Fitch Downgrades McKesson's L-T Rating to 'BBB+'; Outlook Negative
CHICAGO -- February 6, 2014
Fitch Ratings has downgraded the long-term ratings of McKesson Corp. (NYSE:
MCK), including the long-term Issuer Default Rating (IDR), to 'BBB+' from
'A-'. The Rating Outlook is Negative.
A full list of rating actions follows at the end of this release.
The rating actions follow the close of MCK's agreements with Franz Haniel &
Cie GmbH (Haniel) and Elliott Fund Management (Elliott) to acquire the firms'
respective stock and convertible bond holdings of Celesio AG (Celesio). These
transactions are valued at approximately EUR3.7 billion (US$5.1 billion).
KEY RATING DRIVERS
-- MCK's acquisition of Celesio is strategically sound, though moderate event
risk remains as to the subsequent steps in the acquisition process. Increased
scale from the deal will allow MCK to drive cost savings, particularly related
to generic drug sourcing, and future growth.
-- Fitch expects MCK's post-deal capital structure to include a materially
increased amount of long-term debt. Pro forma debt-to-EBITDA could exceed
2.5x, but MCK's strong cash generating ability should allow for de-leveraging
to around 2x by fiscal year-end 2016. Liquidity is expected to remain strong.
-- U.S. drug distributors maintain exceptionally stable operating profiles and
consistent and strong cash generation, owing to steady pharmaceutical demand
and generally oligopolistic markets. Margins and cash flows continue to
benefit from the mostly durable effects of the unprecedented generic wave,
which is set to ramp up again in calendar 2014.
-- Fitch sees the European drug channel as somewhat less stable and efficient,
and generally higher risk, than the U.S. market due to increased
competitive/regulatory pressures. MCK's acquisition of Celesio adds
incremental but manageable business risk related to operating a new business
line (retail pharmacy) and engaging new geographies (Europe, Brazil).
-- MCK holds top U.S. market positions in specialty drug distribution,
medical-surgical distribution, and healthcare IT, as well as drug distribution
in Canada. These businesses will support intermediate-term growth and
profitability and, in addition to measured expansion in other non-U.S.
markets, are likely to represent areas in which MCK will pursue future growth
Maintenance of a 'BBB+' IDR will require MCK to direct sufficient cash flows
toward debt repayment such that debt-to-EBITDA of 2x or below is achieved over
the next 24-30 months. Long-term funding plans have not been made available,
but Fitch expects MCK's significant cash generating ability, enhanced by the
addition of Celesio in the intermediate term, to be sufficient to achieve this
target. Fitch forecasts cumulative free cash flow (FCF; cash from operations
minus capital expenditures minus dividends) to exceed $4.5 billion in fiscal
2015-2016 for the combined firm.
Ratings flexibility will be limited during the de-leveraging timeframe.
Significant M&A activity or the resumption of large-scale share repurchases in
the next 2-3 years could contribute to downward ratings pressure, to the
extent that such actions restrict MCK's ability to repay debt maturities as
they come due. The addition of more long-term debt than currently expected
could also pressure the 'BBB+' ratings.
A positive rating action is not anticipated in the near-to-intermediate term.
The Negative Outlook represents the large amount of de-leveraging necessary to
support the 'BBB+' ratings, plus uncertainty related to the longer-term
post-deal capital structure. Furthermore, some event risk remains surrounding
future acquisition-related transactions and processes. Significant setbacks in
any of these areas requiring the use of material amounts cash or external
financing could contribute to negative ratings pressure.
CELESIO DEAL IS STRATEGICALLY SOUND; LIMITED NEAR-TERM FINANCIAL BENEFITS
Fitch views the acquisition of Celesio by MCK as strategically sound, as it
offers the potential for better buy-side drug pricing and additional growth
opportunities outside the largely penetrated U.S. market. The realization of
these benefits, however, is likely to take several years. Fitch sees
relatively few financial synergies in the near term.
The combination of MCK and Celesio is differentiated from the scale-plays
engaged by other drug channel participants. Both of MCK's competitors,
AmerisourceBergen Corp. (ABC) and Cardinal Health, Inc. (Cardinal), have
entered into drug purchasing joint ventures with other drug channel
participants - ABC with Walgreen Co. and Alliance Boots GmbH, and Cardinal
with CVS Caremark Corp. Thus, these firms must share the benefits of increased
scale, namely buy-side cost savings on the purchase of generic drugs.
Conversely, MCK will retain all the benefit of expected cost savings, but will
also bear fully the risks associated therewith. The overall relative benefits
of these differing globalization/scale-enhancing schemes cannot yet be
ascertained and will take some time to be fully realized.
STABLE OPERATIONS IN THE U.S. AND EUROPE
MCK and its peers in the drug distribution industry continue to exhibit
exceptionally stable operations and financial performance. Despite still weak
macroeconomic conditions and moderately decreased utilization of healthcare in
the U.S., core business growth at MCK has remained largely in-step with or
ahead of broader market growth. Organic long-range growth in the low-single
digits is driven by consistent demand for pharmaceuticals and is realized
relatively uniformly, given the largely oligopolistic market.
