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Fitch Affirms Agilent's Ratings at 'BBB+'; Outlook Stable
December 14, 2016 / 3:27 PM / a year ago

Fitch Affirms Agilent's Ratings at 'BBB+'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, December 14 (Fitch) Fitch Ratings has affirmed the ratings of Agilent Technologies, Inc. (Agilent) at 'BBB+'. The Rating Outlook is Stable. The ratings apply to approximately $1.9 billion of debt at Oct. 31, 2016. A full list of rating actions follows at the end of this release. KEY RATING DRIVERS --Agilent's financial policy reduces ratings headroom. The company has committed to a capital deployment policy that will see the company issue incremental debt of $250 million each year to help fund share repurchases. The financial policy leaves Agilent's ratings more vulnerable to event risk, including debt-funded acquisitions of significant size. Fitch nevertheless believes that Agilent is committed to maintaining strong investment-grade ratings and is expected to operate with a moderate leverage profile, with run-rate gross debt-to-EBITDA expected to range between 2.0x-2.3x. --Agilent's business has a stable operating and cash flow profile, owing to a large proportion of recurring revenues (about 55%) and steady end-market demand. Fitch forecasts improving margins and normalized FCF (cash from operations less capital expenditures and dividends) of between $400 million-$500 million for the next few years. --Agilent remains well-diversified in terms of product categories, end markets, and geographies. Diversification supports stability, although exposure to academic and government research budgets (about 10% of revenues) may lead to dampened or negative sales growth in periods of macroeconomic weakness. --Agilent holds leading positions in its largest markets, providing a significant installed base with a significant amount of recurring sales of consumables, etc. Nevertheless, several of its primary competitors have greater overall scale and financial flexibility than Agilent. For Agilent, becoming a leader in diagnostics and genomics may require large-scale aggregate M&A but larger firms may have the ability to outbid Agilent and other mid-sized corporations as new technologies emerge and as consolidation occurs over time. As such, competition will remain heightened and consolidation is likely to remain a key theme. In the life sciences sector, sustained commitment to R&D investment for new product development is necessary to maintain market leadership. --Fitch expects that Agilent will focus on smaller, capabilities-based deals, since few transformational targets remain. For Agilent, becoming a leader in diagnostics and genomics may require large-scale aggregate M&A. But larger firms may have the ability to outbid Agilent and other mid-sized corporations as new technologies emerge and as consolidation occurs over time. While larger deals are not out of the question, Fitch expects that any transactions of meaningful size will be executed in a manner consistent with Agilent's history of and commitment to conservative financial management. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Agilent include: --Revenues grow by around 4% annually through the forecast period, reflecting robust growth in emerging markets offset by softer demand in more developed markets. --Fitch models EBITDA growth resulting from growing revenues and incremental margin expansion, benefitting from cost savings derived from recent restructuring activities and operating leverage. --EBITDA growth backstops stronger cash flow generation. FCF exceeds $400 million throughout the forecast period, benefitting from manageable CAPEX requirements, modest pension funding requirements, and long-dated debt maturities. --Incremental annual debt increases of $250 million annually from 2017-2019 to help finance share repurchases, resulting in gross leverage ranging between 2.0x-2.3x throughout the forecast period. --Fitch expects acquisitions to be targeted in nature and manageable in size. RATING SENSITIVITIES Maintenance of Agilent's 'BBB+' ratings will require gross debt-to-EBITDA generally maintained between 2.0x-2.5x. Temporary increases to fund strategic M&A accompanied by a credible de-leveraging plan could be appropriate at the current rating category. Fitch recognizes that a long-term strategy in key areas like diagnostics and genomics may require sizeable acquisitions over the medium term. Modest margin expansion, suggesting successful new product introductions and operational efficiencies, would be supportive of the 'BBB+' ratings. A downgrade could result from lower than expected cash flows, leading Agilent to issue more than the expected additional debt to fund dividends or share repurchases. A downgrade could also result from the consummation of an acquisition of a size such that cash flows would not be sufficient to permit adequate and timely de-leveraging. Margin deterioration due to market commoditization or the inability to flex costs in response to weak demand (e.g. from government and research budget cuts) could also precipitate downward ratings pressure. An upgrade is not anticipated in the near to medium term. Although not expected, a public commitment to maintain gross debt leverage below 2.0x could lead to a ratings upgrade. Fitch's 'BBB+' ratings provide Agilent with flexibility to take part in the consolidation characterizing the life sciences and diagnostics sector in the near to medium term. COMMITMENT TO SHAREHOLDER RETURNS LIMITS RATINGS HEADROOM Agilent's commitment to return 85% of pre-dividend FCF to shareholders through dividends and share repurchases reduces flexibility at the current rating level, as the company plans to finance the share repurchases by issuing $250 million of annual incremental debt. If Agilent were to execute a debt-funded transaction of material