NEW YORK - (Business Wire) Standard & Poor
’s Ratings Services revised its outlook on Jacksonville, Fla.-based PSS World Medical Inc. (NASDAQ GS: PSSI) to positive from stable. At the same time, Standard & Poor
’s affirmed its ratings on PSS, including the
‘BB
’ corporate credit rating.
The outlook revision reflects PSS’ solid operating performance and our growing comfort that the company will maintain its less aggressive financial risk profile.
The ‘BB’ rating on PSS reflects the company’s narrow operating focus as a niche distributor of medical products to alternate-site health care providers, the potential negative impact of the U.S. economy on its customers, and the potential for a more aggressive share repurchase or acquisition strategy. Partially offsetting these concerns are PSS’ leading position in its niche markets, identifiable opportunities for sales growth and improved profitability, and significant supplier and client diversity.
While Standard & Poor’s believes that PSS has established a solid niche position, the company is narrowly focused and competes with larger, more broad-based companies. The credit risks in the company’s customer base also are a concern; physician practices and elder care business could experience reduced reimbursement beyond 2009, cost pressures, and growth of the uninsured population. These pressures could lead to higher bad debt for PSS or customer bankruptcies. However, PSS has effectively managed through the weak U.S. economy to date; the company is willing to walk away from unprofitable business. In fact, PSS has managed to reduce days’ sales outstanding by 10 days over the last two years in its Elder Care business while reducing bad debt charge-offs to 0.25% from 0.35% of total revenue during the same period. In addition, surgery centers, hospice facilities, and in-home care providers represent sales growth opportunities. Also, the company’s customer and supplier diversity provides insulation from customer losses and supply price inflation.
Given its low operating margins (typical for a distribution company), cost controls are particularly important for PSS. While the company is vulnerable to general cost inflation and rising fuel costs, it has proven its ability to manage these expenses appropriately. In fact, margins have expanded during recent years, despite rising fuel costs.
Not considering the company’s strong cash position, PSS’ current FFO to total lease-adjusted debt of about 23% and lease-adjusted debt to EBITDA of approximately 4x are still within our guidelines for a ‘BB’ financial risk profile. However, Standard & Poor’s believes that PSS will use its cash to repay the $150 million of unsecured notes due in March 2009. Therefore, our assessment of the company’s financial risk profile incorporates our expectation of lease-adjusted debt to EBITDA of about 2.5x.
Liquidity
Given the company’s strong cash position, aided by a recent $230 million debt issuance and consistent free operating cash flow, liquidity is expected to be sufficient for the company’s ongoing needs. We believe that the company has about $70 million of its $200 million senior secured revolving credit facility drawn. Availability under the company’s $200 million revolver is based on inventory and receivables balances and therefore is not subject to traditional financial covenants. As of June 30, 2008, PSS could borrow additional funds up to its current $200 million limit; the revolver can be increased to $250 million at the company’s option. PSS has generated a three-year average annual operating cash flow of $67 million. We expect it to generate about $75 million of operating cash flow in fiscal 2009.
PSS has no significant near-term maturities (excluding the $150 million of convertible notes due March 2009). Capital expenditures are expected to be about $15 million-$25 million annually, with maintenance expenditures representing about half of the spending. We expect the company’s credit facility and cash flow to provide enough flexibility to fund working capital expansion, modest acquisitions, and moderate share repurchases.
Recovery analysis
See Standard & Poor’s recovery report on PSS World Medical, published on RatingsDirect on July 30, 2008.
Outlook
The rating outlook is positive. We believe that the company’s financial risk profile is strong for the rating, assuming the company uses its existing cash balances to repay $150 million of convertible debt in March 2009. The rating could be raised within the next year if PSS’ is able to offset the potential impact of the rising uninsured population through operating efficiencies, new customer, and expanded relationships with existing customers and sustain its improved financial position. Pro forma for the anticipated debt repayment, total lease-adjusted debt to EBITDA is expected to be about 2.5x (less than the 3.0-4.5x guideline). FFO to total lease-adjusted debt is also expected to average above the 15%-30% guideline for the rating category.
The company’s operating margins improved to 5% in fiscal 2008 from 4.2% in fiscal 2005 due to a shift to more profitable private label, leveraging revenue growth, and increased operating efficiencies. These trends are expected to continue and will be necessary to offset the potential impact of a weakening U.S. economy. In fact, we estimate that a 100 basis swing in gross margin could increase or decrease the company’s debt leverage ratio by roughly 0.5x.
The outlook could be revised to stable if industry pressures, substantial acquisitions, or large debt-financed share repurchases were to weaken the company’s credit metrics to below the previously stated guidelines on a sustained basis.
Ratings List
| Ratings Affirmed; Outlook Action | | | | | | | | |
| |
| | | | To | | | | From |
| PSS World Medical Inc. | | | | | | | | |
| Corporate Credit Rating | | | | BB/Positive/-- | | | | BB/Stable/-- |
| |
| Ratings Affirmed | | | | | | | | |
| |
| PSS World Medical Inc. | | | | | | | | |
| Senior Unsecured (2 issues) | | | | BB- | | | | |
| Recovery Rating | | | | 5 | | | | |
Complete ratings information is available to subscribers of RatingsDirect, the real-time Web-based source for Standard & Poor’s credit ratings, research, and risk analysis, at www.ratingsdirect.com. All ratings affected by this rating action can be found on Standard & Poor’s public Web site at www.standardandpoors.com; select your preferred country or region, then Ratings in the left navigation bar, followed by Credit Ratings Search.
(NASDAQ GS: PSSI) - G
Standard & Poor’s
Jesse Juliano, CFA
Boston
617-530-8317
jesse_juliano@standardandpoors.com
