Fitch Rates Agilent's Senior Notes Offering 'BBB+'; Outlook Stable
The ratings apply to approximately $1.9 billion of debt at July 31, 2016. A full list of current ratings follows at the end of this release.
KEY RATING DRIVERS
--Fitch believes Agilent is committed to maintaining strong investment-grade ratings and is expected to operate with a moderate leverage profile (run-rate gross debt-to-EBITDA of around 2.0x or a bit higher), despite a capital deployment policy that will see Agilent issue incremental debt of $250 million each year from 2016-2018 to help fund share repurchases. The company's financial policy nevertheless reduces headroom at the current rating category and leaves its ratings more vulnerable to event risk, including debt-funded acquisitions of significant size.
--In the near term, Fitch expects that Agilent will focus on smaller, capabilities-based deals, since fewer transformational targets remain in the wake of recent transactions. Larger deals are not out of the question, however, within the parameters of Agilent's history of and commitment to conservative financial management.
--Agilent's business has a stable operating and cash flow profile, owing to a large proportion of recurring revenues (approximately 50%) and steady end-market demand. Fitch forecasts improving margins and normalized free cash flow (FCF; cash from operations less capex and dividends) of between $350 million-$400 million for the next four fiscal years.
--Agilent remains well-diversified in terms of product categories, end markets, and geographies. Diversification supports stability, although exposure to academic and government research budgets (approximately 10% of revenues) may lead to constrained or negative sales growth in periods of macroeconomic weakness.
--Agilent holds leading positions in its largest markets, providing a significant installed base with a significant amount of recurring sales of consumables, etc. Nevertheless, competition will remain heightened and consolidation is likely to remain a key theme. A sustained commitment to R&D investment for new product development will be necessary to maintain market leadership.
--Fitch anticipates that revenues will grow between 3%-4% annually from 2016-2019, reflecting growth in end-user demand and benefit of new products.
--Fitch models EBITDA growth resulting from growing revenues and incremental margin expansion, benefitting from cost savings derived from recent restructuring activities and increased operating leverage.
--Fitch models incremental annual debt increases of $250 million annually beginning in fiscal 2016 to help finance share repurchases, resulting in gross leverage ranging between 2.0x-2.25x throughout the forecast period.
--Any acquisitions are expected to be targeted in nature and manageable in size.
Maintenance of Agilent's 'BBB+' ratings will require gross debt-to-EBITDA generally maintained between 2.0x-2.5x. Temporary increases to fund strategic M&A accompanied by a credible de-leveraging plan could be appropriate at the current rating category. Fitch recognizes that a long-term strategy in key areas like diagnostics and genomics may require sizeable acquisitions over the medium term. Modest margin expansion, suggesting successful new product introductions and operational efficiencies, would be supportive of the 'BBB+' ratings.
A downgrade could result from lower than expected cash flows, leading Agilent to issue more than the expected additional debt to fund dividends or share repurchases. A downgrade could also result from the consummation of an acquisition of a size such that cash flows would not be sufficient to permit adequate and timely de-leveraging. Margin deterioration due to market commoditization or the inability to flex costs in response to weak demand (e. g. from government and research budget cuts) could also precipitate downward ratings pressure.
An upgrade is not anticipated in the near - to medium-term. Fitch's 'BBB+' ratings provide Agilent with flexibility to take part in the consolidation characterizing the life sciences and diagnostics sector in the near - to medium-term.
CURRENT FINANCIAL POLICY REDUCES FINANCIAL FLEXIBILITY
Management intends to return 85% of pre-dividend FCF (up from historical levels of around 40%) to shareholders over the next three years through dividends and share repurchases. Agilent will help finance the share repurchases with $250 million of incremental debt each year from 2016-2018. In Fitch's view, this stance remains in line with the current 'BBB+' ratings, as resulting gross leverage is likely to remain between 2.0x-2.25x if EBITDA growth largely offsets incremental debt issued. Fitch views gross debt leverage in this range as supportive of Agilent's current rating level, given the company's good earnings visibility and a stable operating profile characterized by steady demand, light CAPEX requirements, and stable operating margins.
Importantly, Fitch believes Agilent would remain committed to returning 85% of FCF to shareholders for the 2016-2018 fiscal years, even if it were to execute a debt-funded transaction of material size. This expectation reduces flexibility at the current rating category. If the company were to pursue a strategic acquisition without a credible deleveraging plan to reduce the company's gross debt-to-EBITDA to levels between 2.0x-2.5x within 12-18 months following the transaction, Fitch would likely downgrade Agilent's ratings by one notch.
STEADY GROWTH OUTLOOK WITH PROFITABILITY ENHANCEMENTS EXPECTED
Fitch expects Agilent to achieve low - to mid-single-digit organic growth in each of its key business areas, benefitting from favorable secular and demographic trends that should increase end-user demand, particularly in emerging markets. New products could further benefit top-line gains although the pace of uptake is more difficult to predict. The biggest risk to near-term top-line gains could be continued foreign currency translation headwinds. If currency translation continues to work against the company, reported EBITDA margins could be challenged to show marked improvement. However, even if revenues are flat, the company should be able to generate more modest margin improvement due to cost saving initiatives and product portfolio rationalization that includes the recent exit of two unprofitable business lines.
STRONG, DIVERSE MARKET POSITIONS
Agilent holds strong market positions in most of the markets in which it participates. However, several of the its primary competitors have greater overall scale and financial flexibility than Agilent, including Thermo Fisher Scientific Corp. (Thermo Fisher); Danaher Corp.; Abbott Laboratories; and Roche. Thermo Fisher in particular has been aggressively expanding its genomics capabilities, and its acquisition of Life Technologies Corp. resulted in an organization four times the size of Agilent. New product launches will be vital to maintaining leadership positions and to sustaining pricing.
For Agilent, becoming a leader in diagnostics and genomics may require large-scale aggregate M&A. But larger firms may have the ability to outbid Agilent and other mid-sized corporations as new technologies emerge and as consolidation occurs over time.
Agilent maintains a solid liquidity profile, although U. S. cash balances are kept relatively low (approximately $124 million at July 31, 2016). Fitch estimates that roughly 25% of total operating cash flow is generated in the U. S. but that between 40%-50% of Agilent's cash flows are regularly available to address funding requirements in the U. S., which is sufficient to fund operational needs, service the company's debt, and pay shareholder dividends. The company's increased share repurchase commitment will require incremental debt of $250 million in each of the next three years. Following the completion of Agilent's refinancing transactions discussed above, full availability under the firm's $700 million revolver due Sept. 15, 2019 should be adequate to fund smaller U. S.-based acquisition targets.
Only $100 million of 2018 debt matures over the next four fiscal years, mitigating the risk of lower U. S. cash balances. Agilent's next debt maturity is $500 million due in 2020, with the remaining $1 billion due thereafter. Long-dated debt maturities could provide flexibility for the use of shorter-term debt to fund acquisitions over the ratings horizon.
FULL LIST OF RATING ACTIONS
Fitch currently rates Agilent as follows:
--Long-Term Issuer Default Rating at 'BBB+';
--Senior unsecured bank facility at 'BBB+';
--Senior unsecured notes at 'BBB+'.
The Rating Outlook is Stable.