December 7, 2016 / 5:46 PM / a year ago

Fitch Affirms PerkinElmer's Ratings at 'BBB'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, December 07 (Fitch) Fitch Ratings has affirmed PerkinElmer Inc.'s (PerkinElmer) Issuer Default Rating (IDR) at 'BBB'. The Rating Outlook is Stable. A full list of PerkinElmer's ratings follows the end of this release. KEY RATING DRIVERS --Gross debt leverage has generally remained between 2.0x and 2.5x, and Fitch expects this metric to continue to approximate these levels in most periods. As has been the case historically, Fitch anticipates that gross leverage could temporarily exceed 2.5x if the company issues incremental debt to finance targeted acquisitions. --Adjusted EBITDA margins have stabilized at levels near 20%, which represents a 400 basis points (bps) improvement over levels reported in 2011, benefitting from successful execution of restructuring and a shift in business mix toward higher margin consumables and services businesses. Fitch projects that the company will be able to sustain and likely improve upon these levels going forward. --Fitch anticipates low or mid-single digit organic growth over the forecast period, driven by growing demand in emerging markets supplemented by new products. These growth drivers should more than offset industry headwinds that include softer demand in government and academic end markets. FX headwinds have eased in 2016 after pressuring reported revenue growth by 6% in 2015. --Free cash flow (FCF) generation has been consistently solid and should remain so for the foreseeable future. Fitch projects annual FCF of $250 million or more for the next few years, benefitting from EBITDA growth, minimal required contributions to pension plans and continued manageable CAPEX requirements. --The present top priority for capital usage remains asset purchasing, specifically small opportunities. In the absence of acquisitions, Fitch believes that shareholder returns, especially opportunistic share repurchases, will take precedence over debt reduction. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for PerkinElmer include: --Revenues increase in 2016 to 2019 by a compound annual growth rate (CAGR) of 2.3%, reflecting slower growth in 2016 due to a shorter fiscal year, modest FX headwinds and a soft near term outlook for instrument sales, followed by stronger growth later in the forecast period. --Fitch models EBITDA growth resulting from growing revenues and moderate margin expansion, derived from cost efficiencies resulting from ongoing Lean operating initiatives. --EBITDA growth backstops stronger cash flow generation. FCF exceeds $250 million in 2016 and builds from there, benefitting from stable capital expenditures, modest pension funding requirements, and long-dated debt maturities. --Incremental debt increases of $50 million from 2017-2019 to help fund acquisitions, resulting in gross leverage approximating 2.3x-2.4x throughout the forecast period. --Potential for increased share repurchasing and/or leveraging transactions; however, Fitch expects that that the actions, if realized, would be undertaken in a financially disciplined manner. RATING SENSITIVITIES Maintenance of PerkinElmer's 'BBB' rating would be supported by average gross debt leverage levels between 2.0x-2.5x, EBITDA margins approximating 20%, and U.S.-generated cash flows well in excess of annual debt servicing requirements. Near term upward ratings momentum is unlikely in the near term. Longer term, an upgrade could be considered if PerkinElmer were to achieve the following: --Maintain gross debt leverage below 2.0x for a period of consecutive years accompanied by EBITDA margins approximating 20%; --Continue to generate U.S.-based cash flows well in excess of annual debt servicing requirements; --Significantly increase its scale and further expand the scope of products and services. Downward rating action could result from heavy pressure on operations or leveraging shareholder-friendly actions or acquisitions such that debt leverage was expected to exceed 2.5x for 18-24 months or longer. PerkinElmer's ratings could also be downgraded if the company's U.S.-generated cash flows decreased to a level where the company's ability to internally fund its annual debt servicing requirements came into question. Operational weakness could stem from lower-than-anticipated results due to poorer-than-expected sales performance as the company's diversified portfolio cannot withstand headwinds of capital expenditure constraint in Europe, and tightened global research spending. EMERGING MARKETS DRIVE GROWTH Continued, strong demand in emerging markets has helped to offset softer conditions in developed markets, particularly in PerkinElmer's more capital-intensive businesses. In particular, government and academic end markets have been more challenging, as well as industrial and, more recently, environmental businesses. Importantly, Fitch believes that substantial runway remains for continued robust growth in PerkinElmer's key emerging markets, particularly China and India. This constructive outlook is supported by global population growth and an expanding middle class in emerging markets that will continue to generate demand for high quality health care outside of the U.S. This is particularly true in the area of reproductive health, where PerkinElmer enjoys a strong competitive position globally. PerkinElmer's Environmental Health business should likewise benefit from growing demand for food supply chain security and a world-wide shortage of clean water. These factors are driving increased regulatory scrutiny and spurring demand for increased monitoring of air, food and water quality. Fitch sees the potential for double digit organic growth in emerging markets over the forecast period that will more than offset single digit organic revenue declines in developed markets, where PerkinElmer has recently seen reductions or delays in instrument purchases. The recent softness in demand for equipment bears watching. It could reflect short term delays or reduction in capital outlays due to the uncertain global economic and political environment, including possible concerns about implications of Britain's pending exit from the EU or the outcome of the recent U.S. presidential election. On the other hand, if lower demand for PerkinElmer's instruments persists over a longer time period, it could suggest a weakening in PerkinElmer's competitive position in these areas that could ultimately have negative rating implications. Fitch projects that PerkinElmer could report compound growth in reported revenues of around 2.3% through 2019. Continued demand for PerkinElmer's diversified portfolio should be further bolstered by new offerings