Feb 12 (The following statement was released by the rating agency)
Fitch Ratings has affirmed the ratings of Cardinal
Health, Inc. (Cardinal), including the long-term Issuer Default Rating (IDR), at
'BBB+'. The Rating Outlook is Stable.
The ratings apply to approximately $3.9 billion of debt at Dec. 31, 2013. A full
list of rating actions follows at the end of this release.
KEY RATING DRIVERS
-- The oligopolistic nature of the U.S. drug distribution industry and steady
pharmaceutical demand contribute to exceptionally stable operating profiles for
Cardinal and its peers, excluding recent contract switches. Drug distribution,
though low margin, is relatively insulated from pricing and regulatory pressures
faced by other areas of healthcare in the U.S.
-- Margins and cash flows continue to benefit from the mostly durable effects of
the generic wave, which is set to ramp up again in calendar 2014-2015.
Cardinal's joint venture (JV) with CVS Caremark Corp. (CVS) and the anticipated
introduction of biosimilar drugs to the U.S. drug channel should further support
margins beginning in 2015-2016.
-- Overall industry trends, including brand-to-generic conversions, favorable
drug pricing, and base business growth, are offsetting the Fitch-estimated $230
million of lost EBITDA from expired contracts with Express Scripts, Inc. (ESRX)
and Walgreen Co. (Walgreens). Fitch projects modestly higher EBITDA in fiscal
2014 and 2015 compared to 2013, despite the loss of about $30 billion in annual
-- Cardinal's material underrepresentation in the specialty drug distribution
space relative to its peers could hinder intermediate-term growth and
profitability. The acquisition of AssuraMed and Cardinal's plans for growing its
Medical business present compelling growth opportunities and could offset this
concern somewhat, but could also introduce new forms of operating risk (e.g.
product liability) depending on the strategies pursued.
-- Fitch expects Cardinal to generate cash sufficient to fund operations,
shareholder payouts, targeted M&A, and debt service. Solid liquidity is
supported by relatively large available cash balances, and only $500 million of
debt is due before October 2016.
Maintenance of a 'BBB+' IDR will require debt leverage generally maintained
below 1.7x, accompanied by continued robust cash flows and stable or growing
margins over the ratings horizon (excluding the impact of the lost Walgreens
contract). Liquidity should be adequate to fund targeted M&A that bolsters the
firm's intermediate-term growth outlook; but there is currently limited room for
additional long-term debt at the 'BBB+' ratings.
An upgrade to 'A-' is not anticipated in the intermediate term. Upward ratings
migration could result from a demonstration of and commitment to operating with
debt leverage below 1.2x-1.3x, combined with responsible M&A activity that
contributes to an overall improved intermediate-term growth outlook. A sustained
commitment to Cardinal's core distribution business will also be necessary to
support the consideration of an upgrade.
A downgrade to 'BBB' could result from a leveraging transaction that causes debt
leverage to increase to above 1.7x for materially more than 12-18 months.
Debt-funded shareholder-friendly activities could also precipitate a negative
rating action. The development of a material competitive gap between Cardinal
and its peers, possibly arising from the firm's lagging position in specialty
distribution, could also pressure ratings.
MODESTLY GROWING EBITDA DESPITE SIGNIFICANT CONTRACT LOSSES
The Fitch-estimated $200 million-$250 million in EBITDA associated with the lost
Walgreen Co. (Walgreens) and Express Scripts, Inc. (ESRX) contracts is being
offset by the effects of generic conversions, favorable drug pricing, and the
addition of AssuraMed. Another wave of generic conversions is now accelerating
and will support margins over the next couple years. Fitch forecasts modestly
growing EBITDA and relatively steady credit metrics for Cardinal in fiscal
2014-2015 compared to 2013. Notably, Cardinal's peers are experiencing similar
margin support from industry trends without significant volume declines.
Despite the very low-margin nature of the aforementioned contracts and the now
decreased customer concentration, the removal of such a large amount of drug
volumes is a moderate credit negative. Cardinal will no longer benefit from the
operating stability and superior growth prospects generally associated with
these drug channel participants. Furthermore, the removal of such a large amount
of volumes will lessen Cardinal's ability to leverage the largely fixed cost
structure inherent in drug distribution.
