Fitch Downgrades Fortrea's IDR to 'B'; Outlook Negative

Published: 2025-03-18 06:52:16 ET FTRE

Fitch Ratings has downgraded Fortrea Holdings, Inc.'s Long-Term Issuer Default Rating (IDR) to 'B' from 'BB-' and senior secured ratings to 'B+' with a Recovery Rating of 'RR3' from 'BB+'/'RR2'.

The Rating Outlook is Negative.

The two-notch downgrade reflects Fortrea's weakening credit profile and near-term growth prospects, which have been more significantly impacted than anticipated. Despite debt reduction efforts in 2024, Fitch forecasts that EBITDA leverage will remain in the 6.0x to 8.0x range in the near term.

The Negative Outlook reflects Fitch's view that limited or delayed growth, resulting from ongoing volatilities in the biopharmaceutical end markets or unsuccessful business strategies, could result in a further downgrade.

Key Rating Drivers

Growth to Slow: Fitch expects Fortrea's revenues to decline by 7.3% in 2025 and assumes revenue growth will return in 2026 in the 3.0% to 4.0% range. Fitch's revenue assumptions consider a reduction of 100 basis points (bps) in backlog conversion rates due to the revenue mix of mature and longer-duration projects, and a net book-to-bill ratio of 1.15x to 1.20x. The uncertain operating environment and Fortrea's lack of consistent revenue growth have lowered Fitch's expectations that the company can achieve prior revenue expectation of $3.2 billion by 2027.

Fitch believes the CRO industry can generate mid-single-digit growth in a stable macroeconomic environment and expects Fortrea to grow at least in line with the market over the long term. Fitch anticipates Fortrea will have sufficient liquidity to navigate near-term challenges. However, strategic failures could compromise its ability to compete with larger, better-capitalized peers and affect deleveraging efforts. Consistent revenue growth is crucial for stabilizing and expanding profit margins.

Margins Under Pressure: Fitch expects EBITDA margins to decline by 30 bps in 2025 from 7.4% in 2024 due to higher operating costs as a standalone company and a lower contribution from higher-margin post-spin awards. Over the forecast period, Fitch assumes margins will gradually expand but likely sustain in the high-single-digit range. Margin contraction in 2025 reflects benefits from Fortrea exiting all transition service agreements with LabCorp and net savings of $40 million to $50 million from restructuring activities, partially offset by Fitch's expectation of gross margin contraction by 70 bps.

Thereafter, Fitch assumes selling, general and administrative expenses will remain relatively fixed as Fortrea looks for opportunities to further optimize its cost structure. Gross margins are assumed to expand due to a favorable revenue mix and employee productivity, partially offset by increases in incentive compensation. Combined, Fitch assumes that EBITDA margins will expand by 50 to 100 bps per annum after 2025.

Deteriorating Credit Profile: Fitch expects EBITDA leverage to rise to 8.0x in 2025 and sustain in the 6.0x to 7.0x range in 2026 and 2027. While Fortrea repaid $483 million of outstanding debt in 2024, the company fully drew on its receivables (A/R) securitization facility, which Fitch treats as senior debt in the total debt calculation, to provide liquidity. Deleveraging will rely on Fortrea's ability to stabilize its profit margins while prioritizing organic investments to support growth opportunities.

Prioritizing Organic Investments: Capital allocation priorities remain unchanged, with Fortrea shifting its focus to targeted investments to drive organic growth. Fitch assumes capex will be 1.0% of revenue in 2025 and rise to 1.5% thereafter, excluding discretionary capex. Fitch expects Fortrea to use a combination of cash on hand and the milestone payments from the sale of its Enabling Services business to redeem $76 million of the 2030 senior secured notes in 2025. Excess cash above operational requirements, if any, will be allocated to debt repayment.

Continued Volatility: While the CRO industry continues to show resilience amid an unfavorable macro environment, Fitch expects end-market demand will remain volatile and cancellations across the industry will remain elevated in 2025. Biopharmaceutical companies will continue to reprioritize pipeline assets and remain cautious with spending to navigate uncertainties stemming from government policies, including but not limited to reduced government agency resources and slower pharmaceutical product and medical device approvals.

Peer Analysis

The 'B' IDR considers Fortrea's competitive position as a global CRO that offers a broad range of clinical development solutions to biopharmaceutical and medical device customers. However, these strengths are currently offset by its elevated credit risks and weakening cash flow profile as the company continues to face challenges in stabilizing its business following the spin-off from LabCorp.

The majority of Fortrea's CRO peers benefit from larger scale, higher profitability levels, and lower leverage. Charles River Laboratories International, Inc. (BBB-/Stable) participates in the pre-clinical CRO segment (as opposed to Fortrea in the clinical CRO market) and maintains a competitive position with a track record of leverage maintenance. Star Intermediate Holdings, Inc. (B+/Negative) is a direct competitor that is larger in scale and provides broader service offerings.

