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Fitch Downgrades Abbott's and St. Jude's IDRs to 'BBB'; Outlook Stable
January 5, 2017 / 3:36 PM / a year ago

Fitch Downgrades Abbott's and St. Jude's IDRs to 'BBB'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, January 05 (Fitch) Following the acquisition of St. Jude Medical, Inc. (St. Jude) by Abbott Laboratories' (ABT, Abbott), Fitch Ratings has downgraded both companies' Long-Term Issuer Default Ratings (IDRs) to 'BBB' with a Stable Rating Outlook. Fitch has also downgraded Abbott's short-term IDR to 'F2'. A full list of rating actions follows at the end of this release. KEY RATING DRIVERS --St. Jude is a good strategic fit, but 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 that 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 that 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 good strategic fits. Both expand Abbott's market presence in segments that the company currently operates, 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 forecasted to remain above 3.0x through 2019. Without the Alere acquisition, forecasted leverage would likely remain near or above 3.0x through 2018. Fitch expects Abbott will reduce leverage to durably below 3.0x 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). The 'BBB'/'F2' ratings assumes 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 forecasted 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 durable 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. Forecasted revenue growth and moderately improving margins will drive cash generation. Capital expenditures and dividends incrementally increase 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 affects margins less than reported revenues because the company has significant operations (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 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 St. Jude's and Alere's 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 to increase 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 the following: --Successful integration of the St. Jude and Alere acquisitions, including the realization of the stated synergies of $500 million and $300 million, respectively; --Continued operational improvements that support long-term positive revenue growth and margin improvement; --Consistently positive adjusted FCF; --Conservative cash deployment, including debt reduction so that ABT's resulting capital structure that would durably maintain leverage near or below 3.0x in 2019 and thereafter. Negative: Future developments that may individually or collectively, lead to a negative rating action include the following: --Failure to successfully integrate the St. Jude acquisition and attain the stated synergries $500 million and $300 million, respectively; --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 3.0x at year-end 2019 and thereafter. LIQUIDITY Adequate Liquidity: Fitch expects Abbott to maintain adequate liquidity, as it will term out all of its and STJ's short-term borrowings ($3.5 billion to $4 billion) and ultimately end up with full availability on its $5 billion revolving credit facility that expires in July 2019 and availability on its CP program. FULL LIST OF RATING ACTIONS Fitch has taken the following rating actions: Abbott Laboratories --Long-Term IDR downgraded to 'BBB' from 'A', Outlook Stable; --Bank credit facility downgraded to 'BBB' from 'A'; --Senior unsecured debt downgraded to 'BBB' from 'A'; --Short-Term IDR downgraded to 'F2' from 'F1'; --Commercial paper program downgraded to 'F2' from 'F1'. St. Jude Medical, Inc. --Long-Term IDR downgraded to 'BBB' from 'A-', Outlook Stable; --Senior unsecured debt downgraded to 'BBB' from 'A-'; --Term loan ratings withdrawn; --Short-Term IDR withdrawn; --Commercial paper program rating withdrawn. Fitch assumes that Abbott will make the outstanding St. Jude Medical, Inc. unsecured notes pari passu with that of Abbott Laboratories senior unsecured notes. 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: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: Fitch has made no material financial adjustments that are not disclosed within the company's public filings. Additional information is available on Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1017219 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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