Fitch Affirms Merck & Co.'s Long-term IDR at 'A+'; Outlook Remains Negative
CHICAGO -- April 24, 2014
Fitch Ratings has affirmed Merck & Co.'s (Merck) long-term ratings, including
the Issuer Default Rating (IDR) at 'A+'. The Rating Outlook remains Negative.
In addition, Fitch has affirmed the company's short-term ratings at 'F1'. A
full list of rating actions follows at the end of this release.
The ratings apply to approximately $24.6 billion in outstanding debt.
KEY RATING DRIVERS
The Negative Outlook mainly reflects that leverage (total debt/EBITDA) has
remained above 1.5 times (x) since Merck's $5 billion, largely debt-funded
share repurchases in second-quarter of 2013. While leverage has declined to
1.65x from its peak of 1.92x at June 30, 2013, it remains higher than what
Fitch would expect for an 'A+' credit rating for this issuer.
Fitch expects that Merck will continue to favor share repurchases over
deleveraging, acknowledging the possibility of further debt-funded stock
buybacks. Notably, the company has roughly $10.4 billion remaining on its
existing repurchase authorization.
Sales at-risk to patent expiries have declined to roughly 20% of total firm
sales. Roughly one-third of those sales are generated by biologics, which tend
have significantly less market share erosion in the face of generic
(biosimilar) than do traditional small molecule drugs.
Merck has made progress in building its late-stage pipeline. The company has
approximately 20 new molecular entities (NMEs) in phase 3 development or
Merck initiated a restructuring program in October 2013, which Fitch expects
will be supportive to margins during the intermediate term. The company will
focus on costs in a number of areas including manufacturing, general
administration and research & development.
Fitch believes the rumored sale of the company's consumer business would be
strategically sound, as it would increase the company's focus on its core
mission of developing and marketing innovative medicines. However, unless the
company were to use some of the proceeds to pay down debt, the incremental
loss of diversification and EBITDA would be incrementally negative for Merck's
Fitch expects modest growth for Merck's Januvia/Janumet franchise, as the
market becomes increasingly crowded with new entrants. Although, the growth in
the number of diabetic patients and some share gains from older generic
treatment modalities should offset the competitive headwind.
Fitch forecasts that Merck will generate $5.8 billion - $6.1 billion in FCF
during 2014 as improving margins offset soft revenue.
Debt Financed Share Repurchases
Fitch expects that Merck will continue with shareholder friendly actions
during the near term, some of which may be funded by debt. Merck purchased
$5.3 billion (net of issuances) of its common stock during 2013, compared to
$1.3 billion during 2012. The repurchases were executed under a $15 billion
program authorized in May 2013 and a previously authorized program. The
company has approximately $10.4 billion remaining under the May 2013 share
repurchase program. The repurchases were funded, in large part, with debt
Patent Exposure Easing
The company faces significant number of patent expiries during the next two
years. However, roughly only 20% of total firm sales are at risk. In addition,
Remicade and PEG-Intron, which account for about 6.2% of total firm, are
biologics and tend not to experience the rapid sales loss to generic
competition as do traditiona, one small molecule pharmaceuticals.
Expanding Late Stage Pipeline
Fitch expects Merck to continue to build its late-stage pipeline, despite the
company's intention to narrow its focus its focus on R&D projects. The
company's late stage pipeline is broad with new molecular entities (NMEs) to
treat cancer, bacterial and viral infections, diabetes, cardiovascular
disease, central nervous system disorders, osteoporosis, allergies and other
While the majority of these projects are internally developed, Merck has
partnered with other innovator firms to take advantage of technological
advancements that were discovered externally. The landscape for drug
development is expanding, particularly as more is learned about how genetics
influence the development, prevention and treatment of disease.
Cost Cutting Continues
In October 2013, Merck initiated a new global restructuring program, in an
effort to sharpen its global commercial and research & development focus. The
company expects to reduce its total workforce by approximately 8,500
positions, including those in sales, administration and research &
Merck will sell some real estate, move its corporate headquarters and continue
to work towards improving the efficiency of its manufacturing and supply
network. The restructuring program is expected to be substantially completed
by the end of 2015. Estimated pre-tax restructuring costs are approximately
$2.5 billion - $3 billion, of which two-thirds will be cash-related.
Consumer Business Possibly for Sale
Fitch believes the sale of Merck's consumer products business would be a net
negative for the company's credit profile, with the expectation that the
proceeds of the sales would not be used for debt reduction. While the consumer
business accounts for roughly 4% of total firm sales, Fitch estimates the
segment's contribution to the firm's total EBITDA is less than that.
Regardless, we believe the negative effects of a less diversified product
portfolio and a lower base of profitability will more than offset the benefits
to the firm from increasing its focus on its core competency of drug
development and marketing in the near term.
More Competition for Januvia/Janumet
Fitch expects that the growing number of diabetic patients and continued
market share gains from some older generic diabetes treatments will more than
offset the increasing number of competitors in the diabetes treatment market,
resulting in relatively soft sales growth for Januvia/Janumet, Merck's largest
selling franchise. Growth has slowed in recent years due to competition (DPP-4
inhibitors, SGLT2 inhibitors, GLP-1 agonists) entering the diabetes market. In
addition, concerns over the safety of these drugs(DPP-4 inhibitors) have been
a headwind to growth, although the FDA recently reaffirmed their safety
regarding pancreatitis and pancreatic cancer.
Solid Free Cash Flow Expected
Fitch forecasts that Merck will continue to generate significantly positive
free cash flow generate, including expected 2014 FCF of $5.8 billion - $6.1 in
FCF during 2014. Improving margins driven by an improving sales mix and strong
cost control should more than offset the negative effect that expected soft
top-line growth will have on cash generation.
Fitch looks for Merck to maintain adequate liquidity through strong FCF
generation and ample access to the credit markets. FCF for the LTM ending Dec.
31, 2013 was $8.35 billion. At the end of the period, Merck had approximately
$17.5 billion in cash plus short-term investments and full availability on its
$4 billion revolver, maturing in May 2017.
At Dec. 31, 2013, Merck had roughly $24.6 billion in debt outstanding, with
$4.7 billion maturing in 2014, $2 billion in 2015, $2.3 billion in 2016 and $1
billion in 2017. Fitch expects near- to mid-term maturities will be satisfied
primarily through refinancing in the public debt markets.
Fitch would consider revising the Rating Outlook to Stable if Merck pursued a
capital deployment strategy that maintained gross debt leverage below 1.5X
during the long term, including managing through operational stress such as
patent expiries and clearly taking a more conservative approach to its use of
debt. In addition, the company must demonstrate long-term positive sales
growth through demand for core drug products and uptake of new medicines.
Rating pressure would stem from total debt leverage remaining above 1.5x in
the intermediate term. The high leverage would likely be driven by incremental
borrowing to fund acquisitions or share repurchases. Leverage pressure could
also result from operational weakness due to an inability to achieve in
achieving cost containment targets or generating sales growth despite is
improving patent risk profile and expanding late-stage pipeline. In addition,
Fitch anticipates that FCF would be constrained in this scenario.
Fitch has affirmed the follow ratings for Merck:
--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 Rating Outlook on the long-term ratings remains Negative.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 12, 2013);
--'Rating Pharmaceutical Companies - Sector Credit Factors' (Aug. 9, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and
Rating Pharmaceutical Companies
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Bob Kirby, CFA, +1 312-368-3147
Fitch Ratings, Inc.
70 West Madison Street
Chicago, IL 60602
Michael Zbinovec, +1 312-368-3164
Michael Weaver, +1 312-368-3156
Brian Bertsch, +1 212-908-0549
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