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Fitch Revises Sanofi's Outlook to Negative; Affirms IDR at 'AA-'
December 16, 2016 / 5:35 PM / 10 months ago

Fitch Revises Sanofi's Outlook to Negative; Affirms IDR at 'AA-'

(The following statement was released by the rating agency) LONDON, December 16 (Fitch) Fitch Ratings has revised French pharmaceutical company Sanofi SA's Outlook to Negative from Stable and affirmed the group's Long-Term Issuer Default Rating (IDR) at 'AA-'. Fitch has also affirmed the senior unsecured rating 'AA-' and Short-term IDR at 'F1+'. The revision of the Outlook to Negative reflects Fitch's belief that Sanofi's financial leverage, cash generation and liquidity will be affected by the company's plan to increase shareholder returns and pursue M&A. Meanwhile, sales and margins are under pressure from generic competition and increasing price sensitivity across the industry. The rating reflects Sanofi's solid market position as a leading, diversified player in the global pharmaceutical industry, which we believe will continue to benefit from economies of scale in the field of R&D, marketing and distribution, and with its dealings with regulators. The rating is also underpinned by significant financial flexibility and its available strategic options such as asset disposals to protect its balance sheet. The development of the financial risk profile will ultimately depend on the timing and structure of any anticipated corporate activity especially if larger in size than expected. KEY RATING DRIVERS Increase in Business Risks The Negative Outlook assumes continued pressure on sales and profitability on Sanofi's core pharmaceutical business, particularly due to increasing generic competition across the diabetes franchise. Sanofi's pharmaceutical division has seen the US patent expiry of its key diabetes drug. However, this has been counterbalanced by new product launches in the field of diabetes, rare diseases and specialty pharma, as well as vaccines. We expect a faster decline in off-patent drugs and slower than anticipated product launches to affect sales and margins in 2016 and 2017. Anticipated Corporate Activity We expect the financial risk profile to gradually deteriorate based on our assumptions of structural pressures on productivity, high shareholder returns, and M&A. Therefore we anticipate that free cash-flow (FCF) margin will breach our negative sensitivity of below 5% and FFO adjusted net leverage will rise above our guidance of 2.0x compatible with the assigned 'AA-' over the next two years. This assumption is based on increasing shareholder distributions and up to EUR20bn spent on M&A over the rating horizon. Sanofi's financial risk profile remains, however, underpinned by significant financial flexibility as evidenced by strong annual FFO generation exceeding EUR8bn over the four-year forecast period and the strategic options available to it. Changing Product Mix Affecting Profitability Fitch expects profitability and cash flows to be lower by 2017, due to the expected changes to the drug mix in its pharma division and associated launch costs for new treatments. In addition, the group is pursuing growth outside innovative pharma ie, generics and consumer health, which have structurally lower profitability. This leads to an EBITDAR margin falling towards 30% by 2017, which is weaker than the average of 34% achieved between 2012 and 2015. While the future development of revenue and profitability is a key rating driver for the group, we recognise that Sanofi's internal restructuring programme is aimed at reducing some of the pressure on profitability. Innovation Drives Treatment Diversification Fitch views Sanofi's pipeline as promising in the field of rare diseases, vaccines and oncology, where it announced a deepening R&D cooperation with its US partner Regeneron in the field of immuno-oncology and related combination therapies. Key recent R&D milestones for Sanofi were the EU authorisation of Cerdelga (Gaucher's disease) as well as Praluent (Cholesterol) and of the first Dengue Fever vaccine which received approval in Mexico, the Philippines and Brazil in December 2015. Evolving Strategic Developments Fitch expects the group's strategic development to continue following the announced asset swap transaction with German pharma company Boehringer Ingelheim (BI) and the failed bid for Medivation earlier in 2015. Sanofi guides for acquisition budget of up to EUR20bn, which we believe will be used to either increase scale in the consumer-facing business or invest