Fitch believes Cardinal has adjusted appropriately thus far and will continue to
review and optimize its cost structure as it annualizes the Walgreens contract
expiration so as to limit the credit impact of these developments.
INTERMEDIATE-TERM GROWTH CONCERNS; OFFSET SOMEWHAT BY MEDICAL STRATEGY
Fitch remains concerned about Cardinal's intermediate-term growth profile,
primarily due to the company's significant under-representation in specialty
drug distribution. Cardinal's lagging position in this important growth market
could become more glaring after the bulk of the generic wave has washed through
the channel and biosimilars begin to gain market acceptance in 2016 and beyond.
Fitch is not convinced that Cardinal's current strategy will take a significant
share of the specialty distribution market over the ratings horizon.
Fitch estimates AmerisourceBergen Corp. (ABC), McKesson Corp. (McKesson),
and Cardinal control approximately 55%, 25%, and 5% of the specialty drug
distribution (primarily to care providers) market in the U.S., respectively.
Cardinal's 2013 acquisition of AssuraMed does provide a profitable growth
platform for the firm; but it does not fully address Fitch's concerns.
Especially since losing its contract with Walgreens, Cardinal has focused more
of its public comments on its strategy to grow its Medical business. Fitch
generally views this shift in strategy as appropriate and expects both internal
and external investment to support solid Medical segment growth over time.
On balance, Fitch thinks Cardinal will pursue these opportunities responsibly
and that most transactions will be funded with cash on hand. Success in this
area could alleviate Fitch's intermediate-term growth concerns over time. Fitch
views certain tenets of Cardinal's outlined strategy for growing its Medical
segment cautiously though, depending on the pacing thereof. Specifically, Fitch
is wary of new types of business risk that could accompany potential acquisition
targets (i.e. product liability with manufacturing).
JV WITH CVS TO DRIVE COST SAVINGS; DIFFERENTIATED FROM PEERS
The 10-year joint venture Cardinal announced with CVS Caremark Corp. (CVS) in
December 2013 should provide both firms with cost savings, ramping up over the
course of calendar 2015 and beyond. Cardinal also disclosed that it had extended
its distribution contract with CVS through 2019. Fitch thinks future
collaborative agreements between the two firms are possible, though the current
relationship is strictly for the procurement of generic drugs, excluding
injectables. Notably, CVS' Caremark PBM business is served under a contract with
McKesson that was just renewed in April 2013.
The CVS/Cardinal JV will become the largest purchaser of generic drugs in the
U.S., and the second-largest in the world. The JV is similar in principle to the
other scale-aggregating deals executed over the last 12 months, though it lacks
the equity ownership components of the other two. Fitch expects the benefits of
increased scale to be recognized more or less in proportion to the purchasing
power of each entity over the course of the next few years. The longer-term
implications of the various degrees of business integration are at this time
difficult to measure and predict.
GOOD LIQUIDITY, CASH FLOWS; MANAGEABLE DEBT MATURITIES
Fitch expects Cardinal's liquidity to remain strong over the ratings horizon,
bolstered in the near term by a significant cash inflow from working capital
associated with the expired WAG contract. Cash flows will remain robust, with
annual free cash flow (FCF) forecasted to exceed $1 billion in the forecast
period. Fitch thinks the firm will generate sufficient cash to sufficiently fund
operations and internal investment, to fulfill its public commitment to
shareholder payouts, and to consummate small-to-medium sized M&A that
strengthens intermediate-term growth prospects.
Debt maturities are manageable, with only $500 million of debt coming due before
October 2016. Fitch estimates debt maturities as follows: $500 million in fiscal
2015; $770 million in 2017; $560 million in 2018; and $1.78 billion thereafter.
Fitch expects debt to be refinanced as it comes due over the ratings horizon.
Fitch has affirmed Cardinal's ratings as follows:
-- Long-term IDR at 'BBB+';
-- Senior unsecured bank facility at 'BBB+';
-- Senior unsecured notes at 'BBB+';
-- Short-term IDR at 'F2';
-- Commercial paper at 'F2'.
Fitch has also assigned a long-term IDR of 'BBB+' to Allegiance Corp., an issuer
subsidiary of Cardinal.
The Rating Outlook is Stable.