Fitch Ratings has upgraded Avantor, Inc.'s Long-Term Issuer Default Rating (IDR) to 'BB-'/Stable Outlook from 'B+'/Positive Outlook.
The upgrade is supported by strong operating performance and realization of deal synergies related to the VWR Inc. acquisition, a strong FCF and liquidity profile, and continued deleveraging to around 5.0x gross debt/EBITDA. While operations will be impacted from the coronavirus pandemic near term, we expect the company will be able to operate with gross debt/EBITDA below 5.0x in more normalized operating periods. The ratings apply to roughly $5.1 billion of debt outstanding at March 31, 2020.
KEY RATING DRIVERS
Manageable Coronavirus Effects: Fitch expects some near-term demand softness for Avantor's products as a result of coronavirus related business disruption influencing the company's customers. However, the business profile is relatively resilient because of good end market diversification and non-cyclical demand for healthcare products. Avantor's biopharma end markets have held up fairly well and have benefited from COVID-19 related testing demand. The industrials end markets have seen more significant business disruption effects from the pandemic, but because of the diversity of the customers served in the advanced technologies and applied materials businesses, demand for the company's products has remained relatively stable.
Fitch anticipates some EBITDA margin pressure in the near term due to weaker demand but expects this to be partially offset by the company's ability to reduce operating expenses and continued synergy realization from the VWR acquisition. Fitch's forecast incorporates roughly $220 million of annual cost synergies by year-end 2020.
Ample Liquidity during Pandemic: Fitch expects Avantor to maintain a comfortable liquidity cushion throughout the pandemic related business disruption. Between cash on hand, ongoing cash generation and committed lines of revolving credit, Fitch expects the company to have adequate liquidity to support operations, capital spending needs, preferred dividends and required term loan amortization during 2020. Avantor's good level of FCF generation is supportive of the 'BB-' IDR and could exceed $300 million annually in 2020-2023, even though 2020 will face coronavirus-related operational headwinds, representing a FCF margin of 5%-6%. If the company is able to refinance high interest debt, a decline in cash interest expense will provide upside for Fitch's FCF forecast.
Leverage Continues to Decline: Avantor's gross debt/EBITDA was 4.7x at March 31, 2020, and Fitch forecasts leverage of 5.0x at the end of 2020, assuming some coronavirus-related pressure on EBITDA and limited debt reduction as the company prioritizes maintaining liquidity in the near term. The company has successfully reduced debt since the merger with VWR, from a Fitch-calculated nearly 10x following the close of the transaction. This is the result of the combined effects of EBITDA growth and debt reduction, which was partly funded through the proceeds of an initial public offering.
Good Progress Realizing Cost Synergies: EBITDA growth has been helped by the realization of cost synergies since the VWR merger. Continued progress will help to offset coronavirus-related pressure on operating margins during 2020. Since the closing of the transaction the company has realized $300 million of synergies on a run-rate basis as of March 31, 2020, and Fitch's forecast incorporates roughly $220 million of annual cost synergies by year-end 2020. Fitch believes revenue synergies should also continue to be achievable going forward but does not incorporate this in its forecast.
Strong Competitive Position and Good Diversification: Avantor is well diversified through end markets and product categories, with biopharma representing about 50% of total sales. Advanced technologies and applied materials end markets represent roughly 25% of sales and includes a mix of more cyclical end markets that benefit from highly recurring consumable sales. Consistent cash generation is supported through highly diversified consumables- and service-focused revenues representing roughly 85% of sales, and more limited exposure to equipment and instrumentation (15% of sales) versus peers. Strength and diversification in high-growth end markets should offset slower growth and cyclical end markets, resulting in single-digit revenue growth above the average life sciences industry.
Avantor's strongest competitors are significantly larger, with leading positions in the broader life sciences industry and greater financial flexibility. Thermo Fisher (BBB/Stable) is Avantor's closest peer within the lab products industry. Thermo Fisher, a direct distribution competitor, is materially larger than Avantor, has an industry-leading manufacturing business, and is much more conservatively capitalized. Other 'BB-' rated healthcare companies operating in different industry sub-sectors typically have leverage sensitivities in the 4.0x - 5.0x range.
Fitch's Key Assumptions Within Our Rating Case for the Issuer
COVID-19 affects Q2'20 revenue the most, but strengths in biopharma and the expected return to work for Avantor's customers in H2'20 will aid recovery in the second half of the year. As a result, Fitch forecasts flat revenue growth for 2020. EBITDA margins see some compression of roughly 30 bps, but variable cost structure and continued cost synergies from VWR acquisition somewhat offset dampened revenue pull-through.
2021-2023 organic revenue growth in the low- to mid-single-digits.
2021-2023 EBITDA margins of 17.75% to 18%. Fitch's EBITDA forecast includes $220 million of cost synergies by the third year after the Avantor acquisition.
CAPEX is forecasted to be around 1.5% of revenues.
Free cash flow exceeding $300 million in 2020-2023.
Gross debt/EBITDA is maintained around 5.0x in 2020 and maintained between 4.5x-5.0x through 2022.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Operating with gross debt/EBITDA sustained below 4.5x;
Continued operational strength that results in (cash flow from operations - capex)/total debt around or above 7.5%.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Operating with gross debt/EBITDA sustained above 5.0x;
Pressures to profitability or increased expenses that result in (cash flow from operations - capex)/total debt sustained below 6%.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
LIQUIDITY AND DEBT STRUCTURE
Adequate Liquidity: Liquidity was supported by cash on hand of $346 million and availability of $248 million under a $250 million first lien secured revolver due 2022 as of March 31, 2020. Avantor's senior secured credit facility does not include financial maintenance covenants aside from a springing first lien net leverage covenant of 7.35x if 35% of the revolver is drawn. Additionally, working capital needs are supported by a $300 million accounts receivable securitization facility, of which $287 million was unused at March 31, 2020.
Debt Maturities Manageable: The company's debt maturities and amortizations are manageable with term loan amortization of roughly $20 million per year for the next two years. The first lien secured notes mature in 2024 and the unsecured notes mature in 2025. The receivables facility matures in March 2023.
Senior Unsecured Notes Notched Up: Fitch rates the senior unsecured notes 'BB/RR2', one notch above the IDR of 'BB-'. While the debt structure is weighted toward secured debt at roughly 60% of total, Fitch estimates superior recovery for both the secured and unsecured debt.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
The highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
ENTITY/DEBT RATING RECOVERY PRIOR
Avantor, Inc LT IDR BB- Upgrade B+
LT BB Affirmed RR2 BB
LT BB+ Affirmed RR1 BB+
VIEW ADDITIONAL RATING DETAILS
Additional information is available on www.fitchratings.com