|[January 23, 2014]
Fitch Places Quest Diagnostics' Ratings on Rating Watch Negative
CHICAGO --(Business Wire)--
Fitch Ratings has placed Quest Diagnostics, Inc. (Quest) ratings,
including the 'BBB+' Issuer Default Rating (IDR), on Rating Watch
Negative. The rating action applies to approximately $3.37 billion of
See a full list of ratings placed on Rating Watch Negative below.
KEY RATING DRIVERS
Acquisition of Solsats Will Increase Leverage
The Rating Watch Negative reflects an expectation of higher leverage
(total debt to EBITDA) as the result of the funding of the acquisition
of of Solstas Lab Partners Group (Solstas) for $570 million. Fitch does
see the acquisition of the commercial lab operator as strategically
appropriate, given the acquisition will broaden Quest's reach in the
Southeast region where Solstas operates in nine states, and add around
5% in annualized revenues.
However, incremental debt for the purchase would stress leverage that is
already high for the 'BBB+' rating. Debt leverage increased to 2.58x for
the latest 12-month (LTM) period ending Sept. 30, 2013 from 2.16x in
2012, as operating cost savings have not entirely offset pressured
revenues while the debt load remained steady. Fitch anticipates Quest
would need a combination of operational improvement and a reduced debt
load to return to its leverage (total debt to EBITDA) target of 2.0
times (x) to 2.25x, a level Fitch considers to be consistent with the
Negative Trends Compress Margins
Continued negative health care utilization trends and government
reimbursement constraint have dampened Quest's operating performance
during 2013. Revenues in the first nine months of 2013 dropped by 3.9%
versus the same period in 2012, driven by a 4.3% decrease in diagnostic
testing revenues comprising a 3.8% drop in revenue per requisition and a
0.5% fall in volume. Cost savings from the $600 million Invigorate
program has not kept pace with the revenue pressure leading to EBITDA
margin compressing to 18.4% for the LTM ending Sept. 30, 2013 from 20.8%
in 2012. Fitch is cautious about operational improvement this year, but
some relief may stem from greater throughput arising from higher volumes
associated with increased patient access and utilization following the
initiation of Medicaid expansion and the state health insurance
exchanges starting this year under the Affordable Care Act.
Maturities Manageable, Ample Liquidity
While a large portion of Quest's long-term debt (totaling $1.4 billion)
is due in 2014 to 2017, Fitch believes the maturities are well-laddered
and manageable. The maturing debt provides an option to wind down debt
leverage, especially in light of yestrday's Solstas acquisition
announcement. Currently, Quest has ample liquidity provided by operating
cash flow generation of more than $800 million annually and a cash
balance of $158 million at Sept. 30, 2013. External sources of liquidity
are a $525 million receivables program and a $750 million revolving
credit facility due September 2016.
Shareholder Returns Jump
Quest's management is committed to returning the majority of free cash
flow to equity holders. Both dividends and share repurchases spiked in
2013 with a 76% increase to the dividend to $1.20 per share annually and
more than $990 million of common share buybacks for the first nine
months of the year. Asset sales of nearly $770 million during 2013
comprising the HemoCue business and ibrutinib intellectual property
rights have partially funded the increased dividend and share
repurchases. If Quest chooses to pull back on share repurchase activity
following the purchase of Solstas and instead prioritize debt reduction
as a use of cash flow, it would provide support for the ratings.
Fitch will resolve the Rating Watch when there is more information about
Quest's plans to fund the Solstas acquisition. A one-notch downgrade to
'BBB' is likely unless the company demonstrates a clear plan to reduce
leverage to below 2.25x within 12-18 months following the close of the
acquisition. Given the ongoing weak operating trends, characterized by
weak growth in organic volumes and government reimbursement pressures,
Fitch expects that reducing debt to this level will require the
application of some cash to paydown debt.
Positive rating action is not likely over the ratings horizon in light
of an anticipated increase in already higher-than-expected total debt
leverage due to potential debt funding needed to complete the proposed
acquisition of Solstas.
Fitch has placed the following ratings on Rating Watch Negative:
--Issuer Default Rating (IDR) of 'BBB+';
--Senior unsecured debt rating of 'BBB+';
--Bank loan rating of 'BBB+'.
Additional information is available at www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' dated Aug. 5, 2013.
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent
and Subsidiary Linkage
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