European Pharma: An S&P Report Card

New products, strong sales, and productive M&As helped overseas pharma outperform the U.S. sector for the very first time

From Standard & Poor's RatingsDirect

The European pharmaceuticals market continued to record above-average growth in the first quarter of 2006, after Europe's 7% beat the U.S. sector's growth rate of 5% in 2005, for the first time ever.

What's behind the outperformance? For one thing, European companies' healthier pipeline of drugs under development has meant more new drug approvals from regulators than U.S. counterparts. European pharmas are also placing a stronger focus on indications for oncology, the fastest-growing pharmaceutical segment, and on the specialist segment, which grew faster than the primary-care segment.

Due to the positive effect of strong sales growth on the profits and cash-flow generation of the rated companies, credit quality has continued to improve during the past 12 months. No positive rating actions have yet resulted, since most of the players already had overcapitalized balance sheets, but flexibility within the ratings has increased.

We expect the strong mergers and acquisitions trend to continue in this market. The global pharmaceuticals industry remains comparatively fragmented—the top 10 global players command slightly more than one-half of the market. In addition, balance sheets are getting stronger due to record average cash flow levels for the industry in 2005 and the first quarter of 2006

This trend is likely to persist in the near future due to most European companies' healthy product pipelines and, on average, lesser exposure to patent expirations than their U.S. peers. Mergers also give opportunities to cut costs and develop critical mass in research and development, by far the strongest determinants of success and credit quality in the industry.

Here is Standard & Poor's view of the rated companies in the sector (ratings are as of Aug. 1, 2006):

AstraZeneca (AZN)

Rating/outlook: AA+/Stable

The trend of strong currency-adjusted sales growth continued in the first quarter of 2006: At 12% it's significantly ahead of the industry average of about 6%. Based on high growth rates in its existing drug portfolio and an improving late-stage pipeline, S&P expects AstraZeneca to maintain above-average sales growth for the coming quarters. This is also due to a limited patent-risk and patent-loss situation and is despite the withdrawal of Exanta earlier in 2006.

The company's arrangements with Merck in the U.S. are not likely to result in total payments higher than $3.3 billion by 2008, which should be paid from the company's cash flow. After the change in top management, S&P will monitor the company's potentially higher appetite for risk in the context of future acquisitions.

Bayer (BAY)

Rating/outlook: BBB+/Positive

Bayer's financial profile, which has been poor for three years, remains weak after the acquisition of Schering. In the first quarter of 2006 Bayer's cash flows improved slightly, thereby offsetting the slightly higher net debt at the end of the period. Performance in the next couple of quarters will bear the impression of the Schering acquisition and integration, which will depress credit metrics, due to the up-front impact of the additional debt, and despite the diagnostics divestiture.

Fresenius Medical Care/Fresenius AG (FMS)Rating/outlook: BB/Negative

Fresenius and FMC have below-par pro forma debt-protection measures for the BB ratings category after the acquisitions of German hospital management operator Helios Kliniken and U.S. dialysis-care provider Renal Care Group. The BB ratings could be lowered in the next 12 to 18 months if FMC and Fresenius fail to demonstrate the ability to achieve and sustain adjusted net debt to earnings before interest, taxes, depreciation, and amortization (EBITDA) of about 3.5 to 3.8 times and funds from operations (FFO) to net debt of about 17% by financial yearend 2007.

First-quarter 2006 results reflected the integration of Helios and continued strong organic growth: Compared with the first quarter of 2005, group sales net of currency effects increased by 27%, of which 9% were attributable to organic growth. We expect the two recent acquisitions to contribute to further operating improvements in the future. These growth expectations should also contribute to the group's deleveraging in the medium term.

GlaxoSmithKline (GSK)

Rating/outlook: AA/Stable

The company's pharmaceutical division's comparable sales growth of 10% in the first quarter of 2006 was comfortably ahead of the market's 6%. This was mainly due to strong growth in the metabolic, vaccines, cardiovascular, and urogenitals indications. Free cash-flow generation therefore stayed high during the first quarter.Based on the benefits of the company's strong pipeline, we expect similar trends in the coming quarters for sales and free cash-flow generation. Glaxo therefore has significant flexibility within the ratings and we expect it to stay comfortably within requirements.

