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July 24 (The following statement was released by the rating agency)
Fitch Ratings has assigned Phoenix PIB Dutch Finance B.V's planned seven-year issue of fixed-rate senior notes an expected senior unsecured rating of 'BB(EXP)'. The final rating of the bonds is contingent upon the receipt of final documents conforming to the information already received by Fitch.
The fixed-rate senior notes will be unconditionally and irrevocably guaranteed by ultimate parent and Germany-based pharmaceuticals wholesaler Phoenix Pharmahandel GMBH & Co KG (Phoenix; BB/Stable), in addition to a subsidiary guarantee network capturing at least 70% of turnover and EBITDA. The structure is identical to the EUR300m 2013 bond issue, ranking equally with bank debt. The new issue will provide additional flexibility for general corporate purposes and help complete the refinancing of the EUR506m bond repaid in July 2014 (which was partly prefunded by the EUR300m 2013 issue) thus reducing drawings under the revolving credit facility.
A successful issue of the notes, in addition to the recently agreed amendments to its bank loans, will establish a solid long-term capital structure for the group going forward, improving liquidity and associated funding costs.
KEY RATING DRIVERS FOR UNSECURED CREDITORS
Fitch rates Phoenix's bonds and bank debt (which both rank pari passu) at the same level as the Issuer Default Rating (IDR) of 'BB', reflecting only limited subordination from the group's prior ranking on-balance sheet ABS, factoring lines and Italian credit lines representing EUR522m at the financial year ended January 2014.
Prior ranking debt to EBITDA in FY14 was 1.2x (up from 1.0x in prior year given the group's reduced profitability) and the agency expects this to remain around 1.5x, which is comfortably below the 2.0x-2.5x threshold that Fitch typically applies in its recovery analysis to assess subordination issues for unsecured bond holders. In addition, subordination is also mitigated by the upstream guarantee network capturing a minimum 70% of turnover and EBITDA.
KEY RATING DRIVERS FOR IDR
Sector Pressures and Competitive Environment
Phoenix, as with wholesale sector peers, operates with structurally limited profitability compared with pharmaceuticals manufacturers, as it is subject to intense competitive and regulatory pressures.
Phoenix's profitability in its home market, Germany, remains under significant pressure following intense and unsustainable price competition triggered by regulatory change in FY13, which cost Phoenix a loss of market share. In FY14, Phoenix focussed on regaining its market share to 28%, with the aim of translating it into improved profitability.
Near-term Pressure on Profitability & FCF Generation
Weaker profitability in Q1FY15 due to competitive pressures, together with planned investment in working capital to support growing sales and working capital efficiencies, should result in negative FCF in FY15.
Elevated Leverage Reduces Flexibility
The tough trading environment translates into elevated debt protection ratios, leading Fitch to forecast FFO adjusted net leverage peaking at 4.8x in FY15 (FY14: 4.3x), removing headroom under the current rating (Fitch applied a EUR125 adjustment for restricted cash and intra-year working capital swings as per its criteria).
The Stable Outlook, however, assumes that this trend will reverse over the next 12-18 months as sector pressures bottom out and Phoenix will use its regained market share to gradually rebuild profitability. Fitch expects that FFO-adjusted net leverage will return to 4.5x in FY16, a level more commensurate with the 'BB' rating, in line with management's commitment towards an improving financial profile. Failure to repair profitability in its home market and continued weak FCF generation would, however, put prolonged pressure on the credit metrics and the ratings.
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 per annum from 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 and hence we assume only a modest increase of EBITDAR margin post FY16 to peak at 2.9% (which is, however, also dependent on the wider pricing environment). This is reflected in our current Stable Outlook.
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 countries. The pharmaceutical wholesale sector is, however, subject to comprehensive regulation, affecting major aspects of the underlying business model, especially the distribution chain, reimbursement and pricing levels, including margin structures of pharmaceutical distribution and related services. Regulatory intervention recognises pharmaceutical distribution as a key healthcare cost in national systems.
Integrated Business Model
Phoenix's 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.
Continued Expansion in Retail Markets
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 for a small budget of around EUR50m, reflecting management's commitment to limited M&A activity. The adverse credit impact arising from acquisitions is balanced by Phoenix's commitment to maintain a conservative financial policy with no plans for dividends.
LIQUIDITY AND DEBT STRUCTURE
Phoenix has a diversified financial structure, maturity profile and adequate internal liquidity following the issue of EUR300m bond in July 2013 and the extension of the EUR1,050m RCF to 2019 from 2017. The proceeds from the new bond would be used to repay the amount drawn under the RCF and for general corporate purposes.
At end-FY14 Phoenix had headroom of around EUR1.5bn under its committed facilities and a cash position of EUR370m (this reflects also the EUR125m of not readily available cash, comprising EUR25m of restricted cash and EUR100m for intra-year working capital swings) which is more than sufficient to cover short-term financial liabilities of EUR1,249m including the EUR506m bond due and repaid in July 2014.
Negative: Future developments that could lead to a negative rating action include:
-Net (lease, factoring and ABS) adjusted FFO adjusted net leverage above 4.5x on a sustained basis (FY14: 4.2x)
-FFO fixed charge coverage below 2.2x (FY14: 2.4x)
-FCF/EBITDAR falling below 25% on a sustained basis (FY14: 30%)
-Continued and/or increasing competitive pressures in key geographies slowing or eroding expected profitability recovery
Positive: Future developments that could lead to a positive rating action include:
-Stabilisation of operating performance and conservative financial policy driving FFO-adjusted net leverage to below 3.5x
-FFO fixed charge coverage above 3x
-FCF/EBITDAR sustainably above 40%
-Slowing competitive pressure in Phoenix's major markets and sustainable recovery of the group-wide profitability
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