Natura & S A : Rating Report - S&P

Research Update:

Natura & Co Assigned 'BB' And 'brAAA' Issuer Credit Ratings; Natura Cosméticos Proposed Notes Rated 'BB'; Outlook Stable

Research Update: Natura & Co Assigned 'BB' And 'brAAA' Issuer Credit Ratings; Natura Cosméticos Proposed Notes Rated 'BB'; Outlook Stable

Rating Action Rationale

Resilient business model and fast digital expansion has sustained growth and margins.

Natura&Co has broad geographic diversification with revenue distribution of 30%-35% in Brazil, 35%-40% in APAC and EMEA, 25% in Latin America excluding Brazil, and 0%-5% in other regions. It also has a diversified sales channel with strong positions in direct selling, e-commerce, and retail. This diversification helped to keep its business resilient during the pandemic, along with agile execution to foster the use of digital tools by its representatives, to increase the At-Home channel at The Body Shop (TBS), and to promote e-commerce in all its dvisions. Those factors have offset most of the revenue contraction in its retail stores. The subsidiary Aesop had online sales growth of 190% and TBS of 72% in the fourth quarter of 2020, which combined with currency depreciation resulted in revenue growth in 2020 of 50% and 20%, respectively.

Despite the uncertain conditions from the restrictions caused by COVID-19 globally, we believe that Natura&Co's strategies will support revenue expansion over the next several years. The group is working on its entrance into the Chinese market with local stores Aesop and TBS, and is intensifying the At-Home and digital channels of TBS and growing in the U.S. and Japan markets. We expect Aesop's growth momentum to continue in the next couple of years based on geographic expansion, higher digital sales, and expanding fragrance product portfolio. The group will also explore synergy opportunities to boost cross-selling revenues among Natura and Avon that could add $90 million-$120 million of revenue per year.

Avon's operational overhaul is still a significant risk, but signs of recovery are coming into

focus. Avon's adjusted EBITDA margins were only 2.5% in 2020 versus 6.0% in 2019 due to significant restructuring charges and one-off expenses related to the integration with Natura&Co and the pandemic's hit to its direct sales. 2021 should still be a challenging year for Avon's international operations because of continuing pandemic-related restrictions, but we forecast margins to return to 5%-7% in 2021 and 10%-12% in 2022. As Avon's margins improve, the group's consolidated EBITDA margins should rise above 13% in 2022 from the current 10%-11%.

Avon's operations in Brazil and Latin America have posted improving results since the second half of 2020, with revenue growth at constant currency of about 4.9% in Brazil and 3.0% in Latin America (excluding Brazil) in the fourth quarter. This growth has come mainly from aligning commercial practices, communication strategies, and expanding digital tools offered to the clients and representatives.

The group achieved $73 million of synergies in 2020 from the integration of Avon with Natura, mainly from administrative and procrument gains, and total synergies could reach $350 million to $450 million per year. On top of administrative and sourcing, the recurring synergies would also stem from revenue synergies, and the integration of logistic distribution and product manufacturing. For example, Avon's Poland plant will produce some TBS products, replacing outsourced suppliers.

The full achievement of synergies will likely boost consolidated EBITDA margins 150-250 basis points (bps) above our base case and lead to an additional R$500 million-R$1.0 billion of free operating cash flow per year.

Robust balance sheet, large liquidity cushion, and commitment to contain leverage support the

ratings. Natura&Co has a strong balance sheet to withstand current volatile conditions and fund its growth strategy. It ended 2020 with a cash position of R$8.3 billion and an adjusted net debt to EBITDA of 1.9x. Also, the group illustrated its commitment to a conservative capital structure

Research Update: Natura & Co Assigned 'BB' And 'brAAA' Issuer Credit Ratings; Natura Cosméticos Proposed Notes Rated 'BB'; Outlook Stable

through the capitalization of R$2 billion in the second quarter of 2020 and the R$5.6 billion equity follow-on in fourth quarter of 2020, along with the prepayment of $900 million (or about R$5.0 billion) of Avon's secured debt. The company will further strengthen its capital structure with the new proposed notes and plans to use the proceeds to prepay the outstanding 2023 notes of Natura Cosméticos and fund the amortization of its debentures due September 2021. With that, it will extend its debt maturity profile and increase financial flexibility because the new notes don't have financial covenants.

Outlook

The stable outlook reflects our expectation that Natura&Co will sustain its current strong credit metrics and healthy liquidity to cushion volatility related to the pandemic and improve Avon's margins. Still high capex in 2021 will prevent a larger deleverage this year, but we expect stronger results in 2022. We expect Natura&Co to keep debt to EBITDA close to 2.0x in 2021 and close to 1.5x afterward, and FFO to debt consistently above 35%.

