CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the following ratings of Quest Diagnostics Incorporated (Quest):
--Issuer Default Rating (IDR) at 'BBB+';
--Senior unsecured debt rating at 'BBB+';
--Bank loan rating at 'BBB+'.
The ratings apply to $2.99 billion of outstanding debt. The Rating Outlook is Stable.
On Jan. 31, 2011, Quest announced its intention to purchase around 15.4 million shares (approximately $865 million) that GlaxoSmithKline plc (GlaxoSmithKline) is divesting via its wholly-owned subsidiary, SB Holdings Capital Inc. (SB Holdings). SB Holdings held around 30.8 million of Quest's shares, an approximately 18% ownership stake, which stems from Quest's purchase of SmithKline Beecham Clinical Laboratories in 1999. Last week, Quest's Board of Directors increased the share purchase authorization by $750 million to a total of $1 billion, which will be used for the share repurchase. The company plans to finance the purchase through borrowings against a $525 million receivable securitization program and a $750 million revolver as well as cash on hand. At the end of the third quarter of 2010, the company had full capacity against a $525 million receivable program and a $750 million revolving credit facility due May 2012. Cash and equivalents at the end of 2010 were approximately $449 million.
Incremental borrowings used for the share repurchases as well as a potential legal settlement with the California Department of Health Services is anticipated to increase total debt-to-EBITDA to slightly greater 2.0 times (x) at the end of 2011 from 1.9x at the end of 2010. Quest maintains a debt leverage target of 1.5x to 2.25x, and Fitch expects the company to prioritize use of cash for debt reduction if a transaction results in leverage above the upper range of the company's target level. This was most recently demonstrated when the company dropped leverage into the target range within one year of acquiring AmeriPath in 2007.
Fitch recognizes Quest's solid liquidity which is provided by steady free cash flow generation as indicated by free cash flow margin in the range of 9% to 11.5% since 2006. Free cash flow was around $841 million in 2010 representing a margin of 11.4%. Fitch expects free cash flow margin to fall in the range of 7.5% to 9% in the intermediate term, pressured by EBITDA margin compression as well as increasing capital intensity. Quest management expects to generate operating cash flow of $1.1 billion in 2011 and spend capital of $220 million in 2011.
Pressures on top-line growth arose during 2010 due to lower volume impacted by decreased physician office visits and a business mix shift resulting from a slowdown in higher margin anatomical pathology demand dampened by increased competition from physician in-sourcing of pathology work coupled with an increase in lower-margin drug screening. This slowdown in higher margin testing demand, coupled with increased investment dedicated to improving customer service levels, contributed to a 90 basis point compression of EBITDA margin, to 21.8% in 2010, and Fitch estimates a incremental 60 basis point decline in 2011. The impact of the aforementioned items on profitability has been offset by ongoing cost reduction efforts since 2007, and in 2010 Quest twice reduced headcount to manage expenses in light of the current revenue pressures..
Quest's stated first priority for capital deployment is tuck-in acquisitions; however, no meaningful transaction has been consummated since a series of transactions in 2007. Over the past few years, cash flow has been used to aggressively repurchase common shares, including $750 million in 2010 and $500 million in 2009. Despite the company's stated priority to use cash for acquistions, Fitch expects that in the near term capital deployment will be directed to reduce incremental debt incurred in 2011. A transforming acquisition beyond the intermediate term to broaden its overall health care offering would not be surprising based on the company's history.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
'Corporate Rating Methodology' dated Aug. 16, 2010
Applicable Criteria and Related Research:
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=546646
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