Key Assumptions

Revenue of $2.5 billion in 2025 and annual revenue growth of low- to mid-single-digit range thereafter;

EBITDA margins of 7.0% to 8.0% in 2025 and 2026;

Effective interest rates of 6.5% to 7.5% over the forecast period, moving with SOFR;

Working capital will be a use of cash, averaging about 1.0% of revenue per annum;

Capex of $25 million in 2025 and $50 million to $60 million per annum thereafter, inclusive of discretionary capex;

Negative free cash flow (FCF) in 2025 and 2026 that will turn positive to 1.5% of revenue by 2027;

Redemption of $76 million of the 2030 senior secured notes in 2025;

The A/R facility and the revolving facility and term loan A are refinanced at their maturities;

No allocation of discretionary FCF toward acquisitions or shareholder-friendly activities.

Recovery Analysis

The 'B+'/'RR3' ratings for the senior secured debt instruments reflect Fitch's assumption that Fortrea would be reorganized in bankruptcy as a going concern (GC) rather than being liquidated, to maximize the value distributable to claims.

Fitch estimates an enterprise value (EV) on a GC basis of approximately $850 million, after deducting 10% for administrative claims assumed to accrue from restructuring. The estimated EV reflects an estimated GC EBITDA of approximately $195 million, reflecting Fitch's view that GC EBITDA at this level is likely to trigger a default or restructuring amid significant refinancing risk from negative cash flow generation and high leverage.

The GC EBITDA is based on the following scenarios: a volatile operating environment reduces research and development spending and delays customer spending decisions; an unfavorable revenue mix results in slower backlog conversion rates; and operating inefficiencies sustain profit margins at compressed levels. Fitch assumes a moderate level of improvement in GC EBITDA from corrective measures in a restructuring which results in the GC EBITDA approximating current levels.

The EV also reflects Fitch's use of a 6.5x EV/EBITDA multiple. This reflects the following: high barriers to entry for becoming a large-scale CRO that can serve customer demand on a global scale; generally stable biopharmaceutical research and development spending through economic cycles; Fortrea's competitive position among global CROs; and its weak profit margins compared with other CROs in Fitch's coverage universe. The 6.5x multiple compares to the median 6.3x multiple observed in Fitch's case studies of previous bankruptcies in the healthcare sector.

In estimating claims, Fitch assumes that the A/R facility, given its importance to working capital funding, would be replaced by an equivalent super-seniority facility in bankruptcy and would have priority over the existing senior secured debt. Fitch also assumes that Fortrea would draw the full amount available under the $450 million revolving facility and includes that amount of debt in the claims waterfall. The waterfall analysis further reflects senior secured claims of approximately $1.1 billion in term loans and notes.

Fitch assumes that the non-guarantor subsidiaries do not have outstanding debt and the value generated by those subsidiaries will be fully available to creditors in bankruptcy, resulting in the senior secured debt recovering within the 'RR3' range, which generates a one-notch uplift from Fortrea's 'B' IDR.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

Fitch's expectation that EBITDA leverage will be sustained above 7.0x, driven by weaker or delayed growth and margin expansion;

Fitch's expectation that (CFO-capex)/debt will be maintained below 1.5% and EBITDA interest coverage below 2.0x.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

Fitch's expectation that EBITDA leverage will be sustained below 6.0x, driven by stronger growth recovery and meaningful margin expansion;

Fitch's expectation that (CFO-capex)/debt will be maintained above 2.5% and EBITDA interest coverage above 2.5x.

Liquidity and Debt Structure

Liquidity is supported by $119 million of cash on hand and an undrawn revolving facility of $450 million as of Dec. 31, 2024. Fitch forecasts negative CFO in 2025 but expects CFO to turn positive and gradually improve to $90 million in 2027. Over the forecast period, Fitch expects Fortrea to have sufficient liquidity to cover working capital requirements, capex, and organic investments. However, adverse operating conditions will result in reliance on the revolving facility to meet short-term liquidity needs.

Fortrea is required to redeem $76 million of the 2030 senior secured notes in 2025 and has term loan amortization of $5 million in 2026 and $25 million in 2027. The company will have $300 million of the A/R facility and approximately $390 million of the term loan A maturing in 2027 and 2028, respectively. Over the forecast period, Fitch assumes effective interest rates of 6.5% to 7.5%.

Issuer Profile

Fortrea Holdings, Inc. is a global CRO providing clinical development solutions for the biopharmaceutical and medical device industries. Its services include Phase I through IV clinical trial management, clinical pharmacology, and consulting services across 20 therapeutic areas.

Summary of Financial Adjustments

Fitch adjusts historical and projected EBITDA to remove non-cash and non-recurring expenses, including stock-based compensation, disposition-related and discontinued operation expenses, spin-off-related costs, and restructuring and other related expenses. Fitch also includes the outstanding amount of the A/R facility in the total debt calculation.

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.

MACROECONOMIC ASSUMPTIONS AND SECTOR FORECASTS

Click here to access Fitch's latest quarterly Global Corporates Macro and Sector Forecasts data file which aggregates key data points used in our credit analysis. Fitch's macroeconomic forecasts, commodity price assumptions, default rate forecasts, sector key performance indicators and sector-level forecasts are among the data items included.

ESG Considerations

Fortrea Holdings Inc. has an ESG Relevance Score of '4' for Management Strategy due to financial underperformance and significant execution risk. The divergence between management strategy and business performance raises concerns about management's track record, which has a negative impact on the credit profile and is relevant to the rating in conjunction with other factors.

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.