April 12, 2017 / 3:40 PM / 9 months ago

Fitch Revises Unilever Outlook to Negative; Affirms at 'A+'

(The following statement was released by the rating agency) MILAN/LONDON, April 12 (Fitch) Fitch Ratings has revised the Outlook for Unilever NV and Unilever PLC (together Unilever) to Negative from Stable. The Long-Term Issuer Default Ratings (IDRs) and senior unsecured ratings for Unilever are affirmed at 'A+' and the Short-Term IDRs at 'F1'. The senior unsecured ratings of Unilever Capital Corporation (UCC) and Alberto-Culver Co. are affirmed at 'A+', and the commercial paper programmes of Unilever NV, Unilever PLC and UCC are affirmed at 'F1'. Both UCC and Alberto-Culver benefit from cross-guarantees with Unilever NV, Unilever PLC and Unilever United States, Inc. The Negative Outlook reflects Unilever's departure from its historically conservative financial policy towards greater shareholder returns as well as the potential for more spending on bolt-on M&A. The announcement of a EUR5 billion share buyback programme increases funds from operations (FFO) adjusted net leverage to around 2.9x at end-2017 in our rating case. Such leverage is not commensurate with an 'A+' rating. The risk that leverage may remain at this level beyond 2017 is mitigated by heightened scope for asset divestment, initiatives to increase profitability, and our expectation that free cash flow (FCF) will remain in the region of EUR1.1 billion-EUR1.3 billion. In the absence of further payouts, we expect deleveraging capacity and metrics to return to levels commensurate with the current ratings. KEY RATING DRIVERS FMCG Industry-Leading Organic Growth: We continue to expect revenue growth to be in the 3%-5% range and for the EBITDA margin to improve to around 18.5% by 2019. The opportunity for growth continues to lie in Unilever's emerging markets business, with accelerated growth being driven by recovering macroeconomic factors. Unilever maintained good organic growth in 2016 (3.7%) despite the economic disruptions experienced in India and Brazil, and the adverse FX impact (-5.1%) which caused a 1.0% decline in overall revenue. Profit Margin Expansion: We believe that Unilever is well placed to deliver a further 80bp margin expansion by 2021 given its track record over the last few years in a difficult trading environment. In 2016, the EBITDA margin rose to 17.6%, a 50bp increase on 2015's level. This was achieved through a combination of margin-accretive innovations and acquisitions and the benefits of Unilever's cost rationalisation programmes, including efficiencies in advertising and promotions through more extensive use of digital media, and reductions in overheads and, in the lower-margin home-care business, of stock keeping units. Portfolio Reorganisation: Unilever has announced its intention to divest or spin off the Spreads unit (part of its Food business) and to establish an integrated Food & Refreshment unit. This should allow it to streamline operations and exploit cost savings potential. In our base case, we assume EUR6 billion of proceeds from disposal of the spreads business, which could be allocated to debt reduction, reducing leverage by 0.6x. We believe the disposal makes strategic sense, allowing management to focus more on core products. Dual Headquarters: We view Unilever's announcement that it will review its dual structure positively. We are confident that the portfolio reorganisation will help accelerate the targeted margin progression and could facilitate any strategic decision in terms of sizeable M&A or more sizeable restructuring in the future, aimed at focusing on the Personal and Home Care businesses only. It also reduces complexity and gives greater transparency. In our base case, we assume that any changes to the group structure will have a neutral effect on instrument ratings and that any structural or contractual subordination mirrors that of the current dual structure. Any changes to this assumption could have an impact on the ratings. M&A Activity: The ratings do not factor in large M&A, but assume a moderate step-up in bolt-on annual acquisition spending to EUR1.5 billion for 2017, EUR3 billion for 2018 and EUR1.5 billion from 2019 onwards. This exceeds annual FCF of EUR1.1 billion-EUR1.3 billion. Unilever has become more acquisitive since 2009 in pursuit of higher growth and innovative products. It spent an average EUR1.7 billion a year in 2015-2016. Still, we believe this type of spending will continue in a measured manner as the company can continue to rely on its organic growth capability. The scope for future divestments has increased butin our current base case, we only include the disposal