February 28, 2017 / 8:52 PM / 6 months ago

Fitch Rates Abbott's Notes Offering 'BBB'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, February 28 (Fitch) Fitch Ratings has assigned a 'BBB' rating to Abbott Laboratories' senior unsecured notes offering. The notes are offered to exchange for the roughly $3.1 billion outstanding senior unsecured notes of St. Jude Medical, Inc. (St. Jude), which Abbott acquired in January 2017. The Rating Outlook is Stable. KEY RATING DRIVERS --While St. Jude is a good strategic fit, the acquisition will significantly stress leverage for at least two years, with or without the acquisition of Alere. --Abbott's diversified product portfolio is positioned to deliver mid-single-digit organic growth over the forecast period. --Fitch anticipates Abbott's efforts to improve operating margins will continue to yield results through improvements in sales mix and cost control plus integration-related cost synergies. --Fitch forecasts Abbott generating positive free cash flow (FCF) excluding the near-term negative effect of one-time acquisition/integration related costs. --The company's Nutrition, Diagnostics and Established Pharmaceuticals segments stand to benefit from the growth in emerging markets. --Abbott's ongoing focus on new product introductions across virtually all of its business segments bodes well for growth and margins. --The company faces challenges regarding reimbursement for some of its products and select international economic stress. --Fitch expects Abbott will maintain adequate liquidity through cash generation, bank credit and access to the capital markets. Sound Acquisitions/High Leverage: Abbott's acquisition of St. Jude and potential acquisition of Alere are both a good strategic fit. Both expand Abbott's market presence in current operating segments by providing the company with broader product offerings. The acquired portfolios, in aggregate, will also offer organic growth potential. Abbott filed suit to terminate its acquisition of Alere for $5.8 billion cash (equity value) and around $2.6 billion of assumed net debt. However, Abbott's 'BBB' rating will not be affected if it does not complete the Alere acquisition. The two acquisitions will significantly increase debt, with leverage forecast to remain above 3x through 2019. Without the Alere acquisition, forecast leverage would likely remain near or above 3x through 2018. Fitch expects Abbott will reduce leverage to durably below 3x thereafter, through a combination of debt reduction and increased EBITDA. Operating margins will likely improve because of favorable shifts in sales mix, good cost control and integration-related synergies. FCF should stay significantly positive (excluding one-time restructuring costs). Fitch's 'BBB'/'F2' ratings assume Abbott will pursue a more conservative approach to capital deployment, with share repurchases, dividend increases and acquisitions remaining modest, at least during the post-transaction deleveraging period. The addition of St. Jude's products will significantly expand Abbott's medical device portfolio, particularly in the area of cardiovascular disease. The deal will position Abbott as the number-one or number-two player in many of the sub-segments of the cardiovascular device market. The combination provides relatively modest overlap in product categories and offers Abbott a larger presence in the faster-growing device areas of atrial fibrillation, structural heart and neuromodulation. Abbott estimates that it will realize roughly $500 million in annual cost and revenue synergies by 2020 from the St. Jude acquisition. Broader portfolios within the sub-segments of cardiovascular should provide Abbott with increased contracting/shelf space opportunities when contracting with hospital management and purchasing groups. Cost-related synergies in the areas of sourcing plus some overlap in sales force and administrative functions should be attainable. In addition, Abbott has a demonstrable record of accomplishment with acquiring and successfully integrating acquisitions. Alere Expands Point-of-Care Diagnostics: While recent legal wrangling between Abbott and Alere add uncertainty to the completion of the transaction, Fitch believes an acquisition of Alere would make strategic sense. The combination would increase Abbott's presence in point-of-care diagnostics and prospects to expand Alere's products into international markets. Abbott already has a strong position in the medical diagnostics market. The point-of-care segment of the diagnostics market will likely grow faster than the in-vitro diagnostic market during the intermediate term. The company also expects that it would achieve nearly $300 million in pre-tax synergies by 2019 and more thereafter. Durable Margin Improvement: Abbott will presumably focus on improving margins through cost control and generating a favorable shift in sales mix. In addition to securing the forecast acquisition-related synergies, Fitch looks for Abbott to continue driving efficiencies across its business segments. Innovative, value-added product launches should be able to secure attractive pricing. Margin improvements should be robust during the intermediate term. Stable Operations Prior/Post Acquisition: Fitch forecasts that Abbott's diversified product portfolio will continue to produce mid-single-digit organic growth in the intermediate term, given the strength of its product offerings and its geographic mix. However, adverse foreign exchange movements