OREANDA-NEWS. Fitch Ratings has upgraded the Issuer Default Rating (IDR) for Levi Strauss & Co. (Levi) to 'BB' from 'BB-'. In addition, Fitch has upgraded the ratings on Levi's secured bank credit facility to 'BBB-/RR1' from 'BB+/RR1' and senior unsecured notes to 'BB/RR4' from 'BB-/RR4'. The Rating Outlook is Positive. Levi had $1.2 billion of debt outstanding as of Aug. 30, 2015.

KEY RATING DRIVERS

The upgrade reflects Levi's continued EBITDA growth and Fitch's increased comfort in the company's ability to drive low- to mid-single digit EBITDA growth over the next 24-36 months. Fitch expects leverage to remain in the mid 3x range (3.7x on a trailing 12-month basis as of Q3 2015) over the next 24-36 months, assuming flat debt levels.

The Positive Outlook recognizes the company's incremental opportunities to drive leverage from the current mid 3x range to the low 3x range via mid-single digit revenue growth, better than expected benefit from its cost cutting initiatives, deployment of FCF towards further debt paydown, or a partial combination of the above. The rating continues to reflect Levi's well-known brands, strong market shares and wide geographic diversity as well recognize lacklustre growth in the mid-tier apparel space.

Stabilizing Top Line

Levi has produced stable-to-improving top line results, with low-single digit growth expected in FY 2015 following 3% growth in FY 2014 (all figures constant currency basis). In the Americas (60% of sales in FY 2014), revenue is expected to decline slightly to $2.8 billion, due in part to a fiscal calendar shift and transition of the Dockers women's business from wholesale to a license model. Before the impact of the strong dollar, international sales are expected to grow mid-single digits, with Europe (24% of sales in FY 2014) outperforming Asia (16% of sales in FY 2014). On a reported basis, consolidated FY 2015 revenue is expected to be down mid-single digits to $4.6 billion, due to the strong dollar and one fewer week than FY 2014. Beginning FY 2016, Fitch projects 2%-3% consolidated annual sales growth, with similar growth rates across regions.

Improving EBITDA Story on Relatively Flat Top Line

From 2011 to 2013, Levi grew EBITDA 27% (on a reported basis) from $463 million to $590 million on a 2% sales decline. While lower cotton prices significantly contributed, Levi reduced SG&A by 4% to $1.88 billion, allowing the company's SG&A-to-sales ratio to decline despite lower sales.

In early 2014, Levi announced a $175 million-$200 million cost reduction program, to be implemented over the next three years. By 2017, when the program is fully realized, SG&A spend should be flat to 2013 levels despite modest sales growth. There could be EBITDA upside if the company achieves the high end of its targeted range or if further cost opportunities are identified.

In FY 2015-2016, modest sales growth, coupled with cost reductions, should drive mid-single digit EBITDA growth on a constant currency basis. Reported FY 2015 EBITDA, however, is projected to be down 5% to $570 million due to the strong dollar. FY 2016 EBITDA growth is projected to be 6% to approximately $600 million, on 2% reported revenue growth and expense savings. Following 2016, Fitch assumes annualized EBITDA growth of 3%-4%, slightly higher than sales growth, due to fixed-cost leverage and completion of the cost savings initiatives. EBITDA growth should yield annualized free cash flow (post dividends) in the $200 million range.

Reasonable Credit Metrics

Levi ended FY 2014 with leverage at 3.5x, significantly lower than the 5.0x level from FY 2012, as total debt declined 14% to $2.8 billion and EBITDA grew 29% to $595 million. Fitch expects leverage to remain in the mid-3.0x range over the next three years on EBITDA growth and flattish debt levels. Fitch expects minimal debt paydown following the 2016 repayment of Levi's $33 million Eurobonds, although the company could reduce leverage to the low 3.0x range through deployment of its expected $200 million annual free cash flow to debt paydown.

KEY ASSUMPTIONS

Fitch's key assumptions are as follows:
--Annual revenues on a constant currency basis grow at 1%-2% beginning in FY16;
--EBITDA trends toward $600 million-$625 million over the next 24 months, versus a pro forma $568 million in fiscal 2015;
--FCF of $200 million annually;
--Adjusted leverage remains in the 3.5x range, assuming no further debt paydown.

RATING SENSITIVITIES

A positive rating action would be considered if Levi sustained 3%-5% revenue growth, drove mid-teens EBITDA margins, or deployed FCF to debt paydown, a partial a combination of which results in leverage trending to the 3.0x range.

A negative rating action would be considered if EBITDA margin remains under pressure longer term due to soft sales trends and increased investment in marketing/promotion, resulting in adjusted debt/EBITDAR increasing to the 4.0x range.

LIQUIDITY

Levi's liquidity is strong, supported by cash of $273 million and revolver availability of $549 million as of Aug. 30, 2015. The $850 million facility due 2019 is secured by North American inventories, receivables, and the U.S. Levi trademark, and also benefits from upstream guarantees from the domestic operating companies. Annual FCF should be close to $200 million through 2018. In April 2015, the company issued $500 million of 5% senior unsecured notes due 2025 to repay (along with revolver borrowings) $525 million of 7.625% senior unsecured notes due 2020, reducing annual interest expense by $15 million. Levi's next maturities are $33 million in Eurobonds due 2016 and $532 million of unsecured notes due 2022.

FULL LIST OF RATING ACTIONS

Fitch has upgraded Levi's ratings as follows:

Levi Strauss & Co.
--IDR to 'BB' from 'BB-';
--$850 million secured revolving credit facility to 'BBB-/RR1' from 'BB+/RR1';
--Senior unsecured notes to 'BB/RR4' from 'BB-/RR4'.

The Rating Outlook is Positive.