OREANDA-NEWS. Fitch Ratings has affirmed Germany-based consumer goods and industrial adhesives company Henkel AG & Co. KGaA's (Henkel) Long-term Issuer Default Rating (IDR) at 'A' and its Short-term IDR at 'F1'. The rating of the company's EUR1.3bn hybrid bond, due 2104, has also been affirmed at 'BBB+'. The Outlook on the Long-term IDR is Stable.

The affirmation reflects a fall in Henkel's net leverage in 2014, a diversified business portfolio, its robust profitability and strong cash flow generation ability. The ratings also provide headroom for the possibility of large acquisition spending, in particular if Henkel is to meet its 2016 revenue target of EUR20bn.

KEY RATING DRIVERS
Challenges to 2016 Targets
Henkel's targets include achieving revenues of EUR20bn by 2016, increasing its presence in emerging markets to 50% of revenues and enhancing its organic growth capability. While the company has now achieved its organic growth target, Fitch calculates that organic growth may not be sufficient on its own to enable the company to achieve its EUR20bn revenue target by 2016. The agency calculates that the company may still need to add between EUR1bn and EUR2bn revenue through acquisitions.

Following EUR1.8bn of acquisitions in home and personal care and in adhesive technologies sectors in 2013-2014, the company announced a small acquisition in May 2015 (entire range of laundry detergents and pre-wash brands in Australia/New Zealand from Colgate-Palmolive) for EUR0.2bn.

Rating Headroom for Further Acquisitions
Henkel benefits from strong free cash flow (FCF) generation ability and low leverage; its hybrid- and lease-adjusted funds from operations (FFO) net leverage fell further to 0.6x in 2014 from 1.1x in 2013, following the repayment of a EUR1bn bond in 2014. Henkel has enough headroom in its 'A' rating to support large acquisitions amounting up to EUR5bn. However, M&A spending will depend on available targets and competitive interest. Assuming EUR5bn M&A spending is spread out over 2015-2016, Fitch calculates that due to expected further increase in EBITDA and FCF Henkel should be able to maintain its hybrid- and lease-adjusted FFO net leverage at below 2.0x, which is the upper threshold for its 'A' rating.

Healthy 2014 Performance
Henkel delivered organic sales growth of 3.4% in 2014, mainly fuelled by volume increases (+3%) but with limited pricing (+0.4%), reflecting a fiercely competitive environment. Despite promotional pressure continuing to affect the market, the company reported 3.6% organic growth in 1Q15, equally balanced between price and volume increases.

Continuous Improvement in Profitability
Henkel improved its pre-exceptional EBIT margin to from 15.8% in 2014 from 10.3% in 2008, and to a further 16% in 1Q15, with contributions from all divisions. Henkel's consolidated EBIT margin and its margin in home and personal care are now more aligned with major industry peers such as Unilever PLC/NV (A+/Stable) and Procter & Gamble. These improvements were achieved on the back of cost-saving measures, efficiency gains, and a portfolio optimisation strategy.

Improving Emerging Market Exposure
Henkel is working to further increase its exposure to fast-growing emerging markets to 50% by 2016 (44% in 2014). Fitch views this strategy positively as it provides sales growth opportunities and economies of scale in these regions.

However, Henkel's emerging-market strength is mostly concentrated in eastern Europe and the company still generates two-thirds of its profits in the developed world. Increasing sales from emerging markets also exposes the company to currency volatility. In 2014, adverse foreign exchange movements shaved 3.5% off Henkel's revenue. Fitch expects the adverse effect to unwind in 2015 as a strengthening dollar offsets weaker emerging market currencies.

Strong Adhesives Business
Approximately 50% of Henkel's profits are generated through its global business-to-business and consumer adhesives operations, which enjoy a well-diversified customer base by industry and where Henkel is the global leader. Despite Henkel's diversity of outlet markets and the structural growth of demand for adhesives, Fitch believes that the vulnerability of these operations to the cyclicality of global industrial manufacturing and construction implies for Henkel a higher degree of credit risk than for its pure home and personal care peers.

KEY ASSUMPTIONS
-Low single-digit organic growth and stable-to-slightly improving EBITDA margin
-Favourable mid single-digit impact from foreign currency movements in 2015
-Positive FCF generation driven by strong profit, net of EUR575m-EUR525m of capex and 30% dividend pay-out ratio
-EUR3bn of acquisition spending between 2015 and 2016, and EUR1bn annually thereafter

RATING SENSITIVITIES
Negative: Future developments that could lead to a negative rating action include:
-Significant deterioration in profitability and cash flow generation due to adverse operating performance or a more aggressive financial policy leading FFO fixed charge cover below 8x (2014: 31.5x) and hybrid- and lease-adjusted FFO net leverage above 2.0x, all on a sustained basis.

Positive: Future developments that may, individually or collectively, lead to positive rating action include:
-Expanded scale and geographic reach in different product areas while maintaining profitability in line with major industry peers, accompanied by management's commitment to financial ratios commensurate with a higher rating.

LIQUIDITY
As of end-December 2014, Henkel had EUR2.3bn of directly available liquidity, consisting of EUR0.7bn unrestricted cash and cash equivalents on balance sheet (based on Fitch's definition), EUR1.5bn committed syndicated credit facilities serving as back-up for its commercial paper programmes, and EUR104m committed bilateral line with a revolving term of up to one year. In addition, the company has EUR0.3bn of cash invested in short-term securities and deposits.