Fitch Affirms Owens & Minor at 'BBB-'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed the ratings of Owens & Minor, Inc. (NYSE: OMI) at 'BBB-'. The Rating Outlook is Stable.

The ratings apply to approximately $212 million of debt at Dec. 31, 2013. A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS

-- OMI holds a strong share (~35%-40%) of the steady and oligopolistic acute care medical-surgical (med-surg) products distribution market. Fitch believes OMI is well-positioned to maintain and/or grow market share in light of hospital consolidation and physician employment trends in the U.S.

-- Revenue growth is being constrained by weak utilization, flat pricing, and continued sell-side margin pressure. Fitch forecasts fairly flat EBITDA margins on low-single digit revenue growth in 2014, driven by the expectation that these trends will persist. Margin expansion will likely be linked to growth at Movianto.

-- Cash flows are consistent and sufficient to fund OMI's moderately elevated capex and its dividend. Fitch forecasts funds from operations (FFO) to be $160-$200 million per year over the ratings horizon. That said, Fitch notes that free cash flow may be constrained in 2014 due to the working capital required to on-board a large for-profit hospital customer.

-- A very low debt balance yielding gross debt leverage around 0.8x provides OMI ample flexibility at its current ratings. Ratings are constrained by management's stated willingness to materially increase debt leverage for M&A. OMI's history of relatively conservative financial management, combined with the limited number of sizeable deals currently available within OMI's core competencies, mitigate this risk somewhat.

-- Though still in the early growth stages Fitch believes OMI's healthcare logistics business and international platform represent important strategic growth drivers and tactics for improving its positioning with its manufacturer customers/suppliers in the medium-to-longer term.

RATING SENSITIVITIES

A low debt balance, consistent and sufficient FFO, and a solid liquidity profile afford OMI ample headroom at its current 'BBB-' ratings. Maintenance of OMI's current 'BBB-' rating will require debt leverage generally maintained at or below 2.5x with FFO of at least $120 million. OMI's target leverage is 2.0x, which is in line with ratings in the triple-B range.

OMI's current credit metrics and stable performance could support positive ratings momentum over the ratings horizon. However, some margin and cash flow pressures in 2011-2013 constrain the ratings somewhat. Fitch may consider a ratings upgrade in the medium-term with evidence of sustainable margin and cash flow improvements. In the meantime, Fitch believes the current 'BBB-' ratings provide OMI flexibility to consummate appropriate and targeted M&A.

M&A that causes leverage to increase to 3.0x-3.5x, in line with OMI's core competencies, could be appropriate at the current 'BBB-' ratings, if accompanied by a commitment to de-lever within 12-18 months. A downgrade is unlikely to result from operational or competitive pressures over the ratings horizon. But a downgrade could result from an otherwise transformational acquisition or from a shift away from OMI's historically conservative financial management strategy.

STRONG MARKET SHARE, STABLE OPERATIONS

Fitch believes OMI's strategy of achieving growth with large and growing integrated delivery networks (IDNs) is sound and will position the firm to benefit from prevailing healthcare consolidation trends. This strategy is likely to result in some gross margin pressure over time with respect to its base distribution services to these larger customers. However, it also gives OMI the opportunity to sell other value-adding services (including enhanced supply chain and inventory management services) and to increase the overall volume of product through its largely fixed cost operations. Growth in OMI's healthcare logistics business should also drive incremental margin expansion over the ratings horizon.

PERSISTENTLY WEAK HEALTHCARE UTILIZATION, PRICING TRENDS

Organic top-line growth expectations for OMI's base distribution business remain soft, largely due to continued weak healthcare utilization, low product price inflation, and modestly increasing sell-side margin pressure. Fitch expects these trends to continue through 2014 and probably into 2015, contributing to organic top-line growth of less than 1% and only very modest margin expansion. Material upside to these forecasts could come from additional new customer wins or better-than-expected penetration of value-adding services to existing customers during the year. Fitch thinks some incremental volumes from the coverage expansion provisions of the ACA are possible in 2014; but any correlated benefit will likely be very modest.

GROWTH OPPORTUNITIES FROM NEW CUSTOMER, HEALTHCARE LOGISTICS/MOVIANTO

Fitch expects that nearly all of OMI's growth in 2014 will be the result of its new large for-profit hospital customer or Movianto. Despite the relatively small dollar impact compared to OMI as a whole, the new customer win is significant, as it gives credence to the firm's strategy and provides an opportunity for an increasingly penetrated relationship over time. Growth in OMI's healthcare logistics business, including its Movianto platform in Europe, also represents material medium-to-longer term growth potential. Fitch sees the continuation of global healthcare trends supporting consolidation and specialization of services over the ratings horizon.

CONSISTENT CASH FLOWS, GOOD LIQUIDITY

Aided by very good working capital management, Fitch expects OMI to generate cash from operations sufficient to fund its elevated capital expenditures and its dividend. Fitch expects FFO to approximate $160 million to $200 million in 2014 and 2015, still somewhat pressured by the trends cited above. Given OMI's commitment to its dividend ($61 million in 2013) and the expectation for increased capex in 2013 ($60 million forecasted for 2014), Fitch believes that FFO of at least $120 million is necessary to support the current 'BBB-' ratings. Notably, FCF is expected to be negatively impacted in 2014 by a use of cash related to the build of inventory related to onboarding OMI's new large for-profit hospital customer.

OMI's liquidity profile is solid, consisting of $102 million of cash on hand at Dec. 31, 2013 and an undrawn $350 million unsecured revolver due June 2017. Debt maturities are very manageable, with only the $200 million of notes due in 2016.

Fitch has affirmed the ratings of OMI as follows:

--Long-term IDR at 'BBB-';

--Senior unsecured bank facility 'BBB-';

--Senior unsecured notes at 'BBB-'.

The Rating Outlook is Stable.

Applicable Criteria and Related Research:

-- 'Corporate Rating Methodology: Including Short-term Ratings and Parent and Subsidiary Linkage' (Aug. 5, 2013);

-- '2014 Outlook: U.S. Healthcare - Secular Challenges Require a Compelling Value Proposition' (Nov. 25, 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

2014 Outlook: U.S. Healthcare - Secular Challenges Require a Compelling Value Proposition

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724141

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=826425

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Contacts

Fitch Ratings
Primary Analyst:
Jacob Bostwick, CPA, +1-312-368-3169
Director
Fitch Ratings, Inc., 70 W Madison St., Chicago, IL 60602
or
Secondary Analyst:
Bob Kirby, CFA, +1-312-368-3147
Director
or
Committee Chairperson:
Megan Neuburger, +1-212-908-0501
Senior Director
or
Media Relations:
Brian Bertsch, New York, +1 212-908-0549
brian.bertsch@fitchratings.com

Sharing

Contacts

Fitch Ratings
Primary Analyst:
Jacob Bostwick, CPA, +1-312-368-3169
Director
Fitch Ratings, Inc., 70 W Madison St., Chicago, IL 60602
or
Secondary Analyst:
Bob Kirby, CFA, +1-312-368-3147
Director
or
Committee Chairperson:
Megan Neuburger, +1-212-908-0501
Senior Director
or
Media Relations:
Brian Bertsch, New York, +1 212-908-0549
brian.bertsch@fitchratings.com