Fitch has affirmed its ratings on Avon Products, Inc.'s (Avon) and fully parent-guaranteed subsidiary Avon Capital Corporation as follows:
--Issuer Default Rating (IDR) at 'A';
--Bank Credit Facility at 'A';
--Senior Unsecured Notes at 'A';
--Commercial paper at 'F1'.
The Rating Outlook remains Negative. Fitch's ratings apply to Avon's approximately $1.82 billion in senior unsecured debt and its $1 billion bank credit facility which supports the $1 billion commercial paper program ($413.5 million outstanding at Sept. 30, 2006).
The rating reflects Avon's unique position in the beauty market, as the world's largest direct-to-consumer seller of beauty and related products with last 12 month revenues (LTM) of $8.45 billion. It is one of the most geographically diverse companies generating 69% of revenues and 80% of operating income before global expenses in the international arena. Accelerating levels of activity in developing markets propelled double-digit revenue growth in 2003 and 2004 and served to offset slower or declining revenue or representative levels in more mature markets such as the U.S. Although revenue growth rates slowed to single digit levels in 2005, Avon's remains a strong cash generator though there has been some expected weakening of late as the company implements its $500 million restructuring program. Cash flow from operations increased from $565 million in 2002 to $896 million in 2005. For the nine months ending Sept. 30, 2006, cash flow from operations at $438.5 million remains ahead of the comparable period in 2005. Avon has maintained cash balances in excess of $1 billion since 2005 and balances are expected to remain high, which adds to the company's strong liquidity. Further, while it is noted that debt balances increased to fund share repurchases and a small acquisition, credit metrics with FFO Adjusted Leverage of 2.36 times (x) and EBITDA to interest of 12.5x through LTM Sept. 30, 2006 nevertheless remain comfortably within the rating category and underpin the rating.
The Outlook reflects the negative trend in the company's business and operating performance, which arose in 2005. Avon is currently undergoing a major restructuring designed to fund increased levels of brand support activities (increased advertising, commissions and new product introductions) to maintain top line growth against more focused mass-market players in developing markets. The company has made solid strides in cost reduction, particularly in de-layering, which will take greater costs out of the system than originally anticipated. However, in the interim there is a decline in profitability with EBITDA margins (before restructuring charges) declining from a high of 17.8% at Dec. 31, 2004 to 14% at LTM Sept. 30, 2006. A continuation of these trends could dampen cash flow in the short to medium term. Further, there are uneven performance metrics -- slowing or negative growth in volumes or representatives -- in several markets that have resulted in Central & Eastern Europe and Latin America accounting for 83% of operating profits before global expenses in the past nine months (70% excluding restructuring charges).
The company's restructuring and other initiatives such as Product Line Simplification and the Strategic Sourcing Initiative, whose potential costs have not been defined, should increase profitability and the company's competitive stance in the medium term. It is encouraging that quarter over quarter revenue growth, which had trended steadily downward from 19.5% in the first quarter of 2004 to 3.9% in the fourth quarter in 2005, appears to have stabilized to mid-single digits and higher in 2006. However, Fitch notes that the more than half of the 6.8% growth in revenues to $6.1 billion in the past nine months was due to the Colombian acquisition and positive foreign exchange impacts. Before reassessing its outlook, Fitch would like to see a solid increase in organic growth, improved profitability and more balance in regional operating profit concentration levels. The expectations are that these improvements should be seen in the latter half of 2007. Fitch expects that debt balances will not increase materially from current balances as management executes its restructuring program and that any shareholder friendly initiatives will be funded with internally generated cash.
Avon is the world's largest direct seller of beauty and related products with three product categories: Beauty, which includes cosmetics, fragrance and toiletries (70% of net sales for the LTM ending Sept. 30, 2006); Beauty Plus, composed of jewelry, watches, apparel and accessories (19%); and Beyond Beauty, which includes home products, gift and decorative, and candles (11%). Key brands include Anew, Skin-So-Soft, Avon Color, Avon Solutions and Avon Naturals. Direct sales are conducted through approximately 5.1 million representatives operating in 114 countries/territories. In fiscal year 2006 Avon increased it's geographically based segments to six from four. Latin America is the largest region, accounting for 32% of sales and 50% of segment operating profits before global expenses.
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