September 26, 2017 / 3:40 PM / a month ago

Fitch Affirms L'Oreal SA at 'F1+'

(The following statement was released by the rating agency) MILAN/LONDON, September 26 (Fitch) Fitch Ratings has affirmed L'Oreal SA's (L'Oreal) Short-Term Issuer Default Rating (IDR) and commercial paper (CP) programme at 'F1+'. The agency has also affirmed L'Oreal USA Inc's CP programme, guaranteed by L'Oreal SA, at 'F1+'. The rating reflects L'Oreal's strong market position as the largest beauty company globally and robust financial profile supported by low leverage and superior financial flexibility. The rating benefits from the company's strong brand portfolio and diversification by geography, product category and price point, which supports steady organic revenue and profit growth. We assume L'Oreal will maintain its conservative balance sheet structure and to continue generating healthy free cash flow (FCF), which will allow it to implement its strategy of bolt-on acquisitions, without compromising its strong credit profile. KEY RATING DRIVERS Strong Performance: Fitch expects L'Oreal's operating performance to remain strong, with low- to mid-single-digit organic sales growth in cosmetics over 2017-2020, supported by favourable industry fundamentals and the company's strong innovation capacity and marketing power. We also assume some improvements in profitability due to tight control over costs, efficiencies of scale and disposal of The Body Shop in 2017, which had substantially lower EBIT margin than the company's core cosmetics operations (2016: 3.7% vs. 20.7%). Consolidating Leading Market Position: L'Oreal's strong business profile is underpinned by the company's leading position in the cosmetics industry and consistent market share gains. Fitch expects L'Oreal's sales to continue growing faster than the cosmetics market in all the company's geographical areas of operations. The latest bolt-on acquisitions announced in 2017 should further cement L'Oreal's leadership in the cosmetics industry worldwide. Healthy FCF: L'Oreal's robust operating performance enables the company to generate strong cash flows and manage a conservative balance sheet, despite the acquisition activity conducted to date. We project annual FCF to remain high at around EUR1.5 billion based on further EBITDA uplift, which should accommodate increasing working capital needs in line with sales, and a steady increase in dividends. Body Shop Disposal: Fitch views the disposal of The Body Shop in September 2017 as favourable to L'Oreal's credit profile. Since its acquisition in 2006 The Body Shop's performance has been lagging the group's cosmetics divisions and exhibiting greater volatility. In addition, it was a drag on the group's operating margins. Although disposal proceeds of EUR1 billion were applied towards debt reduction, we assume that over the longer term it will be used for acquisitions that are complementary to L'Oreal's cosmetics business. Bolt-on M&A Spending: In 2017 L'Oreal acquired skincare brands from Valeant for USD1.3 billion and we expect the company to remain on the look-out for further targeted bolt-on acquisitions, in particular of companies that could provide L'Oreal further scope for organic growth. These could include businesses characterised by innovative products or distribution models, or a strong position in emerging markets. We assume annual M&A spending of EUR1.5 billion over 2018-2020, which should be funded with internal cash flows and therefore have no impact on the company's leverage. Stable Financial Policy Assumed: Our projections assume that the forthcoming expiry (at end-March 2018) of a clause in the agreement between the two main shareholders, the Bettencourt-Meyers family and Nestle SA (AA-/ Stable) preventing them from increasing their ownership of L'Oreal, will not lead to an increase of Nestle's stake nor to a material step-up of share buyback by L'Oreal. In 2014 Nestle sold 6% of its L'Oreal shares back to L'Oreal partly for cash. Overall, we do not assume any change to L'Oreal's governance or to its conservative financial policies. Robust Credit Metrics: Fitch projects L'Oreal's funds from operations (FFO) adjusted gross leverage to remain low at around 1x over the medium term (2016: 1.0x), providing comfortable financial flexibility to the current 'F1+' rating. While we assume the approximately EUR1 billion cash proceeds from the divestment of Body Shop will be used to fund bolt-on M&A, we calculate that the deconsolidation of operating lease expenses at Body Shop leads to an around 0.1x decrease in lease-adjusted leverage metrics. Diversified Operations: L'Oreal's revenues are well-balanced across key cosmetics categories, price points and geographic regions. Over the past 10 years L'Oreal has successfully enlarged the share of "new markets" (mainly emerging markets) to 39% of its revenue from 27%, benefiting from fast-growing beauty products demand in these geographies. The resulting exposure to currency fluctuations is mitigated by the geographic diversity of L'Oreal's markets, with weakness in one currency being offset by the strength of another. DERIVATION SUMMARY L'Oreal has the same Short-Term IDR as Nestle SA (F1+). Its smaller scale is compensated by lower leverage and higher FCF margin. Both companies have strong business profiles supported by leading market positions and geographically diversified operations. L'Oreal is rated higher than Kimberly-Clark Corp. (F1) and Henkel AG & Co. KGaA (F1) due to its stronger credit metrics and larger size. Moreover, Henkel faces potentially greater volatility from its adhesive technologies business, which bears a higher risk than consumer and personal care, in which L'Oreal operates. No Country Ceiling, parent/ subsidiary linkage or operating environment aspects impact the rating. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Low-to mid-single-digit organic sales growth and slight EBIT margin improvement over time, driven by innovation and pricing power; - Capex at around 5.5% of revenue; - Dividends increasing by 10% per year; - Bolt-on M&A of around EUR1.5 billion a year from 2018; - Share buybacks not exceeding EUR0.5 billion a year. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Sharp deterioration of FCF. - FFO adjusted gross leverage above 2.0x (2016: 1.0x) or FFO adjusted net leverage above 1.5x (2016: 0.7x) on a sustained basis . - Total CP back-up lines falling below 100% of total amount drawn under the CP programmes. LIQUIDITY Sufficient Liquidity Back-Up: Fitch estimates that a full liquidity back-up is available for L'Oreal's short-term obligations, which consist mostly of CP. At end-June 2017, short-term debt of EUR3.2 billion was more than covered with cash of EUR1.7 billion and available undrawn committed bank lines of EUR3.5 billion. Since end-June liquidity was further supported by EUR1 billion proceeds from The Body Shop disposal and renewal of a EUR250 million committed facility for three years. Additional financial flexibility comes from L'Oreal's 9.15% stake in Sanofi SA (AA-/Negative) held as a financial investment, which the company could monetise in case of need. Contact: Principal Analyst Anna Zhdanova, CFA Associate Director +7 495 956 2403 Supervisory Analyst Giulio Lombardi Senior Director +39 02 8790 87214 Fitch Italia S.p.A. Via Morigi 6 20123 Milan Committee Chairperson Sophie Coutaux Senior Director +331 44 29 91 32 Media Relations: Francoise Alos, Paris, Tel: +33 1 44 29 91 22, Email: francoise.alos@fitchratings.com; Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. Summary of Financial Statement Adjustments Cash: Fitch adjusted available cash at end-2016 by deducting EUR300 million to reflect average intra-year working capital swings. Additional information is available on www.fitchratings.com. 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