Fitch Downgrades Vogue's IDR to 'B '; Withdraws Ratings
Fitch has not assigned a rating to the \$205 million add-on term loan launched yesterday. Proceeds from the new term loan will be used to pay dividends to Vogue's shareholders. Term loan balances upon closing will be in the \$600 million range with pro forma leverage, based on Sept. 30, 2014 latest 12 months [LTM] EBITDA of approximately 4.9x, compared with actual leverage as of Sept. 30 of 3.3x.
The downgrade reflects Fitch's view that Vogue is likely to operate with higher leverage than originally anticipated as exemplified by the above mentioned debt-financed dividend. Fitch recognizes that Vogue's financial performance has been better than expected and that the company has the ability to de-lever rapidly. However, a 'B+' IDR reflects business risk associated with Vogue's small size relative to larger well capitalized competitors as well as uncertainty regarding the company's on-going financial strategy.
KEY RATING DRIVERS
PROVEN MARKETER
Vogue is a small private company whose point of differentiation is in offering products using ingredients that address specific hair conditions similar to the products found in a salon but at more affordable price points. Most of the company's brand support is with retailers rather than investments in national advertising to pull consumers into the store. Consumers make the final purchase decisions in store. Vogue's approach has proven successful despite low brand awareness relative to competitors and it is continuing to gain share.
Vogue has had a growing presence on-shelf with major retailers, particularly in the mass and drug channel, for more than a decade. Major retailers such as Target have grouped Vogue's OGX brand under a 'salon affordable' banner, easily attracting consumers desiring specific hair solutions. Fitch notes that over the past several years many large household and personal care companies have modestly pulled back on advertising and increased trade spending to gain more last minute attention from consumers.
GROWING NICHE, GOOD POSITIONING
Vogue participates in the mass premium hair care category, which has exhibited solid growth rates vis a vis a relatively flat overall category. Financially pressured consumers limited visits to the expensive salon channel and migrated down to mass premium brands during the Great Recession and sales trends have remained positive through the recovery. As a point of reference, Fitch notes that Nexxus, a leading a mass premium brand competitor, also had strong revenue growth during the recession, despite premium pricing to mid-tier brands. Given this, Fitch believes there is good support for Vogue's subcategory throughout the economic cycle.
Vogue's ability to generate new, well-received products has led to increased sales among existing and new customers. New product development is led by the 51% owner (post The Carlyle Group's investment), Todd Christopher. Fitch expects Mr. Christopher to continue leading the business.
ATTRACTIVE COST STRUCTURE, FCF
Manufacturing is outsourced resulting in a highly variable cost structure. Net sales growth has exceeded the low to mid-single digit average organic rate experienced by the company's significantly larger peers. Margins have improved sequentially for a number of years due to top line growth and a more modest rate of overhead increases. Limited fixed investments are required. The company's free cash flow (FCF) efficiency (Cash Flow from Operations - Capex/Net Income) has been in the 90% range, in line with larger consumer product companies such as the Procter & Gamble Company, and is expected to remain so.
SIZE, LACK OF DIVERSIFICATION
Vogue participates primarily in hair care, with the majority of its revenues derived from the United States. Revenues are also small in relationship to its several large peers. Vogue may not have the scale or resources to compete if a large competitor invested heavily in advertising and trade spending for a protracted period of time.
EVENT RISK VIEWED AS HIGH
The Carlyle Group (Carlyle) owns 49% of Vogue after its \$391 million investment. Carlyle is expected to exit its position in its investment at some point which could increase event risk.
DEBT STRUCTURE AND LIQUIDITY
Mandatory excess cash flow requirements in Vogue's credit agreement and the company's strong cash flow give Vogue the opportunity to meaningfully reduce debt. Protection for creditors is provided by a net first lien leverage ratio which steps down from 5.25x at June 30, 2014 to 3.75x at March 31, 2016 and thereafter. It is anticipated that Vogue will continue to ably meet requirements with a solid cushion.
Liquidity is adequate and supported mainly by Vogue's cash flow and the \$30 million, five-year senior secured revolver. Capital requirements are minimal and debt maturities on the term loan are structured to be modest at approximately \$4.2 million annually.
Recovery Ratings
The 'RR1' recovery rating on Vogue's secured debt reflects Fitch's expectations regarding the firm's pro forma capital structure and view of the new company's enterprise value as a going concern. Fitch estimates that recovery on Vogue's secured revolver and term loan A would be outstanding at 100% in a distressed situation.
Key Assumptions:
--Vogue's operating performance, in terms of sales growth and operating cash flow generation, will remain solid;
--Management may be willing to maintain higher leverage than Fitch had originally anticipated.
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