September 21, 2017 / 2:47 PM / 10 months ago

Fitch Affirms Eli Lilly at 'A'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, September 21 (Fitch) Fitch Ratings has affirmed Eli Lilly and Company's (LLY, Lilly) Issuer Default Rating (IDR) 'A' with a Stable Outlook. Fitch has also affirmed Lilly's Short-Term IDR at 'F1'. The rating action reflects the company's improving operational profile and prospects for deleveraging in 2018 to 1.7x or below. The rating applies to roughly $12.3 billion of debt outstanding at June 30, 2017. A full list of ratings can be found near the end of this release. KEY RATING DRIVERS Increasing-but-Manageable Patent Expiries: Lilly is facing relatively manageable patent expiries, with roughly 26% of total sales at risk through 2019, excluding the uncertainty of Alimta's patent. Strattera's patent expired in May 2017 (4% of total firm sales), Effient - October 2017 (3% of sales), Cialis - November 2017 or May 2018 (12% of sales) and Forteo - December 2018 (7% of sales). Forteo, a biologic, will likely lose sales to biosimilar competition at a much slower pace than small molecules do to generics. Alimta's (9% of sales) compound patent expired in January 2017. However, its patent for use with folate therapy (expires in May 2022) was upheld by a court of appeals in January 2017 but is still being challenged. Support from Patent-Protected Products: Fitch expects Lilly will mitigate revenue headwinds from expected patent expiries with growth of currently marketed drugs including Cyramza (cancer), Lartruvo (cancer), Trulicity (diabetes), Taltz (psoriasis), Basaglar (diabetes), Jardiance (diabetes) and Tradjenta/Jentadueto (diabetes). These products, in aggregate, are currently generating strong double-digit growth and provide support for growth in the longer term. Refilling Late-Stage Pipeline: Lilly has generated a number of pipeline successes with the recent approvals of Basaglar (diabetes), Lartruvo (cancer) and Taltz (psoriasis). Recent approvals and the clinical setback of solanezumab (Alzheimer's) highlight the importance of refilling its late-stage pipeline. The company is making progress on that front with the expected FDA filing for Olumiant/baricitinib (rheumatoid arthritis) in late 2017 and the submission of abemaciclib (breast cancer) earlier this year. Phase III candidates, lasmiditan (migraines/obtained from the acquisition of CoLucid), galcanezumab (migraines), and advancing phase II candidates should continue to strengthen the late-stage pipeline. Support for Margin Expansion: The company improved its EBITDA margin to 27.8% during the LTM period ended June 30, 2017, versus 25.6% in the prior year period. An 80 basis points (bps) decrease in SG&A (as a percentage of sales), a 12 bps improvement in gross margin and a 144 bps decline in R&D (as a percentage of sales) drove the results. Fitch expects the company will continue to improve margins during the intermediate term through the growth of higher-margin products and solid cost control including its recently-announced restructuring. Growing FCF: Fitch forecasts annual FCF of approximately $1.3 to $1.6 billion during 2017-2018 as Lilly generates organic growth and improved margins. Expected cash flow from operations of $4.6 to $4.9 billion is expected to fund approximately $2.2 billion in cash dividends and $1.1 billion in capital expenditures. FCF should continue to grow throughout the forecast period and be sufficient to fund targeted acquisitions or moderate share repurchases. Targeted Acquisitions: Fitch incorporates targeted acquisitions in its forecasts through 2020, partly funded with debt. Cash on hand should fund roughly $2 billion in aggregate share repurchases and incremental dividend increases during the same forecast period. Maintenance of the 'A' assumes that Lilly would moderate its share repurchases if it were to pursue larger strategic acquisition targets. Expect Deleveraging in 2018: Lilly's current leverage (total debt/EBITDA) of 2.0x is high for its 'A' rating. However, Fitch expects the company to deleverage to 1.7x or below during 2018 through a combination of debt reduction and EBITDA growth. Opportunities to repay debt include $800 million of notes maturing in 2018 and $1.4 billion of outstanding commercial paper. Lilly has kept net share repurchases for the year to a relatively modest level, at roughly $200 million. Payers Increasingly Demanding Value: While drug pricing is always near the top of contentious issues in healthcare, it has become increasingly so during the past two years. Some of the scrutiny has been self-inflicted by a few firms pursuing significant price increases and long-established drugs. Other