Dec 5 - Fitch Ratings has affirmed the long-term ratings, including the
Issuer Default Rating (IDR), of McKesson Corporation (MCK) at 'A-'. A
full list of rating actions is provided at the end of this release.
The ratings apply to approximately $4.5 billion of debt outstanding as of the
date of this release. The Rating Outlook is Stable.
KEY RATING CONSIDERATIONS
-- Steady pharmaceutical demand and the oligopolistic market position support a
stable operating profile.
-- The branded patent cliff is driving solid growth in MCK's appropriately low
margins. Fitch forecasts EBITDA margin expansion of 7-10 basis points (bps) in
MCK's fiscal 2013, though increased pricing pressure is possible over the
-- Fitch sees the pending acquisition of PSS World Medical Inc. (PSS World) as
strategically sound and expects the deal to be financed in a manner consistent
with MCK's current 'A-' ratings.
-- MCK's strong market positions in specialty drug distribution,
medical-surgical distribution, and healthcare IT will support intermediate-term
growth and profitability. Given the lack of opportunities in pure U.S. drug
distribution, Fitch expects MCK to explore growth opportunities in these areas.
-- Robust cash flows and solid capital market access contribute to a strong
liquidity profile. Fitch forecasts funds from operations (FFO; cash from
operations before working capital) to exceed $2 billion in 2014 and 2015.
GUIDELINES FOR FUTURE RATING ACTIONS
Maintenance of an 'A-' IDR will required debt-to-EBITDA leverage generally below
1.4x. Continued strong and steady FFO, accompanied by expected margin expansion
driven by the tailwinds propelling the industry (i.e. the generic wave and
specialty pharma market growth) are also expected at current ratings.
A negative rating action could result from a material debt-funded acquisition
leading to sustained leverage above 1.4x. Fitch does not expect MCK to engage in
M&A activity outside the company's core businesses; but a move into a
non-adjacent product space or geography could also threaten the current 'A-'
ratings. Debt-funded shareholder friendly activities would likely pressure
ratings as well.
A positive rating action is not expected over the ratings horizon. Fitch
believes MCK would need to commit to and demonstrate the ability to sustain debt
leverage below 0.8x to achieve an 'A' rating. Margin expansion and robust cash
flows would also be required to support this rating action.
STEADY PHARMA DEMAND, OLIGOPOLY PROVIDE EXCEPTIONAL STABILITY
MCK and its peers in the drug distribution industry continue to exhibit
exceptionally stable operations and financial performance. Despite weak
macroeconomic conditions and moderately decreased utilization of healthcare
overall, core business growth at MCK has remained largely in-step with or ahead
of broader market growth. Organic low-single digit growth is driven by
consistent demand for pharmaceuticals and is realized relatively uniformly,
since the largest three drug distributors account for approximately 95% of the
The drug distribution industry is in a position to maintain good operating
stability through the ratings horizon and beyond. The industry's very slim
margins make it an unlikely target for extra taxes and fees (like those imposed
on the pharma and medical device sectors). Furthermore, the industry excels in
adding value to the drug channel through the supply chain management and other
services it offers to both its upstream and downstream customers.
STRONG MARGIN EXPANSION FROM GENERIC WAVE, PRICING PRESSURE POSSIBLE
MCK and its peers are benefitting from the unprecedented wave of branded drug
patent expirations, especially in MCK's fiscal 2013. Most drug channel
participants, including distributors, earn higher margins - though less revenues
- on the sale of lower-cost generic drugs. Fitch forecasts relatively flat
revenues and EBITDA margin expansion of 7-10 bps in MCK's fiscal 2013, driven
primarily by generic conversions. Fitch believes much of this margin expansion
is durable as several of the most-prescribed medications in the U.S. have
recently been or soon will be converted to generic. Generic penetration in the
U.S. is likely to remain at or above 80% for many years to come.
Fitch believes margins could be pressured by additional pricing pressure within
the drug channel over the next several years. Especially in light of legislated
healthcare reform, it is possible that third-party payors will begin to focus
more intently on profits associated with specialty and, to a lesser extent,
generic drugs. Drug distributors, while not immune, are well-insulated from
these types of pressures.