may moderately hamper reported growth in the near term, although margins should remain moderately insulated from the trend. Revenue growth and margin support should provide for solid FCF generation. Positive FCF/Conservative Capital Deployment: Fitch estimates that Abbott will generate normalized FCF in 2018 and 2019 of roughly $1.5 billion to $1.6 billion, with one-time transaction-related costs hampering FCF before then. Projected revenue growth and moderately improving margins should drive cash generation. Capital expenditures and dividends increase incrementally during the forecast period, as the company focuses on strengthening its balance sheet and credit profile. FCF should be sufficient to fund debt reduction, modest share repurchases and small acquisitions. Select Market Headwinds: Abbott faces a few challenges in select geographic markets, including restrictive reimbursement rates for diabetic supplies and infant nutritionals in the U.S. Unfavorable foreign exchange rate movements may hamper reported top-line growth. However, foreign exchange should affect margins less than reported revenues because the company has significant operations (i.e. costs) in some geographies that are experiencing currency devaluation. Emerging Markets Supporting Growth: Fitch expects a significant portion of Abbott's growth will come from emerging markets, fueled by favorable demographics and economic growth. Nutrition, Diagnostics and Established Pharmaceuticals, in particular, should benefit from the rapidly growing middle class in these markets. Consumer out-of-pocket purchases account for a large portion of revenues in these markets. This is in contrasts to developed markets, where the vast majority of purchases involve third-party payers. As such, rising disposable income is an important driver of demand in these markets. New-Product Flow: Abbott continues to refresh its product portfolio across all of its business segments, helping to drive growth through market expansion and/or market penetration. Newer products with improved efficacy and safety profiles often garner value-added prices, offering support for margins. Many of the company's launches are tailored to specific geographies. Fitch expects the potential addition of the St. Jude and Alere pipelines will further support innovative product introductions over the long term. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Abbott Laboratories include: --Leverage increases significantly in the near- to intermediate-term. --Abbott completes the acquisition of Alere. However, Abbott's rating will not be affected if it terminates its merger agreement with Alere. --Mid-single-digit organic revenue growth with organic growth modestly offset by negative foreign exchange rate effects. --Incrementally improving margins, particularly in Nutritional Products and Diagnostics, given Abbott's efforts to improve efficiencies in these two segments. --Further margin enhancements from St. Jude integration synergies and Alere. --Normalized FCF in 2019 of $1.5 billion to $1.6 billion (excluding one-time costs), with one-time costs hampering it in the near term. --Gross debt leverage declining to around 3x in 2019, driven by increased EBITDA and debt reduction. RATING SENSITIVITIES Future developments that individually or collectively may support maintaining the 'BBB' rating include: --Abbott's successful integration of the St. Jude acquisition, including the realization of the stated synergies of $500 million; --Continued operational improvements that support long-term positive revenue growth and margin improvement; --Consistently positive adjusted FCF; --Conservative cash deployment, including debt reduction that results in a capital structure that could consistently maintain leverage near or below 3x in 2019 and thereafter. Negative: Future developments that may individually or collectively lead to a negative rating action include: --Failure to successfully integrate the St. Jude acquisition and attain the stated $500 million in synergies; --Material deterioration in operations and FCF for an extended period; --Aggressive cash deployment relative to FCF generation that precludes adequate debt reduction, resulting in gross leverage remaining meaningfully above 3x at year-end 2019 and thereafter. LIQUIDITY Adequate Liquidity: Fitch expects Abbott to maintain adequate liquidity with full availability on its $5 billion revolving credit facility that expires in July 2019 and availability on its commercial papter program. FULL LIST OF RATINGS Fitch currently rates the entities as follows: Abbott Laboratories --Long-Term Issuer Default Rating 'BBB', Outlook Stable; --Senior unsecured bank credit facility 'BBB'; --Senior unsecured debt 'BBB'; --Short-Term IDR 'F2'; --Commercial paper program F2'. St. Jude Medical, Inc. --Long-Term IDR 'BBB', Outlook Stable; --Senior unsecured debt 'BBB'. Contact: Primary Analyst Bob Kirby, CFA Director +1-312-368-3147 Fitch Ratings, Inc. 70 West Madison St. Chicago, IL 60602 Secondary Analyst Megan Neuburger, CFA Managing Director +1-212-908-0501 Committee Chairperson David Silverman Senior Director +1-212-908-0840 Media Relations: Elizabeth Fogerty, New York, Tel: +1 (212) 908 0526, Email: elizabeth.fogerty@fitchratings.com; Hannah James, New York, Tel: + 1 646 582 4947, Email: hannah.james@fitchratings.com. Date of relevant committee: Jan. 3, 2017. Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation. 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