Fitch Ratings has assigned an 'A' rating to St. Jude Medical, Inc.'s (STJ) notes offering. The company intends to use the net proceeds of this offering for general corporate purposes, which may include the repayment of certain indebtedness.
The Rating Outlook is Stable, and the ratings apply to approximately $3.06 billion of debt outstanding as of Dec. 31, 2012. A full list of STJ's ratings is available at the end of this release.
KEY RATING DRIVERS
STJ's ratings and Stable Outlook reflect the following:
--Leverage (total debt/EBITDA) of 1.66 times (x) at Dec. 31, 2012 leaves STJ no flexibility for additional debt within its 'A' credit rating, although Fitch expects it to decline to 1.3x-1.5x during the next 12 months.
--Fitch believes STJ's broad device portfolio and new market introductions will support low single-digit revenue growth and fairly stable margins, driving 2013 free cash flow (FCF) of roughly $800 million.
--Volume pressure from the weak economy and pricing pressure from hospitals will likely continue through 2013.
--Fitch expects STJ will balance acquisitions, share repurchases and dividends with a credit profile supportive of an 'A' rating.
DECLINING LEVERAGE EXPECTED
Fitch expects STJ will decrease leverage to 1.3x-1.5x during the next 12 months through increased EBITDA and debt reduction financed with cash balances and FCF generation. As such, Fitch expects that STJ will not refinance the entire $450 million 2.20% notes due in September 2013. Current leverage of approximately 1.66x is mainly the result of acquisition and share repurchase activity.
SOFT VOLUME GROWTH
Fitch expects STJ will generate low single-digit revenue growth during the next 12-18 months. The weak economic/employment environment has reduced the rolls of the insured and dampened procedure growth. STJ's continued geographic expansion and sizeable pipeline of new devices should partially offset the drivers of soft volume growth. The critical nature of many of STJ's devices and aging demographics support a trend of increasing utilization. In addition, implementation of the Affordable Care Act (ACA) will likely increase the number of insured during 2014-2016, which should incrementally improve volume growth.
Unrelated to the economy, surgeons are employing a more judicious approach to implanting cardioverter defibrillators, following a cautionary study published in the Journal of the American Medical Association January 2011. In addition, possible negative market reaction to STJ's formerly-manufactured Riata leads may temporarily soften sales growth in STJ's cardiac rhythm management (CRM) business. Fitch expects the negative impact of the above two issues on the CRM segment will dissipate within the next 12-18 months, as the market resets and returns to a normal growth trend.
POTENTIAL MARGIN PRESSURE
Hospitals are reportedly becoming more aggressive in contract negotiations. However, margins for device makers have remained relatively stable, likely due to mix shift to newer, higher margin devices and focus on cost control. Fitch believes hospitals will continue to pay for meaningful improvements in medical devices but probably at more restrictive rates than in the past. If significant consolidation continues within the hospital sector, some participants will gain even more negotiating leverage. However, it is worth noting that the hospital market is still very fragmented, and consolidation will likely be gradual.
The ACA could shift payer mix in a way that pressures hospital margins and causes hospitals to direct volume to lower cost procedures and medical devices, potentially pressuring device prices. In addition, the ACA began imposing a 2.3% excise tax on U.S. medical device sales in 2013. STJ's restructuring efforts and anticipated market launches of new higher-margin, value-added medical devices should partially offset the negative effect on margins. As such, Fitch expects potential margin compression will be modest.
Fitch believes that modest revenue growth and somewhat stable margins will enable STJ to generate $750 million - $850 million of annual FCF (cash flow from operations minus capital expenditures of roughly $300 million minus dividends of roughly $310 million)) during the next two years. Cash generation should be sufficient to fund targeted acquisitions and moderate share repurchases.
Fitch believes STJ will remain acquisitive, focusing on companies or device platforms that offer innovation and growth, as technological advancement in the device sector is still relatively fragmented. Share repurchases will likely continue, especially in the absence of viable acquisition targets. The company's recently instituted cash dividend may moderate the level of share repurchases. Fitch expects STJ will balance its transactions within the context of maintaining an 'A' credit rating profile.
LIQUIDITY AND DEBT STRUCTURE
At Dec. 31, 2012, STJ had adequate liquidity, comprised of approximately $1.19 billion in cash plus short-term marketable securities and roughly $907 million (net of $593 million commercial paper borrowings) in availability on its $1.5 billion bank revolving credit facility, which expires on Feb. 28, 2015. STJ generated approximately $771 million in FCF (net of $280 million of capital expenditures and $284 million of dividends) during latest 12 months (LTM), ended Dec. 31, 2012. The company had approximately $3.06 billion in debt with approximately $526 million maturing or amortizing in 2013, $700 million in 2014, $593 million in 2015, $500 million in 2016 and $754 million thereafter. Fitch expects the vast majority of STJ's maturities will be refinanced with its ample access to credit markets.
Fitch does not anticipate an upgrade in the near to intermediate term. However, STJ would need to commit to and operate with leverage stronger than 1.3x-1.4x while maintaining relatively stable operations and solid FCF, in order for Fitch to consider a positive rating action.
A downgrade of the ratings could result from debt sustained above 1.6x EBITDA without the prospect for timely deleveraging. This could result from a scenario in which revenue and margins are significantly stressed (more than Fitch anticipates); resulting FCF weakens; and capital deployment not being adjusted to reduce the company's need for debt financing. As such, debt-financed share repurchases or acquisitions in the near term would likely prompt a negative rating action, given the limited flexibility associated with the company's current leverage.
Fitch rates STJ as follows:
--Issuer Default Rating (IDR) 'A';
--Senior unsecured bank debt 'A';
--Senior unsecured debt 'A';
--Short-term IDR 'F1';
--Commercial paper 'F1'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology', dated Aug. 8, 2012.
Applicable Criteria and Related Research
Corporate Rating Methodology
Bob Kirby, +1 312-368-3147
Fitch Ratings, Inc.
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Michael Zbinovec, +1 312-368-3164
Michael Weaver, +1 312-368-3156
Brian Bertsch, +1 212-908-0549