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Fitch Affirms Bio-Rad's IDR at 'BBB-'; Outlook Stable
April 5, 2017 / 2:04 PM / 8 months ago

Fitch Affirms Bio-Rad's IDR at 'BBB-'; Outlook Stable

(The following statement was released by the rating agency) AUSTIN, April 05 (Fitch) Fitch Ratings has affirmed the ratings of Bio-Rad Laboratories, Inc. (Bio-Rad), including the 'BBB-' Issuer Default Rating (IDR). The ratings apply to approximately $437 million of debt at Dec. 31, 2016. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release. KEY RATING DRIVERS Evolving Capital Allocation Strategy: Bio-Rad recently announced long-term targets for revenue growth and operating margins through 2020. The company also announced that it plans to publicly articulate a long-term capital allocation strategy later in 2017, pending input from four new independent directors expected to replace board members not sitting for re-election at the upcoming annual meeting of stockholders. Historically Conservative Capital Structure: Bio-Rad has historically operated with a conservatively capitalized balance sheet, with lease adjusted leverage maintained at or below 2.3x since 2013. This is strong for the 'BBB-' rating level and helps offset corporate governance risk related to the company's ownership structure, with voting power concentrated in the hands of the founding family. A more formalized approach to capital allocation would be supportive of the credit profile if it reinforces maintenance of this historically conservative approach. While Fitch does not expect the forthcoming review to culminate in a markedly more aggressive approach to capital allocation, such an outcome would pressure the ratings. Stable Revenue Base: About 70% of Bio-Rad's revenues are from sales of recurring consumables. Consumables are relatively low-priced items that do not exhibit much cyclicality in end market demand, supporting an expectation of stable revenues and cash flows. In addition, Bio-Rad's geographic diversification mitigates lower customer demand resulting from tightened government funding for scientific research in any single geography. Given these favorable attributes, Fitch sees sustained organic revenue growth in the low single digits over the ratings horizon, although FX headwinds will likely remain a challenge. Bio-Rad operates in two main segments; Fitch believes that the clinical diagnostics business will continue to grow at a steady rate in the low single digits (currency neutral), as the unfavorable impact of lab consolidation and pricing pressure is offset by steady growth in patient demand and stabilized by a high percentage of recurring revenues. Given that the life sciences business faces less pricing pressure and benefits from replacement cycles driven by introductions of new products, Fitch anticipates that growth in Bio-Rad's life sciences business will outpace clinical diagnostics over the next three years, with sales growth in the low- to mid-single digits on a currency-neutral basis. As the life sciences business historically generates lower margins than the clinical diagnostics business, the shift in product mix will also challenge margin expansion. Margins Lag Peers: Bio-Rad's EBITDA margins ranged between 14%-15% during 2014-2016, which is roughly 400-500bps lower than peak levels last achieved in 2011 and 2012 and below life sciences peers. The majority of the margin deterioration has been a result of the acquisitions consummated in the past three to four years, considering these technology-based acquisitions have required additional R&D investment. The remaining deterioration reflects operating expenses related to investment in infrastructure and systems that began in 2013 and will continue until the company's roll-out of its enterprise resource planning (ERP) system is completed, likely not before the end of 2019. Fitch attributes forecasted near-term margin enhancement to the recent acquisitions becoming accretive. Measured M&A Strategy: Bio-Rad's approach to business development has been to pursue modest and targeted acquisitions to fill in product portfolio gaps. Since 2012, the company has funded M&A through internal cash generation with no transaction being large enough to require external financing. Fitch expects Bio-Rad to continue to participate in ongoing consolidation in both the life sciences and clinical diagnostics segments. Evidence of an increased appetite for larger transactions that require external funding could result in pressure on the ratings absent a plan for deleveraging in the wake of a debt-funded transaction. KEY ASSUMPTIONS Fitch's key assumptions within the rating case include: --Organic currency neutral revenue growth of 3%-4% annually; --EBITDA margin improvement of about 300bps by the end of the 2020 forecast period mostly from reduced operating expenses for ERP implementation; --Free cash flow averages between $100 million-$130 million; --Total adjusted debt/operating EBITDA maintained between 2.5 and 3.0x with some incremental debt-funding assumed for acquisitions. RATING SENSITIVITIES Maintenance of Bio-Rad's 'BBB-' IDR considers adjusted leverage (lease adjusted debt/EBITDAR) in the range of 3.0x-3.5x. Fitch will also look for organic revenue growth in the 3%-4% range and FCF margins of around 4%-5% to maintain the current rating. Positive rating action could be supported by adjusted leverage maintained below 3x, particularly if this commitment is reinforced by the new capital allocation strategy. However, upward momentum of the ratings is limited by corporate governance concerns related to the company's ownership structure. A downgrade would likely result from a large debt-funded acquisition or shareholder-friendly transaction that would drive adjusted leverage to 4.0x without a plan to reduce leverage to below 3.5x within 18-24 months. Negative rating action could also be prompted by significantly pressured operating margins from an accelerating weak market environment. In addition, while not currently anticipated, a negative rating action could result if Bio-Rad details a long-term capital allocation plan that is expected to result in a capital structure not consistent with an investment-grade rating. Fitch's rating sensitivities for Bio-Rad use a lease adjusted debt leverage target given the material difference between Bio-Rad's unadjusted debt leverage and lease adjusted debt leverage figures (1.5x versus 2.3x at Dec 31, 2016). Fitch capitalizes long-term rent expense at an 8x multiple, which is deemed appropriate for assets with a long economic life, such as property, in an average interest-rate environment. SIMPLE MATURITY PROFILE, SOLID LIQUIDITY Bio-Rad's cash and short-term investments of $839 million exceeded outstanding debt of $437 million on Dec. 31, 2016, which consisted primarily of $425 million of senior unsecured notes due 2020. Approximately 72% of the cash and securities balance resides in the U.S. and is sufficient to fund operations and on-going projects. In addition, the company has full availability under its $200 million senior unsecured revolving credit facility. FULL LIST OF RATING ACTIONS Fitch affirms Bio-Rad's ratings as follows: --IDR at 'BBB-'; --Senior unsecured notes at 'BBB-'; --Senior unsecured bank facility at 'BBB-'. The Rating Outlook is Stable. Contact: Caitlin Blalock Associate Director +1-512-215-3732 Fitch Ratings, Inc. 111 Congress Ave Austin, TX 78701 Megan Neuburger, CFA Managing Director +1-212-908-0501 Committee Chairperson Mark Sadeghian Senior Director +1- 312-368-2090 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: 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: --Stock-based compensation and impairment losses on goodwill are excluded from EBITDA. 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