TEXT-S&P revises VCA Antech outlook to stable

Thu Jul 12, 2012 10:45am EDT

Overview
     -- U.S.-based animal hospital and laboratory operator VCA Antech  
     has maintained debt leverage below 4x, a level we thought might be breached
with 
aggressive acquisition activity and EBITDA pressure from weak pet spending.  
     -- This increases our confidence that VCA can produce increasing EBITDA 
and free operating cash flow that limits additional borrowing for acquisitions.
     -- We are affirming our 'BB' corporate credit rating on VCA Antech, and 
our 'BB+' issue-level ratings on subsidiary Vicar Operating Inc. 
     -- We are revising our rating outlook to stable, because we believe VCA 
will maintain a "significant" financial risk profile

Rating Action
On July 12, 2012, Standard & Poor's Ratings Services affirmed its 'BB' 
corporate credit rating on Los Angeles-based veterinary health company VCA 
Antech Inc., and its 'BB+' issue-level rating on subsidiary Vicar Operating 
Inc. We revised our rating outlook to stable from negative, because we are 
increasingly confident that VCA can expand, while maintaining leverage below 
4x.

Rationale
The ratings on Los Angeles-based VCA Antech Inc. reflect our assessment of 
VCA's business risk profile as "fair," based on a leading, but narrow market 
focus. Its financial risk profile is "significant," revised from "aggressive," 
according to our criteria. The ratings incorporate our expectation that VCA, 
through acquisitions, will increase revenues through 2013 at low-double-digit 
rates. We assume some limited price increases will blunt a decline in margins, 
given still-weak volume and costs tied to a Web-based veterinary initiative, 
and that debt-financed expansion will not take debt leverage above 3.5x. 

The fair business risk profile reflects VCA's narrow focus in a mature 
business, subject to a sluggish economy. Fueled by acquisitions, the company 
has grown over time to become the largest player in veterinary services, by 
far, with 589 animal hospitals (77% of revenues) and 53 veterinary diagnostic 
laboratories (21%). In the 2012 first quarter, acquisitions increased its 
animal hospital count nearly 10%. Its leading market position provides scale 
advantages in a fragmented field, and benefits from pet owners' reluctance to 
cut spending on non-elective visits to animal hospitals. At the same time, 
VCA's business concentration in the animal health field exposes the company to 
the uncertain level of pet spending, given the discretion of owners to limit 
expenditures, especially if the U.S. economy is soft. Two companies with 
similar sensitivity to consumer spending are Service Corp. International 
(BB/Stable/--) and Butler Animal Health Supply (BB/Stable/--). A larger 
consolidator in a different business, Service Corp. International, also has a 
"fair" business risk descriptor, incorporating its similar narrow, albeit 
leading, position in its field--death care services. Butler Animal Health 
Supply, a leading distributor of animal health products with a revenue base 
about two-thirds the size of VCA, with lower margins, has a business risk 
profile we assess as "weak."  

Beginning in the third quarter of 2011, VCA posted low-single-digit same-store 
sales growth in its hospital segment, following a downtrend beginning in the 
fourth quarter of 2007. Through 2013, we expect VCA to register 
low-single-digit organic revenue growth, given our economic forecast of a 2% 
increase in U.S. GDP, a rise in consumer spending of 2%, and an 8% 
unemployment rate during that time. We expect VCA to continue generating some 
revenue growth through increased pricing, but believe the sustainability of 
price increases is limited by competition with numerous local and regional 
veterinary providers.

We expect revenue growth over the next 18 months to be in the low-double-digit 
range, aided by ongoing acquisition activity. On Jan. 31, 2012, VCA completed 
the $71 million acquisition of the 80% of Associated Veterinary Clinics (44 
animal hospitals in Canada) it did not already own. In 2011, among other 
acquisitions, VCA acquired VetStreet, with $23 million in annualized revenue, 
for $146 million. Along with its acquisition of ThinkPet for $21 million ($11 
million cash and stock) in February 2012, this investment is a strategy for 
leveraging a large pet database in its existing business and with the larger 
veterinary community.

