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TEXT-S&P rates Laboratory Corp. of America Holdings notes 'BBB+'
Aug 20 - Overview -- Laboratory Corp. of America Holdings (LabCorp), a U.S. provider of clinical laboratory services, is refinancing some of its debt. -- We are assigning our 'BBB+' rating to LabCorp's proposed senior unsecured notes due 2017 and senior unsecured notes due 2022. -- We expect proceeds to be used to repay borrowing from LabCorp's revolving credit facility ($450 million outstanding as of June 30, 2012) and $350 million of notes maturing in January 2013. -- The stable rating outlook reflects our expectation LabCorp will continue to generate substantial discretionary cash flow and will maintain adjusted debt leverage near 2x. Rating Action On Aug. 20, 2012, Standard & Poor's Ratings Services affirmed its 'BBB+' corporate credit rating on Burlington, N.C.-based Laboratory Corp. of America Holdings. The rating outlook is stable. We assigned our 'BBB+' rating, the same as the corporate credit rating, to its proposed senior unsecured notes due 2017 and senior unsecured notes due 2022. Rationale The ratings on Burlington, N.C.-based Laboratory Corp. of America Holdings (LabCorp) reflect its "satisfactory" business risk profile (according to our criteria), as a highly efficient U.S. provider of clinical laboratory services. Its "intermediate" financial risk profile is supported by its generation of robust discretionary cash flow (DCF). Over the next few years, we expect low-single-digit annual organic revenue growth, supplemented by growth from acquisitions. This assumes very modest volume growth in routine testing (57% of 2011 net sales) in 2012 and 2013 and somewhat higher volume growth in genomic and esoteric testing (38%), consistent with continued gradual improvement in the U.S. economy. Organic revenue growth in the first half of 2012 was in line with our expectations. With minimal organic growth, we expect LabCorp's profit margins to contract, but it should continue to generate robust cash flow. This will allow LabCorp to make frequent acquisitions and large share repurchases while maintaining an adjusted debt to EBITDA ratio below 2.5x. As of June 30, 2012, adjusted debt to EBITDA was 2.4x, pro forma for the new notes, repayment of the revolver, and the acquisition of MEDTOX Scientific Inc. on July 31, 2012. We believe acquisitions of higher margin, esoteric testing companies will remain a core strategy for revenue growth and margin preservation. However, we have lowered our forecast for near-term volume growth of LabCorp's esoteric testing business, and we believe a further shift in mix to more profitable esoteric testing is less likely. In the second quarter of 2012, genomic and esoteric test volume rose only 1.3% and net sales for this segment declined 1.3%, both year over year. We project costs will rise more than revenues over the next few quarters, despite LabCorp's ongoing efforts to enhance efficiency. In 2012 and 2013, we estimate LabCorp's adjusted EBITDA margin will be approximately 24.5%, compared with 24.9% in 2011 and 25.8% in 2010. LabCorp's satisfactory business risk profile recognizes its superior operating efficiency, track record of relatively strong and fairly stable profit margins, and the industry's significant barriers to entry. Still, we believe intensifying price pressure, competitive challenges, and volume growth and service mix uncertainties somewhat offset these advantages. Although LabCorp provides essential health care services, we believe its business has some sensitivity to economic conditions, particularly employment levels. Also, it could suffer as a result of certain broad trends in the health care industry. Beginning in 2014, we expect newly insured individuals to cause an unfavorable shift in service mix. We believe a migration to integrated accountable care (with fixed per capita payments) from fee-for-service health care, which is far from certain, could potentially hurt the volume and pricing of testing performed by independent labs. Third-party reimbursement pressure constrains LabCorp's profitability and is a key credit factor in its business risk profile. We believe managed care payors, which account for about 46% of LabCorp's revenue, are trying to reduce payments to clinical laboratories, especially the larger independent labs with which they have national contracts. Payors are endeavoring to restrain prices and curb test utilization. While contracts with managed care payors are not directly linked to government reimbursement levels, government rates can influence private rates. LabCorp will negotiate upcoming contract renewals against a backdrop of declining government reimbursement rates. Medicare reimbursement rates for clinical lab services, which account for about 15% of LabCorp's total revenue, rose a modest 0.65% in 2012. This rate will fall 2.95% in 2013. Sequestration will cut the rate a further 2% in 2013 unless the 2011 Budget Control Act is