TEXT-S&P raises Pall Corp rating to 'BBB+'
Overview -- Port Washington, N.Y.-based filtration and separation equipment and products manufacturer Pall Corp. has maintained solid credit measures, and we believe its financial policy will be sufficiently conservative to support a 'BBB+' rating. -- We are raising our ratings on Pall, including the corporate credit rating to 'BBB+' from 'BBB'. -- The stable outlook reflects our expectation for credit measures to remain appropriate for the 'BBB+' rating even if the company pursues some acquisitions that result in leverage consistent with its public guidance. Rating Action On Oct. 3, 2012, Standard & Poor's Ratings Services raised its corporate credit and issue ratings on Pall Corp. by one notch to 'BBB+' from 'BBB'. The outlook is stable. Rationale The upgrade reflects our expectation that Pall's financial policy will remain sufficiently conservative to support the higher rating. The company's CEO has recently reiterated the company's financial policy regarding debt usage, which includes a target of about 30% or lower net debt to net capitalization. We believe that the company could pursue this financial policy and maintain credit measures that are appropriate for the 'BBB+' rating, including adjusted funds from operations (FFO) to total debt of about 40%. Current credit measures are well in excess of this given the company's currently underleveraged position relative to its public financial policy target. We assess the company's financial risk profile as "intermediate" and its business risk profile as "satisfactory," which limit further upside potential to the ratings at this time. We also believe risks related to contingent liabilities have eased over the past several years. The IRS closed its tax audit of Pall for fiscal years 1999-2005 in May 2011, and the company does not expect to make any further cash payments to the IRS with respect to those years. The SEC and Department of Justice still have outstanding investigations into Pall's restatement of past financial statements, though the investigations have been inactive since fiscal 2010 (Pall's fiscal year ends July 31). We believe the risk of large cash outflows related to these matters is reduced. Our fiscal 2013 base-case expectations include the following assumptions: -- Revenue will increase about 3% on an organic basis in fiscal 2013--excluding the effect of the sale of the company's blood collection, filtration, and processing product line, which generated about $230 million of sales. -- We believe the company will maintain an adjusted EBITDA margin of more than 20% in fiscal 2013 and free cash flow generation of more than $250 million. -- We assume the company will pursue share repurchases of at least $300 million. -- We believe Pall has capacity for debt-funded acquisitions of about $500 million, although we don't anticipate activity of this magnitude in the next year. We believe Pall will maintain its good business position as a leading (No. 1 or No. 2 in most of its markets) global manufacturer of filtration products for industrial and life science applications. The company's overall competitive advantages include its long-standing customer relationships, its technological expertise, and its global reach. Consumable products, which account for more than 80% of its sales, provide a largely predictable, high-margin revenue stream, offsetting exposure to certain cyclical end markets. We believe the prospects for the filtration, separation, and purification industry are generally good and are likely to outpace GDP growth. A well-established track record of new product introduction supports the company's competitive position. The company's focus on filtration products limits our satisfactory business risk profile assessment. Pall's intermediate financial risk profile is marked by good cash flow protection measures. However, shareholder initiatives or acquisition activity could absorb a significant amount of cash, which tempers our assessment. Total debt to EBITDA (adjusted for lease and pension obligations) as of July 31, 2012, was about 1.3x, and FFO to total debt was greater than 50%. For the ratings, we expect the company to maintain total debt to EBITDA of about 2x and FFO to total debt of about 40%. Pall also has more than $400 million available under its open-ended share repurchase authorization, and we believe it could fund a repurchase of this magnitude with cash, given its solid credit measures, without hurting the current rating. Liquidity Our 'A-2' short-term rating reflects Pall's "adequate" liquidity under our criteria. Our liquidity assessment incorporates the following factors and assumptions: -- We expect Pall's sources of funds to be more than 1.2x uses over the next 12 months. -- We expect the company to maintain sufficient headroom under covenants (including the maximum consolidated leverage ratio and 3.5x net interest coverage ratio) should EBITDA decline 15% from projected levels. -- We believe Pall has sound relationships with banks, a satisfactory standing in credit markets, and generally prudent financial risk management. Liquidity sources include cash and short-term investments of about $500 million as of July 31, 2012, and ample availability under its $500 million (net of outstanding commercial paper balances, which were about $205 million as of July 31, 2012) revolving credit facility maturing in 2015. Uses of liquidity include capital expenditures that average about 6% of total sales, which we consider to be significant. The company's nearest sizable debt maturity is its approximately $116 million Japanese-denominated loan due fiscal 2013. Outlook The outlook is stable. We expect that the company will maintain credit measures consistent with the higher rating, including adjusted FFO to total debt of about 40% and debt to EBITDA of about 2x. We also expect adjusted EBITDA margins will remain very good, at more than 20%. We have not factored material liabilities from ongoing investigations into the ratings--adverse developments could result in us taking a negative rating action. Similarly, shareholder rewards or acquisitions that are more aggressive than we expect could have the same result. This would be likely if these steps lead to a deterioration of credit ratios such that FFO to total debt falls to less than 35% without near-term prospects for improvement. For instance, we estimate that if Pall completed $500 million in acquisitions but very weak market conditions resulted in no revenue growth and margins deteriorated, we could lower the rating. However, sizable cash balances (exceeding $200 million) could offset weaker credit measures in our assessment. Rating upside is limited by our assessment of the company's business risk profile as satisfactory and its financial risk profile as intermediate. Given the company's focus on filtration products and its public statements regarding financial policy, we do not expect to raise either assessment in the next several years. Related Criteria And Research -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Key Credit Factors: Criteria For Rating The Global Capital Goods Industry, April 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Upgraded; Outlook Stable; Ratings Affirmed To From Pall Corp. Corporate Credit Rating BBB+/Stable/A-2 BBB/Positive/A-2 Upgraded To From Pall Corp. Senior Unsecured BBB+ BBB Ratings Affirmed Pall Corp. Commercial Paper A-2
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