June 20, 2017 / 6:50 PM / a month ago

Correction: Fitch Affirms Avon's IDR at 'B+'; Outlook Negative

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(The following statement was released by the rating agency) NEW YORK, June 20 (Fitch) This is a correction of release published earlier today. It includes the affirmation of Avon International Operations, Inc.'s IDR at 'B+', which was omitted from the original release. Fitch Ratings has affirmed Avon Products, Inc.'s (Avon) Long-Term Issuer Default Rating (IDR) at 'B+'. The Rating Outlook is Negative. A full list of rating actions follows at the end of this release. KEY RATING DRIVERS Weak Operating Trends: Avon's operating results have been on a declining trajectory over the past five years. Two of the key metrics that demonstrate the health of a direct-selling organization, representative base and volume growth, have shown continued declines. Avon has taken some positive steps, targeting operating margin improvement through a three-year "Transformation Plan", and selling a majority stake in the low-margin, EBITDA-neutral North American business in 2016, which allows Avon to focus on more profitable geographies. Turnaround Visibility: Avon's recently reported first quarter showed a 2% increase in revenue (-1% constant currency). It was Avon's first quarter of positive growth since 3Q11 (including currency impact). Fitch notes that the growth is a result of higher price mix, as units sold continue to decline. Margins continue to be challenged as Avon invests back in advertising and contends with significantly higher bad-debt expense out of Brazil. The company does appear to be on track with its Transformation Plan which delivered $120 million in savings in 2016, ahead of expectations. FX, Emerging Markets Exposure: Avon is one of the most geographically diverse companies, selling to 57 countries and territories. Avon's top 10 markets, mostly Emerging Markets, account for 70% of revenue. Latin America represents 52% of revenue, with Brazil, the single largest market, contributing 21% of 2016's total revenue. Negative FX translation has had an outsized impact on Avon's financials as most of its cash flows and profits are generated outside the U.S.; economic and political volatility can also have a significant impact. Direct-Selling Model Challenge: The beauty industry is structurally attractive and tends to be a resilient category throughout economic cycles. Beauty & Personal Care categories reached $426 billion in annual sales globally and Direct Selling reached $131 billion in 2015. With the channel shift towards e-commerce and specialty stores, Avon, the world's #1 direct selling beauty company, is facing intensified competition from multi-national beauty giants who are implementing omni-channel strategies, as well as smaller, nimbler, fast-growing companies. Improved Financial Resiliency: The divestiture of the Liz Earle business in 2015, sale of preferred stock, and partial sale of the North American business in 2016 to Cerberus, enabled Avon to raise liquidity and improve its capital structure, by repaying its 2016 notes and extending its maturity profile. No long-term debt is due until March 2019. In 2016, Avon reduced debt by approximately $260 million. The Cerberus investment and dividend suspension provided Avon with incremental liquidity. Fitch expects Total Debt/EBITDA to remain within 4x-5x over the next three years. DERIVATION SUMMARY Avon's IDR reflects its sizable scale as a leading direct-selling beauty company with $5.7 billion revenue in 2016 and its well-recognized brand in the beauty industry. However, its operating results have been on a declining trajectory in recent years as the company faces challenges from its direct-selling model, emerging market exposure, and FX headwinds. The Negative Outlook continues to reflect the company's declining EBITDA trend, due to its challenged business model and exposure to weak markets such as Brazil and Russia. Fitch's recovery analysis assumes $400 million going-concern EBITDA, which represents approximately a 22% haircut to Avon's 2016 EBITDA of $510 million and a recovery multiple of 4x, driving an estimated enterprise value (EV) of $1.6 billion. The going-concern EBITDA reflects continued decline in Avon's key markets, deteriorating margin due to competitive pressure, and business model weakness. The recovery multiple of 4x EV/EBITDA multiple is at the low end of recent consumer products transactions but considers Avon's operating challenges. Avon is currently trading at 6x-7x EV/LTM EBITDA range. Avon International's senior secured revolver and senior secured notes are expected to have outstanding recovery prospects (91% - 100%) and as such are rated 'BB+/RR1' with 100% recovery prospect. The revolver and senior secured notes are secured by Avon International Operations, Inc., a wholly owned subsidiary of Avon, and are guaranteed by Avon. Avon's senior unsecured notes are expected to have average recovery prospects (31% - 50%) and are rated 'B+/RR4' with a 39% recovery prospect. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --Revenue is expected to grow at very low-single-digit rates, primarily driven by pricing mix, barring further currency movements --EBITDA (Fitch adjusted), which was approximately $510 million in 2016, is projected to temporarily decline to approximately $470 million in 2017, due primarily to upfront investment in Avon's Transformational Plan. Fitch expects that the combination of modest revenue growth and expense management will drive EBITDA towards the mid-$500 million level by 2020. --FCF is expected to be slightly negative in 2017 and turn positive from 2018 onward given the completion of the Transformation Plan and its associated cash costs in 2017. Fitch assumes the company's dividend remains suspended throughout the forecast period. --Leverage, which was 4.2x in 2016, is expected to increase to mid-4x in 2017 on lower EBITDA, and improve toward 4.0x thereafter on EBITDA improvement and some debt paydown. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action --Stabilization of the Outlook is based on sustaining flat-to-modestly positive representative growth as well as low-single-digit organic growth; --While pricing may drive the bulk of organic growth in the near term, Fitch expects positive volume to also be a contributor. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --Continued sales declines; --EBITDA sustained below $500 million after 2017; --Reduced confidence in positive FCF after 2017; --Sustained increases in leverage over 5x; --Currency challenges in significant markets such as Brazil and Russia. Avon's debt is dollar-based and cash flow for debt service is generated offshore. LIQUIDITY Adequate Liquidity: As of March 31, 2017, Avon had cash on the balance sheet of $560 million, and $356 million in revolver availability (after netting out $44 million outstanding letters of credit). The senior secured revolving credit facility (RCF) has total capacity of $400 million and expires in June 2020, provided that it terminates on the 91st day prior to the maturity of the 6.50% notes due 2019 and the 4.60% notes due 2020, if on the 91st day, the applicable notes are not redeemed, repaid, discharged or otherwise refinanced in full. This facility is secured on a first-priority lien basis by substantially all of the assets of Avon International Operations (AIO, the wholly-owned domestic subsidiary) and the subsidiary guarantors. Capital Structure: As of March 31, 2017, Avon had total debt of $2.13 billion, including an undrawn revolver with capacity of $400 million, $500 million in senior secured bonds due 2022, $1.4 billion of senior unsecured bonds, and $450.4 million of preferred stock to which Fitch assigned 50% equity credit. AIO is the borrower for the revolving credit facility as well as the senior secured notes, whereas the senior unsecured notes are obligations of the parent, Avon Products Inc. The RCF contains a minimum interest coverage ratio and a maximum total leverage ratio. Avon was in compliance with all covenants as of March 31, 2017. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings: Avon Products, Inc. --Long-Term IDR at 'B+'; --Senior unsecured notes at 'B+/RR4'. In addition, Fitch has withdrawn Avon Products, Inc.'s Short-Term IDR of 'B' as the company no longer has a commercial paper program. Fitch has affirmed the following ratings: Avon International Operations, Inc. --Long-Term IDR at 'B+'; --Senior secured revolver at 'BB+/RR1'; --Senior secured notes at 'BB+/RR1'. The Rating Outlook is Negative. Contact: Primary Analyst Ellen Itskovitz, CFA Senior Director +1-312-368-3118 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst David Silverman, CFA Senior Director +1-212-908-0840 Committee Chairperson Stephen Boyd Senior Director +1-212-908-9153 Summary of Financial Statement Adjustments: Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation, restructuring costs, and other one-time costs. 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