Fitch expects the U.S. drug distribution industry to maintain good operating
stability. The industry's very slim margins make it an unlikely target for
extra taxes and fees (like those recently imposed on the pharma and medical
device sectors in the U.S.). Distributors excel in adding value to the drug
channel through the supply chain management and other services they offer to
both upstream and downstream customers.
The Celesio transaction will provide MCK with significant new exposure to the
European drug distribution and pharmacy markets. Fitch sees the European drug
channel as relatively less stable and efficient than that found in the U.S.
Furthermore, Fitch believes risks related to drug pricing and reimbursement
are greater for drug channel participants in Europe than in the U.S.,
especially given that regulatory and reimbursement constructs generally vary
from country to country. The opportunity for increasing generic penetration in
most markets could provide upside, however, over the ratings horizon.
A FEW MORE YEARS OF THE UNPRECEDENTED GENERIC WAVE
MCK and its peers - both in the U.S. and in Europe - continue to benefit from
the unprecedented wave of branded drug patent expirations in calendar
2012-2014. Most drug channel participants, including distributors, earn higher
margins - though less revenues - on the sale of lower-cost generic drugs.
Fitch believes much of the margin expansion MCK and its peers have achieved in
recent years is durable.
Further margin growth is expected to benefit from the introduction of
biosimilars to the U.S. drug channel, as well as from new branded biologic
drugs, as the pace of traditional branded-to-generic conversions slows
post-2015. Fitch believes biosimilars could represent an even more compelling
margin expansion opportunity for drug distributors than traditional generics
in the intermediate-to-longer term.
SOLID PRESENCE IN SPECIALTY, MED-SURG, AND HIT
Traditional drug distribution in the U.S. is a consolidated industry
characterized by steady growth in the low-single digits. Traditional drug
distribution accounts for roughly 80% of MCK's overall revenues. The remaining
20% comes from the company's leading market positions in the distribution of
specialty pharmaceuticals and of med-surg supplies, and in healthcare
information technology (HIT). MCK is one of only a handful of companies with a
significant share of these relatively fragmented markets.
As a result, Fitch believes MCK is uniquely positioned to benefit from growth
opportunities related to its ancillary businesses as those markets grow and
consolidate over time. To that end, Fitch expects MCK to continue consummating
small, tuck-in acquisitions in especially the med-surg and HIT spaces.
ROBUST CASH FLOWS AND SOLID LIQUIDITY
MCK's stable margins, efficient operations, and good asset management
contribute to stable and strong cash generation measures. Funds from
operations (FFO) and FCF for the latest 12 months (LTM) period ended Dec. 31,
2013 were $3.1 billion and $2 billion, respectively. The firm's solid
liquidity position also includes a $1.3 billion unsecured revolver due
September 2016 and a $1.35 billion accounts receivable facility due November
2014. Cash on hand as of Dec. 31, 2013 was $2.4 billion ($1.5 billion held
outside the U.S.).
Debt maturities are estimated as follows: $350 million for the remainder of
fiscal 2014; $1.1 billion in 2016; $980 million in 2017 (including EUR 350
million of Celesio bonds); $1.2 billion in 2018 (including EUR 500 million of
Celesio bonds), and $2.4 billion thereafter.
Fitch has downgraded the following ratings of MCK:
-- Long-term IDR to 'BBB+' from 'A-';
-- Unsecured bank facility to 'BBB+' from 'A-';
-- Unsecured senior notes to 'BBB+' from 'A-'.
Fitch has affirmed the following ratings of MCK:
-- Short-term IDR at 'F2';
-- Commercial paper at 'F2'.
The Rating Outlook is Negative.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and
Subsidiary Linkage' (Aug. 5, 2013);
--'U.S. Healthcare Stats Quarterly - Third-Quarter 2013' (Jan 2, 2014);
--'2014 Outlook: U.S. Healthcare — Secular Challenges Require a Compelling
Value Proposition' (Nov. 25, 2013);
--'Trekking the Path to Biosimilars - The Destination' (Oct. 4, 2013);
--'Vital Signs - Currents in the Drug Channel' (Podcast) (April 25, 2013);
--'Navigating the Drug Channel - Drug Distributors: A Deeper Dive' (April 24,
Applicable Criteria and Related Research:
U.S. Healthcare Stats Quarterly — Third-Quarter 2013
Navigating the Drug Channel -- Drug Distributors: A Deeper Dive
Vital Signs -- Currents in the Drug Channel
Trekking the Path to Biosimilars -- The Destination
2014 Outlook: U.S. Healthcare — Secular Challenges Require a Compelling Value
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS.
PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK:
HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING
PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND
METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF
CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL,
COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM
THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER
PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS
OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN
EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER
ON THE FITCH WEBSITE.
Jacob Bostwick, CPA,+1 312-369-3169
Fitch Ratings, Inc.
70 W Madison Street
Chicago, IL 60602
Bob Kirby, CFA,+1 312-368-3147
John Culver, CFA,+1 312-368-3216
Media Relations, New York
Brian Bertsch, +1 212-908-0549
Press spacebar to pause and continue. Press esc to stop.