Through 2013, our base-case expectation is for adjusted EBITDA margins to be 
below last year's 22.2%. We assume ongoing economic sluggishness and the 
VetStreet integration challenges to contribute to an EBITDA margin squeeze of 
almost 100 basis points in 2012. We expect more effective marketing and 
operations of VetStreet to contribute to some recovery in 2013 margins, 
overall, but expect them to remain below 22%. We assume improvement in animal 
hospital margins will be limited by consumer sensitivity to the weak economy. 
This could be evidenced by VCA's limited ability to raise prices (in the 
low-single-digit range), pet owners' proclivity to purchase pet medications 
through distribution channels outside of the veterinary clinic, and their 
tendency to limit more discretionary services and lab tests. We expect 
continued pressure on VCA's laboratory margins, because of price discounting 
on services that compete with unrated IDEXX Laboratories' bundled diagnostic 
machine/reagent offering. Still, we believe that a maturation of new 
investments should contribute to an upward inflection in overall return on 
capital that has trended lower, to 12% at March 31, 2012, from 15% since the 
first quarter of 2010. 

VCA's significant financial risk profile incorporates our view that adjusted 
debt to EBITDA should gradually recede from a peak level of 3.5x at March 31, 
2012, as debt-financed investments that increased leverage this year add to 
EBITDA. This contributes to our belief that funds from operations (FFO) to 
debt (including capitalized operating leases that comprise almost half of the 
total) will be sustained above the 20% level. These expectations are more 
consistent with guidelines for a significant financial risk profile, rather 
than our former aggressive assessment.

Liquidity
We consider VCA's liquidity as adequate. We expect sources of cash to exceed 
uses over the next 12 to 24 months. Relevant aspects of VCA's liquidity are:
     -- With sources exceeding uses by more than $150 million, we expect 
coverage of uses to be more than 1.2x over the next 12 to 24 months.
     -- Sources of liquidity include cash on hand of $73 million (March 31, 
2012) and funds from operations in excess of $225 million annually. VCA has 
full availability of its $125 million revolving credit facility maturing in 
2016. The cushion under loan covenants are ample: at March 31, 2012, the 
fixed-charge coverage ratio of 1.76 to 1.00 exceeded the required 1.20 to 
1.00, and the leverage ratio was 2.16 to 1.00, well above the 3.00 to 1.00 
mandate.
     -- We expect uses of cash to include some investment in working capital, 
capital expenditures of roughly $80 million, and mandatory amortization 
payments on the term loan A of $24 million in 2012 and 36 million in 2013.

Recovery analysis
Our rating on the senior secured credit facility of VCA subsidiary Vicar 
Operating Inc. is 'BB+' (one notch higher than the corporate credit rating on 
VCA) and the recovery rating is '2', indicating our expectation of substantial 
(70% to 90%) recovery in the event of a payment default. (For the complete 
recovery analysis, please see the recovery report VCA Antech, to be published 
following this report on RatingsDirect.) 

Outlook
Our stable rating outlook on VCA reflects our expectation for 
acquisition-aided double-digit revenue growth, even in the face of ongoing 
economic weakness. We assume margin pressure in 2013 will ease as the 
VetStreet integration issues are addressed. Under these circumstances, we 
believe VCA can produce increasing EBITDA and free operating cash flow that 
limits additional borrowing for acquisitions, contributing to a decline in 
adjusted leverage (at a historic high 3.5x). There is substantial capacity in 
the financial risk profile for debt-financed acquisitions and share 
repurchases (although there is a history of limited buybacks) within a 4x debt 
to EBITDA guideline. Accordingly, the most likely cause of a downgrade would 
be lackluster returns on new investment contributing to the prospect of an 
extended decline in return on capital. A rating upgrade is unlikely, given 
VCA's narrow business focus and acquisitive nature. 

Related Criteria And Research
     -- Methodology And Assumptions: Liquidity Descriptors For Global 
Corporate Issuers, Sept. 28, 2011
     -- Criteria Guidelines For Recovery Ratings, Aug. 10, 2009
     -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

Ratings List

Ratings Affirmed; Outlook Action
                                        To                 From
VCA Antech Inc.
 Corporate Credit Rating                BB/Stable/--       BB/Negative/--

Ratings Affirmed

Vicar Operating Inc.
 Senior Secured Debt                    BB+                
   Recovery Rating                      2