RPT-Fitch: Walgreens deal likely positive for AmerisourceBergen; no immediate ratings impact

Tue Mar 19, 2013 9:21am EDT

March 19 (Reuters) - (The following statement was released by the rating agency) The announced long-term strategic agreement among AmerisourceBergen Corp. (ABC), Walgreen Co. (Walgreens), and Alliance Boots GmbH (Alliance Boots) is likely positive for ABC, according to Fitch Ratings. The agreement has no immediate impact on ABC's current 'A-' ratings. A complete list of ABC's ratings is provided at the end of this release. The Rating Outlook is Stable. Fitch expects ABC to remain committed to operating within its current 'A-' ratings. Maintenance of an 'A-' Issuer Default Rating (IDR) will require debt-to-EBITDA generally maintained at or below 1.2x, accompanied by strong and steady cash generation. Fitch believes ABC remains committed to maintaining its current credit ratings. ABC has ample flexibility at its current ratings, but Fitch notes that free cash flow will likely be strained near the end of ABC's fiscal 2013 due to the significant working capital ramp-up necessary to on-board the new Walgreens business. Furthermore, EBITDA margins are likely to show some compression in ABC's fiscal 2013 and 2014, as discussed below. It is unlikely that this margin compression and cash flow pressure will result in a negative rating action. ABC's long-term relationship with Walgreens and Alliance Boots includes provisions for the following: -- Increased generics purchasing scale through the addition of ABC to Walgreens' and Alliance Boots' generic purchasing joint venture; -- A 10-year exclusive contract between ABC and Walgreens for the distribution of branded, generic, and specialty pharmaceuticals in the U.S.; -- The opportunity for Walgreens to own up to 30% of ABC's outstanding stock over the next several years through a combination of possible warrant exercises and open-market share purchases. IMPROVED GENERIC PURCHASING DYNAMICS Fitch expects the greatest benefit to ABC will be derived from improved generics purchasing dynamics. ABC will join Walgreens Boots Alliance Development GmbH, which is a generic procurement joint venture created by Walgreens and Alliance Boots. The combined scale of the three entities should enable ABC to achieve improved generic pricing, translating into improved profit margins on the sale of generic drugs, particularly to its non-Walgreens customers. As it pertains to generic drug procurement, Fitch believes that the buy-side margin improvement represented by this new relationship is likely to offset any potential sell-side margin pressure over the ratings horizon. MARGIN COMPRESSION EXPECTED FROM UNIQUE DISTRIBUTION CONTRACT The nearly $30 billion of new Walgreens business will add materially to ABC's top-line and overall profits over the course of its fiscal 2014 and beyond. As the exclusive distributor of pharmaceuticals to Walgreens' U.S. retail drugstores, mail-order facilities, and specialty pharmacies, ABC will be able to leverage the fixed costs associated with drug distribution and retain certain profits related to the distribution of generic drugs to Walgreens. It is noteworthy that Walgreens, the largest retail pharmacy chain in the U.S., has decided to source generic and specialty pharmaceuticals through ABC. Each of the largest retail and mail-order pharmacies - and some mass merchandisers with pharmacy operations - currently source and distribute most generic and specialty products on their own. Though the specifics of the distribution contract are unknown, Fitch expects EBITDA margins to show some compression in ABC's fiscal 2013 and 2014. This expectation is based on the low-margin nature of distributing branded drugs to a customer as large as Walgreens, as well as to the incremental variable costs associated therewith. Nevertheless, cash flows are expected to increase materially beginning in ABC's fiscal 2014. Cash flows in fiscal 2013 will be pressured by a significantly negative working capital swing near the end of ABC's fiscal 2013 in anticipation of the new Walgreens business, which will take effect Sept. 1, 2013. Fitch acknowledges the potential for some loss of business as a result of ABC's alignment with Walgreens, especially among its other pharmacy customers. However, Fitch does not expect this risk to be materially negative to ABC's overall credit profile. FUTURE PARTNERSHIPS AND INTERNATIONAL EXPANSION ABC has voiced its interest in expanding its presence in non-U.S. markets, especially as it pertains to specialty drug distribution and manufacturer service offerings. This new relationship, coupled with ABC's market-leading position in U.S. specialty drug distribution and recent expansion in other service-oriented businesses, further empowers ABC to achieve this goal in the intermediate term through possible collaborations with Alliance Boots. ABC has a long history of demonstrated conservative financial management, and Fitch continues to expect that ABC will be responsible and measured in its international expansion ambitions. WALGREENS OWNERSHIP COULD HAVE LONGER-TERM IMPLICATIONS The new relationship will grant Walgreens the right to own as much as 30% of ABC over the next several years. Future ownership in excess of the terms announced could weigh on ABC's credit profile. However, Fitch does not view this facet of the agreement as a current credit negative and acknowledges that its specifics are likely outside the current ratings horizon. Fitch further expects that ABC will be able to finance any hedges it may enter into in conjunction with the warrants ABC has issued to Walgreens in a manner consistent with its current 'A-' ratings. Fitch currently rates ABC as follows: --Long-term Issuer Default Rating (IDR) A-'; --Short-term IDR 'F2'; --Senior unsecured bank facility rating 'A-'; --Senior unsecured notes 'A-'; --Commercial paper 'F2'. The Rating Outlook is Stable.