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Fitch Affirms Brown-Forman's Ratings at 'A'; Outlook Revised to Stable from Negative
September 20, 2017 / 3:11 PM / a month ago

Fitch Affirms Brown-Forman's Ratings at 'A'; Outlook Revised to Stable from Negative

(The following statement was released by the rating agency) NEW YORK, September 20 (Fitch) Fitch Ratings has affirmed Brown-Forman Corporation's (Brown-Forman) ratings including the Long-Term Issuer Default Rating (IDR) at 'A' and Short-Term IDR at 'F1'. The Rating Outlook has been revised to Stable from Negative. A full list of ratings follows at the end of this release. Brown-Forman's affirmation and Outlook revision to Stable reflects an improving financial profile due to expectations for decreased leverage, a more balanced capital allocation policy, and improved operating performance that should drive higher profitability and increased EBITDA generation. Brown-Forman is experiencing good growth across its premium positioned spirits portfolio that is supported by a recovery in emerging market regions. A good innovation pipeline including the anticipated launch of Jack Daniels Tennessee Rye and a cost efficiency program to increase investment behind the brands should help offset growing competition in the U.S. craft whiskey category. KEY RATING DRIVERS Strong Anchor Brand: Brown-Forman's ratings are supported by the sizeable operating earnings and consistent cash flow generation that is derived from the strong competitive brand portfolio of one of the largest worldwide spirits companies with 52% of net sales generated overseas. 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. On an annual basis, the Jack Daniel's Family represents approximately 70% of the volume depletions. Brown-Forman's other major brands including El Jimador, Woodford Reserve, Herradura and Finlandia Vodka have all experienced recent volume growth while Canadian Mist performance remains pressured. Brown-Forman has also repositioned its spirits portfolio by monetizing non-strategic secular challenged brands and acquired a couple of small single malt Scotch Whisky and Irish Whiskey brands that offer good longer-term growth potential that can leverage Brown-Forman's global distribution network. Favorable Demand Trends: Since 2010, the U.S. spirits industry has grown at a mid-single-digit CAGR while gaining market share from beer driven by the favorable demand trends in premium and super premium categories within American whiskey (including flavored) and bourbon. Fitch believes the current industry demand trends should remain positive for the foreseeable future with substantial opportunity internationally for Brown-Forman in underpenetrated emerging and developing market regions. However, competition has increased in the premium and above whiskey categories in developed markets and is expected to place more pressure on pricing. Brown-Forman's three-year $100 million cost efficiency program targeting revenue management, cost of goods sold and SG&A efficiencies should enable the company to reallocate resources in order to more aggressively invest behind its brands to offset these competitive pressures. Strong Cash Flow Generation: Brown-Forman has a lower-than-average risk business profile that generates consistent cash flow reflecting the regular product consumption, the absence of technology and R&D risk or heavy and volatile investment along with good profitability and FCF margins typically in the high-single-digit range. Foreign currency and recent asset divestitures have pressured reported operating performance and cash generation. However, underlying trends have remained healthy, evidenced by operating income CAGR of 8% during the past three years, and foreign currency headwinds are expected to diminish in FY2018. Brown-Forman's focus on brown spirits also requires more substantial investments in terms of working capital, expected in the range of $80 million to $100 million annually over the forecast period, as maturing stocks need to be retained before the finished product can be marketed. Financial Profile Improving: Fitch expects total adjusted debt to EBITDAR and lease adjusted FFO gross leverage during FY2018 to improve to approximately 1.9x and 2.5x, respectively, compared to 2.2x and 2.9x at the end of FY2017. Total adjusted debt to EBITDAR for the LTM period ending July 31, 2017 was 2.2x. Brown-Forman's credit profile had deteriorated the past two years following $2.1 billion in accelerated share repurchases that were substantially debt-funded. During FY2017, while Fitch's forecast assumed Brown Forman would repurchase $1 billion in shares, the company completed only $670 