PSS WORLD DEAL EXPECTED TO BE FINANCED CONSISTENT WITH 'A-' RATINGS
Fitch expects that MCK will finance the proposed $2.1 billion acquisition of PSS
World in a manner consistent with the company's 'A-' ratings. As such, it is
expected that pro forma debt leverage (debt-to-EBITDA) will be at or below 1.4x
within 12-18 months of the close of the acquisition. Rating flexibility may be
limited in the interim.
Fitch views the deal as strategically sound. Increased scale provides the
company with additional negotiating power with suppliers and provides the
opportunity to further leverage fixed costs. MCK and PSS World are currently two
of the largest distributors of medical-surgical supplies to non-acute care
providers in the U.S. The two businesses together generate more than $5 billion
in annual revenues.
SOLID PRESENCE IN SPECIALTY, MED-SURG, AND HIT
Traditional drug distribution in the U.S. is an industry mostly consolidated and
characterized by steady growth in the low-single digits. This activity accounts
for roughly 80% of MCK's overall revenues. The remaining 20% comes from the
company's strong market positions in the distribution of specialty
pharmaceuticals and of med-surg supplies, and in healthcare information
technology (HIT). MCK is one of only a handful of companies with a significant
share of these relatively fragmented markets.
As a result, Fitch believes MCK is uniquely positioned to benefit from growth
opportunities related to its ancillary businesses as those markets grow and
consolidate over time. To that end, Fitch expects MCK to continue consummating
small, tuck-in acquisitions in especially the med-surg and HIT spaces. In
general, the company approaches M&A opportunistically and responsibly.
ROBUST CASH FLOWS AND SOLID LIQUIDITY
MCK's stable margins and good asset management contribute to stable and strong
cash generation measures. FFO for the latest 12 months (LTM) period ended Sept.
30, 2012 was a robust $2.7 billion. Free cash flow (FCF; cash from operations
less dividends and capital expenditures) for the same period was muted by a
negative working capital swing and large cash payouts in relation to the Average
Wholesale Price (AWP) litigation, but was still nearly $1.5 billion.
The company maintains a very strong liquidity profile. At Sept. 30, 2012, MCK
had $2.8 billion ($1.6 billion OUS), as well as full availability of its $1.3
billion revolver due September 2016 and its $1.35 billion accounts receivable
facility due May 2013. The revolver provides 100% support for the company's
commercial paper program.
Debt maturities are well-laddered and mature as follows: $500 million for the
remainder of fiscal 2013; $350 million in 2014; $1.1 billion in 2016; $500
million in 2017; and $2 billion thereafter. MCK issued $900 million of notes in
November 2012 to prefund the $500 million of notes due in March 2013 and to
refinance $400 million of notes that were repaid in February 2012. Fitch expects
MCK to refinance future debt maturities as they come due.
Fitch has affirmed the ratings of MCK as follows:
-- Long-term IDR at 'A-';
-- Short-term IDR at 'F2';
-- Unsecured bank facility rating at 'A-';
-- Unsecured notes rating at 'A-'
-- Commercial paper at 'F2'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'. The ratings above
were solicited by, or on behalf of, the issuer, and therefore, Fitch has been
compensated for the provision of the ratings.
Applicable Criteria & Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Short-Term Ratings Criteria for Non-Financial Corporates' (Aug. 9, 2012);
--'2013 Outlook: U.S. Healthcare - Navigating a Dynamic Operating and Regulatory
Environment' (Nov. 29, 2012;
--'Fitch: McKesson's Ratings Initially Unchanged by PSS World Acquisition
Announcement (Oct. 25, 2012);
--'Fitch Rates McKesson's Proposed Senior Unsecured Notes 'A-';
--'Navigating the Drug Channel - Drug Distributors: A Deeper Dive' (March 13,
Applicable Criteria and Related Research:
Corporate Rating Methodology
Short-Term Ratings Criteria for Non-Financial Corporates
2013 Outlook: U.S. Healthcare -- Navigating a Dynamic Operating and Regulatory
Navigating the Drug Channel -- Drug Distributors: A Deeper Dive