Fitch Affirms Owens & Minor's Rating at 'BBB-'; Outlook Stable

CHICAGO--(BUSINESS WIRE)--

Fitch Ratings has affirmed the ratings for Owens & Minor, Inc. OMI, including the Long-term Issuer Default Rating (IDR), at 'BBB-'. The Rating Outlook is Stable.

A full list of rating actions, which apply to approximately $616 million of debt outstanding at Dec. 31, 2015, follows at the end of this release.

KEY RATING DRIVERS

-- OMI holds a strong share (~35% - 40%) of the steady and oligopolistic market for the distribution of medical-surgical (med-surg) products to U.S. acute care providers. Fitch believes OMI is well-positioned to maintain and/or grow market share in light of hospital consolidation and physician employment trends in the U.S.

-- Fitch expects organic growth in the low-single digits with modestly expanding EBITDA margins. Growth of value-adding services, such as OMI's 3PL and kitting businesses, should provide an offset to Fitch's expectation for overall margin compression associated with the growth of OMI's largest customers over the long-term.

-- Cash flows are consistent and sufficient to fund OMI's capex plans and dividend, though working capital fluctuation can be material. FCF (post-capex, dividends) is relatively light, and cash flow-based leverage metrics could constrain positive ratings momentum.

-- Ratings are constrained by management's stated willingness to materially increase debt leverage for M&A. OMI's history of relatively conservative financial management, combined with the limited number of sizeable deals currently available, mitigate this risk somewhat.

-- Though still in the early stages of growing its 3PL business and international presence, Fitch believes these areas provide an important strategic growth driver and tactic for improving its positioning with its manufacturer customers/suppliers in the medium-to-longer term.

RATING SENSITIVITIES

Moderate debt leverage, consistent and sufficient cash generation, and a solid liquidity profile afford OMI good flexibility at its current 'BBB-' ratings. Maintenance of OMI's current 'BBB-' ratings consider gross debt/EBITDA generally maintained at or below 2.5x with FFO of at least $120 million. OMI's target leverage is 2.0x, which is in line with ratings in the triple-B range.

OMI's current credit metrics and stable performance could support positive ratings momentum over the ratings horizon. However, some margin and cash flow pressures in 2013 - 2015 and management's stated willingness to increase leverage for M&A constrain the ratings somewhat. Fitch may consider a ratings upgrade in the medium term with evidence of sustainable margins and cash flow improvements. In the meantime, Fitch believes the current 'BBB-' ratings provide OMI flexibility to consummate appropriate and targeted M&A.

A downgrade is unlikely to result from operational or competitive pressures over the ratings horizon. But a downgrade could result from an otherwise transformational acquisition or from a shift away from OMI's historically conservative financial management strategy. M&A that causes leverage to increase to 3.0x - 3.5x, in line with OMI's core competencies, could be appropriate at the current 'BBB-' ratings, if accompanied by the ability and a commitment to de-lever within 12 - 18 months.

PERSISTENTLY WEAK (BUT IMPROVING) HEALTHCARE UTILIZATION, PRICING TRENDS

Organic top-line growth expectations for OMI's base distribution business remain soft, largely due to continued weak healthcare utilization growth, low product price inflation, and sell-side margin pressure. Fitch expects these trends to improve in 2015, owing to increasing healthcare coverage and improving overall utilization of healthcare services. Still, Fitch forecasts organic top-line growth of only 2% - 3% in the U.S.

Material upside to these forecasts could come from additional new customer wins or better-than-expected penetration of value-adding services to existing customers during the year. Some incremental volumes from the coverage expansion provisions of the ACA are expected in 2014, but any correlated benefit will likely be very modest.

CREDIT METRICS NOW MORE IN LINE BUT STILL STRONG FOR 'BBB-' RATINGS

A low debt balance, stable cash generation, steady underlying demand, and a good liquidity profile still provide OMI good flexibility at its 'BBB-' ratings. Financial metrics, including pro forma debt leverage of 2x at Dec. 31, 2014, could imply a rating higher than OMI's current ratings. OMI's stable operations and the steady and oligopolistic nature of healthcare distribution could also support higher ratings. Notably, cash flow-based leverage metrics are comparatively weak for the current ratings.

Fitch believes OMI's 'BBB-' ratings provide flexibility for the company to consummate sizeable targeted M&A over the ratings horizon. The 'BBB-' ratings could sustain debt leverage up to 3.5x, so long as it was anticipated that this figure would moderate to 2.5x or lower within 12-18 months. OMI has evidenced its commitment to rapidly repay debt after large M&A deals in the past, and Fitch expects this commitment to be maintained.

GROWTH OF KITTING, 3PL, INT'L BUSINESSES SHOULD OFFSET MARGIN PRESSURE FROM LARGEST U.S. CUSTOMERS

Fitch is concerned that OMI's strategy of aligning with the largest healthcare providers, which are expected to be among the most rapid growers, will expose the firm to rising margin pressure. Larger purchasers can often garner lower pricing from distributors, so the growth of these customers could contribute to gradual margin pressure for OMI.

However, Fitch notes that the largest providers are often the most innovative, providing potential upside for OMI to sell services that are more value-adding and higher-margin. Growth of the firm's newly acquired kitting capabilities and 3PL business should also support margins over the ratings horizon. Notably, 3PL services usually carry higher gross margins but also higher SG&A expense; so Fitch expects OMI's overall cost structure to shift accordingly as the 3PL business grows.

SOLID LIQUIDITY; LIGHT DEBT MATURITIES

OMI's solid liquidity profile comprises $25 million of readily available cash on hand (net of $31.5 million held overseas) and $411 million available on its $450 million revolver due Sept. 2019. Fitch sees relatively few domestic M&A targets that would exceed OMI's available internal liquidity, but also believes the firm has adequate access to the capital markets to raise funding if necessary. The company has no material debt due before 2021.

KEY ASSUMPTIONS

-- Organic base business growth of 2% with inorganic growth from the new acute care hospital customer, Medical Action, and ArcRoyal contributing to total top-line growth of 5% in 2015.

-- Stable to modestly expanding margins over the forecast period, affected by OMI's ability to drive growth in its 3PL and kitting businesses offset by pricing pressure from OMI's largest customers.

-- Steady debt leverage at or slightly below 2x.

-- Funds from operations (FFO) around $170 million per year; normalized FCF of at least $40 million after the significant negative working capital impact at year-end 2014 is worked out during 2015.

Fitch has affirmed OMI's ratings as follows:

-- Long-term IDR at 'BBB-';

-- Senior unsecured bank facility at 'BBB-';

-- Senior unsecured notes at 'BBB-'.

The Rating Outlook is Stable.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

-- 'Corporate Rating Methodology' (May 28, 2014);

-- '2015 Outlook: U.S. Healthcare' (Dec. 4, 2014).

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=749393

2015 Outlook: U.S. Healthcare (The Value Debate Intensifies While Aggressive M&A Continues)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=824368

Additional Disclosure

Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=982493

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