Hill-Rom Holdings Inc. Ratings Affirmed On Acquisition Of Mortara Outlook Stable

Stocks and Financial Services Press Releases Friday January 20, 2017 09:03
BOSTON--20 Jan--S&P Global Ratings

BOSTON (S&P Global Ratings) Jan. 19, 2017--S&P Global Ratings said today that it affirmed its BB+ corporate credit rating on Hill-Rom Holdings Inc. following the planned acquisition of Mortara Instrument. The outlook is stable.

We also affirmed our 'BB' issue-level rating to its unsecured debt, reflecting a recovery rating of '5' and expectation of modest (10%-30%) recovery in the event of default.

We affirmed the ratings because the Mortara acquisition is consistent with our view that the company will pursue portfolio diversification and expansion and that debt to EBITDA will remain 3x-4x. The last major acquisition, Welch Allyn Inc., was successfully integrated and provides a more diverse product portfolio by adding medical diagnostic equipment to Hill-Rom's beds, surfaces, and surgical equipment portfolio. The Mortara acquisition would expand that diagnostic cardiology and patient monitoring base. While these two latest acquisitions improve the company's business risk profile, we already accounted for additional diversification and expansion into our current business risk assessment and feel Hill-Rom would need to demonstrate an ability to leverage its scale in markets outside of beds before we change our view of its business risk. From a financial risk perspective, the Mortara acquisition does not change our view because it only increases leverage slightly, and we expect Hill-Rom to incrementally improve leverage levels over the next two years.

Hill-Rom's reliance on beds (where it commands more than 50% of the market and derives 37% of its revenue) and surfaces operations subjects the company to variable U.S. hospital capital spending. However the targeted growth strategies have demonstrated the company's ability to expand its offering into ancillary markets, allowing for a broader product portfolio. We believe Hill-Rom is increasing the value provided to hospital customers by consolidating suppliers. While hospitals are under constant pressure to contain costs and tighten budgets, Hill-Rom has expanded upon its core bed business to sell systems in wound care and prevention and respiratory health.

The acquisition of Welch Allyn increased the company's product diversity by expanding operations within clinical workflow technologies. The successful integration helped the company leverage its marketing presence, enhance distribution capability, and increase participation in a broader suite of products used in the hospital setting. That benefitted the overall business by providing a business line that has higher organic growth prospects than the rest of the organization. Domestic sales are expected to contribute low- to mid–single-digit percentage organic growth, and mergers and acquisitions (M&A), including the Mortara acquisition, are expected to add further growth. Concurrently, we expect international sales to decline slightly, contributing to overall growth of 7%-8% in 2017 (incorporating a half year of Mortara) and in 2018 (including a full year of Mortara). Excluding acquisitions, organic growth for 2017 is expected to be in line with the industry. All five of the product categories (advancing mobility, wound care and prevention, clinical workflow, surgical safety and efficacy, and respiratory care) have large competitors such as Stryker, Invacare, and GE Healthcare, which have the resources to match the clinical expertise and product utility Hill-Rom provides. But pricing pressures--derived from an increased focus on hospital asset and resource efficiency, competitive dynamics, and reimbursement constraints--are offset somewhat by growth via M&A and cost-cutting measures from Hill-Rom's global footprint optimization strategy.

Financial risk reflects our expectation that the company will continue to operate with leverage of 3x-4x for 2017 and beyond. Acquisitions are expected to remain an integral part of the growth and diversification strategy. We expect the company to use excess free cash flow for dividends and acquisitions, given no significant maturities until 2021. With leverage of 4.3x in fiscal-year 2016, including the slightly leveraging impact of the Mortara acquisition, we expect the company to reduce leverage to 4x by the end of fiscal 2017 and further in the projected periods.

Revenue growth between 7% and 8% for 2017, benefiting from increasing domestic sales and the acquisition of Mortara Instrument, but offset by international headwinds.
EBITDA margin to remain around 19%, stabilized by a greater scale in operations.
Acquisition spending of the $330 million paid for Mortara in 2017 and falling to $125 million in 2018 as the company continues to look for targets with high growth profiles.
Free operating cash flow (FOCF) of $190 million-$225 million in 2017, bolstered by increasing income from operations and stable capital expenditures.

With sources expected to exceed uses by more than 1.2x, we believe Hill-Rom has an adequate liquidity profile. The company is viewed as having well established and solid banking relationships, satisfactory standing in credit markets, generally prudent risk management, adequate cushion on its covenants, and the ability to withstand high-impact, low-probability events, albeit with limited financing.

For the forward-looking periods, we expect:
Principal liquidity sources
$350 million in undrawn revolver availability;
$232 million in balance sheet cash;
Funds from operations (FFO) generation of $342 million; and
$3 million of working capital inflows.
Principal liquidity uses
Capital expenditures (capex) of $121 million; and
Debt amortization of $73 million.

While we expect more acquisitions, they are not contracted and, as such, we do not include them in our liquidity analysis. The Mortara acquisition has not been consummated and is not included. We also believe the company would stop paying its dividend in stress scenarios and therefore do not include it in the liquidity analysis.

Our stable rating outlook on Hill-Rom reflects our expectation that the company will reduce leverage to about 4x by the end of 2017 and to 3.8x by the end of 2018 from 4.3x. This view assumes the company continues to pursue acquisitions that are of smaller scale than that of Welch-Allyn, and keeps leverage near 4x.

The rating could be lowered if the company's acquisition activity is more aggressive such that leverage increases above 4x, and we believe the company's acquisition activity will remain aggressive such that leverage would remain above that threshold. This could occur if Hill-Rom increases debt by $100 million without incremental EBITDA and we think leverage will remain over 4x, and if free cash flow declines to about $100 million due to unsuccessful acquisition activity or further pricing pressure that may hurt margins. Additionally, while unlikely, we could lower the rating if the company fails to integrate recently acquired firms or has further trouble in its international markets such that EBITDA margins fall below 15%, increasing leverage above 5x.

Hill-Rom could be upgraded if we see it take market share from competitors, indicated by sustained growth rates that exceed the respective markets in which they operate. While the company has adequate barriers to entry, it often competes on price outside of its core beds market due to the relative inability to structure assets such that competitive pricing is avoided. If we see Hill-Rom keep capex at current levels, increase its overall EBITDA margin above 20%, and increase its market share, we would feel the company has demonstrated an ability to compete more effectively and would be considered for an upgrade.

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