in the science base of the company. To mitigate the balance-sheet effect of such transactions in times of high shareholder returns, the generics division is earmarked to be sold and could form part of a potential asset swap transaction to accelerate the strategic repositioning of the group. DERIVATION SUMMARY Sanofi's financial profile remains in line with the weak 'AA' rating category with debt protection ratios, profitability and cash generation trailing Novartis and Roche (both rated 'AA'/Stable). However, we do not expect Roche and Novartis to experience deteriorations in margin, FFO fixed charge cover and FFO adjusted net leverage like we forecast for Sanofi. Sanofi's business and financial risk profile is still considered better than AstraZeneca and GlaxoSmithKline (both rated 'A'/Stable), supporting the rating differential to its British peers. KEY ASSUMPTIONS Fitch's expectations are based on the agency's internally produced, conservative rating-case forecasts. They do not represent the forecasts of rated issuers individually or in aggregate. Key Fitch forecast assumptions include: -Near-term pressure on organic sales as the pharmaceutical division remains subject to generic competition and new drugs are introduced to the market. -EBITDAR-margins falling towards below 30% over the four-year rating horizon as a result of pressure and sales and structural growth of lower-margin businesses -R&D spending assumed at around 15% of sales - Near-term pressure on working capital to support product launches, normalisation thereafter -A degree of FX volatility, especially emerging-market and US dollar exposure, resulting in continued FX translation risks -An annual acquisition budget of EUR4bn (leading towards the total of up to EUR20bn as guided by the company -Annual EUR1.5bn of share buybacks plus additional programme of EUR3.5bn over 2016-17 in addition to a progressive increase in dividends to >EUR4.0bn over the rating horizon -Capex assumed at 5.0% of sales -Asset swap with BI concluded in June 2016, with full effect visible in FY17, generating EUR4.7bn cash inflow in 2016 RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Major debt-financed acquisitions or share buybacks, which result in FFO adjusted net leverage greater than 2.0x on a continuing basis - FFO net fixed charge cover below 9.0x on a continuing basis - Top-line erosion due to slower than anticipated product launches and/or stronger decline of off-patent drugs - Weaker profitability leading to FCF margin below 5% on a sustained basis Future Developments That May, Individually or Collectively, Lead to Positive Rating Action (including a revision of the Outlook to Stable). - A sustained industry-leading profitability and cash-flow generation combined with a commitment to financial ratios in line with a higher rating (ie, FFO adjusted net leverage about 1.2x and FFO net fixed charge cover of about 16.0x on a continuing basis) - Return to a more mature top-line performance, characterised by successful introduction of drugs from Sanofi's late-stage pipeline, counterbalancing the current threat from generic competition. -Successful execution of the strategic repositioning, balancing shareholder returns and investment in the business in a balance sheet efficient way (ie, use of asset swaps). - Improvement in cash-flow generation leading to FCF margin above 7% LIQUIDITY Healthy Liquidity Fitch assesses Sanofi's liquidity as strong with readily available cash at EUR8.2bn as of end-2015 (as defined by Fitch) and undrawn committed term bank facilities totalling EUR8.0bn, which are not subject to financial covenants, covering near-term maturities of EUR3.3bn in FY17 and FY18 comfortably. Sanofi continues to benefit from good access to the capital markets. Contact: Principal Analyst Quentin Dumouilla Analyst +44 203 530 1790 Supervisory Analyst Frank Orthbandt Director +44 203 530 1037 Fitch Ratings Ltd 30 North Colonnade London E14 5GN Committee Chairperson Pablo Mazzini Senior Director +44 20 3530 1021 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com. Summary of Financial Statement Adjustments - Fitch capitalises Sanofi's long-term lease obligations (EUR204m in FY15) by applying an 8x capitalisation multiple to arrive at a lease-adjusted debt equivalent figure of EUR1.6bn. - We also estimate EUR1.0bn restricted cash is absorbed in intra-year working-capital swings, which is reflected in our readily available cash figure. Additional information is available on www.fitchratings.com. 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