Fitch Revises Outlook for Arrow Electronics to Negative; Affirms IDR at 'BBB-'
2008-12-03 18:00:04 -
Fitch Ratings has revised the Ratings Outlook for Arrow Electronics, Inc. (Arrow) to Negative and affirmed the following ratings:
--Issuer Default Rating (IDR) at 'BBB-';
--Senior unsecured notes at 'BBB-';
--Senior unsecured bank credit facility at 'BBB-'.
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. 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 to decline 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 declines 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 buybacks 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 Arrow reflects the above considerations as well as the following:
--Fitch believes that Arrow's declining organic revenue growth rates combined with declining profitability since 2006 suggests weakening operating metrics heading into the downturn which could lead to greater than anticipated pressure on operating margin going forward. Specifically, Fitch estimates that Arrow's organic revenue growth rate (adjusted for acquisitions and foreign exchange) has declined from approximately 11% growth in 2006 to 3% growth in 2007 to 1% growth in the latest twelve month period ending September 2008. EBITDA margin, after adjusting to hold the level of doubtful account reserves constant relative to total accounts receivable outstanding, has declined from 5.1% in 2006 to 4.4% in the LTM period ended September 2008 (including 3.3% EBITDA margin in the September 2008 quarter, down 115 basis points over the prior year period). However, this partially reflects a change in revenue mix toward increased systems sales as Fitch estimates that return on invested (tangible) capital has remained constant near 15%.
--Revenue growth and profit margin have been positively impacted by strength of 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 Arrow 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: i) the company's leading market positions in both component and enterprise computing distribution worldwide, ii) the ability to generate cash from operations in a downturn from reduced working capital requirements as well as the ability to generate cash with revenue growth rates in excess of 10%, given the current margin profile and CCC days; iii) a highly diversified supplier and customer base with no customer representing greater than 2% of revenue and only one supplier representing greater than 10% of revenue in 2007; and iv) increasing end-market and geographic diversification driven by higher growth rates in the Asia-Pacific region and market share consolidation within the Enterprise Computing Solutions (ECS) business.
As of Sept. 30, 2008, liquidity was sufficient and supported by cash and cash equivalents of $243 million; an undrawn $800 million senior unsecured revolving credit facility expiring January 2012; and an undrawn $600 million accounts receivable securitization facility expiring March 2010. Consistent annual free cash flow which has averaged near $400 million the past three years also supports liquidity.
Total debt was $1.3 billion as of Sept. 30, 2008 and consisted primarily of: $200 million 9.15% senior debentures due 2010; a $200 million term loan due January 2012; $350 million 6.875% notes due 2013; $200 million 6.875% senior debentures due 2018; and $200 million 7.5% senior debentures due 2027. Fitch estimates Arrow's leverage (total debt/total operating EBITDA) at 1.6 times (x) as of September 2008 (2.1x 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 this site.
Fitch Ratings
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