OREANDA-NEWS. Fitch Ratings has downgraded Avon Products, Inc.'s (Avon) Issuer Default Rating (IDR) to 'B+' from 'BB-'.

Fitch has also downgraded the ratings on Avon's senior unsecured notes to 'B+/RR4' from 'BB-/RR4'. For issuers with IDRs at 'B+' and below, Fitch performs a recovery analysis for each class of obligations of the issuer. Issue ratings are derived from the IDR and the relevant Recovery Rating and notching based on the expected recoveries in a distressed scenario of each of the company's debt issues.

A full list of rating actions follows at the end of the release. The Rating Outlook is Negative as stabilization in key operating metrics is uncertain.

The downgrade reflects Fitch's increasing concern regarding Avon's business model and its ability to reverse persistently flattish-to-slightly-negative organic growth trends. Recently reported Q3 2015 results illustrate continued operating deleverage on modest sales declines (constant currency), and the company's reduced operating margin guidance suggests the trend will continue. The company's inability to articulate a viable strategy to improve organic sales and/or address its cost structure yields difficulty in predicting a reversal in the negative EBITDA trend.

Avon's constant currency sales performance has trended negative with volume declines accelerating towards the mid-single digits and was -5% in the third quarter, net of the Liz Earle disposition. In its Q3 earnings report, management indicated its expectation for full year operating margin compression in the 100bps range on a constant dollar basis and that 2015 FCF (defined by Avon as operating cash flow less capital expenditures) would be positive but less than the $100 million previously communicated.

Fitch acknowledges that the direct selling model, which involves millions of touchpoints to individual representatives, makes any one fix difficult. Further, execution has been compounded with macro-economic declines in the key markets of Brazil and Russia and further exacerbated by weakening currencies against the US dollar. However, without a credible plan of action, Fitch cannot predict a bottoming in the current trend of flat-to-negative organic growth coupled with operating margin compression.

While leverage remains moderate near 4x and the company has taken a number of actions to preserve liquidity and reduce debt by selling off non-core acquisitions such as Silpada and Liz Earle, there is little visibility of turning around the business today given the lack of a well-articulated business strategy. Therefore, liquidity and credit protection measures could continue to weaken.

KEY RATING DRIVERS

Operating Performance Challenged
Adjusted operating margins, which had shown sequential improvement over the past three years, have declined year to date under the weight of sales deleveraging caused by operational pressures from volume and representative declines and significant F/X translation and transaction costs. Fitch expects EBITDA margins to decline to the 8.5% range in 2015 versus 11% in 2014.

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 company absorbed $315 million of F/X translation and transaction costs in 2014. The run rate this year is higher with around $350 million thus far.

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 around $200 million of annual dollar-based interest and dividend payments is being eroded and internally generated cash flow is limited.

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 8%. 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.

KEY 2015 ASSUMPTIONS
--Constant dollar revenues down around 1% mainly as negative volume trends continue at a slightly higher pace as the company prices for currencies in slowing economies;
--Currencies hold at current levels negatively impacting revenues about 19% in 2015 year, in line with management's November 2015 guidance;
--EBITDA of approximately $575 million with margins in the 8.3% range;
--FCF negative in the $150 million range.

RATINGS SENSITIVITIES

Positive:
--Stabilizing the Outlook is dependent on Avon's ability to articulate and begin to execute a credible turnaround plan at its January 2016 Analyst Day, which would enable it to stabilize volume and active representative growth and restructure its business to stem EBITDA declines.

Negative:
Future developments that may, individually or collectively, lead to a negative rating action:
-- Continued sales declines, which would be exemplified by active representative and volume declines accelerating towards and being sustained in the mid-single digits range;
--Further margin compression beyond the 100bps after 2015;
--Negative FCF past 2015 which would occur if the organization has not been right-sized for what appears to be less than a $7 billion revenue company which would eat into liquidity;
--Sustained increases in leverage over 5x.

LIQUIDITY ADEQUATE BUT DECLINING

Cash balances are unrestricted and available for debt repayment but have declined to $587 million at the end of September 2015 from $1.2 billion in 2013. Including full availability on its $400 million revolver that matures in 2020, total liquidity currently stands at almost $1 billion. Fitch expects FCF (operating cash flow less capital expenditures and dividends) to be in the negative $150 million range in 2015. FCF could remain negative in 2016 and beyond unless sales and EBITDA stabilize.

FULL LIST OF RATING ACTIONS

Fitch has taken the following rating actions on Avon:

--Long-term IDR downgraded to 'B+' from 'BB-';
--Senior unsecured notes downgraded to 'B+/RR4' from 'BB-/RR4';
--Short-term IDR affirmed at 'B'.

The Rating Outlook is Negative.