News Column

Fitch Affirms St. Jude Medical's at 'A'; Outlook Stable

August 20, 2014

CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has affirmed St. Jude Medical, Inc.'s (STJ) Issuer Default Rating (IDR) at 'A' with a Stable Rating Outlook. Fitch has also affirmed the company's short-term IDR at 'F1'. A full list of Fitch's rating actions is available at the end of this release.

The ratings apply to approximately $4.21 billion of debt outstanding as of June 28, 2014.

KEY RATING DRIVERS

Fitch's rating actions reflect the following:

--Fitch expects leverage (total debt/EBITDA) of 2.4 times (x) at June 28, 2014 to decline to 1.4x-1.5x during the next 12 - 18 months.

--The stabilizing domestic cardiac rhythm management (CRM) market, new product introductions and emerging market strength support an expectation of low- to mid-single-digit revenue growth during 2014 and 2015.

--Fitch believes STJ's focus on cost control and improving its sales mix will partially offset the negative effect that pricing and excise taxes will have on margins.

--Moderate sales growth and modestly pressured margins should drive 2014 free cash flow (FCF) of $750 million to $850 million.

--Fitch expects STJ will balance acquisitions, share repurchases and dividends with a credit profile supportive of an 'A' rating.

--STJ is anticipated to maintain adequate liquidity through cash balances, reliably positive FCF and ready access to the credit markets.

HIGH LEVERAGE TO DECLINE

Fitch expects STJ will decrease leverage to 1.4x-1.5x during the next 12 - 18 months through increased EBITDA and meaningful debt reduction. Continued improving operational performance should provide for EBITDA growth as well as increased cash generation. Current leverage of approximately 2.4x is largely the result of acquisitions and to a lesser extent share repurchases.

REVENUE GROWTH EXPECTED IN ALL BUSINESS SEGMENTS

Fitch expects STJ to generate low- to mid-single-digit revenue growth during the next 12-24 months. New product introductions, expansion into faster growing product- and geographic markets, stabilization of the cardiac rhythm market and two favorable facilities re-inspections by the FDA should more than offset the negative effect of a weak domestic economic environment and the relatively austere European markets.

STJ has recently launched, or expects to launch in the near term, devices in all four of its business segments [Cardiac Rhythm Management (CRM), Atrial Fibrillation (AF), Cardiovascular (CV) and Neuromodulation (NM)]. A number of these are differentiated by their clinical effectiveness and safety profiles, as well as by the ability to reduce medical costs compared to competing devices. Fitch believes the company's new product development and commercialization efforts will continue to support favorable pricing and potentially incremental market share gains.

While markets outside of the three developed markets of U.S., Europe and Japan account for only 16% of total firm sales in 2013, their contribution has increased from roughly 13% in 2011. STJ's annual growth rate in the three developed markets from 2011 to 2013 was a negative 2%, compared to a growth rate of 6% for its other markets. Fitch expects positive growth rates to return to the developed markets; however, growth in the other markets will likely continue to outperform the developed markets.

CRM demand has somewhat stabilized despite a continued a weak employment environment, and STJ's recently introduced quadripolar leads have enabled the company to capture share. The negative effect on volumes from a January 2011Journal of the American Medical Association (JAMA) article suggesting the implantable cardioverter defibrillators (ICDs) are overused has likely run its course.

MARGIN HEADWINDS PARTIALLY OFFSET BY COST CONTROL AND MIX

Fitch forecasts incrementally stressed margins for STJ, given a number of persistent headwinds. While STJ margins have remained relatively strong, owing to mix shift to newer, higher margin devices and its ongoing focus on cost control, a more challenging hospital reimbursement environment and the ACA excise tax should modestly offset the supporting trends. Longer term, Fitch expects that the company will incrementally improve its margins through continued gains in efficiency and favorable mix shifts (product and geographic).

RELIABLE FCF

Fitch believes that increasing revenue with modestly pressured margins will result in STJ generating $750 million - $850 million of annual FCF (cash flow from operations minus capital expenditures of roughly $230 million and dividends of roughly $300 million) during the next two years. Cash generation should be sufficient to fund targeted acquisitions and moderate share repurchases.

TARGETED ACQUISITIONS AND SHARE REPURCHASES LIKELY

Fitch believes that STJ will remain acquisitive, focusing on companies or device platforms that offer innovation and growth, as technological advancement in the device sector is still relatively fragmented. Share repurchases will likely continue, especially in the absence of viable acquisition targets. The company's recently instituted cash dividend may moderate the level of share repurchases. Fitch expects STJ will balance its transactions within the context of maintaining a credit profile supportive of its 'A' ratings.

PLANO AND SYLMAR FACILITIES APPROVED TO PRODUCE NEW DEVICES

STJ has allayed concerns regarding device production for its CRM and NM business. During the past few months, the company has resolved the manufacturing issues that have slowed new product approvals at two of its facilities in Sylmar, CA and Plano, TX. The FDA has greenlighted both facilities to produce new devices following recent re-inspections. The Sylmar facility manufactures CRM devices, such as Durata and Optim, while the Plano facility makes NM devices.

ADEQUATE LIQUIDITY ANTICIPATED

At June 28, 2014, STJ had adequate liquidity, comprised of approximately $1.58 billion in cash plus short-term marketable securities and roughly $114 million (net of $1,336 million commercial paper borrowings) in availability on its $1.5 billion bank revolving credit facility, which expires in May 2018. STJ generated approximately $641 million in FCF (net of $196 million of capital expenditures and $292 million of dividends) during latest 12 months (LTM), ended June 30, 2014.

The company had approximately $4.2 billion in debt with (excluding $1,336 million in commercial paper outstanding) approximately $64 million maturing in 2014, $500 million in 2015, $500 million in 2016 and $1,805 million thereafter. Fitch expects the vast majority of STJ's maturities will be refinanced with its ample access to credit markets.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include the following:

--Fitch does not anticipate an upgrade in the near to intermediate term.

--However, STJ would need to commit to and operate with leverage stronger than 1.3x-1.4x while maintaining relatively stable operations and solid FCF, in order for Fitch to consider a positive rating action.

Negative: Future developments that may, individually or collectively, lead to negative rating action include the following:

--Debt sustained above 1.6x-1.7x EBITDA without the prospect for timely deleveraging.

--This could result from a scenario in which revenue and margins are significantly stressed (more than Fitch anticipates); resulting FCF weakens; and capital deployment not being adjusted to reduce the company's need for debt financing.

--As such, significant debt-financed share repurchases or acquisitions in the near term would likely prompt a negative rating action, given the limited flexibility associated with the company's current leverage.

RATING ACTIONS

Fitch has affirmed STJ's ratings as follows:

--IDR at 'A';

--Senior unsecured bank debt at 'A';

--Senior unsecured debt at 'A';

--Short-term IDR at 'F1';

--Commercial paper at 'F1'.

The Rating Outlook is Stable.

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

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=854574

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 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.



Fitch Ratings

Primary Analyst

Bob Kirby, +1 312-368-3147

Director

Fitch Ratings, Inc.

70 W. Madison St.

Chicago, IL 60602

or

Secondary Analyst

Megan Neuburger, +1 212-908-0501

Senior Director

or

Committee Chairperson

Michael Weaver, +1 312-368-3156

Managing Director

or

Media Relations:

Brian Bertsch, +1 212-908-0549

brian.bertsch@fitchratings.com

Source: Fitch Ratings


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