Jan 14 Standard & Poor's Ratings Services
assigned Madison, NJ-based Zoetis Inc. a 'BBB-' long-term
corporate credit rating and a short-term rating of 'A-3'. The
rating outlook is stable.
At the same time, we assigned the company's senior unsecured
$1 billion revolver a 'BBB-' issue-level rating, and we assigned
the company's commercial paper program a 'A-3' rating.
The ratings on Zoetis Inc. reflect our assessment of the
company's business risk profile as "satisfactory" and its
financial risk profile as "significant." Key credit factors
considered in our business risk assessment include Zoetis'
strong market positions in the animal health medicines and
vaccines segment, good diversification across product categories
and product lines, and its direct relationships with customers.
We also believe the company will benefit from its established
research and development operations, continued access to
Pfizer's proprietary compound library, and the lesser role of
generic competition in the animal health medicines and vaccines
segment when compared with human health. Partially offsetting
these factors are Zoetis' concentration on the animal health
segment, the highly competitive nature of the industry, and the
operational risks associated with its transition from Pfizer.
The financial risk profile reflects our expectation for improved
credit measures over the two-year outlook period. We also
anticipate that the company will make small tuck-in acquisitions
and return value to its shareholders through dividends.
For the last 12 months ended Sept. 30, 2012, Zoetis
generated about $4.3 billion in revenues with an adjusted EBITDA
margin of approximately 27%. In fiscal-year 2013, we expect
revenues to grow in the mid-single digits driven by continued
growth in the emerging markets, lower livestock production costs
for customers, and higher pet spending given the generally
improving economic environment. We anticipate its adjusted
EBITDA margin will remain close to its current level with
operational improvements mostly offset by increased promotional
spending and transition costs. Based on these estimates, and
working capital usage greater than $50 million, we project cash
from operations of around $700 million in 2013.
Zoetis discovers, develops, manufactures, and commercializes
animal health medicines and vaccines, with a focus on livestock
(cattle, swine, poultry, sheep, and fish) and companion animals
(dogs, cats, and horses). It is the largest animal health
medicines and vaccines business in the world with leading market
positions by geography, product category, and species. While
concentrated in animal health products, we believe Zoetis has
diversity on many levels that provides offsetting benefits. The
company sells its products in more than 120 countries, with a
particular strength in the emerging markets where there are good
growth prospects. Its product portfolio crosses eight core
animal species and five major product categories, including
vaccines, parasiticides, anti-infectives, medicated feed
additives, and other pharmaceutical products. Additionally, it
has more than 300 product lines, with no single product line
accounting for more than 8% of revenues and its top 10 products
contributing less than 38% of revenues. The company is more
concentrated on providing livestock products (about 66% of
revenues), which could be less profitable down the road with the
consolidation of livestock producers improving their negotiating
leverage. However, we do not anticipate a significant impact in
the medium term as the cost of animal health medicines and
vaccines is small relative to other livestock production costs.
The company operates in a highly competitive market that
includes the animal health businesses of large pharmaceutical
companies as well as specialty animal health companies. In this
market, we believe Zoetis has a good competitive position with
its large sales team, direct-selling relationships,
complementary services, as well as minimal generic competition
in the sector. These factors are especially relevant since
Zoetis derives about 80% of its revenue from products that are
not protected by patents. Unlike in human health, though, patent
expiration does not typically lead to a sharp reduction in sales
for animal health medicines and vaccines. This is partially due
to the close relationships that firms in the animal health
business have with their key customers as well as their
customers' demand for quality. Nonetheless, generic products are
increasing their market share in certain regions of the world
and could pose a greater threat in the long term.
Over the next few years, there will be a transition period
as Zoetis operates under its transitional serve agreements with
Pfizer. We believe this transition adds operational risk since
the company could encounter shortcomings while switching to
their own IT system, building out their supply and logistics
operations, and phasing out their transactional finance support.
Given the company's successful execution to date, we do not
currently anticipate setbacks that could significantly impact
profitability or the effectiveness of its operations. Zoetis
already has well-established operations that include its
manufacturing capabilities, proven ability to bring products to
market, and established distribution network across the globe.
