RPT-Fitch Affirms St. Jude Medical's Ratings at 'A'; Outlook Stable

Fri Sep 6, 2013 9:24am EDT

Sept 6 (Reuters) - (The following statement was released by the rating agency)

Fitch Ratings has affirmed St. Jude Medical, Inc.'s (STJ) Issuer Default Rating (IDR) at 'A'. The Rating Outlook is Stable. Fitch has also affirmed the company's short-term IDR at 'F1'. A full list of ratings follows at the end of this release.

The ratings apply to approximately $3.61 billion of debt outstanding as of June 30, 2013.

KEY RATING DRIVERS

Fitch's rating actions reflect the following:

--Fitch expects leverage (total debt/EBITDA) of 2.0x at June 30, 2013 to decline to 1.4x - 1.5x during the next 18 months.

--Fitch believes flat sales and incrementally improving margins will drive 2013 free cash flow (FCF) of $750 million to $850 million.

--Volume pressure from the weak economy and European austerity measures will generally offset STJ's growth in emerging markets and new device platforms through 2013.

--Fitch anticipates that STJ will maintain adequate liquidity through cash balances, reliably positive FCF and ready access to the credit markets.

DECLINING LEVERAGE EXPECTED

Fitch expects STJ will decrease leverage to 1.4x - 1.5x during the next 18 months through increased EBITDA and debt reduction, financed with cash balances and FCF generation. As such, Fitch expects that STJ will not refinance the $450 million 2.20% notes due in September 2013 with long-term debt, but rather with short-term borrowings. Current leverage of approximately 2.0x is mainly the result of acquisitions and share repurchases.

SOFT VOLUME GROWTH

Fitch looks for STJ to generate flat to low single-digit revenue growth during the next 12 - 18 months. The weak economic/employment environment has reduced the rolls of the insured and dampened procedure growth. STJ's continued geographic expansion and sizeable pipeline of new devices should partially offset the drivers of soft volume growth. The critical nature of many of STJ's devices and aging demographics support a trend of increasing utilization. In addition, the implementation of the Affordable Care Act (ACA) will likely increase the number of insured during 2014 - 2016, which should modestly improve volume growth.

Unrelated to the economy, surgeons are employing a more judicious approach to implanting cardioverter defibrillators, following a cautionary study published in the Journal of the American Medical Association January 2011. The reported negative market reaction to STJ's formerly-manufactured Riata leads appears to be abating, which should ease the pressure on sales growth in STJ's cardiac rhythm management (CRM) business. Fitch expects the net impact of the above two issues will be, at most, modestly negative to the CRM segment (accounts for roughly 52% of total firm sales) during the next 12-24 months, as the market appears to have stabilized during the last two quarters.

INCREMENTALLY IMPROVING MARGINS DESPITE LONG-TERM HEADWINDS

Fitch forecasts incrementally improving margins for STJ despite the above-mentioned operating headwinds. Margins will be supported by mix shift to newer, higher margin devices and a focus on cost control. These trends continue to offset an increasingly challenging hospital contracting environment and the 2.3% ACA medical device sales tax which was implemented in January 2013. As such, Fitch expects that any intermediate- to longer-term margin compression will be modest and gradual.

RELIABLE FCF

Fitch believes that flat revenue and incrementally improving margins will enable STJ to generate $750 million - $850 million of annual FCF (cash flow from operations minus capital expenditures of roughly $280 million and dividends of roughly $300 million) during the next two years. Cash generation should be sufficient to fund targeted acquisitions and moderate share repurchases.

TRANSACTIONS TO CONTINUE

Fitch expects that STJ will remain acquisitive, focusing on companies or device platforms that offer innovation and growth, as technological advancement in the device sector is still relatively fragmented. Share repurchases will likely continue, especially in the absence of viable acquisition targets. Fitch thinks the company will continue to increase its cash dividend over time.

ADEQUATE LIQUIDITY ANTICIPATED

At June 30, 2013, STJ had adequate liquidity, comprised of approximately $1.22 billion in cash plus short-term marketable securities and roughly $1.23 billion (net of $275 million commercial paper borrowings) in availability on its $1.5 billion bank revolving credit facility, which expires on May 31, 2018. STJ generated approximately $589 million in FCF (net of $269 million of capital expenditures and $284 million of dividends) during latest 12 months (LTM), ended June 30, 2013. The company had approximately $3.6 billion in debt with (excluding commercial paper borrowings) approximately $450 million maturing in 2013, $500 million in 2016, $500 million in 2015, $83 million in 2017 and $1.8 billion thereafter. After the Sept. 2013 maturity, Fitch expects the vast majority of STJ's maturities will be refinanced with its ample access to credit markets.

RATING SENSITIVITIES

Fitch does not anticipate an upgrade in the near to intermediate term. STJ would need to commit to and operate with leverage stronger than 1.3x - 1.4x while maintaining relatively stable operations and solid FCF in order for Fitch to consider a positive rating action.

A downgrade of the ratings could result from debt sustained above 1.6x - 1.7x EBITDA without the prospect for timely deleveraging. This could result from a scenario in which revenue and margins are significantly stressed; resulting FCF weakens; and capital deployment not being adjusted to reduce the company's need for debt financing. Debt-financed share repurchases or acquisitions in the near term would likely prompt a negative rating action, given the limited flexibility afforded by the company's current leverage of 2.0x at June 30, 2013.

RATING ACTIONS

Fitch has affirmed STJ's ratings as follows:

--Issuer Default Rating (IDR) at 'A';

--Senior unsecured bank debt at 'A';

--Senior unsecured debt at 'A';

--Short-term IDR at 'F1';

--Commercial paper at 'F1'.

The Rating Outlook is Stable.