amended. Our economists believe there will be an amendment. In the past decade, the diagnostic testing industry consolidated rapidly, partly because of pricing pressure from third-party payors. LabCorp cemented its No. 2 position, with a current market share of about 8%, through a series of acquisitions and contract wins. But its position (and that of other independent labs) has eroded in recent years because of customer in-sourcing of anatomic pathology services. In addition, we believe hospital laboratories, which serve more than 60% of the market, are gaining share from the independent labs as a result of doctors becoming hospital employees. Industry leader Quest Diagnostics Inc. has a market share of only about 11%, which we do not view as a significant competitive advantage relative to LabCorp. LabCorp's highly efficient operations give it competitive advantages that will help it withstand market pressures and enable it to reap benefits from acquired businesses. Its EBITDA margins have been more than 200 basis points higher than Quest's. We believe this reflects LabCorp's standardized lab and billing systems and overall low cost structure. LabCorp has a good track record of successfully integrating acquisitions. We expect acquisitions and share repurchases to consume much of LabCorp's free operating cash flow, so significant debt reduction (apart from the upcoming $350 million debt maturity) is unlikely. However, we do not expect company-transforming, debt-financed acquisitions or share repurchases. As of June 30, 2012, pro forma adjusted total debt to EBITDA was 2.4x. We capitalize operating leases, we exclude non-recurring 2011 expenses from EBITDA, and we make other customary adjustments when calculating this ratio. We expect LabCorp to operate at 1.5x to 2.5x adjusted debt to EBITDA, below or at the low end of the guideline for an intermediate financial risk profile. Liquidity We view LabCorp's liquidity as "strong." Relevant aspects of LabCorp's liquidity are: -- We expect sources of liquidity, including more than $800 million of operating cash flow in 2012, to exceed uses by more than 1.5x over the next 12-24 months. Even if EBITDA is 30% below our expectations, sources would still exceed uses. -- Sources of liquidity as of June 30, 2012, included cash on hand of $124 million. Pro forma for the refinancing, we expect LabCorp to have an additional $355 million of cash and $963 million available from its $1 billion revolving credit facility (after deducting letters of credit). -- We assume acquisitions and share repurchases will consume at least $600 million per year. However, these activities are discretionary and could be curtailed if cash flow unexpectedly weakens. LabCorp does not pay cash dividends. -- We expect uses of cash to include capital expenditures of about $150 million to $160 million per year in 2012 and 2013. LabCorp's effective management of working capital contributes to our expectation that working capital needs will be modest. -- Our assumed cash uses in 2012 include LabCorp's potential cash obligation upon conversion of its zero-coupon convertible subordinated notes. If they convert, LabCorp must settle the conversion in cash for the accreted value of the notes-- $134.4 million as of June 30, 2012. -- We expect LabCorp to maintain substantial headroom under its loan agreement covenant. Outlook Our rating outlook on LabCorp is stable, reflecting our expectation that it will continue to generate substantial DCF. We expect LabCorp to remain acquisitive over the intermediate term, as it seeks to further expand its footprint. Because we expect cash flows to remain robust, we believe it can maintain an intermediate financial risk profile. We could lower the rating if it makes debt-financed acquisitions or share repurchases that keep leverage above 2.5x for an extended period of time. With pro forma debt leverage at 2.4x, there is only about $165 million of debt capacity without the benefit of incremental EBITDA. We might also consider a downgrade if the lease-adjusted EBITDA margin declines more than 200 basis points, suggesting a weaker business risk profile. This could occur if prices erode more than we expect, the service mix shifts unfavorably or volume falters and these developments are not mitigated by cost reductions. We believe an upgrade is unlikely within the next two years, because of the market conditions we expect and LabCorp's financial policies. If cash flow is stronger than we forecast and acquisition opportunities are limited, we would expect LabCorp to return much of its DCF to shareholders. Related Criteria And Research -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 Ratings List Laboratory Corp. of America Holdings Ratings Affirmed Corporate Credit Rating BBB+/Stable/-- Senior Unsecured BBB+ Subordinated BBB New Rating Sr. unsecured notes due 2017 BBB+ Sr. unsecured notes due 2022 BBB+ Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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