Jan 30 (The following statement was released by the rating agency)
Fitch Ratings has affirmed Germany-based pharmaceuticals wholesaler Phoenix Pharmahandel GmbH & Co. KG's (Phoenix) Long-term Issuer Default Rating (IDR) and senior unsecured rating at 'BB'. It has also affirmed the EUR506m bond due 2014 issued by Phoenix PIB Finance BV and the EUR300m bond due 2020 issued by Phoenix PIB Dutch Finance BV at aBBa. The Outlook is Stable.
The affirmation reflects Phoenixas resilient credit metrics despite an intense competitive environment, its ability to gain back market share in its core market and the companyas commitment to a prudent financial policy. Fitch expects Phoenixas free cash flow (FCF) to remain positive and net leverage to remain consistent with its ratings, in spite of margin pressure. Fitch projects that net adjusted (lease and ABS/factoring) debt/EBITDAR will in FY14 increase to the threshold for negative rating trigger, from 3.74x in FY13, before falling back to 3.5x in FY16.
KEY RATING DRIVERS
Sector Pressures, Bottoming Out
Phoenix, like all of its sector peers, operates with fairly low profitability compared with pharmaceuticals producers (in FY13 Phoenixas EBITDAR margin was 3.2%). In 2013 the German wholesale market (where Phoenix generates around 31% of revenue) faced intense price pressure due to price wars. As a result Fitch projects EBITDAR margin will decline by 50bps to 2.7% in FY14. We believe that the price war in Germany is unsustainable given the low margins in the sector and therefore do not expect to see any further significant decline in Phoenixas profitability.
Recovering Market Share
In FY14 Phoenix was able to win back the market share that it previously lost to competitors at the expense of EBITDAR margins. For the next two years, we project that the companyas market share in Germany will remain stable. We do not, however, expect any material improvement in profitability despite the implementation of cost-saving initiatives. This is because the company will be focused on retaining its current market share amid challenging competition, particularly in light of the announced merger between Celesio and US-based McKesson (A-/RWN).
Deleveraging Slows in FY14
Overall net adjusted (lease and ABS/factoring) debt /EBITDAR decreased to 3.7x in FY13 from 4.3x in FY11. Fitch expects this ratio to deteriorate to slightly above 4x in FY14 due to an estimated 18% drop in EBITDAR, before falling to 3.5x in FY16. The reduction in leverage will be driven by expected positive free cash flow and further declines in net debt.
Phoenix Forward Programme
The Phoenix Forward Programme will support EBITDAR margins over the next three years. Phoenix estimates that the programme will provide sustainable savings of at least EUR100m till FY16. The programme focuses on improving efficiencies, including bundling of administrative functions to increase operational focus and refinement of warehouse efficiency which we believe is a sensible approach. However, Fitch expects some of these cost savings to be reinvested to maintain competitive pricing.
Wholesale Pharmaceuticals Leader
Phoenix is one of the largest European players in the pharmaceuticals wholesale market. The rating reflects its geographical diversification, which helps strengthen its market position with pharmaceutical manufacturers and makes it fairly resilient to healthcare policy changes in single countries.
Integrated Business Model
Phoenixas leading position in the European wholesale market is complemented by retail and supplier service activities. Phoenix owns pharmacies in most countries it operates in and where multiple pharmacy ownership is possible such as the UK. Integrating supplier services and retail activities has enabled Phoenix to achieve synergies and to fully capture the available margin between pharmaceutical manufacturers and end-customers. We expect retail margins to remain stable for the next four years.
Resilient Positive Free Cash Flow
Despite the expected reduction in profitability in FY14 Fitch expects continuing positive free cash flow (FCF), although it may be tempered in the near term due to investments in working capital to support sales growth initiatives. Fitch expects EBITDAR to FCF conversion to average 30% by January 2017. Although this is lower than the average 54% over the past three years, it should translate into annual positive FCF of EUR150m which is comfortable in relation to its future debt maturities.
Pressure for Pharmacy Acquisitions; No Dividends
As its competitors are acquiring pharmacies, Phoenix could be at risk of losing customers, particularly if pharmacy markets in Europe liberalise. Therefore our forecasts assume some annual acquisition spending on retail pharmacies, but only with a small budget of EUR20m, reflecting managementas commitment to limited M&A activity. The adverse credit impact arising from acquisitions is balanced by Phoenixas commitment to maintain a conservative financial policy with no plans for dividends.
Average Recoveries for Bondholders
Fitch rates Phoenixas bonds at the same level as the IDR, reflecting limited subordination from the groupas prior-ranking on-balance sheet ABS and factoring lines and Italian credit lines that together represented EUR473m at end-FY13. Prior-ranking debt/EBITDA was at 0.8x in FY13 and is expected by Fitch to remain below 1.5x in FY14. This is well below the 2x threshold that Fitch typically applies under its generic recovery approach to assess subordination issues for unsecured bondholders who are protected by guarantees from material subsidiaries representing at least 75% of the groupas consolidated revenues and EBITDA.
Positive: Future developments that could lead to the positive rating action include:
-Stabilisation in operating performance and conservative financial policy driving net (lease, factoring and ABS) adjusted debt / EBITDAR to below 3x (FY13: 3.7x). This would be equivalent to FFO adjusted net leverage below 3.5x (FY13: 3.7x)
-Operating EBITDAR net fixed charge cover above 3.5x (FY13: 2.9x) on a sustained basis. This would be equivalent to FFO fixed charge coverage above 3x (FY13: 2.7x)
-FCF/EBITDAR sustainably above 40% (FY13: 47%)
-Slowing competitive pressure in Phoenixas major markets
Negative: Future developments that could lead to a negative rating action include:
-Net (lease, factoring and ABS) adjusted debt / EBITDAR above 4x (equivalent to FFO adjusted net leverage above 4.5x)
-Operating EBITDAR net fixed charge cover below 3x on a sustained basis (equivalent to FFO fixed charge coverage below 2.2x)
-FCF/EBITDAR falling below 25% on a sustained basis
LIQUIDITY AND DEBT STRUCTURE
The group has a diversified financial structure and adequate internal liquidity following its EUR300m bond issue in May 2013 and the refinancing of its Italian credit lines with a new EUR400m revolving credit facility that will slightly improve the companyas debt maturity profile. At end-9MFY14 Phoenix had headroom of around EUR2bn under its committed facilities and a cash position of EUR334m, which was more than enough to cover its short-term financial liabilities of EUR1,324m (including a EUR506m bond due in July 2014). In September and November 2013 the group paid back its EUR300m term loan (due in 2016) in full from existing cash.