Fitch Affirms Merck & Co.'s 'A+' IDR; Outlook Revised to Positive
CHICAGO -- October 05, 2012
Fitch Ratings has affirmed Merck & Co.'s (Merck) ratings as follows:
--Long-term Issuer Default Rating (IDR) at 'A+';
--Senior unsecured debt rating at 'A+';
--Bank loan rating at 'A+';
--Short-term IDR at 'F1';
--Commercial paper rating at 'F1'.
The ratings apply to approximately $21.5 billion in outstanding debt including
the recent $2.5 billion debt issuance. The Rating Outlook is revised to
Positive from Stable.
Margins Steady Through Patent Cliff:
Merck has successfully managed through a very long period of key drug patent
expirations that will ease over the next year after annualizing the loss of
market exclusivity for its bestseller Singulair that started in August. Cost
savings programs initiated since 2008 have supported margins in light of a
patent cliff dating back to 2006. Since 2006, three of Merck's top-5 selling
pharmaceuticals - Zocor, Fosamax, and Cozaar/Hyzaar - each of which generated
at least $3 billion in annual sales - have lost market exclusivity.
Merck maintained EBITDA margin above 30% during this period, with the
exception of 2010, when there were cost pressures related to the integration
of Schering-Plough. In the first half of 2012, the EBITDA margin rose to
39.3%, from 37% in the same period in 2011, driven primarily by the savings
initiatives that lowered SG&A by 5.5% and cost of goods sold by 1.2%. Fitch
sees EBITDA margin compressing in the second half of 2012 due to pressure on
gross profit as high-margin Singulair sales dramatically decline, outweighing
the company's recent success in its cost reduction program. However, Fitch
expects EBITDA margin to be maintained above 30% at the end of 2012 supported
by restructuring actions that will continue through 2013.
Revenue Pressures Easing:
Fitch believes that Merck's revenue decline due to expiring drug patents will
peak in 2013 driven by rapidly eroding sales of its bestseller Singulair
following the commercialization of multiple generic drugs in August. Excluding
the loss of Singulair, Merck is subject to patent lapses that represent 16.9%
of overall revenues over the next three-year horizon, including the potential
expiration of Remicade internationally. The figure shows a moderation from 30%
exposure at the end of 2009. Pressure on top-line performance also arises from
the anticipated dissolution of Merck's commercialization agreement with
AstraZeneca that will erase over $1 billion in annual sales in 2012 to 2013,
in Fitch's estimation.
An upgrade is contingent on Merck's ability to generate sales growth after
reaching a projected floor in 2013. Fitch recognizes that demand for the
current diversified product portfolio, and commercialization of a broad
late-stage research program could offset the pressures from drug patent
expirations over the long term.
Fitch presently anticipates compound annual growth (CAGR) in 2012-2016 for the
overall company of 0.99%. Key growth drivers are the Januvia franchise,
Isentress, Zetia, and the vaccine portfolio. Fitch sees much improved CAGR of
2.26% during 2013-2016, once the company has lapped the patent loss of
Singulair. Uptake of new drug approvals from the late-stage R&D program are
anticipated to contribute around 1% growth annually in 2014-2016, depending on
Merck's success in filing seven potential therapeutics with drug regulators by
the end of 2013.
Leverage Improvement From EBITDA Expansion:
Strong EBITDA growth bolstered by the contribution from Schering-Plough and
restructuring programs has led to a reduction in debt leverage since the end
of 2009. Gross debt leverage and adjusted debt leverage have fallen to 1.1
times (x) and 1.3x, respectively, for the latest 12 months (LTM) ending June
30, 2012 from 2.1x and 2.2x, respectively, in 2009 following the merger with
Schering Plough. The drop in leverage resulted mostly from EBITDA growth
rather than a reduction in outstanding debt. EBITDA more than doubled to $17.4
billion from $8.5 billion, strongly driven by margins expansion to 36.1% from
31%, during that time frame.
Fitch currently sees total debt leverage staying below 1.3x (pro forma for the
recent issuance of $2.5 billion), which, if sustained, could support a
one-notch upgrade of the IDR to 'AA-'. Fitch's total debt leverage forecast
assumes that the company will refinance $6 billion of debt maturing in
2013-2015 given the absence of a commitment to deploy capital toward debt
Steady Free Cash Flow:
Merck generated free cash flow of $6.1 billion in the LTM period ending June
30, 2012, in line with Fitch's expectation of annual free cash flow in excess
of $5 billion. Restructuring costs, higher capital spending, and pressured
earnings from rapidly declining Singulair revenues will dampen cash flow in
2012 leading to free cash flow of $5 billion (yielding free cash flow margin
of 10.7%) this year. Free cash flow will remain above $5 billion annually with
free cash flow margin sustained above 10% through 2014. The free cash flow
forecast includes an expectation of an increasing dividend and higher capital
Merck's strong liquidity is supported by cash and short-term investments of
$17.5 billion and $4.1 billion of long-term investments on June 30, 2012. In
addition, Merck had full capacity under a five-year $4 billion revolving
credit facility due May 2017. The company has ample liquidity to address
upcoming debt maturities of $1.8 billion in 2013, $2.1 billion in 2014, and
$2.1 billion in 2015.
What Could Trigger A Rating Action:
Positive rating action would follow sustained gross debt leverage in the range
of 1.0x to 1.3x over the next 12-18 months, which indicates that Merck
successfully traversed its long-running patent expiration period. In addition,
Merck must demonstate positive sales growth, through demand for core drug
products and uptake of new medicines, subsequent to a trough in 2013.
Rating pressure would stem from a rise in total debt leverage above 1.5x in
the intermediate term. The increase in total debt leverage could result from
operational weakness due to inability in achieving cost containment targets or
generating sales growth despite the imminent end of the company's patent
cliff. A leveraging transaction could lead to higher leverage prompting
negative rating action.
Additional information is available at 'www.fitchratings.com'. The ratings
above were unsolicited and have been provided by Fitch as a service to
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' dated Aug. 8, 2012;
--'Rating Pharmaceutical Companies - Sector Credit Factors', dated Aug. 9,
Applicable Criteria and Related Research:
Corporate Rating Methodology
Rating Pharmaceutical Companies
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