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Fitch Places Quest Diagnostics' Ratings on Rating Watch NegativeCHICAGO --(Business Wire)-- Fitch Ratings has placed Quest Diagnostics, Inc. (Quest) ratings, including the 'BBB+' Issuer Default Rating (IDR), on Rating Watch Negative. The rating action applies to approximately $3.37 billion of outstanding debt. See a full list of ratings placed on Rating Watch Negative below. KEY RATING DRIVERS Acquisition of Solsats Will Increase Leverage The Rating Watch Negative reflects an expectation of higher leverage (total debt to EBITDA) as the result of the funding of the acquisition of of Solstas Lab Partners Group (Solstas) for $570 million. Fitch does see the acquisition of the commercial lab operator as strategically appropriate, given the acquisition will broaden Quest's reach in the Southeast region where Solstas operates in nine states, and add around 5% in annualized revenues. However, incremental debt for the purchase would stress leverage that is already high for the 'BBB+' rating. Debt leverage increased to 2.58x for the latest 12-month (LTM) period ending Sept. 30, 2013 from 2.16x in 2012, as operating cost savings have not entirely offset pressured revenues while the debt load remained steady. Fitch anticipates Quest would need a combination of operational improvement and a reduced debt load to return to its leverage (total debt to EBITDA) target of 2.0 times (x) to 2.25x, a level Fitch considers to be consistent with the 'BBB+' rating. Negative Trends Compress Margins Continued negative health care utilization trends and government reimbursement constraint have dampened Quest's operating performance during 2013. Revenues in the first nine months of 2013 dropped by 3.9% versus the same period in 2012, driven by a 4.3% decrease in diagnostic testing revenues comprising a 3.8% drop in revenue per requisition and a 0.5% fall in volume. Cost savings from the $600 million Invigorate program has not kept pace with the revenue pressure leading to EBITDA margin compressing to 18.4% for the LTM ending Sept. 30, 2013 from 20.8% in 2012. Fitch is cautious about operational improvement this year, but some relief may stem from greater throughput arising from higher volumes associated with increased patient access and utilization following the initiation of Medicaid expansion and the state health insurance exchanges starting this year under the Affordable Care Act. Maturities Manageable, Ample Liquidity While a large portion of Quest's long-term debt (totaling $1.4 billion) is due in 2014 to 2017, Fitch believes the maturities are well-laddered and manageable. The maturing debt provides an option to wind down debt leverage, especially in light of yestrday's Solstas acquisition announcement. Currently, Quest has ample liquidity provided by operating cash flow generation of more than $800 million annually and a cash balance of $158 million at Sept. 30, 2013. External sources of liquidity are a $525 million receivables program and a $750 million revolving credit facility due September 2016. Shareholder Returns Jump Quest's management is committed to returning the majority of free cash flow to equity holders. Both dividends and share repurchases spiked in 2013 with a 76% increase to the dividend to $1.20 per share annually and more than $990 million of common share buybacks for the first nine months of the year. Asset sales of nearly $770 million during 2013 comprising the HemoCue business and ibrutinib intellectual property rights have partially funded the increased dividend and share repurchases. If Quest chooses to pull back on share repurchase activity following the purchase of Solstas and instead prioritize debt reduction as a use of cash flow, it would provide support for the ratings. RATING SENSITIVITIES Fitch will resolve the Rating Watch when there is more information about Quest's plans to fund the Solstas acquisition. A one-notch downgrade to 'BBB' is likely unless the company demonstrates a clear plan to reduce leverage to below 2.25x within 12-18 months following the close of the acquisition. Given the ongoing weak operating trends, characterized by weak growth in organic volumes and government reimbursement pressures, Fitch expects that reducing debt to this level will require the application of some cash to paydown debt. Positive rating action is not likely over the ratings horizon in light of an anticipated increase in already higher-than-expected total debt leverage due to potential debt funding needed to complete the proposed acquisition of Solstas. QUEST'S RATINGS Fitch has placed the following ratings on Rating Watch Negative: --Issuer Default Rating (IDR) of 'BBB+'; --Senior unsecured debt rating of 'BBB+'; --Bank loan rating of 'BBB+'. Additional information is available at www.fitchratings.com'. Applicable Criteria and Related Research: --'Corporate Rating Methodology' dated Aug. 5, 2013. Applicable Criteria and Related Research: Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139 Additional Disclosure Solicitation Status http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=816661 ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON (News - Alert) THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE. |
