Fitch Rates Spectrum Brands, Inc.'s Proposed EUR375MM Senior Unsecured Notes 'BB/RR4'
Spectrum's ratings reflect its well-diversified portfolio that can deliver low-single digit organic growth over time, and the company's track record of opportunistically integrating new brands onto its platform. Fitch expects Spectrum to remain acquisitive while managing leverage towards the 4x - 4.5x range post an acquisition over the medium term.
KEY RATING DRIVERS
Diversification and Marketing Strategy Leads to Solid Results
Spectrum's diversified product portfolio has resonated well with retail customers and consumers due to its generally non-discretionary nature, replacement cycles, and product innovation. Categories such as pet care, home and garden, and home hardware have proven to be stable growers over time. Organic growth rates have trended around 2.5% - 3.0% over the past three years, which in combination with margin-accretive synergies have led to EBITDA margin growth from 15% in 2013 to 17% in 2015. 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 post acquisitions.
Short-Term Increases in Leverage Expected Given Acquisitive Strategy
Fitch expects adjusted leverage to trend below 4.0x over the next 12 - 18 months on EBITDA growth and debt paydown following the debt-financed acquisition of Armored AutoGroup (AAG) in 2015. The acquisition was designed to expand Spectrum's portfolio into auto care through brands with leading market shares including ArmorAll and STP. Fitch views the acquisition favorably due to the industry's stable growth trends and the company's strong brands. Spectrum plans to reduce leverage below 4.0x, which Fitch believes is feasible by 2017, barring any acquisitions.
Spectrum's acquisitive posture has resulted in periodic but temporary increases in leverage. Over the past three years leverage has ranged from the low-4.0x range to the low-5.0x range, with the upper end of the range occurring following a debt-financed acquisition. Recent company acquisitions have added brands in categories such as auto care, pet food/treats, animal repellents and commercial locks. Spectrum has a positive track record of integration and Fitch expects Spectrum to continue making acquisitions over the forecast horizon. Without further acquisitions, Spectrum's leverage could trend in the mid-high 3.0x range beginning 2017. However, Fitch expects Spectrum will remain acquisitive and is likely to maintain leverage in the 4x - 4.5x over the medium term.
Spectrum is a controlled company. HRG Group Inc. (HRG, Fitch IDR 'B'/Outlook Stable) owns approximately 58% 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, mitigate concerns.
--Sales are expected to grow 8% - 10% in fiscal 2016 (ends September) on low-single digit organic growth and full-year inclusion of the AAG acquisition. Organic sales growth is expected to track in the low-single digit range beginning 2017.
--EBITDA growth is expected to modestly outpace sales growth over the forecast horizon, due to positive mix shifts, fixed-cost leverage, and ongoing cost structure reductions.
--Free cash flow after dividends (FCF) is projected to be $300 million to $400 million annually and is expected to be used for debt paydown in fiscal 2016 to meet Spectrum's target of reducing adjusted debt/EBITDAR at or below 4.0x.
--Spectrum could issue debt to fund an acquisition. Fitch's expectation would be that the company uses FCF to reduce leverage to the 4.0x - 4.5x range 24 - 36 months following an acquisition.
A negative rating action could occur given the following:
--Spectrum sustained leverage above 4.5x, due to either low-single digit sales declines on weak execution or margin erosion due to increased promotions to defend market share;
--The company effects a sizable acquisition of a weak brand with turnaround execution risk, violating the company's posture of acquiring brands with top market shares;
--Spectrum executes an outsized, debt-financed transaction which reduced confidence in the company's ability to return leverage below 4.5x over the following 24 - 36 months;
--Spectrum's debt covenants change to allow higher restricted payments, increasing risk of cash flow leakage to majority owner HRG.
Given Spectrum's acquisitive posture, an upgrade is unlikely due to the risk of a leveraging transaction. However, Fitch would view positively a commitment to sustain leverage below the 4.0x level.
LIQUIDITY AND DEBT STRUCTURE
As of July 3, 2016, Spectrum had $117 million in cash and $277 million availability on its $500 million revolving credit facility. Spectrum's FCF was in the $280 million range in 2015, down slightly from $300 million in 2014 due to the acquisitions of AAG and Tell. Fitch expects FCF to be near $300 million in FY2016, trending toward the $400 million range by FY2018, bolstered by the AAG acquisition.
Spectrum has been recording residual U. S. and foreign taxes on undistributed foreign earnings since 2012 in order to accelerate paydown 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.
Spectrum refinanced its capital structure in June 2015 with a $1.45 billion term loan, EUR300 million term loan, and CAD75 million term loan. Additionally, the company launched a new five-year $500 million senior secured cash flow revolver. The cash flow revolver replaced the $400 million asset based lending (ABL) facility, providing additional liquidity and financial flexibility. A portion of the proceeds was also used to retire the $300 million 6.75% senior unsecured notes due 2020.
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; however, the company has continued to delever through debt paydown and EBITDA expansion. Similarly, leverage increased from the low-4x range in 2014 to the low-5x range in 2015 though Spectrum is expected to delever in 2016. Fitch expects leverage to decrease to 4.0x over the next 12 - 18 months absent further acquisitions.
Fitch has assigned recovery ratings (RRs) to the various debt tranches in accordance with criteria, which allows for the assignment of recovery ratings for issuers with IDRs in the 'BB' category. Given the distance to default, recovery ratings in the 'BB' category are not computed by bespoke analysis. Instead, they serve as a label to reflect an estimate of the risk of these instruments relative to other instruments in the entity's capital structure. Fitch assigned an 'RR1' to first lien secured debt, notching up two from the IDR and indicating outstanding recovery prospects (91% - 100%) given default. Unsecured debt will typically achieve average recovery, and thus was assigned an 'RR4', or 31% - 50% recovery.
FULL LIST OF RATING ACTIONS
Fitch currently rates Spectrum as follows:
Spectrum Brands, Inc.
--Long-Term Issuer Default Rating 'BB';
--Secured revolver 'BBB-/RR1';
--Senior secured term loans 'BBB-/RR1';
--Unsecured notes 'BB/RR4'.
The Rating Outlook is Stable.