size without altering its commitment to shareholder returns, the company could be challenged to de-lever within a reasonable time frame. In the absence of a credible deleveraging plan to reduce the company's gross debt-to-EBITDA to levels between 2.0x-2.5x within 12-18 months following an acquisition, Fitch would likely downgrade Agilent's ratings by one notch. However, Agilent's acquisition strategy remains focused on smaller tuck-in acquisitions similar in size and profile to Seahorse Bioscience, a manufacturer of instruments and assay kits for measuring cell metabolism and bioenergetics that Agilent acquired for $235 million in November 2015. In general, Fitch believes that Agilent will seek to continue to augment its portfolio of equipment and service offerings through the addition of fairly small companies that would benefit from inclusion in Agilent's greater scale and expansive global platform. Absent material debt-funded M&A, Fitch views Agilent's current financial policy as in line with the current 'BBB+' ratings. Gross debt leverage is likely to remain between 2.0x-2.3x if EBITDA growth largely offsets incremental debt issued, as Fitch expects. Fitch views gross debt leverage in this range as supportive of Agilent's current rating level, given the company's good earnings visibility and a stable operating profile characterized by steady demand, light CAPEX requirements, and stable operating margins. Fitch expects Agilent's publicly committed dividend and share repurchase commitment to total roughly $600 million in 2017 and grow to approximately $660 million by 2019. Assuming $250 million of annual incremental debt is issued, Fitch estimates that Agilent will need to generate annual cash from operations of between $700 million to $800 million in order to generate adequate cash in the U.S. to fund the annual shareholder returns over this time period. Based on Fitch's current forecast, Agilent appears likely to generate sufficient cash to fund these commitments. EMERGING MARKETS DRIVE FAVORABLE GROWTH OUTLOOK Fitch expects Agilent to achieve low to mid-single digit organic growth in each of its key business areas, benefitting from positive secular and demographic trends that should increase end user demand, particularly in emerging markets. Fitch believes that substantial runway remains for particularly robust growth in Agilent's key emerging markets, particularly China and India. This constructive outlook is supported by global population growth and an expanding middle class in emerging markets that will continue to generate demand for high quality health care outside of the U.S. New products could further benefit top line gains although the pace of uptake is more difficult to predict. These favorable market dynamics are offset by persistent weakness in chemical and energy end markets. At roughly 23% of revenues, this market comprises the second largest of Agilent's six serviced markets, behind only pharmaceuticals (29%), where demand has been consistently strong and is expected to remain so over the forecast period. If chemical and energy markets were to strengthen, it could provide upside to Fitch's top-line forecasts of around 4% annually. Agilent's earnings visibility benefits from high percentage of revenues derived from higher-margin recurring sales of reagents, consumables, and services that currently present around 55% of total revenues. However, even if revenues are flat, the company should be able to generate more modest margin improvement over the next few years due to cost savings related to ongoing operational efficiency initiatives. The most significant risk to revenue and earnings forecasts could be the potential for slowing growth in emerging markets, particularly China (16% of fiscal 2015 revenues). Factors that could adversely impact growth prospects in emerging markets include deterioration of trade relations with the U.S. or material softening of demand due to a weaker global economic environment, possibly exacerbated by concerns over Britain's pending exit from the E.U. LIQUIDITY Agilent maintains a solid liquidity profile, although U.S. cash balances are kept relatively low (approximately $114 million at Oct. 31, 2016). Fitch estimates that roughly 25% of total operating cash flow is generated in the U.S., but between 40%-50% of Agilent's cash flows are regularly available to address funding requirements in the U.S. This is sufficient to fund operational needs, service the company's debt, and pay shareholder dividends. The company's share repurchase commitment will require incremental debt of $250 million in each of the next three years. Full availability under the firm's $700 million revolver due Sept. 15, 2019 should be adequate to fund smaller U.S.-based acquisition targets. Only $100 million of 2018 debt matures over the next four fiscal years, mitigating the risk of lower U.S. cash balances. Agilent's next debt maturity is $500 million due in 2020, with the remaining $1.3 billion due thereafter. Long-dated debt maturities could provide flexibility for the use of shorter-term debt to fund acquisitions over the ratings horizon FULL LIST OF RATING ACTIONS Fitch affirms Agilent's ratings as follows: --Long-term Issuer Default Rating at 'BBB+'; --Senior unsecured bank facility at 'BBB+'; --Senior unsecured notes at 'BBB+'. The Rating Outlook is Stable. Contact: Primary Analyst Greg Dickerson Director +1-212-908-0220 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Jacob Bostwick, CPA Director +1-312-368-3169 Committee Chairperson Megan Neuburger Managing Director +1-212-908-0501 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: --Fiscal 2016 EBITDA was adjusted to add back share based compensation, excess and obsolete inventory related charges, impairment of investments and loans, and other non-cash expenses. 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