Fitch Affirms Avnet's IDR at 'BBB-'; Outlook Stable

KEY RATING DRIVERS

The ratings and Outlook reflect:

--Avnet's leading market positions in both segments of its business, Electronics Marketing (EM) and Technology Solutions (TS). Avnet's growing scale and breadth continues to increase its importance and value in the global supply chain.

--Fitch's expectations for $400 million to $700 million of annual free cash flow (FCF) through FY 2018. In a downturn, cash from the liquidation of inventory should offset lower operating EBITDA to support FCF. Fitch's expects Avnet will use FCF for organic growth, small bolt-on acquisitions, and share repurchases. Avnet has roughly $407 million in remaining share repurchase authorization and has repurchased $291 million in shares over the LTM period. The ratings incorporate Fitch's expectations that Avnet would moderate share repurchases in the face of pressured FCF.

--Fitch expects Avnet's reasonably conservative balance sheet and approach to capital allocation with expectations for total adjusted leverage (total debt adjusted for rent expense to total operating EBITDAR) to remain below 3.5x, versus a Fitch estimated 2.3x for the latest 12 months ended Oct. 2, 2015.

--The relative low profit margins and high capital intensity as a percentage of EBITDA of the distributor model, as well as the inherent cyclicality and significant swings in working capital investment. Fitch expects Avnet's EBITDA margins will range from 3.5% to 4.5% over the intermediate term vs. 4.1% for the LTM ending Oct. 2, 2015. In a downturn, Fitch expects operating EBITDA margin could approach 3%, as was the case in 2009.

--The company's inorganic growth strategy is also a potential source of event risk for bondholders, since larger acquisitions would also carry integration risk that is amplified/intensified by low profit margins. Fitch expects larger acquisitions likely would be debt-financed, resulting in higher than expected leverage. Such a scenario could pressure ratings if Fitch did not expect Avnet to return leverage to historical levels in the short-run.

--Fitch believes distributers will increasingly play a critical role in connecting cloud venders to the distributer channel given the scale and reach distributers provide. There is risk that cloud computing and other as-a-service solutions may cannibalize on-premise IT spending, however, increased complexity and value added integration of these solutions may result in higher margins.

-- Fitch believes Avnet's diversification into converged infrastructure, security, analytics and cloud could strengthen Avnet's credit profile over the long-term. Demand for these products and services should be less volatile than the traditional hardware and components businesses.

--Fitch's expectations for mid-cycle revenue growth in the low-single digits over the intermediate term, driven by a recovery in European IT spending and increased demand from growing software and electronics content.

--Avnet's quarterly dividend plan implemented in 2013 does not impact the ratings but does reduce financial flexibility. This could pressure the investment grade rating in a stressed environment, particularly if share repurchase activity exceeds free cash flow generation before changes in working capital.

Credit strengths include the company's:

--Leading market positions and critical function serving small- and medium-sized customers in both component and enterprise computing distribution worldwide;
--The ability to generate cash from operations in a normal revenue growth environment, as well as achieve solid free cash flow in a downturn from reduced inventory; and
--Highly diversified supplier and customer base.

Credit concerns include Avnet's:
--Thin operating margins, which are typical of the IT distribution market;
--Significant investment levels required to increase share geographically, including potentially debt-financed acquisitions and the attendant integration risks; and
--Avnet's exposure to the cyclical demand patterns and cash flows associated with the semiconductor and networking sectors.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

--Management will manage debt levels resulting in total adjusted leverage remaining below 3.5x;
--Expectation for mid-cycle operating EBITDA margins ranging from 3.5% - 4.5%;
--Revenue growth in the low-single digits over the intermediate-term.
--FCF is used principally for share repurchases and bolt-on acquisitions;
--Avnet would moderate share repurchases in the face of pressured FCF.
-Additional debt of $60 million through FY 2018 to maintain domestic cash balances.
-Assumes $200 million of annual share repurchases.
-Assumes $200 million of acquisitions (70% foreign using offshore cash).
-Maturing debt is expected to be refinanced.

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

--Expectations adjusted leverage will be sustained above 3.5x, most likely due to domestic cash limitations or debt-financed acquisitions and/or share repurchases;
--Significant revenue declines and margin compression due to the SMB end-market shifting its technology spending away from distributers toward large cloud providers that have the size to buy directly from ODMs.

Positive: Upside movement in the ratings is limited given Avnet's razor-thin operating margin profile with significant cyclical demand exposure. Significant sustained improvement in credit metrics paired with a long-term strategic business rationale and demonstrated commitment from management to maintain a higher rating would be necessary.

LIQUIDITY

As of Oct. 2, 2015, liquidity was solid with $825 million in cash of which $719 was held outside the United States and $820 million available from $1.25 billion senior unsecured revolving credit facility which expires in June 2019. Domestic cash is expected to remain below $100 million over the forecast period, and additional debt may be required to maintain an adequate domestic cash balance while maintaining shareholder returns at current levels or to fund domestic acquisitions.

Fitch's expectations that Avnet will generate $400 million to $700 million of annual FCF through FY 2018 also support liquidity. In a downturn, cash from the liquidation of inventory should partially offset lower operating EBITDA to support FCF. Fitch believes Avnet would generate significantly less FCF if organic growth accelerates due to cash being spent on inventory expansion. Avnet has roughly $288 million available under a $900 million accounts receivable securitization (ARS) facility maturing in August 2016. Availability under the ARS facility is subject to the company having sufficient eligible receivables to support desired borrowings. Average daily borrowings under the ARS facility was approximately $534 million in FY 2015.

Total debt as of Oct. 2, 2015 was $2.1 billion and consisted principally of the following:

--$429 million drawn on the company's $1.25 billion revolver expiring July 2019
--$617 million drawn on the company's $900 million A/R securitization facility expiring August 2016;
--$300 million 6.625% senior notes due September 2016;
--$300 million 5.875% senior notes due June 2020; and
--$350 million 4.875% senior notes due December 2022.

Fitch has affirmed the following ratings:

Avnet, Inc.
--IDR at 'BBB-';
--$1.25 billion senior unsecured revolving credit facility at 'BBB-';
--Senior unsecured debt at 'BBB-'.

The Rating Outlook is Stable.