million. Fitch does not expect Brown-Forman will repurchase any shares during FY2018 and has indicated plans to repay its January 2018 senior notes maturity of $250 million with cash. Fitch anticipates the company will resume share repurchases in FY2019 with leverage remaining in the upper 1x range for total adjusted debt to EBITDAR and mid-2x range for lease adjusted FFO gross leverage. DERIVATION SUMMARY Brown-Forman's business profile and profitability are well positioned in the 'A' category relative to major peers such as Diageo plc (A-/Stable) and Pernod Ricard S.A. (BBB-/Stable). Diageo and Pernod have moderately better market positions with materially larger scale, more developed distribution networks, more diversity across their product portfolios and greater emerging markets exposure. The competitive strength in Brown-Forman's spirits portfolio resides in its brown spirits portfolio which is anchored in American whiskeys that include Jack Daniel's, the fourth-largest premium global spirits brand. Brown-Forman has a stronger financial profile than either Diageo or Pernod with modestly higher EBITDA margins and lower financial leverage than Diageo. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --Underlying revenue growing in the upper 4% range in FY2018 and lower 4% range in FY2019; --EBITDA margins increasing in FY2017 to approximately 37.5% and roughly 40bps in FY2018 driven by organic growth and operating leverage; --Working capital usage in the $80 million to $100 million range throughout the forecast; --Capital spending peaking in fiscal 2018 at $140 million, declining moderately in fiscal 2019; --FCF margin increasing to 8% in FY2018 and 9% in FY2019; --No share repurchases in FY2018; share repurchases pacing above FCF in FY2019; --Total adjusted Debt/EBITDAR declining to 1.9x range in FY2018 which assumes Brown-Forman repays the $250 million maturity in 2018 and remaining stable in FY2019. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action Positive rating actions are not anticipated in the intermediate term given the increase in leverage but could occur on continued strong operating performance driven by the Jack Daniel's Brand Family combined with: --Commitment to sustain total debt to EBITDAR below the upper 1x range and lease adjusted FFO gross leverage below the low 2x range; 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 Negative Rating Action --Evidence of weakening market position particularly involving the Jack Daniel's brand, reduced operating efficiency, and/or pricing power resulting in weak sales growth and profit margins for a sustained period; --Total debt to EBITDAR sustained above 2.5x and lease adjusted FFO gross leverage sustained above 3.0x; --FCF margin sustained below 5%; --Further aggressive shareholder-based initiatives. LIQUIDITY Solid Liquidity Underpins Profile: Brown-Forman's cash balances, stable FCF generation and undrawn credit facility provide good liquidity. As of July 31, 2017, Brown-Forman had $238 million of cash with $180 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 $210 million. The company has an undrawn $800 million five-year credit facility that matures in November 2018, which can be expanded by $400 million. Fitch expects Brown-Forman will renew and extend the facility on similar terms before coming current later this year. The credit facility is primarily used to support the company's $800 million commercial paper program. CP borrowings were $253 million for the quarter ended July 31, 2017, leaving credit facility availability of $547 million. The credit facility includes an interest coverage financial maintenance covenant of 3.0x which, the company had substantial cushion at 17x. Manageable Maturity Schedule: Brown-Forman maintains a very manageable maturity profile. During the next five years, the only maturity coming due is $250 million in January 2018. The company expects to repay the maturity with excess cash. FULL LIST OF RATING ACTIONS 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 has been revised to Stable from Negative. Contact: Primary Analyst Bill Densmore Senior Director +1-312-368-3125 Fitch Ratings, Inc. 70 W. Madison St. Chicago, IL 60602 Secondary Analyst Carla Norfleet Taylor, CFA Senior Director +1-312-368-3195 Committee Chairperson Michael Weaver Managing Director +1-312-368-3156 Summary of Financial Statement Adjustments - No material adjustments have been made that have not been disclosed in public fillings of this issuer. Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: alyssa.castelli@fitchratings.com. Additional information is available on www.fitchratings.com. 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