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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 months.
-- 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 its banks.
-- 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. 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
Ratings List New Rating
Corporate Credit Rating BBB-/Stable/A-3
$1B sr unsecd revolver due 2017 BBB-
$1B commercial paper program A-3
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