NEW YORK--(BUSINESS WIRE)--Avon credit default swaps (CDS) are trading at record wide levels as the company continues to wrestle with liquidity and the top line, margins and cash flow decelerate, according to Fitch Solutions and Fitch Ratings.
Five-year CDS widened 22% over the past month as of November 11, to a record wide 1,109 basis points. Those levels underperform the broader North America Consumer Goods sector (3% wider). CDS referencing Avon are trading 130% wider than they were at the beginning of this year, a steep increase in the cost of protection.
Avon liquidity has tightened but remains adequate in the near term. The company recently stated that free cash flow (FCF) this year will be below the $100 million guidance just 5 months ago on July 30, 2015. Cash balances have also fallen by more than $370 million from year end. Additionally, as the company evaluates the foreign exchange (F/X) impact on cash and cash flow into 2016, the $100 million or so in dividends could be in jeopardy. While a dividend cut would be positive for creditors, it is also a signal of increased pressure on liquidity.
Negative F/X has had an outsize impact on Avon, which has also been compounded by slowing emerging markets, particularly Brazil. Neither factor appears likely to turn around in the near term, further pressuring margins and cash flows.
The company has nearly $1 billion in liquidity, including a $400 million fully available, secured revolver. However, the modest liquidity cushion does not allow enough flexibility to accelerate a cash restructuring that can better match costs to a much smaller company. Avon's revenues have decelerated at sequentially faster rates since 2012, when it declined 5% to $10.5 billion. Annual revenue growth rates accelerated to negative 7% in 2013, negative 12% in 2014 and is currently negative 18% for the nine months ended Sept. 30, 2015. The company is on pace to end 2015 with about $7 billion in revenues vs. the $10.5 billion recorded in 2012.
However, overhead reductions, as measured by adjusted SG&A, have not kept pace with revenue declines, decreasing only 2% in 2012 and 14% for the nine months of 2015. The rapidly strengthening dollar since 2014 has been a factor in the difficulty of expense reductions keeping pace. Moreover, direct selling, with its millions of representative touchpoints, makes it more difficult to change course midstream and reduces Avon's ability to move quickly to right-size the organization despite declining liquidity. Avon's measured pace of restructuring may be necessitated both by its need to conserve resources in the near term and balance disruption to its sales force.
The Nov. 5 downgrade of Avon Products, Inc.'s issuer default rating (IDR) to 'B+' from 'BB-' reflected Fitch's increasing concern regarding Avon's business model and inability to articulate a viable strategy to improve organic sales and/or address its cost structure, resulting in difficulty predicting a reversal in the negative EBITDA trend. The Rating Outlook is Negative, as stabilization in key operating metrics is uncertain.
Additional information is available on www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.