It also benefits from having access to Pfizer's proprietary
compound library and database to develop new products.
With regards to the company's financial risk profile, we
expect Zoetis to have moderate financial policies. We anticipate
the company will make small tuck-in acquisitions to strengthen
its product portfolio and also return value to its shareholders
by paying out quarterly dividends. At the end of fiscal-year
2013, we anticipate Zoetis' adjusted debt-to-EBITDA ratio will
be about 3x and its funds from operations (FFO) to debt will be
about 20%. These credit measures are appropriate for a
significant financial risk profile, which includes guidelines of
adjusted debt to EBITDA of 3x to 4x and FFO to debt of 20% to
30%, and should improve over time. We believe any improvement in
Zoetis' credit measures over the next two years will come from
increased earnings, with debt payments primarily occurring as
the debt matures.
In our opinion, Zoetis has "adequate" liquidity, which
supports their 'A-3' commercial paper rating. This is based on
the following expectations:
-- We expect liquidity sources (including cash, funds from
operations, and availability under its $1 billion revolving
credit facility) to exceed uses by 1.2x or more over the next 12
-- Even if EBITDA were to decline by 20%, we expect
liquidity sources to continue to exceed uses.
-- In our assessment, Zoetis has solid relationships with
-- We believe Zoetis has the ability to absorb, with limited
need for refinancing, high-impact, low-probability events.
Sources of liquidity include a cash balance of $133 million
at Sept. 30, 2012, which we expect to increase following the
separation from Pfizer. Zoetis also has a $1 billion revolving
credit facility that matures in December 2017, which we
anticipate will be undrawn following the separation. The credit
facility serves as a backup to the company's unused $1 billion
commercial paper program. The credit facility contains an
interest coverage ratio covenant of 3.5x and a leverage covenant
of 4.35x that steps down to 3.95x in fiscal 2014, 3.5x in fiscal
2015, and 3x in fiscal 2016 and thereafter; we believe the
company will have significant cushion under its covenants and
the leverage covenant step downs will be easily achievable. We
expect funds from operations to grow over the next few years to
nearly $750 million in fiscal 2013.
Cash uses include working capital, dividend payments, and
capital expenditures. Additionally, the company may use cash for
acquisitions. Working capital was a $402 million use of cash for
the nine months ended Sept. 30, 2012, and we project it to be
about a $50 million use of cash in 2013. Cash dividends paid to
non-Zoetis entities totaled $63 million for the nine months
ended Sept. 30, 2012, and capital expenditures totaled $81
million. We project capital expenditures of about $180 million
in 2013 and we expect the company to pay a dividend. The
relatively high level of capital expenditures will largely be
due to transition costs. Zoetis has not made any significant
acquisitions over the last nine months, though we do expect it
to be a moderate use of cash going forward.
The stable outlook reflects our expectation that Zoetis'
credit measures will improve over the next two years, largely
driven by higher earnings. We believe debt payments will
primarily occur as the debt matures. Therefore, we anticipate
the company's credit measure to improve only modestly and will
remain in range of a significant financial risk profile.
An upgrade would be predicated on achieving and maintaining
improved credit measures appropriate for an intermediate
financial risk profile, including FFO to debt of greater than
30% and adjusted debt to EBITDA of closer to 2x. We believe this
would most likely occur if the company were to pay down debt,
though it could also achieve these levels if its EBITDA margin
were to expand by 400 basis points from current levels and
revenue growth were to accelerate to the low double digits.
We could consider a downgrade if Zoetis were to pursue more
aggressive financial policies that would lead to credit measures
maintained at the weaker end of a significant financial risk
profile. While unlikely, we believe a downgrade could be caused
by increased acceptance of generic products in the market or
public concerns over the impact of animal health medicines and
vaccines on humans.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept.
-- 2008 Corporate Criteria: Analytical Methodology, April 15,
-- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15,
Corporate Credit Rating BBB-/Stable/A-3
$1B sr unsecd revolver due 2017 BBB-
$1B commercial paper program A-3