Fitch Affirms Avnet's Ratings at 'BBB-'; Outlook Stable
Fitch Ratings has affirmed the ratings for Avnet, Inc. (Avnet) as follows:
--Issuer Default Rating (IDR) at 'BBB-';
--Senior unsecured bank credit facility at 'BBB-';
--Senior unsecured notes at 'BBB-'.
The Rating Outlook is Stable.
Fitch's stable outlook for IT distributors in 2013 reflects the companies' strong liquidity and countercyclical cash flows which help offset Fitch's expectations for a difficult competitive environment and softening end market demand. Fitch's base scenario is for flat to modestly negative revenue change in 2013, although risk is weighted to the downside with the potential for a cyclical decline pending global economic conditions. Fitch views a reasonable stress scenario for the distributors at this point in time as consisting of a double digit decline in 2013 continuing through part of 2014. Under both scenarios, Fitch would expect significant margin compression but for EBITDA margins to remain positive across the sector. Free cash flow (FCF) generation would likely be significantly positive, given the expected resulting decline in working-capital balances under such a scenario.
Fitch believes Avnet would maintain its investment-grade ratings under such a scenario. This assumes cash generated from working-capital declines does not go to shareholders or aggressive acquisitions that would ultimately result in higher leverage once growth returns and working capital would be expected to increase. Fitch would be concerned if revenues declined from a loss of market share, either to other distributors or suppliers increasingly going direct to market.
The ratings and Outlook incorporate the above considerations as well as the following:
--Fitch expects mid-single digit organic revenue declines in fiscal 2013 as Avnet manages choppy end market demand and macroeconomic concerns. Fitch expects EBITDA margins (currently 4.1% for the latest 12 months [LTM] ending Sept. 29, 2012) to continue to compress given slowing end market demand. In a stress scenario, Fitch would expect EBITDA margins to decline to levels near the trough of the last downturn, roughly 3%, or moderately lower if revenue declines are more severe. In a flat revenue environment, Fitch estimates Avnet would generate approximately $500 million in annual FCF. In a stress scenario, Fitch would expect working capital cash inflows to roughly offset lower EBITDA levels and FCF to be near $500 million.
--The ratings incorporate expectations that Avnet would maintain leverage (total debt to total operating EBITDA) of 2.5 times (x) or below (3.0x when adjusted operating leases) given Avnet's business model and credit profile. Fitch estimates current leverage at 2.3x (2.8x on an adjusted basis) and interest coverage at 11x.
--Fitch expects uses of cash flow and excess cash will principally go to fund organic growth, working capital needs, potential small acquisitions, and share repurchases. Avnet has repurchased $365 million of shares in the LTM, with an additional $293 million in remaining repurchase authorization. Fitch believes Avnet has headroom for a moderate amount of share repurchases given substantial liquidity and the cash generative nature of the business. However, aggressive shareholder-friendly actions in the face of increasing macroeconomic uncertainty could pressure ratings if such action would be expected to ultimately result in higher leverage once growth returns. Fitch believes Avnet could potentially pursue debt-financed acquisitions resulting in higher than expected leverage if opportunities arise going forward. Such a scenario could pressure ratings if Fitch did not reasonably expect that Avnet would reduce leverage closer to historical levels in the short-run through the use of FCF for debt reduction and EBITDA growth.
Credit strengths include Avnet's leading market positions in both component and enterprise computing distribution worldwide; the ability to generate cash from operations in a normal growth environment, as well as achieve significant FCF in a downturn from reduced working capital; a highly diversified customer base and well-diversified supplier base with only IBM representing greater than 10% of revenue as of July 2012.
Credit concerns include Avnet's thin operating margins, which are typical of the IT distribution market; significant investment levels required to increase share in the faster-growing Asia-Pacific region, including potentially debt-financed acquisitions; integration risk stemming from Avnet's acquisition growth strategy; Avnet's exposure to the cyclical demand patterns and cash flows associated with the semiconductor and networking sectors; and the potential for future debt-financed share-repurchase programs.
Fitch assumes Avnet's $350 million 10-year note issuance in November 2012 will be used to pay down short-term debt outstanding under its credit facilities. Pro forma total available liquidity is estimated at $2 billion consisting of: $1 billion of cash and cash equivalents as of Oct. 1; $1 billion under Avnet's senior unsecured bank credit facility expiring November 2016; and $89 million available under the upsized $800 million A/R securitization facility expiring August 2013. Aside from the A/R securitization facility debt, Avnet's next scheduled maturity is $300 million of notes in 2014.
Fitch believes Avnet's total debt, pro forma for its recent $350 million issuance, is approximately $2.2 billion and consists of:
--$711 million drawn on the company's $800 million A/R securitization facility expiring August 2013;
--$300 million 5.875% senior notes due March 2014;
--$250 million 6% senior notes due September 2015;
--$300 million 6.625% senior notes due September 2016;
--$300 million 5.875% senior notes due June 2020;
--$350 million 4.875% senior notes due November 2022.
WHAT COULD TRIGGER A RATING ACTION
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
--Revenue declines that signal a loss of market share, either to other distributors or suppliers increasingly going direct to market;
--Severe operating margin compression resulting from intense competition;
--Significant debt-financed acquisitions and/or share repurchases, particularly if funded from cash generated from working capital declines.
Positive: Upside movement in the ratings is unlikely given Avnet's the razor-thin operating margin profile with significant cyclical demand exposure.
Additional information is available at 'www.fitchratings.com'. The ratings above were unsolicited and have been provided by Fitch as a service to investors.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology', dated Aug. 8, 2012;
--'Evaluating Corporate Governance', dated Dec. 13, 2011;
--'Rating Technology Companies', dated Aug. 9, 2012.
Applicable Criteria and Related Research:
Corporate Rating Methodology
Evaluating Corporate Governance
Rating Technology Companies
Brian Taylor, CFA
One State Street Plaza
New York, NY 10004
Jason Paraschac, CFA
Jamie Rizzo, CFA
Brian Bertsch, +1-212-908-0549 (New York)