Fitch Affirms Ratings on Avnet (AVT); Outlook Remains Stable
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Fitch Ratings has affirmed the Long-Term Issuer Default Rating of Avnet, Inc. (NYSE: AVT) at 'BBB-'. Fitch has also affirmed the 'BBB-' issue specific ratings assigned to the company's senior unsecured debt and revolving credit facility. The Rating Outlook remains Stable. The company reported approximately $2.5 billion of debt outstanding as of July 2, 2016. A complete list of rating actions follows at the end of this release.
The rating action follows Avnet's announcement that it has reached an agreement to sell its Technology Solutions (TS) business to Tech Data Corporation for $2.6 billion in cash and common stock. Fitch believes the divestiture of the TS business is a positive given the business' negative revenue growth, lower margins and few synergies with the Electronics Marketing (EM) segment, but is offset by the remaining business having less scale and diversification and more cyclicality of demand. The TS business has had negative revenue growth four of the last five years as technology consumers reduce on premise spending and shift to hyper-converged infrastructure and cloud environments. Fitch estimates the remaining company will have approximately 80% exposure to the broader semiconductor market and will be susceptible to the cyclicality of the industry.
Fitch expects proceeds from the asset sale will be used to reduce debt, decreasing leverage below Fitch's 3.0x gross leverage (unadjusted debt to EBITDA) in the near-term. A deviation from our expectation for the company to reduce leverage below 3.0x would likely result in a downgrade. Following debt reduction, Fitch expects excess cash from the divestiture to be used for M&A and shareholder returns.
Avnet announced it entered into a definitive agreement to sell its TS business to Tech Data Corporation for $2.6 billion, including $2.4 billion of cash (approximately $2 billion after taxes) and $200 million of common stock. Prior to the divestiture, the embedded computing solutions business will be transferred from TS to the EM segment and stay with Avnet. The company expects the deal to close in the first half of calendar year 2017.
KEY RATING DRIVERS
--Avnet's strong market position in the EM segment. Avnet's scale and breadth continues to increase its importance and value in the global supply chain.
--Fitch's expectations for $150 million to $300 million of annual free cash flow (FCF) through the forecast. 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 shareholder returns. The ratings incorporate Fitch's expectations that Avnet would moderate share repurchases in the face of pressured FCF.
--Fitch expects Avnet's conservative approach to managing its balance sheet and capital allocation will continue following the close of the transactions and Fitch anticipates the company's total adjusted leverage (total debt adjusted for rent expense to total operating EBITDAR) will remain below 3.5x, versus a Fitch estimated 2.8x for the latest 12 months ended July 2, 2016.
--The ratings reflect the key operating characteristics of the distributor model, namely relatively low profit margins and high capital intensity as a percentage of EBITDA, as well as the inherent cyclicality and significant swings in working capital investment. Fitch expects Avnet's EBITDA margins will range from 4% to 5% over the intermediate term versus 4% for the latest 12 months (LTM) ending July 2, 2016. In a downturn, Fitch expects operating EBITDA margin could approach 3.5%, as was the case in 2009.
--Fitch believes 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 expects mid-cycle revenue growth in the low-single digits over the intermediate term, driven by increased demand for 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 FCF generation before changes in working capital.
Fitch's key assumptions within the rating case for Avnet include:
--Fitch expects organic revenue growth in the low single-digits;
--EBITDA margin expansion from the divestiture of the lower margin TS business and synergies;
--Fitch expects $80 million of synergies from the TS divestiture;
--Small- to medium-sized acquisitions over the rating horizon to build out the digital platform;
--Fitch expects $1 billion to $1.5 billion of debt repayment over the near-term after the divestiture is completed.
--Quarterly dividend payments and excess cash flow used to repurchase stock.
Negative: Fitch's expectation for adjusted leverage (adjusted debt to EBITDAR) to be sustained above 3.5x or gross leverage (unadjusted debt to EBITDA) to be sustained above 3.0x, most likely due to domestic cash limitations or debt financed acquisitions, or the expectation for mid-cycle FCF to adjusted debt below 5%.
Positive: Upside movement in the ratings is limited given Avnet's thin operating margin profile with significant cyclical demand exposure. 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.
Avnet's liquidity is solid and supported by cash of approximately $1 billion ($970 million offshore) as of July 2, 2016 and $1.1 billion available under the company's $1.25 billion senior unsecured revolving credit facility, expiring July 2019. Additionally, Fitch expects mid-cycle FCF of $150 million to $300 million through the forecast.
Pro forma for September 2016 maturities, total debt as of July 2, 2016 consists of:
--$1.25 billion senior unsecured revolving credit facility due 2019 ($150 million drawn);
--$300 million 5.875% senior unsecured notes due 2020;
--$350 million 4.875% senior unsecured notes due 2022;
--$550 million 4.625% senior unsecured notes due 2026;
--$900 million senior secured accounts receivable securitization ($730 million drawn);
--$125 million of other debt.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the ratings for Avnet, Inc. as follows:
--Long-Term Issuer Default Rating (IDR) at 'BBB-';
--Senior unsecured debt at 'BBB-'.
The Rating Outlook is Stable.
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