TEXT-S&P ups Merck to 'A-'; affirms 'A-2' rtg; outlook stable
Nov 30 -
-- Germany-based pharmaceuticals, life science technology, and specialty chemicals producer Merck KGaA continues to generate strong cash flow and reduce its debt.
-- Consequently, Merck's debt protection metrics continue to improve and are now commensurate with a "modest" financial risk profile.
-- We are therefore raising our long-term corporate credit and issue ratings on Merck to 'A-' from 'BBB+' and affirming our short-term corporate credit rating on the group at 'A-2'.
-- The stable outlook reflects our view that Merck will continue to use strong cash flow to reduce its debt, while continuing to adhere to a conservative financial policy.
On Nov. 30, 2012, Standard & Poor's Ratings Services raised to 'A-' from 'BBB+' its long-term corporate credit and issue ratings on Germany-based pharmaceuticals, life science technology, and specialty chemicals producer Merck KGaA. At the same time, we affirmed our 'A-2' short-term corporate credit rating on Merck. The outlook is stable.
The upgrade reflects our view that Merck's credit metrics have improved such that they are now compatible with what we assess as a "modest" financial risk profile and therefore with higher ratings. The improvement reflects the group's continuously strong free cash flow generation and debt reduction since its debt-financed acquisition of life sciences company Millipore Corp. (not rated) in March 2010. We anticipate that Merck's significant free operating cash flow is likely to continue to increase gradually over the next few years, in line with increasing sales and profit margins on the back of the group's efficiency plan.
We estimate that Merck will achieve Standard & Poor's-adjusted funds from operations (FFO) to debt of about 55% in 2012, and assuming that management remains committed to its conservative financial policy, this ratio should improve further in 2013 and 2014. Merck's financial policy, and especially the stance it takes on transformative acquisitions, will be the main rating drivers.
We believe that Merck will be able to achieve at least broadly stable revenues over the next few years. This estimate factors in our assumptions of stable demand for Merck's liquid crystals, despite increasing competition to some of the group's older liquid crystal technologies; as well as low-single-digit organic growth in revenues from Merck Millipore. We assume that sales at Merck's pharmaceuticals subsidiary Merck Serono in 2013 and 2014 will remain broadly flat. Despite new products coming to the market, revenues from the sale of Merck Serono's largest drug, Rebif, which is used to treat multiple sclerosis, will decline only slightly thanks to its good efficacy profile. Rebif loses its patent in 2015 but, because it is a biological drug, manufacturing difficulties should keep it relatively protected from generic competition. After 2014, the development of Rebif sales will depend on the number and uptake of new oral multiple sclerosis drugs on the market.
Following Merck's May 2012 announcement of a restructuring efficiency plan, we anticipate that the group's adjusted EBITDA (including restructuring charges) will be about EUR2.5 billion in 2012, improving significantly within the next two years as Merck realizes the cost savings that the plan envisages. We foresee Merck adhering to a conservative financial policy over this period, with no sizable debt-financed acquisitions.
The ratings on Merck continue to reflect our view of the group's "strong" business risk profile, arising from its sizable presence in prescription pharmaceuticals and market-leading liquid crystals and pigments and cosmetics businesses.
The short-term rating is 'A-2'. It is supported by Merck's liquidity profile, which we assess as "strong" under our criteria. (For more information on our criteria, see "Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers," published Sept. 28, 2011, on RatingsDirect on the Global Credit Portal).
We base our liquidity assessment on the following factors:
-- Merck's current liquidity sources comfortably cover its short-term debt maturities. On Sept. 30, 2012, the group's balance-sheet cash position amounted to about EUR1.5 billion and it had near-cash investments of about EUR1.44 billion. On the same date, short-term debt due in the next 12 months was about EUR1.7 billion.
-- Merck has an undrawn, centrally available, committed credit facility of EUR2 billion expiring in 2014. This facility does not contain any financial covenants and can also be used as a backup for the group's EUR2 billion commercial paper program.
-- We anticipate that Merck should be able to generate at least about EUR1.5 billion in cash from operations per year over the next three years, comfortably covering capital expenditures of about EUR400 million-EUR500 million and dividends of about EUR300 million per year (including profits that Merck transfers to its majority shareholder E. Merck KG).
-- We estimate that Merck's liquidity sources (including cash, funds from operations, and credit facility availability) over the next 12-18 months should exceed its uses by more than 2.5x. Even if EBITDA declined by 50%, we believe that net sources would cover cash requirements by at least 1.5x.
-- Merck's debt maturities are well spread; EUR500 million notes due in December 2012 and EUR750 million bonds expire in 2013. Merck has good relationships with its banks, in our opinion. It also has a good standing in the credit markets, having successfully issued debt during the global recession of 2008-2009.
-- To finance the Millipore acquisition, Merck issued two EUR1.35 billion bonds maturing in 2015 and 2020, and a EUR500 million bond that it repaid in 2012. Merck issued the bonds under a EUR10 billion debt-issuance program. As part of the acquisition, Merck guarantees Millipore's outstanding EUR250 million notes due in 2016.
The stable outlook reflects our view that Merck will continue to use its strong cash flow to reduce its debt, while adhering to a conservative financial policy with no sizable debt-financed acquisitions. We base our view on Merck's sound market positions, presence in industries that have strong demand from emerging markets, and favorable medium-term outlooks for the pharmaceuticals and chemicals industries. We believe these factors will enable the group to maintain at least stable revenues and generate sizable free cash flows over the next three years. We consider adjusted FFO to debt of at least 40% and above to be consistent with the current ratings.
We would consider taking a positive rating action if Merck were to consistently maintain adjusted FFO to debt of much more than 55% and demonstrate a commitment to sustaining a financial policy commensurate with a higher rating.
We could take a negative rating action if Merck were unable to maintain FFO to debt of more than 40% on a sustainable basis. This could stem from either declining profitability--if management fails to restructure the business and deliver the cost savings it envisages through the efficiency plan--or from a sizable debt-funded acquisition. That said, we do not anticipate any such acquisition in the near term.
Related Criteria And Research
All articles listed below are available on RatingsDirect on the Global Credit Portal.
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Principles Of Credit Ratings, Feb. 16, 2011
-- Key Credit Factors: Business And Financial Risks In The Global Pharmaceutical Industry, Jan. 22, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
Upgraded; CreditWatch/Outlook Action; Ratings Affirmed
Corporate Credit Rating A-/Stable/A-2 BBB+/Positive/A-2
Merck Financial Services GmbH
Senior Unsecured* A- BBB+
Merck Finanz AG
Senior Unsecured* A- BBB+
Senior Unsecured* A- BBB+
*Guaranteed by Merck KGaA.