TEXT-Fitch affirms McKesson's ratings at 'A-'
Dec 5 - Fitch Ratings has affirmed the long-term ratings, including the Issuer Default Rating (IDR), of McKesson Corporation (MCK) at 'A-'. A full list of rating actions is provided at the end of this release. The ratings apply to approximately $4.5 billion of debt outstanding as of the date of this release. The Rating Outlook is Stable. KEY RATING CONSIDERATIONS -- Steady pharmaceutical demand and the oligopolistic market position support a stable operating profile. -- The branded patent cliff is driving solid growth in MCK's appropriately low margins. Fitch forecasts EBITDA margin expansion of 7-10 basis points (bps) in MCK's fiscal 2013, though increased pricing pressure is possible over the ratings horizon. -- Fitch sees the pending acquisition of PSS World Medical Inc. (PSS World) as strategically sound and expects the deal to be financed in a manner consistent with MCK's current 'A-' ratings. -- MCK's strong market positions in specialty drug distribution, medical-surgical distribution, and healthcare IT will support intermediate-term growth and profitability. Given the lack of opportunities in pure U.S. drug distribution, Fitch expects MCK to explore growth opportunities in these areas. -- Robust cash flows and solid capital market access contribute to a strong liquidity profile. Fitch forecasts funds from operations (FFO; cash from operations before working capital) to exceed $2 billion in 2014 and 2015. GUIDELINES FOR FUTURE RATING ACTIONS Maintenance of an 'A-' IDR will required debt-to-EBITDA leverage generally below 1.4x. Continued strong and steady FFO, accompanied by expected margin expansion driven by the tailwinds propelling the industry (i.e. the generic wave and specialty pharma market growth) are also expected at current ratings. A negative rating action could result from a material debt-funded acquisition leading to sustained leverage above 1.4x. Fitch does not expect MCK to engage in M&A activity outside the company's core businesses; but a move into a non-adjacent product space or geography could also threaten the current 'A-' ratings. Debt-funded shareholder friendly activities would likely pressure ratings as well. A positive rating action is not expected over the ratings horizon. Fitch believes MCK would need to commit to and demonstrate the ability to sustain debt leverage below 0.8x to achieve an 'A' rating. Margin expansion and robust cash flows would also be required to support this rating action. STEADY PHARMA DEMAND, OLIGOPOLY PROVIDE EXCEPTIONAL STABILITY MCK and its peers in the drug distribution industry continue to exhibit exceptionally stable operations and financial performance. Despite weak macroeconomic conditions and moderately decreased utilization of healthcare overall, core business growth at MCK has remained largely in-step with or ahead of broader market growth. Organic low-single digit growth is driven by consistent demand for pharmaceuticals and is realized relatively uniformly, since the largest three drug distributors account for approximately 95% of the market. The drug distribution industry is in a position to maintain good operating stability through the ratings horizon and beyond. The industry's very slim margins make it an unlikely target for extra taxes and fees (like those imposed on the pharma and medical device sectors). Furthermore, the industry excels in adding value to the drug channel through the supply chain management and other services it offers to both its upstream and downstream customers. STRONG MARGIN EXPANSION FROM GENERIC WAVE, PRICING PRESSURE POSSIBLE MCK and its peers are benefitting from the unprecedented wave of branded drug patent expirations, especially in MCK's fiscal 2013. Most drug channel participants, including distributors, earn higher margins - though less revenues - on the sale of lower-cost generic drugs. Fitch forecasts relatively flat revenues and EBITDA margin expansion of 7-10 bps in MCK's fiscal 2013, driven primarily by generic conversions. Fitch believes much of this margin expansion is durable as several of the most-prescribed medications in the U.S. have recently been or soon will be converted to generic. Generic penetration in the U.S. is likely to remain at or above 80% for many years to come. Fitch believes margins could be pressured by additional pricing pressure within the drug channel over the next several years. Especially in light of legislated healthcare reform, it is possible that third-party payors will begin to focus more intently on profits associated with specialty and, to a lesser extent, generic drugs. Drug distributors, while not immune, are well-insulated from these types of pressures. PSS WORLD DEAL EXPECTED TO BE FINANCED CONSISTENT WITH 'A-' RATINGS Fitch expects that MCK will finance the proposed $2.1 billion acquisition of PSS World in a manner consistent with the company's 'A-' ratings. As such, it is expected that pro forma debt leverage (debt-to-EBITDA) will be at or below 1.4x within 12-18 months of the close of the acquisition. Rating flexibility may be limited in the interim. Fitch views the deal as strategically sound. Increased scale provides the company with additional negotiating power with suppliers and provides the opportunity to further leverage fixed costs. MCK and PSS World are currently two of the largest distributors of medical-surgical supplies to non-acute care providers in the U.S. The two businesses together generate more than $5 billion in annual revenues. SOLID PRESENCE IN SPECIALTY, MED-SURG, AND HIT Traditional drug distribution in the U.S. is an industry mostly consolidated and characterized by steady growth in the low-single digits. This activity accounts for roughly 80% of MCK's overall revenues. The remaining 20% comes from the company's strong 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. In general, the company approaches M&A opportunistically and responsibly. ROBUST CASH FLOWS AND SOLID LIQUIDITY MCK's stable margins and good asset management contribute to stable and strong cash generation measures. FFO for the latest 12 months (LTM) period ended Sept. 30, 2012 was a robust $2.7 billion. Free cash flow (FCF; cash from operations less dividends and capital expenditures) for the same period was muted by a negative working capital swing and large cash payouts in relation to the Average Wholesale Price (AWP) litigation, but was still nearly $1.5 billion. The company maintains a very strong liquidity profile. At Sept. 30, 2012, MCK had $2.8 billion ($1.6 billion OUS), as well as full availability of its $1.3 billion revolver due September 2016 and its $1.35 billion accounts receivable facility due May 2013. The revolver provides 100% support for the company's commercial paper program. Debt maturities are well-laddered and mature as follows: $500 million for the remainder of fiscal 2013; $350 million in 2014; $1.1 billion in 2016; $500 million in 2017; and $2 billion thereafter. MCK issued $900 million of notes in November 2012 to prefund the $500 million of notes due in March 2013 and to refinance $400 million of notes that were repaid in February 2012. Fitch expects MCK to refinance future debt maturities as they come due. Fitch has affirmed the ratings of MCK as follows: -- Long-term IDR at 'A-'; -- Short-term IDR at 'F2'; -- Unsecured bank facility rating at 'A-'; -- Unsecured notes rating at 'A-' -- Commercial paper at 'F2'. The Rating Outlook is Stable. Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings. Applicable Criteria & Related Research: --'Corporate Rating Methodology' (Aug. 8, 2012); --'Short-Term Ratings Criteria for Non-Financial Corporates' (Aug. 9, 2012); --'2013 Outlook: U.S. Healthcare - Navigating a Dynamic Operating and Regulatory Environment' (Nov. 29, 2012; --'Fitch: McKesson's Ratings Initially Unchanged by PSS World Acquisition Announcement (Oct. 25, 2012); --'Fitch Rates McKesson's Proposed Senior Unsecured Notes 'A-'; --'Navigating the Drug Channel - Drug Distributors: A Deeper Dive' (March 13, 2012). Applicable Criteria and Related Research: Corporate Rating Methodology Short-Term Ratings Criteria for Non-Financial Corporates 2013 Outlook: U.S. Healthcare -- Navigating a Dynamic Operating and Regulatory Environment Navigating the Drug Channel -- Drug Distributors: A Deeper Dive