA is below 1.5x;
--FFO adjusted leverage in the low 2x range on a sustained basis.
Any potential ratings upgrade however would be limited given Brown-Forman's dependence on the Jack Daniel's franchise.
Future developments that may, individually or collectively, lead to a negative rating action include:
--Total Debt-to-EBITDA sustained above 2x;
--FFO adjusted leverage sustained above 3x;
--FCF margin sustained below 5%;
--A material leveraging transaction;
--Further aggressive shareholder-based initiatives;
--A significant and sustained loss of market share for the Jack Daniel's brand.
LIQUIDITY
Brown-Forman's cash balances, stable FCF generation and substantial credit facility capacity provides good liquidity. As of Jan. 31, 2016, Brown-Forman had $317 million of cash. FCF for the past 12 months was $299 million. FCF is expected to be at least $140 million in FY2016, improving to $200 million-$300 million annually in FY2017 and beyond as organic growth in the mid-single-digit range and expected decreases in capital spending offset the loss in cash flow from the Southern Comfort brand. Fitch expects Brown-Forman will fund a portion of the acquisition with offshore cash proceeds from the Southern Comfort divestiture and should provide Brown-Forman an opportunity to access future foreign-generated cash.
The company has not drawn on its $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 (CP) program. CP borrowings were $506 million for the quarter ended Jan. 31, 2016, which leaves available capacity of $294 million. The credit facility includes an interest-coverage financial maintenance covenant of 3x. Brown-Forman maintains a very manageable maturity profile with $250 million coming due in 2018.
Fitch affirms the following ratings:
--Long-Term Issuer Default Rating (IDR) at 'A';
--Short-Term IDR at 'F1';
--Commercial paper at 'F1';
--Senior unsecured notes at 'A';
--Bank credit facility at 'A'.
The Rating Outlook is Negative
Additional information is available on www.fitchratings.com
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362
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