Feb 22 - Fitch Ratings has affirmed Quest Diagnostics, Inc.'s
(Quest) Issuer Default Rating (IDR) at 'BBB+'. A complete list of ratings is
provided at the end of this release.
The ratings apply to approximately $3.36 billion of outstanding debt. The Rating
Outlook is revised to Stable from Negative.
KEY RATING DRIVERS
Debt Leverage Within Goal
Quest has reduced leverage (total debt to EBITDA) during 2012 into its stated
target range of 2.0 times (x) to 2.25x, a level Fitch considers to be consistent
with the current rating category. During the year, the company prioritized debt
repayment and paid down $654 million in outstanding debt achieving its goal
between $500 million and $700 million. Fitch expects the debt load to remain
steady through the long term, assuming the company refinances coming maturities
of $200 million in 2014 and $500 million in 2015. Coupled with Fitch's forecast
of modestly improving EBITDA, leverage should be maintained within the targeted
range, leading to the revision in the Rating Outlook to Stable.
New Strategy To Support Growth
Quest continues to face volume pressure from negative health care utilization
trends as well as heightened competition from hospital laboratory in-sourcing.
Revenues in 2012 dropped by 1.7%, but were flat excluding discontinued
operations, HemoCue and OralDNA. The company's new management team, headed by
the new president CEO Steve Rusckowski, articulated a new operating strategy in
November 2012 that seeks to revitalize operating performance; including
refocusing on diagnostic information services, realigning the sales function,
and accelerating cost savings. Fitch's modest top-line growth expectation for
Quest over the next two years assumes some traction in the execution of its
broad strategy. Some relief on revenues should come from higher volumes
associated with increased patient access following the initiation of Medicaid
expansion and the state health insurance exchanges in 2014-2015.
Cost Reductions Increase
The success of a prior cost savings program, completed in 2010, gives Fitch
confidence that Quest can extract sufficient expenses to sustain steady to
slightly improving operating margins, leading to EBITDA growth in-line with to
slightly outpacing topline growth. The company's current cost savings program
was initiated in July 2011 and originally targeted $500 million of annual
savings, but was since expanded to a run rate of $600 million by the end of
2014. Moreover, the company targets incremental savings of $400 million in 2015
and beyond. EBITDA margin has expanded to 21.4% for the latest 12 months (LTM)
ending Sept. 30, 2012 from 21.1% in 2011 due to the growing benefits of the
expense savings. The run rate for cost savings reached $200 million at the end
of 2012 with $160 million generated last year alone.
Liquidity Remains Solid
Quest maintains solid liquidity through consistent operating cash flow, which
has exceeded $1 billion annually (excluding legal settlements) since 2008. Free
cash flow (operating cash less capital spending and dividends) was around $897
million in 2012, which included a 70% hike to the dividend last year. Quest's
continued focus on returning significant dividends to shareholders as well as
rising capital project spending will dampen free cash flow to around $550
million per year through the intermediate term, in Fitch's view. Quest
management forecasts operating cash flow of $1 billion and a capital spend of
approximately $250 million in 2013. External sources of liquidity are a $525
million receivables program and a $750 million revolving credit facility due
Shareholder Returns Highlighted
Fitch expects Quest to consume the majority of operating cash flow after capital
expenditures on share repurchases and dividends. The company has tripled the
dividend in 2013 from the 2011 level rising to $1.20 annually in 2013,
representing an annual cash payout of more than $180 million. Fitch sees the
company devoting most free cash flow (after dividends) to share repurchase
activity, which only temporarily eased in 2012 due to prioritizing debt
reduction. Investment in tuck-in opportunities, the current focus for business
development, is manageable within Fitch's expectations for solid cash flow
generation and heavy shareholder returns.
Positive action would be warranted, if leverage falls and is maintained below
the low-end of its leverage target of 2.0x to 2.25x. However, Fitch expects the
company to consistently manage the balance sheet such that leverage falls within
its stated leverage target.
A downgrade to 'BBB' would be caused by an expectation of debt leverage rising
above 2.25x through the intermediate term as a result of EBITDA compression due
sustained top-line pressure not offset by expense savings derived from the
company's Invigorate cost initiative. Significant leveraged asset purchases or
returns to shareholders could also increase leverage and negatively affect the
rating. Some relief on revenues should come from higher volumes associated with
increased patient access following the initiation of Medicaid expansion and the
state health insurance exchanges in 2014-2015, yet the ultimate effect to
margins is still uncertain.
Fitch has affirmed the following ratings:
--Issuer Default Rating (IDR) at 'BBB+';
--Senior unsecured debt rating at 'BBB+';
--Bank loan rating at 'BBB+'.
Additional information is available at www.fitchratings.com'. The ratings above
were solicited by, or on behalf of, the issuer, and therefore, Fitch has been
compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' dated Aug. 8, 2012.
Applicable Criteria and Related Research:
Corporate Rating Methodology