Fitch's 2009 outlook for the IT distributor industry is negative based on expectations that a reduction in global IT spending will weaken operating profiles and could potentially lead to weakened credit profiles, particularly if combined with the realization of event or execution risk, the company has announced.
Fitch expects IT hardware, including semiconductors, to decline at a faster rate than overall IT demand. Geographically, Fitch expects the U.S. and Western Europe decline to be greater than average, offset by relative strength in emerging markets.
Both trends suggest that rated IT distributors, based on their higher exposure to these market segments, will experience a more pronounced business decline than the overall IT market. Sales decline will likely pressure operating profitability and reduce financial flexibility. While cash generation from reductions in working capital is expected to be substantial, flexibility for share buy-backs and acquisitions will be reduced under current ratings, given lower profitability, as well as the expectation of future working capital requirements upon resumption of growth.
The change in ratings outlook to negative for Avnet reflects the above considerations as well as the following:
- Fitch believes that declining organic revenue growth rates suggest weakening operating metrics heading into the downturn, which could lead to greater than anticipated revenue and profitability declines in 2009. Specifically, Fitch estimates that Avnet's organic revenue growth rate (adjusted for acquisitions and foreign exchange) has declined from growth of approximately 9-to-3-to-1-percent in fiscal 2006, 2007 and 2008, respectively (fiscal year end June 30).
- Revenue growth and profit margin have been positively impacted by strength in the Euro relative to the U.S. dollar in recent years, a trend which is now reversing and could further pressure profitability in 2009.
- Event risk is heightened given depressed asset prices potentially leading to additional acquisitions or shareholder friendly actions.
A downgrade could occur if the economic decline is more significant and prolonged than currently anticipated leading to expectations for reduced profitability over an extended period. Additionally, negative rating actions could occur if Avnet aggressively pursues acquisitions or shareholder friendly actions financed by existing cash, debt issuance or free cash flow generated from reduced working capital requirements.
The ratings are supported by: the company's leading market positions in both component and enterprise computing distribution worldwide; the ability to generate cash from operations with revenue growth rates up to 15-percent, given the current margin profile and CCC days, as well as achieve significant free cash flow in a downturn from reduced working capital; a highly diversified customer base and well diversified supplier base with only IBM (14-percent) representing greater than 10-percent of revenue in fiscal year 2008 (end June-2008); and increasing end-market and geographic diversification driven by higher growth rates in the Asia-Pacific region and market share consolidation within the technology solutions (TS) business.
At Sept. 30, 2008, the total available liquidity was approximately $1.3 billion and consisted of: $387 million of cash and cash equivalents; $473 million available under a $500 million senior unsecured bank credit facility expiring October 2012; and a $450 million A/R securitization facility expiring August 2009 which was fully available. Fitch expects free cash flow to positively support liquidity going forward, averaging roughly $300 million annually in periods of normal organic growth.
Total debt as of Sept. 30, 2008 was approximately $1.2 billion and consisted of: $250 million 6-percent senior notes due September 2015; $300 million 6.625-percent senior notes due September 2016; $300 million 2-percent convertible senior debentures due March 2034, but potable in March 2009; and $300 million 5.875-percent senior notes due March 2014. Fitch estimates Avnet's leverage (total debt/total operating EBITDA) at 1.5 times as of September 2008 (1.9 times when adjusted for operating leases), which Fitch expects to increase due to declining EBITDA in 2009.
Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the Code of Conduct section of the above site.
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