across the Human Health an Environmental Health segments. BOLT-ON ACQUISITIONS REMAIN PRIORITY FOR CAPITAL DEPLOYMENT Although capital used for share repurchases has recently exceeded amounts deployed for acquisitions, Fitch believes that PerkinElmer's highest priority for capital deployment remains asset purchasing. Specifically, Fitch expects that PerkinElmer remains focused on small to moderate-sized opportunities to gain access to technology and broaden the research and product portfolios as well as targets in adjacent markets. For the latest 12 months (LTM) ended Oct. 2, 2016, Fitch calculates that PerkinElmer repurchased $138 million of common equity (net of share issuances), while completing acquisitions of $104 million over the same time period. Fitch attributes this allocation to an absence of attractively priced targets, rather than a shift in financial policy in favour of shareholder returns over business development. While PerkinElmer has occasionally used debt to help fund targeted acquisitions, gross debt leverage has generally remained between 2.0x and 2.5x, and Fitch expects this metric to continue to approximate historical levels in most periods. As has been the case historically, Fitch anticipates that gross leverage could temporarily exceed 2.5x if the company issues incremental debt to finance acquisitions of a slightly larger size. In the absence of attractive acquisition opportunities, Fitch believes that shareholder returns, especially opportunistic share repurchases, will take precedence over debt reduction. Fitch sees potential for increased share repurchasing over the intermediate term given reasonable debt leverage and solid FCF generation. Fitch anticipates that the actions, if realized, would be undertaken in a financially disciplined manner. PerkinElmer has also publicly guided that it is considering pruning its portfolio in Fitch expects any cash proceeds resulting from these dispositions to be reinvested in PerkinElmer's business or returned to shareholders through share repurchases. RECENT MARGIN IMPROVEMENT DURABLE, FURTHER IMPROVEMENT POSSIBLE PerkinElmer has successfully executed its strategic focus on margin expansion as evidenced by EBITDA margins stabilizing at current levels around 20%, which represents meaningful improvement from 15.7% margins generated in 2011. The margin expansion reflects benefits of multiple rounds of restructuring initiatives as well as a shift in product mix toward higher margin businesses, including software services (35% of revenues) and consumables (24%). Additional margin expansion appears achievable, as the company is in the process of implementing various Lean initiatives intended to reduce materials spend and realize manufacturing and logistics efficiencies. Margin expansion could also be aided by selective pruning of businesses that are outside of PerkinElmer's four core areas of focus, which include reproductive health, food analysis, emerging diagnostics, and pharmaceutical services. Each of these four areas is averaging double digit organic growth and generating operating margins greater than the company's current consolidated level of around 18.5%. PerkinElmer targets an additional 400bps of margin expansion by 2020 but Fitch conservatively models more moderate margin improvement over forecast period, leading to EBITDA margins of close to 22% by the end of 2019. GROSS DEBT LEVERAGE SUPPORTIVE OF 'BBB' RATING Gross debt leverage has generally been maintained between 2.2x-2.4x for the past several years as occasional, modest increase incremental debt increases to help fund acquisitions have been offset by EBITDA growth. Fitch views gross debt leverage of between 2.0x-2.5x as commensurate with the company's current 'BBB' ratings. Given Fitch's outlook for low to mid-single-digit revenue growth and moderate margin expansion, the company should be able to maintain leverage within this range fairly comfortably if it so chooses. Fitch nevertheless expects that PerkinElmer will occasionally use debt to help fund acquisitions, which could cause PerkinElmer's gross debt leverage to occasionally exceed 2.5x. Fitch believes that PerkinElmer's 'BBB' rating provides flexibility for the company to temporarily exceed 2.5x gross debt leverage if the company were to demonstrate a pathway to reducing leverage closer to 2.5x within 18-24 months. LIQUIDITY PerkinElmer's debt maturity schedule is laddered and fairly simple. The company's capital structure is comprised of two unsecured debt issuances ($500 million of 5% notes due in 2021 and EUR500 million of 1.875% notes due in 2026) and $45 million of bank borrowings under a $1.0 billion revolving credit facility. PerkinElmer has intermittently drawn under its unsecured credit facility to help fund modest sized acquisitions. All debt, including bank facilities, is held and will be issued at PerkinElmer Inc. as there is no finance subsidiary. Fitch's estimates that incrementally improving EBITDA margins, manageable capital spending, a consistent dividend and modest pension contributions will yield annual FCF of $250 million or more annually. Steps taken in recent years to fund the U.S. defined pension benefit plan and improve operational efficiency have materially boosted cash flows versus levels reported in 2012 and 2013. FCF totalled $259.0 million for the LTM as of Oct. 2, 2016, representing a FCF margin of 11.4%. This result continues a trend of steady improvement that PerkinElmer is poised to build upon over the forecast period, assuming stable debt levels. Fitch anticipates that PerkinElmer will continue to generate cash in the U.S. in amounts that are more than sufficient to fund the company's annual interest expense of roughly $37 million, annual dividends of $32 million, and CAPEX requirements that have ranged between $25 million-$40 million. FULL LIST OF RATING ACTIONS Fitch has affirmed PerkinElmer Inc.'s ratings as follows: --Long-Term Issuer Default Rating at 'BBB'; --Senior unsecured credit facility at 'BBB'; --Senior unsecured notes at 'BBB'. The ratings apply to approximately $1.1 billion of consolidated debt outstanding as of Oct. 2, 2016. The Rating Outlook is Stable. Contact: Primary Analyst Greg Dickerson Director +1-212-908-0220 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Jacob Bostwick, CPA Director +1-312-368-3169 Committee Chairperson Megan Neuburger, CFA Managing Director +1-212-908-0501 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected EBITDA is adjusted to add back non-cash stock based compensation. Additional information is available on Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1016039 Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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