concerns surround the high price points of recently approved innovative drugs. Regardless, pharmaceutical manufacturers will increasingly need to demonstrate the value of their therapies to payers, patients and providers with strong clinical outcomes driven by increased safety and efficacy. This dynamic will place further pressure on the research and development efforts of innovative biopharmaceutical firms. DERIVATION SUMMARY Eli Lilly & Co. (A/Stable) is competitively positioned in terms of scale, breadth, depth, geographic reach and patent risk compared to its industry peers, Bristol-Myers Squibb and Amgen. Relatively manageable intermediate-term patent risk (excluding the uncertainty regarding Alimta's patent), a generally advancing pipeline and a sufficiently diverse product portfolio support the prospects for operational and financial stability. Gross leverage recently around 2.0 times (x) is weak for its 'A' rating. Lilly's rating reflects the smaller and less diversified nature of the company's operating profile relative to larger innovative pharmaceutical industry peers Pfizer and Merck, This is particularly evident regarding scale, breadth, depth, and patent risk. Gross leverage durably below 2.2x, is supportive of Merck's 'A' rating, while maintenance of Pfizer's 'A+' rating considers gross debt/EBITDA of 1.4x-1.7x. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --Low to mid-single digit organic revenue growth in 2017-2020. The forecast is tempered by patent expiries in 2018 and does not consider meaningful generic competition to Alimta. --Operating EBITDA margin improves by about 400 bps through 2019 due to favorable sales mix shift, including new product introductions, and meaningful cost control, with about half of this saving reinvested in R&D; --Annual FCF (cash flow from operations minus capital expenditures minus dividends) of roughly $1.3 - $1.6 billion in 2017-2018; --Leverage to decline to 1.7x or below during 2018 due to a combination of EBITDA growth and about $2 billion of debt retired in 2018. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action --Revenues continue to expand for patent-protected products, including Lartruvo, Cyramza, Jardiance, Taltz, Tradjenta/ Jentadueto and Trulicity; --The company maintains adequate cost controls to generate sufficient profitability while limiting increases in debt to maintain leverage sustainably below 1.3x; --Lilly deploys cash conservatively with a bias of using cash flow as opposed to debt issuance to fund payments to shareholders and M&A. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --Operational stress from factors including, but not limited to, patent expiries, resulting in leverage durably above 1.7x; --Failure to continue to drive growth of patent-protected products and support margins in order to maintain stable operations through the intermediate term; --FCF deteriorates without the expectation of a timely trend reversal. LIQUIDITY Adequate Liquidity: Fitch assumes Lilly will maintain adequate liquidity, supported by FCF generation, balance sheet cash and availability on its revolving credit facility. At June 30, 2017, the company had approximately $5.4 billion of cash and short-term investments (mostly outside the U.S.), $5.17 billion of committed bank credit facilities, $5.00 billion of which was available to support the company's commercial paper program, and roughly $5.7 billion in noncurrent investments. Lilly had approximately $12.3 billion in debt outstanding. Fitch believes the company's long-term debt maturities are manageable with roughly $800 million and CHF 200 million maturing in 2018, $600 million in 2019, and EUR 600 million plus $750 million in 2022. The company has prefunded some of the 2018 maturities through a May 2017 issuance of $750 million of 2.35% notes due in May 2022, $750 million of 3.10% notes due in May 2027, and $750 million of 3.95% notes due in May 2047. FULL LIST OF RATING ACTIONS Fitch has affirmed the following ratings for Eli Lilly & Co. Inc.: --Long-Term Issuer Default Rating (IDR) at 'A'; --Senior unsecured debt rating at 'A'; --Bank loan rating at 'A'; --Short-Term IDR at 'F1'; --Commercial paper rating at 'F1'. The Rating Outlook is Stable. Contact: Primary Analyst Bob Kirby, CFA Director +1-312-368-3147 Fitch Ratings, Inc. 70 West Madison Street Chicago, IL 60602 Secondary Analyst Megan Neuburger, CFA Managing Director +1-212-908-0510 Committee Chairperson Britton Costa, CFA Senior Director +1-212-908-0524 Summary of Financial Statement Adjustments - Historical and projected EBITDA is adjusted to add back non-cash stock based compensation. 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