(The following statement was released by the rating agency)
Oct 10 - Fitch Ratings has affirmed St. Jude Medical, Inc.'s
(STJ) ratings, including the Issuer Default Rating (IDR) at 'A'. The Rating Outlook is Stable, and the ratings apply to approximately $2.9 billion of debt outstanding as of June 30, 2012. A full list of rating actions is available at the end of this release.
STJ's ratings and Stable Outlook reflect the following:
--The AGA Medical Holdings, Inc. (AGA) acquisition is complete, and Fitch believes it will offer STJ long-term growth opportunities in the structural heart market.
--Leverage (total debt/EBITDA) of 1.66 times (x) at June 30, 2012 leaves STJ no flexibility for its 'A' credit rating, although Fitch expects it to decline to 1.3x-1.4x 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 2012 free cash flow (FCF) of roughly $700 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.
AGA INTEGRATION COMPLETE
The successfully completed integration of AGA should provide STJ with new opportunities in market for treating structural heart disorders. These devices fit well in STJ's cardiovascular business and expand the company's portfolio. In addition, AGA's left atrial appendage closure-device offers an additional therapeutic option to prevent blood clots in patients, particularly those who suffer from atrial fibrillation and often need to take anticlotting medicine.
DECLINING LEVERAGE EXPECTED
The AGA acquisition drove an increase in reported leverage to 1.74x, as STJ increased its debt by $400 million to fund the transaction. Subsequently, leverage decreased to 1.66x, owing to an improved profitability. Fitch expects STJ will decrease leverage to 1.3x-1.4x during the next 12 months through increased EBITDA and debt reduction financed with cash balances FCF generation.
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, health care reform legislation will likely increase the number of insured during 2014-2016, which should incrementally improve volume growth during the transition.
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. 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; although it is worth noting that the hospital market is still very fragmented, and consolidation will likely be gradual.
The Affordable Care Act (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 will begin 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 $650 million - $750 million of annual FCF [cash flow from operations minus capital expenditures (roughly $280 million) minus dividends ($280 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 June 30, 2012, STJ had adequate liquidity, comprised of approximately $1.21 billion in cash plus short-term marketable securities and roughly $1.1 billion (net of $446 million commercial paper borrowings) in availability on its $1.5 billion bank revolving credit facility, which expires on Feb. 28, 2015. STJ generated approximately $745 million in FCF (net of $307 million of capital expenditures and $275 million of dividends) during latest 12 months (LTM), ended June 30, 2012. The company had approximately $2.94 billion in debt with approximately $532 million maturing or amortizing in 2013, $700 million in 2014, $946 million in 2016 and $762 million thereafter. Fitch expects the vast majority of STJ's maturities will be refinanced with its ample access to credit markets.
WHAT COULD TRIGGER A RATING ACTION
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 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 is not 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 has affirmed STJ's ratings as follows:
--Issuer Default Rating (IDR) at 'A'; --Senior unsecured bank debt at 'A'; --Senior unsecured debt at 'A'; --Short-term IDR at 'F1'; --Commercial paper at 'F1'. The Rating Outlook is Stable.
(Caryn Trokie, New York Ratings Unit)