OREANDA-NEWS. Fitch Ratings affirms Avon Products, Inc.'s (Avon) Long term Issuer Default Rating (IDR) of 'B+' with a Negative Outlook upon yesterday's announcement that Cerberus Capital Management (Cerberus) will (i) make a $435 million 5% convertible preferred equity investment in Avon, which represents 16.6% of diluted shares outstanding on an as-converted basis, and (ii) invest $170 million for an 80% ownership in Avon North America, which will be separated into a privately held entity. These transactions are expected to close in spring 2016. In addition, Avon will suspend its dividend of approximately $108 million annually effective the first quarter of 2016.

KEY RATING DRIVERS

Fitch views today's announcements positively in that the North American business separation - which had LTM sales of $731 million and estimated EBITDA of $4 million - removes a drag on both operating trends and on management's time, and the cash infusion and dividend suspension will provide a meaningful boost to Avon's liquidity.

However, as Fitch had factored in minimal contribution from the North American business, the credit story has not materially changed. Avon's key international markets remain under considerable pressure as reflected in flattish-to-slightly negative organic growth trends. Stabilizing the Outlook depends on Avon's ability to articulate and begin to execute a credible turnaround plan to stabilize volume and representative growth and stem EBITDA declines at its January 2016 Analyst Day.

Of note, two key markets, Brazil and Russia, have seen increasing levels of competition in the past several years and are in recession. Argentina, a smaller market, appears headed for a recession next year. As a result, Avon's Latin America region, which generated almost 50% of revenues (moderately more post-separation) and 70% of adjusted operating profit for the nine months ended Sept. 30, 2015, has recorded negative volumes and rep count declines. These are likely to continue given the economic outlook and the lack of a plan to reverse the tide.

Negative F/X translation and transaction are having an outsized impact on Avon's recent financial performance, with a strong orientation toward the emerging markets of Brazil and Russia. The company absorbed $315 million of F/X translation and transaction costs in 2014. The run-rate year-to-date is higher at around $350 million.

KEY ASSUMPTIONS

--The proposed transactions close as anticipated in spring 2016;
--Organic revenue growth up around 1% in 2015, with negative volume trends being offset somewhat by high pricing. Positive organic growth of 2% in 2016 excluding North America;
--Currencies hold at current levels negatively affecting revenues by about 19% in 2015 year, in line with management's November 2015 guidance;
--EBITDA of approximately $575 million in 2015 and $525 million to $550 million in 2016;
--Free cash flow negative in the $150 million range in 2015. Preliminary FCF expected to be positive in 2016, north of $125 million with the dividend suspension as well as lower pension payments and royalty stream from Avon North America to Avon.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to a positive rating action:
:
--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.

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 toward and being sustained in the mid-single-digits range;
--Significant EBITDA contraction to a level below $500 million.
--Negative FCF past 2015 which would occur if the organization has not been rightsized for what appears to be a less than $7 billion-revenue company which would eat into liquidity;
--Sustained increases in leverage over 5x.

LIQUIDITY
Avon's liquidity should improve with the dividend suspension and the receipt of a net $505 million from Cerberus in 2016. The $505 million is net of $100 million that Avon will contribute to Avon North America to partially offset the approximately $230 million in pension and other liabilities.

Avon intends to apply $250 million of proceeds towards repaying a portion of the $850 million of debt maturing over 2018 and 2019.

At present, cash balances are unrestricted and available for debt repayment but had 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 was approximately $1 billion.

Fitch expects FCF (operating cash flow less capital expenditures and dividends) be in the negative $150 million range in 2015. Preliminary FCF is expected to be positive in 2016, north of $125 million with the dividend suspension as well as lower pension payments..

Depending on how the $435 million preferred equity is structured, the instrument could have an equity credit component. Fitch may assign that component after documentation review. In the interim, if viewed solely as debt, pro forma leverage as of the last 12 months ended Sept. 30, 2015 would increase modestly to 3.7x from 3.4x.