of the spreads business. Change in Financial Policy: Although management has reset its financial policy and is now targeting a net debt / EBITDA of 2.0x (compared to an average 1.3x-1.4x recorded over 2013-2016), we expect it to continue to operate the business prudently and to adhere to its new targets, which remain conservative. In our base case, we only factor in the announced shareholder return of EUR5 billion in 2017. However, any further shareholder payouts or M&A activity funded with debt and causing FFO-adjusted net leverage to rise above 2.5x on a permanent basis could be negative for the ratings. Strong, Stable Cash Generation: While the higher leverage has weakened Unilever's financial profile, Fitch continues to view the company's cash flow and liquidity as strong. In addition, Unilever's business profile remains stable for its current rating level, benefiting from strong brands and market shares in its core product categories across personal and home care and food & refreshments. This has resulted in a consistent track record of low to mid-single-digit organic revenue growth and steady profit margin expansion, which we expect to continue despite occasional market headwinds. DERIVATION SUMMARY Unilever's 'A+' rating reflects its position as the world's third-largest food and consumer products company, the stability of its operating profile, and the expectation that it will generate sufficient FCF to fund the majority of its bolt-on M&A spending. The announced share buyback programme and the higher returns of capital to its shareholder (12% increase in dividend distribution) will put considerable pressure on 2017 leverage, and the risk that this could continue is reflected in the Negative Outlook. That stated, we expect asset disposals, the portfolio reorganisation, and the acceleration of the saving programmes to improve profitability and debt repayment capacity and to sustain value creation. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Low to mid-single-digit organic revenue growth; - EBIT margin gradually growing by 80bp by 2020 from 2016's 14.8% level; - Capex at around 3.5% of revenue and annual bolt-on acquisitions of EUR1.5 billion in 2017, EUR3 billion in 2018 and EUR1.5 billion from 2019 onwards; - Disposal of the spreads business in 2018, valued at approximately EUR6 billion; - 12% increase in dividend distribution in 2017, with a payout ratio of 77%; - Share buyback of EUR5 billion in 2017. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to a Change of Outlook to Stable - Maintenance of a diversified business portfolio along with continued progress in operational restructuring or business mix, leading to steady long-term organic revenue growth and an EBIT margin remaining above 14% (2016: 14.8%); - FFO-adjusted net leverage returning below 2.5x on a sustained basis; - FFO fixed charge coverage remaining above 6x; - FCF remaining above EUR1 billion. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - FFO-adjusted net leverage staying permanently above 2.5x (2016: 2.3x) as a result of continued share repurchase programmes, special dividends or M&A; - Significant slowdown in growth in the emerging markets to which Unilever is mainly exposed, not fully offset by dynamic growth elsewhere; - FFO fixed charge cover of less than 6x (2016: 8.3x); - FCF consistently below EUR1 billion annually (2016: EUR1.1 billion). LIQUIDITY Strong Liquidity: Liquidity is supported by Unilever's FCF generation and proven access to the capital markets. The group also issues commercial paper at the Unilever NV, Unilever PLC and UCC levels and has access to USD6.5 billion of revolving 364-day bilateral credit facilities. Most debt is at UCC, Unilever NV and Unilever PLC. Unilever NV and Unilever PLC guarantee each other's debt and also that of UCC. Contact: Principal Analyst Marialuisa Macchia Associate Director +39 02 879 087 213 Supervisory Analyst Paula Murphy Director +44 20 3 530 1718 Fitch Ratings Limited 30 North Colonnade London E14 5GN Committee Chairperson Giulio Lombardi Senior Director +39 02 879087 214 Summary of Financial Statement Adjustments: - Leases: Fitch has adjusted the debt by adding 8x of annual operating lease expenses of EUR425m in 2016 related to long-term assets. - Adjustment for restricted/not available cash: Fitch adjusted available cash at end-2016 by deducting EUR240m to reflect cash held in subsidiaries facing cross-border foreign exchange controls and/or other legal restrictions to repatriation. Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Additional information is available on www.fitchratings.com. 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