Upside scenario

A positive rating action would stem from a much stronger-than-expected improvement in Avon's operations, boosting consolidated margins and EBITDA by unlocking synergies despite competition and currency swings. In this scenario, we would expect Natura&Co to maintain its debt to EBITDA below 2.0x, FFO to debt above 45%, and to improve FOCF (free operating cash flow) to debt consistently above 15%. Also, we would expect the company to sustain its healthy liquidity cushion and low margin volatility, and to maintain its ability to withstand a hypothetical default scenario of Brazil.

Downside scenario

We could take a negative rating action in the next 12-24 months if we see increasing cases of COVID-19 worldwide leading to operational disruptions for the company, weaker-than-expected demand, and/or higher working capital needs that could pressure its credit metrics. In addition, if Natura&Co keeps a more aggressive approach toward acquisitions or shareholders remuneration, or if the group's credit quality worsens because Avon continues to drag down cash, it could lead to a downgrade. In those scenarios, we would see debt to EBITDA close to 4.0x and FFO to debt below 20% consistently. This scenario would also squeeze the company's liquidity position and result in tight covenant headroom, which would also limit the company's ability to be rated above the sovereign.

Company Description

Natura&Co is the fourth largest global cosmetics group, with annual revenue of about $7 billion (or R$37 billion). The group controls Natura Cosméticos S.A. (BB/Stable/--) and Avon Products Inc, and owns the brands Natura, Avon, Aesop, and The Body Shop. The group operates in more than 100 countries across all continents, with a leading position in Brazil, and has wide portfolio diversification, with offerings to various customer tiers and channel diversification. The group has strong brands with clear value propositons and a leading position in the direct sales models for cosmetics, with more than 6 million representatives and more than 3,000 stores.

Research Update: Natura & Co Assigned 'BB' And 'brAAA' Issuer Credit Ratings; Natura Cosméticos Proposed Notes Rated 'BB'; Outlook Stable

Our Base-Case Scenario

• Consolidated revenue growth in Brazilian reais of about 10% in 2021 and 6% in 2022, mainly driven by TBS and Aesop that should post growth over 20% in the in 2021 and above 10% in 2022, but also reflecting currency fluctuation;
• Growth of Natura&Co's operations in Latin America (including Brazil) of above 5% in 2021 and 2022;
• Avon's international revenues to grow about 6% in 2021 and 4% in 2022.
• We expect Natura&Co to post modest consolidated EBITDA margin expansion in 2021, but stronger performance in 2022 and 2023 as the company captures synergies and reduces restructuring expenses, pushing consolidated margins above 13%;
• We expect 4%-6% EBITDA margins at Avon in 2021, hampered by expenses in its restructuring process and integration with Natura, and then gradually recovering to double digits in 2022;
• Capex of R$1.4 billion in 2021 and R$1.2 billion-R$1.3 billion in the years afterward. The higher capex in 2021 will be mainly to expand its digital capabilities, expand in Asia and the U.S., integrate Avon, execute postponed capex from 2020 due to the pandemic, and to push forward its 2030 sustainability action plan;
• Dividend payout of 30% of the company's net income; and
• We consider the following macroeconomic assumptions:

A--Actual.F--Forecast

- Based on these assumptions, we forecast the following metrics:

2019A 2020A 2021F 2022F 2020F

Research Update: Natura & Co Assigned 'BB' And 'brAAA' Issuer Credit Ratings; Natura Cosméticos Proposed Notes Rated 'BB'; Outlook Stable

A--Actual.F--Forecast

Liquidity

We consider Natura&Co's liquidity as adequate. We expect Natura&Co's sources over uses of cash over the next 12 months to be about 1.5x and net sources to remain positive even if EBITDA dropped 15%. Natura has strengthened its cash position after the equity follow-on concluded in October 2020, mostly used to prepay Avon's 2022 senior secured notes.

The company's planned new senior unsecured notes issuance should extend its debt maturity profile, primarily by funding the early redemption of the $750 million senior notes due 2023 issued by Natura Cosméticos S.A. and the amortization of the debentures due September 2021. We also consider that Natura&Co has a well-established relationship with banks and high standing in credit markets, indicated by its ability to access equity and debt capital markets.

Primary liquidity sources:

• Cash position of R$8.3 billion as of Dec. 31, 2020.
• FFO of R$2.1 billion over the next 12 months.

Primary liquidity uses:

• Short-termdebt of R$3.8 billion as of Dec. 31, 2020.
• Working capital outflows of R$760 million.
• Seasonal working capital of R$700 million.
• Capex of R$1.4 billion.
• Dividend payment of R$260 million.

Covenants

Natura&Co and Avon don't have financial covenants on their own debts. The debentures held by Natura Cosméticos have a 3.0x net debt to EBITDA covenant that could trigger debt acceleration, but we expect this to have a more than 50% cushion. Natura Cosméticos' current 2023 notes also have a 3.5x net debt to EBITDA covenant. The covenant calculation excluded the impact of