Fitch Affirms Spectrum's IDR at 'BB-' After Acquisition Announcement
The acquisition will be funded with \$1 billion in debt and \$500 million in share issuances. Fitch's calculated pro forma leverage on an as reported basis at the LTM Dec. 31, 2014, which excludes any synergies and less than a full year of AAG's acquisition of the A/C Pro business in March 2014, is 5.5X.
Fitch will address specific facility ratings as the transaction gets closer to completion and further information is provided.
Spectrum's 'BB-' rating encompasses periodic spikes in leverage to accommodate accretive acquisitions such as AAG. Spectrum is expected to direct the bulk of FCF towards debt reduction such that (Debt/EBITDA) leverage should return to under 4.5x in 18 to 24 months. Fitch had previously anticipated annual FCF to be in the \$300 million to \$400 million range and with AAG expected to generate around \$60 million after a full year, Fitch's expectations are now closer to the top end. The company should comfortably reduce leverage within 18 months with EBITDA growth and debt reduction.
AAG is controlled by Avista Capital Partners and produces and markets auto-care products mainly under the ArmorAll appearance and STP performance additives brands. Sixty seven per-cent of its \$300 million in reported revenues at Dec. 31, 2014 were generated in the U.S and its EBITDA margin of 26% is well above Spectrum's roughly 17%. Further, it brings a new channel in the automotive aftercare market and further category diversity.
KEY ASSUMPTIONS
FCF of \$300 million to \$400 million in the 2015 and 2016 fiscal year will be directed towards debt reduction to return leverage under 4.5x within 18 to 24 months.
No material changes in integration or management distraction to the remaining businesses such that there are market share losses in existing major categories.
Terms and conditions of newly issued debt is pari passu with existing outstanding notes.
KEY RATING DRIVERS
Diversification and Marketing Strategy Leads to Solid Results
The firm's value-based market strategy and highly diversified product portfolio has resonated well with retail customers and consumers. Organic growth rates have averaged 2% over the past five years, near the low- to mid-point of the household and personal care sector. Modest sales growth, accretive acquisitions, and cost controls have led to improving margins and ample free cash flow (FCF). Much of the company's FCF has historically been directed toward debt reduction. Fitch expects that to continue into 2015 and 2016.
Short-Term Increases in Leverage Expected
Spectrum is acquisitive which results in periodic but temporary increases in leverage. Over the past five years leverage has been as low as 3.4x and as high as 6.6x but has generally hovered in the 4.5x territory. Generally, Fitch expects the company to operate with leverage just under 4.5x. The company's track record on acquisitions has been positive. On the whole, acquisitions have been accretive and well-integrated.
Spectrum's leverage increased to the mid-6x range in December 2012 after purchasing Stanley Black & Decker, Inc.'s Hardware & Home Improvement Group (HHI) for \$1.4 billion. Fitch's expectation for leverage to return below 4.5x at the fiscal year ended Sept. 30, 2014, was comfortably met. The 4.1x result was due to better than expected EBITDA growth and more than \$200 million of FCF being directed towards debt reduction. Leverage increased moderately at the end of the first quarter of 2015 to 4.7x to accommodate roughly \$430 million in debt issued during December 2014. Proceeds were mainly used to finance the acquisition of Tell Manufacturing, Inc. (Tell) and Procter & Gamble's European pet food business (Pet).
Improved FCF
Spectrum's FCF improved to the \$300 million range in 2014, in line with Fitch's expectations after being below \$200 million in each of the previous five years. HHI, a large acquisition, added roughly \$1 billion in revenues and EBITDA margins that were higher than Spectrum's. Efficient working capital management is also a factor in the company's overall improvement although it is not likely to be as strong a contributor to cash flows going forward. Fitch expects FCF to be near the high end of the \$300 million to \$400 million range in FY2016, nicely bolstered by the AAG acquisition. It is likely to be near the low end in 2015 with the attendant expenses related to making a sizeable acquisition as well as integration costs.
Spectrum began recording residual U.S. and foreign taxes on undistributed foreign earnings since 2012 in order to accelerate pay down of U.S. debt, as well as fund distributions to shareholders etc. As a result, Fitch views much of Spectrum's cash balance as unrestricted and available to reduce debt.
Corporate Governance
Spectrum is a controlled company. Harbinger Group Inc. (HRG, Fitch IDR 'B'/Outlook Positive) owns approximately 59% of Spectrum. HRG has pledged a portion of its Spectrum shares as collateral for its own debt and is also dependent on its portfolio companies for cash flow. However, restrictive and financial covenants in Spectrum's debt facilities, as well as HRG's focus on maintaining moderate debt levels at its portfolio companies, should preserve good credit protection measures.
Cyclicality/Commodity Exposure Increases Modestly
The ArmorAll Brand which is automotive appearance related represented approximately 55% of AAG's \$298 million in reported 2014 revenues. There is some modest cyclicality as these purchases have tended to be more discretionary and correlates to new car purchases. Both ArmorAll and STP use jet fuel as an ingredient, which is currently benefiting from lower oil prices, but prices can be volatile. Nonetheless, given that AAG will contribute to less than 10% of Spectrum revenues, any spikes should be manageable within the larger enterprise and likely to be hedged. Fitch estimates that cyclical products lines such as hardware, small appliances and AAG increases the cyclical portion of the company's portfolio by about 5% to approximately 50%.
RATING SENSITIVITIES
Negative: Any change in financial strategy such that leverage is consistently and materially sustained at higher than 5x levels could have negative rating implications. This is likely to be driven by material transformative acquisitions, which may make strategic sense, but could limit financial flexibility. Fitch would be concerned if there are material market share or secular declines in categories generating a meaningful portion of FCF, such as a combination of Home and Garden and HHI.
Positive: Spectrum's business momentum and credit protection measures were generally improving before the recent spate of acquisitions. However, the potential for an upgrade is likely low in the near term until the company closes, integrates and sustainably operates with leverage under 4x. The company has good cash flow generation and could comfortably operate with lower leverage if the pace and size of discretionary acquisitions falters. However, recent history has shown this likelihood to be low given the company's acquisitive posture.
Fitch affirms Spectrum's ratings as follows:
Spectrum Brands, Inc.
--Long-term IDR at 'BB-';
--\$400 million senior secured asset backed revolver (ABL) due May 24, 2017 at 'BB+/RR1';
--\$510 million senior secured term loan C due Sept. 4, 2019 at 'BB+/RR1';
--\$648 million senior secured term loan A due Sept. 4, 2017 at 'BB+/RR1';
--Euro 150 million (\$181 million) senior secured term loan due Dec. 19, 2020 at 'BB+/RR1';
--\$520 million 6.375% senior unsecured notes due Nov. 15, 2020 at 'BB-/RR4';
--\$570 million 6.625% senior unsecured notes due Nov. 15, 2022 at 'BB-/RR4';
--\$300 million 6.75% senior unsecured notes due March 15, 2020 at 'BB-/RR4;
--\$250 million 6.125% senior unsecured notes due Dec 15, 2024 at 'BB-/RR4'.
Spectrum Brands Canada, Inc.
--Long-term IDR at 'BB-';
--\$34 million senior secured term loan B due Dec. 17, 2019 at 'BB+/RR1'.
Spectrum Brands Europe GmbH:
--Long Term IDR at 'BB-';
--Euro 225M (USD\$283 million) senior secured term loan due Sept. 4, 2019 at 'BB+/RR1'.
The Rating Outlook is Stable.
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