OREANDA-NEWS. Fitch Ratings has affirmed L'Oreal SA's (L'Oreal) Short-Term Issuer Default Rating (IDR) and commercial paper (CP) programme at 'F1+'. The agency has also affirmed L'Oreal USA Inc's CP programme, guaranteed by L'Oreal, at 'F1+'.

The ratings continue to reflect the company's strong market position and product portfolio as well as its robust geographical diversification. Also, L'Oreal continues to demonstrate healthy financial performance and maintain solid financial flexibility. Based on our projections we expect L'Oreal to generate abundant annual free cash flow (FCF) for the company to continue its strategy of bolt-on acquisitions to complement its brand portfolio.

KEY RATING DRIVERS

Robust Performance

Fitch expects L'Oreal's financial performance to remain strong with low-to mid-single-digit organic sales growth across all segments (excluding Body Shop) and regions, following solid results in 2015. In 2015 sales continued to grow faster than the cosmetics market in all its geographical areas of operations, with total organic growth, excluding currency fluctuations, of 3.9% against market growth of 3.7%.

The strong momentum extended into 1H16 as revenue grew 4.2% in organic terms and the company's operating profit margin grew further from the healthy 17.4% recorded in 2015. The strong profits enable the company to maintain one of the largest budgets in advertising, promotions, and media communication in the global consumer goods industry and to benefit from efficiencies of scale.

Strong FCF Generation Ability

L'Oreal exhibits strong cash flow generation capacity; it is therefore able to manage a conservative balance sheet despite the acquisition activity seen to date. In 2015 FCF after dividends was EUR1.5bn (5.9% of sales), higher than the approximately EUR1.3bn achieved annually over 2012 to 2014.

Over 2016-2018 we project FCF to stay high at approximately EUR1.4bn p. a., based on further EBITDA uplift, which should compensate for working capital needs growing in line with sales and for continued steady increase in dividends.

Targeted Bolt-on M&A Spending

Robust FCF has historically been allocated to bolt-on acquisitions and, in 2015, to debt reduction. We expect the company to remain on the look-out for further targeted bolt-on acquisition activity, in particular of strong emerging markets business or for innovative products with scope for growth, due to the strength of L'Oreal's distribution network and processes.

For instance L'Oreal acquired Niely Cosmeticos in Brazil and the Australian franchise of The Body Shop in 2015 and in 2016 it concluded the acquisition of US-based IT Cosmetics, and strengthened its presence in distribution to salons with the acquisition of Raylon Corporation in the US.

Superior Financial Flexibility

Following the debt-funded buyback of 48.5 million of its own shares from Nestle SA (AA/Stable) in July 2014 for EUR4.8bn cash net of assets transferred to Nestle, L'Oreal's funds from operations (FFO) adjusted leverage rose to 1.5x in 2014. However, due to cash flow generation, it returned to 1.0x at end-December 2015, a level that is more aligned with the company's historical average. We expect leverage metrics to remain at this level, providing comfortable financial flexibility for the current 'F1+' rating.

Additional financial flexibility comes from L'Oreal's 8.96% stake in Sanofi SA (AA-/Stable) held as a financial investment, which the company could monetise in case of need.

Consolidating Leading Market Position

L'Oreal's strong business profile is underpinned by the company's leading position in the cosmetics industry. In 2015, sales continued to grow faster than the cosmetics market in all the company's geographical areas of operations. We expect the latest bolt-on acquisitions announced in 2016 to continue to cement the L'Oreal's leadership in the cosmetics industry worldwide.

Strong Geographical Diversification

In 2015, cosmetics revenues were well-balanced among L'Oreal's different regions of operations, with "new markets" (mainly emerging markets) remaining as the largest sales contributor at 39% of total revenues. This reflects a successful strategy of adapting the company's product mix and channels to local consumer tastes against a backdrop of fast-growing beauty products demand in these geographies.

L'Oreal's strong presence in emerging markets offers solid long-term growth prospects despite the resulting exposure to fluctuating currencies. While foreign currency boosted reported sales by 7.2% in 2015, we expect a negative effect of around 3% in 2016.

Difficult Consumer Environment

While we expect some further softening in consumer demand moving into 2017, particularly in relation to the growth deceleration of emerging countries, and to the stagnating western European market, L'Oreal has continued to enjoy sound growth, even in the more cyclical luxury products market.

The company benefits from strong innovation and pricing capacity, marketing power and ability to control costs, allowing it to continuously improve operating margins, as seen in 2015. Also, structural factors benefiting the cosmetics industry, such as an ageing global population and the growing income of middle classes in many emerging markets remain in place.

KEY ASSUMPTIONS

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

- Low-to mid-single-digit organic sales growth and slight margin improvement over time, driven by innovation and pricing power;

- Unfavourable low-single-digit impact from foreign-currency movements in 2016;

- FCF (before acquisitions) to remain above EUR1.3bn annually due to limited working capital outflow and stable capex as a percentage of sales;

- Acquisition spending of EUR1.5bn in 2016; EUR750m annually thereafter;

- Moderate dividend growth in line with the historical trend.

RATING SENSITIVITIES

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

-Sharp deterioration of FCF

-FFO adjusted leverage of more than 2.0x (2015:1.0x) or FFO adjusted net leverage of more than 1.5x

-Total CPs back-up lines falling below 100% of total amount drawn under the CP programmes.

LIQUIDITY

L'Oreal uses mostly CP for its financing needs. At end-2015, it demonstrated adequate coverage of its near-term maturities of EUR740m with in excess of EUR5bn of available liquidity, comprising EUR1.4bn of unrestricted cash and cash equivalents on balance sheet and EUR3.8bn in available committed bank lines.