TEXT-Fitch affirms Cardinal Health at 'BBB+' on AssuraMed acquisition announcement

Thu Feb 14, 2013 9:34am EST

Feb 14 - Fitch Ratings has affirmed the ratings of Cardinal Health, Inc. (Cardinal), including the long-term Issuer Default Rating (IDR) at 'BBB+', following the announcement of the company's acquisition of AssuraMed. The Rating Outlook is Stable.

A full list of Cardinal's ratings is provided at the end of this release. The ratings apply to approximately $2.9 billion of debt at Dec. 31, 2012.

KEY RATING DRIVERS

-- Planned funding for proposed acquisition is appropriate for Cardinal's 'BBB+' rating;

-- Addition of AssuraMed is strategically sound, and Fitch expects the acquisition to bolster Cardinal's intermediate-term growth outlook;

-- Steady pharmaceutical demand and oligopolistic market position support stable operating profile, profit margins, and core cash flows;

-- Profitability improvements due to branded-to-generic conversions have been robust, with another sizeable round of generic conversions expected in calendar 2014;

-- Liquidity is solid and cash flows are strong.

INCREASED DEBT LOAD APPROPRIATE FOR 'BBB+' RATINGS

Planned funding for the approximately $2.07 billion deal will be provided by $1.3 billion of new debt and approximately $770 million of cash on hand. Fitch expects pro forma debt leverage (total debt-to-EBITDA), based on Dec. 31, 2012 figures, to approach 1.7 times (x). This figure represents the upper end of the range Fitch deems appropriate for Cardinal's 'BBB+' ratings. Subsequent deleveraging will be the result of EBITDA growth, driven primarily by generic conversions and growth in the higher-margin AssuraMed business, and the repayment of $300 million of debt due in June 2013.

Steady pharmaceutical demand and the oligopolistic nature of the healthcare distribution industry contribute to exceptionally stable operating profiles for Cardinal and its peers. Cardinal's profit margins have grown significantly in recent years, owing primarily to an unprecedented wave of generic conversions and improved customer mix. Fitch forecasts EBITDA margin expansion of approximately 30 basis points (bps) in Cardinal's fiscal 2013, mostly due to the loss of the lower-margin Express Scripts contract effective Oct. 1, 2012. Material margin expansion will also result from another round of generic conversions in calendar 2014 and 2015.

STRATEGICALLY SOUND, INTERMEDIATE-TERM GROWTH DRIVER

AssuraMed is a leading provider of medical-surgical distribution services to home health customers. As such, the proposed deal allows Cardinal to gain immediate and significant exposure to the fast-growing home healthcare industry, which it currently lacks. The addition of AssuraMed could also aid Cardinal's efforts to increase its exposure to other types of healthcare delivery (e.g. physician offices and other post-acute care) that require the delivery of smaller medical-surgical product units.

Fitch expects the AssuraMed business to continue to benefit from the rapid growth of the home healthcare industry attributable to the aging U.S. population and to payors' search for less costly methods of healthcare delivery. This view is further supported by AssuraMed's relative scale, which will become even more significant as a business unit of Cardinal. Significant synergies are expected due to product portfolio overlap, Cardinal's stronger negotiating stance with suppliers, and the ability to consolidate certain logistic, delivery, and other functions.

Fitch has noted its concern regarding Cardinal's lagging position in U.S. specialty pharmaceutical distribution and the resulting lack of a sufficient intermediate-term growth driver. Despite recently reported strong growth in Cardinal's specialty distribution business, Fitch estimates that Cardinal still holds less than 5% of the specialty distribution market in the U.S., compared to approximately 55% and 25% by AmerisourceBergen Corp. and McKesson Corp., respectively. Though not fully alleviating this concern, the proposed acquisition of AssuraMed could represent a material driver of profits growth in the intermediate term.

STRONG CASH FLOWS, SOLID LIQUIDITY

Fitch expects strong funds from operations and free cash flow of approximately $1.5 billion and $400 million, respectively, in fiscal 2013. Fitch notes that cash flows will be somewhat depressed by a negative working capital impact from the Express Scripts contract loss and from certain tax settlements in fiscal 2013.

Fitch expects Cardinal to maintain a solid liquidity profile subsequent to the transaction. Liquidity at Dec. 31, 2012 was provided by $2.26 billion of cash on hand and an undrawn $1.5 billion unsecured revolver due 2016. Cardinal also maintains a $950 million accounts receivable securitization facility due 2014. Long-term debt maturities are as follows: $300 million in fiscal 2013, $500 million in 2015, $787 million in 2017, and $1.07 billion thereafter.

RATING SENSITIVITIES

The increased debt load resulting from the proposed transaction will limit Cardinal's flexibility at its current 'BBB+' ratings. Maintenance of a 'BBB+' IDR will require debt leverage generally maintained between 1.2x and 1.7x, accompanied by continued robust cash flows and stable or growing margins over the ratings horizon.

An upgrade to 'A-' will require the company to demonstrate a commitment to operating with debt leverage below 1.2x-1.3x, combined with evidence of the successful integration of AssuraMed and an overall improved intermediate-term growth outlook. A sustained commitment to Cardinal's core U.S. drug distribution business, especially in light of several recently added areas of growth, will also be necessary to support the consideration of an upgrade.

A downgrade to 'BBB' could result from an additional leveraging transaction that pushes debt leverage to above 1.7x for more than 12-18 months. Debt-funded shareholder-friendly activities could also precipitate a negative rating action. Evidence or anticipation of material pricing pressure greater and more direct than currently expected would also pressure ratings.

Fitch has affirmed Cardinal's ratings as follows:

-- Long-term IDR at 'BBB+';

-- Short-term IDR at 'F2';

-- Senior unsecured bank facility rating at 'BBB+';

-- Senior unsecured notes ratings at 'BBB+';

-- Commercial paper rating at 'F2'.

The Rating Outlook is Stable.