Merck KGaA

Rating/outlook: BBB+/Stable

Merck's first quarter of 2006 was very good, with double-digit organic sales growth and strong cash-flow generation. We expect strong performance for the rest of the year, which is also helped by the €400 million windfall from the disposal of its Schering stake. In 2006, Merck should continue to benefit mainly from continued strong demand for liquid crystals. Although the group has good flexibility within its ratings, S&P will monitor management's future intentions after its failed Schering bid.

Novartis (NVS)Rating/outlook: AAA/Stable

Based on the continued dynamic development of its oncology and cardiovascular franchises, the company managed to sustain its above-industry-average currency-adjusted sales growth of 9% in the first quarter of 2006. Novartis' slightly underrepresented U.S. business was strengthened, with 15% sales growth in the quarter. Due to the recent cash-funded acquisitions of Hexal Eon Labs and Chiron for $13 billion, Novartis' financial flexibility within the ratings has become limited in relation to the group's expected net-cash-positive position. The company's liquidity profile is nevertheless expected to remain solid during 2006, in the absence of further acquisitions.

Novo Nordisk (NVO)

Rating/outlook: A-/Positive

The company continued to report double-digit currency-adjusted sales growth in the first quarter of 2006. It even accelerated to 18%, compared with 15% in 2005. This was mainly based on strong demand and market-share gains following the rollout of insulin analogues Levemir and NovoMix. North American sales also continued to increase by 32% due to an increased contribution from NovoSeven (a blood-clotting agent). We expect the company to maintain its conservative financial profile, despite its intended share buyback program of Danish krone 6 billion over the coming years.

Nyco HoldingsRating/outlook: B/Negative

Essentially driven by strong growth in the Commonwealth of Independent States, Nycomed posted sales growth of 14% and EBITDA growth of 9%, net of currency effects, for the first quarter of 2006. Although we expect this trend to continue in the second quarter, overall credit quality is driven by Nycomed's aggressive debt-funded growth policy, which aims at the acquisition of new in-licensing products and may require further external funding. Net debt to EBITDA (adjusted for leases, pensions, and payments in kind) is still above the financial yearend 2006 guidance of 6.5 times considered appropriate for the rating.

Roche Holding

Rating/outlook: AA+/Stable

The first quarter of 2006 showed very strong comparable group sales growth of 15% overall, including a 19% rise in the pharmaceutical division. This continues to be significantly in advance of underlying market growth. In particular, its oncology franchise benefited from strong demand for approved drugs and a promising pipeline. S&P therefore expects Roche to continue far above industry-average pharmaceuticals sales growth for the remainder of 2006, partly based on the promising new drug approvals of recent months.

Sanofi-Aventis (SNY)

Rating/outlook: AA-/Stable

The group reported relatively modest first-quarter 2006 comparable sales growth of 4.9%, compared with its competitors. This was mainly due to loss of patent protection for four drugs in the U.S. Due to higher profits and lower debt, however, financial metrics continued their improving trend in the period. Our expectation of similar trends in the coming quarters, underpinned by a strong late-stage pipeline, should contribute to a further improvement in debt protection measures to levels more consistent with the ratings (FFO to net debt of more than 60%).


Rating/outlook: BBB+/Positive

After its acquisition by Bayer, Schering continued its positive earnings trend in the first quarter of 2006, with 16% currency-adjusted sales growth. Growth was supported by all business divisions, led by the gynecology division with 21%, oncology with 20%, and specialized therapeutics with 15% sales growth. Schering's future performance has to be seen in light of its integration into Bayer.


Rating/outlook: A-/Stable

The company recorded strong 16% comparable sales growth in the first quarter of 2006, after sales increased more moderately in 2005. The acceleration in the first quarter was mainly due to the resumed sales growth of Gonal-f (an infertility treatment). Serono's main product, Rebif, a multiple sclerosis drug, continued to increase sales by 18% in the first quarter of 2006. Due to strong cash-flow generation, Serono's financial profile strengthened again, after the $725 million cash outflow for the settlement of the Serostim investigation had temporarily weakened it in 2005.

In the absence of any potential M&A activity, we expect Serono to maintain its conservative financial policy, which has enabled the company to build up substantial financial flexibility within the ratings. We note that the company had previously tried to sell itself, unsuccessfully, and has now entered into a forward strategy that we expect to be detailed over coming quarters.

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