OREANDA-NEWS. Fitch Ratings has downgraded Avon Products, Inc.'s (Avon) Issuer Default Rating (IDR) to 'BB-' from 'BB'. The Rating Outlook is Negative.

Fitch has also downgraded the ratings on Avon's credit facility, term loan notes and senior unsecured notes to 'BB-' from 'BB' and assigned Recovery Ratings (RR) of 'RR4'. The assignment of the RRs reflects Fitch's 'Recovery Ratings and Notching Criteria for Non-Financial Corporates Issuers' criteria dated Nov. 18, 2014, which allows for the assignment of Recovery Ratings for issuers with IDRs in the 'BB' category.

A full list of rating actions follows at the end of the release.

KEY RATING DRIVERS

OPERATING TRENDS CONTINUE TO DECLINE
The downgrade reflects that two of Avon's key operating metrics, representative count and volume growth, continue to trend negatively through the first quarter of 2015, the lengthy turnaround increases the potential of further market share losses, and credit protection measures are weakening. The Outlook remains Negative as stabilization in the key operating metrics is uncertain.

In particular, Latin America, which is Avon's largest region and responsible for 55% of 2014's EBITDA, saw declines in volume of -3% in 1Q'15 (after -3% in 2013 and -4% in 2014) and rep decline of 2% (after 4% decline in 2014). Intensifying competition from beauty oriented multinationals and other local competitors such as Grupo Boticario in Brazil, that also entered direct selling several years ago, continues. Trends were positive for Europe, Middle East & Africa (EMEA), which represented 31% or 2014's revenues and 39% of EBITDA. However, unit sales are likely to be tempered as the company takes price increases to help offset currency weaknesses in this region and other select emerging markets.

Adjusted operating margins, which had shown sequential improvement over the past three years, are expected to decline under the weight of sales deleveraging caused by a significant F/X translation and transaction costs as well as overall operational pressure from volume and representative declines. Fitch expects leverage to increase to 4x with the pressure on EBITDA in 2015, from 2.7x in 2014. Leverage is expected to remain in the 4x range if EBITDA remains in the \$650 million range versus approximately \$960 million in 2014. FFO Adjusted Leverage is expected to increase to over 6x in 2015 from 4.5x in 2014.

Avon is investing in restructuring efforts, product launches, its representatives and dividends. These are future draws on internally generated liquidity from operating cash flow, which has declined sequentially from \$782 million in 2009 to \$274 million through the latest 12 months (LTM). Dividends and capital expenditures have had to be ratcheted downward and cash balances drawn for debt repayment, FCPA settlement payments, and other cash needs.

LIQUIDITY ADEQUATE BUT DECLINING

Cash balances are unrestricted and available for debt repayment but have declined to \$670 million at the end of March 2015 from \$1.2 billion as recently as 2013. While FCF improved to \$232 million in 2013 after a \$300 million dividend cut, it declined to \$119 million last year. Even if the \$67 million first quarter 2015 FCPA payment was excluded, FCF is down to \$110 million at the LTM. Management's guidance for \$100 million free cash flow (before roughly \$101 million in dividends) means the company is unlikely to generate cash internally. Fitch expects FCF to be modestly negative in the -\$50 million range in 2015. Unexpected costs, lower profitability or investments would lead to further declines in cash which had been a large and key component of the company's liquidity.


HIGH DEGREE OF F/X VOLATILITY
Negative F/X translation and transaction are having an outsized impact on Avon's recent financial performance as almost all of its profits and cash flows are being generated outside the U.S., with a strong orientation towards the emerging markets of Brazil and Russia. The real and the ruble have had an average annual devaluation against the US\$ in 2014 of 9% and 21% respectively. These currencies and others such as the Turkish Lira and Euro have continued to weaken this year. The company absorbed \$315 million of F/X translation and transaction costs in 2014. The run rate this year is higher after \$135 million was recorded in the first quarter of 2015, though the impact should be highest in the first three quarters.

If or when the U.S. dollar weakens, some of the noise around the company's financial performance would be removed. However, in the interim, the amount and value of cash generated outside the U.S. that is needed to meet \$225 million of annual dollar-based interest and dividend payments is being eroded and internally generated cash flows is limited. Fitch had previously noted the currency mis-match as a risk for note-holders.

Most companies in the household and personal care space generate more than 30% of revenues internationally but tend to be highly profitable both in their home markets and on a consolidated basis with EBITDA margins in the 20% to 26% range vs Avon's 11%. All companies in the sector are being impacted by the strong dollar, but with a larger and more profitable U.S. component, the negative impact on cash flows is relatively muted vis a vis Avon. As a result and compounded by the business model, the cushion in Avon's credit metrics are required to be meaningfully higher than those that are typically be found in peers.

KEY ASSUMPTIONS
--Currencies hold at current levels negatively impacting revenues about 17% this year in line with management's April 2015 guidance;
--Constant dollar revenues down around 1% mainly as negative volume trends continue at a slightly higher pace when the company prices for currencies in slowing economies;
--EBITDA margin down roughly 200bps and in line with management's public guidance, with annual EBITDA declining to the \$650 million range in 2015 and 2016;
--FCF is modestly negative in 2015;
--The company refinances its March 2016, 2.375% \$250 million senior unsecured notes rather than pay down with cash on hand in order to preserve immediate liquidity.

RATINGS SENSITIVITIES

Positive:
--Stabilizing the Outlook is dependent on Avon's ability to achieve flat to positive consolidated volume and active representative growth over the next few quarters and generate positive annual FCF of at least \$100 million.

--An upgrade is not likely in the next 12 - 18 months due to the slow pace of turnaround and negative operating trends in most markets. However, if there is a significant turnaround in the business and positive FCF can be maintained over the \$200 million level an upgrade could be considered.

Negative: Future developments that may, individually or collectively, lead to a negative rating action:
--If sales declines accelerate, which would be exemplified by active representative and volume declines accelerating towards the mid-single digits; further margin compression; negative FCF and sustained increases in leverage over 4x.

Fitch has taken the following rating actions on Avon:

--Long-term IDR downgraded to 'BB-' from 'BB';
--Bank credit facility downgraded to 'BB-/RR4' from 'BB';
--Senior unsecured notes downgraded to 'BB-/RR4' from 'BB';
--Short-term IDR affirmed at 'B';
--Commercial paper affirmed at 'B'.