OREANDA-NEWS. S&P Global Ratings today affirmed its 'BBB' corporate credit rating and issue-level ratings on Owens & Minor Inc. and revised the outlook to stable from negative.

"The rating actions reflect our view that the company has successfully expanded its operations into Europe and can count on growth from the region, thereby increasing its customer base," said S&P Global Ratings credit analyst Lucas Taylor. We expect EBITDA to grow about 5%, resulting in overall leverage of 2.1x for 2016. We believe the company will maintain this level for the next few years, even with the contract loss, which will begin to affect the company at the end of the year.

The company's business risk profile is characterized by market leadership in supplying medical products to hospitals, particularly in the U. S., and strong relationships with manufacturers. Around 85% of the company's revenues come from sales to member hospitals under contract with large group purchasing organizations (GPOs), and the late-2014 expansion into Europe via its acquisition of ArcRoyal opened up another market. However, the increased scale gives the company only marginal increases in negotiating power; it will likely experience continued pricing pressure, resulting in growth rates that are lower than the expected mid-single-digit rates of the overall health care industry. Offsetting this, the company has consistently demonstrated an ability to increase its operating efficiency and develop a successful inorganic growth strategy with smaller acquisitions.

The financial risk profile is characterized by leverage that is steady throughout the projection period, owing to stable debt loads and EBITDA margins that are flat to slightly up. We don't expect the loss of the $525 million Kaiser Permanente contract announced in April 2016 to affect the company until late in the fourth quarter, with the bulk of the revenue loss occurring in 2017. However, we expect the company's efficient operating structure to allow it to manage this loss without a significant impact on EBITDA and therefore leverage. Additionally, when juxtaposing Owens & Minor with its peer group, it compares favorably, thereby positively affecting the rating.

The stable outlook for Owens & Minor reflects credit measures that are in line with what we expect for a 'BBB' credit as well as stability in those metrics. The expanded geographic and product bases offer greater diversity and a greater likelihood in EBITDA margins remaining at their current levels.

Given its large fixed-cost operating structure, Owens & Minor is particularly sensitive to shifts in margin. Declines of more than 40 basis points would push leverage above 2.5x, thereby increasing the financial risk, and possibly prompting a downgrade. This could occur if the company lost another large contract (in addition to the planned exit of one at the end of fiscal 2016) or experienced greater-than-expected price competition.

While we consider it unlikely, we could raise the rating if Owens & Minor improves its position relative to its customers, giving it more leverage in negotiations. Specifically, this would require greater size such that the company would be larger than the GPOs it generally contracts with. A more likely scenario for an upgrade would be if Owens & Minor's leverage approaches 1.5x, and it improves margins on the order of about 40 basis points. For such events to occur, the company's expansion efforts in the international market would need to take hold, allowing for greater scale to amortize its fixed costs.