April 24, 2017 / 4:05 PM / 4 months ago

Fitch Affirms Avnet's IDR at 'BBB-'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, April 24 (Fitch) Fitch Ratings has affirmed the Issuer Default Rating (IDR) of Avnet, Inc. (Avnet) at 'BBB-' and its senior unsecured debt at 'BBB-'. The Rating Outlook remains Stable. As of Dec. 31, 2016, Avnet had approximately $3.6 billion of debt outstanding. The ratings are supported by Avnet's market leadership and scale, diversified customer base, and FCF generation. Factors limiting the rating include elevated leverage resulting from the Premier Farnell acquisition, weak bargaining power of distributors relative to suppliers, and narrow operating margins. The ratings also reflect Fitch's expectation that Avnet will use $1.5 billion of proceeds from the Technology Solutions (TS) divestiture to reduce debt. The Stable Outlook reflects Fitch's belief that divesting the underperforming TS business and focusing on the company's core components business will stabilize revenue and increase profitability. Semiconductor consolidation has been elevated in recent years causing pricing pressure for distributors. In response, Avnet and its direct competitors have invested in engineers, created design communities and have been providing extensive technical product information to designers. These value-added strategies have stabilized EBITDA margins, and Fitch expects margin expansion over the rating horizon from the margin accretive acquisition of Premier Farnell and synergies related to Premier Farnell and the TS divestiture. KEY RATING DRIVERS Market Leadership and Scale: A top-tier components distributor, Avnet offers customers and suppliers a global footprint that optimizes logistics and connects suppliers with fragmented distribution channels. Fitch believes Avnet is likely to sustain its leadership position due to its broad product portfolio and scale that would be difficult to replicate given the fragmented nature of its customer base. Weak Position of Supply Chain: Avnet's low EBITDA margin profile reflects the constrained pricing power distributors have relative to suppliers and the lower value-added nature of the distribution business. The largest customers go direct to the supplier and during slow growth periods suppliers tend to take more customers direct, exacerbating exposure to semiconductor cyclicality. Moreover, supplier consolidation results in broader product portfolios, which disrupts the distributor business model and results in pricing pressure. Distributors have been investing in engineers for design and technical support to generate higher margin demand-creation sales to help offset pricing pressure. Elevated Leverage: Fitch expects approximately $1.5 billion of proceeds from the sale of Avnet's TS business to Tech Data Corporation will be used to reduce debt and lower total debt adjusted for rental expense to operating EBITDAR (adjusted leverage) below Fitch's 3.5x sensitivity in the near term. A deviation from Fitch's expectation for the company to reduce adjusted leverage below 3.5x would likely result in a downgrade. Following debt reduction, Fitch expects Avnet's capital allocation priorities will focus on M&A and shareholder returns. Strategic Transformation: Fitch views Avnet's strategy to become a standalone electronics component distributor as a positive due to the exit of declining business and expected margin improvement but is offset by less scale and diversification. Fitch believes investments to turn around the TS segment would have been costly and reduced focus on the core business. Recent acquisitions of Premier Farnell and Hackster.io have resulted in a broader suite of products spanning the entire product lifecycle from idea generation and design through production. Fitch expects the acquired customer bases to be stickier and improve margins. FCF and Cyclicality: Fitch expects about $150 million to $250 million of mid-cycle annual FCF, driven by increased electronic content in automotive and industrial end markets. In a downturn, cash from the liquidation of inventory should offset lower operating EBITDA to support FCF. Avnet is exposed to the cyclicality of semiconductor demand causing significant swings to revenue and profitability. Fitch believes semiconductor cyclicality has declined over time due to more rational supplier production and tighter inventory management from distributor consolidation. Capital Allocation Strategy: Fitch expects Avnet to continue to pursue acquisitions in the design space or areas with the potential to disrupt such as aggregators. Acquisitions are likely to be focused on smaller deals until recent acquisitions are integrated and leverage is closer to the company's long-term target. Avnet recently announced a 5.9% increase of its dividend and received board approval for a $500 million share repurchase program, increasing total availability to $675 million as of February 2017. KEY ASSUMPTIONS Fitch's key assumptions within Fitch's rating case for the issuer include: --Fitch expects organic revenue growth in the low single-digits supported by increased electronic content in growth semiconductor verticals including auto and industrial; --EBITDA margins in the mid single-digits with expansion from the divestiture of the lower margin TS business, Premier Farnell acquisition and synergies; --Mid-cycle FCF of $150 million to $250 million annually through the rating cycle; --Small- to medium-sized acquisitions over the rating horizon to build out the digital platform; --Quarterly dividend payments and excess cash flow used to repurchase stock. RATING SENSITIVITIES Negative: Fitch's expectation for adjusted leverage (adjusted debt to EBITDAR) to be sustained above 3.5x or gross leverage (unadjusted debt to EBITDA) to be sustained above 3.0x, most likely due to domestic cash limitations or debt financed acquisitions, or the expectation for mid-cycle FCF to adjusted debt approaching 5% or below could result in a negative rating action. Positive: Upside movement in the ratings is limited given Avnet's narrow operating margin profile with cyclical demand exposure. Sustained improvement in credit metrics paired with a long-term strategic business rationale and demonstrated commitment from management to maintain a higher rating would be necessary. LIQUIDITY Avnet's liquidity is solid and supported by cash of approximately $1.3 billion ($1.2 billion offshore) as of Dec. 31, 2016 and $318 million available under the company's $1.25 billion senior unsecured revolving credit facility, expiring July 2019. Additionally, Fitch expects mid-cycle FCF of $150 million to $250 million through the forecast. Total debt as of Dec. 31, 2016 was $3.6 billion and consisted primarily of: --$1.25 billion senior unsecured revolving credit facility due 2019 ($927 million drawn); --$504 million senior unsecured EUR term loan due 2019; --$300 million 5.875% senior unsecured notes due 2020; --$300 million 3.750% senior unsecured notes due 2021; --$350 million 4.875% senior unsecured notes due 2022; --$550 million 4.625% senior unsecured notes due 2026; --$800 million senior secured accounts receivable securitization ($465 million drawn); --$248 million of other debt. Contact: Primary Analyst Zack Schroeder Associate Director +1-312-368-2056 Fitch Ratings, Inc. 70 W. Madison St. Chicago, IL 60602 Secondary Analyst Jason Pompeii Senior Director +1-312-368-3210 Committee Chairperson David Peterson Senior Director +1-312-368-3177 Date of Relevant Rating Committee: April 21, 2017 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: --No material adjustments have been made that have not been disclosed in public filings of this issuer. Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. 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