November 1, 2017 / 3:53 PM / a year ago

Fitch Affirms GSK at 'A'; Stable Outlook

(The following statement was released by the rating agency) LONDON, November 01 (Fitch) Fitch Ratings has affirmed UK-based pharmaceuticals company GlaxoSmithKline PLC's (GSK) Long-Term Issuer Default Rating (IDR) at 'A' with Stable Outlook. Fitch has also affirmed the senior unsecured rating at 'A' for the debt issued by GlaxoSmithKline PLC, GlaxoSmithKline Capital PLC, and GlaxoSmithKline Capital Inc. The affirmation reflects Fitch's expectation that GSK's leverage should remain at the top end compatible with its rating. At the same time, Fitch recognises that GSK has significant financial flexibility and various strategic options including possible divestments, changes in its capital allocation policy and the structuring of potential acquisitions. Moreover, the current 'A' rating is supported by GSK's scale, good geographical diversification, and range of treatment areas relative to sector peers. KEY RATING DRIVERS Pressure on FY18 Margins: Fitch expects a robust performance for the financial year to December 2017 (FY17) to be followed by a transitional year in which FFO is likely to decline due to the lower profitability of the pharma division. Our expectation of lower FY18 pharma margins is based on the likely entry of generic competition in the US for its highly profitable drug Advair (11% of global LTM September 2017 sales), the patent expiration of Avodart in the EU (2% of global LTM sales to September 17), ongoing pricing pressure affecting the rest of its respiratory portfolio, the launch by Gilead of a competing HIV drug the slowing down growth of its HIV franchise, and by continuing investments in recently launched drugs. Slight Recovery in FY19: Fitch anticipates a modest recovery in profit margins in FY19 and FY20 driven by restructuring efforts in its Consumer Health division and a slight recovery in pharma margins as recently launched drugs mature. Reduced Rating Headroom from FY18: Fitch anticipates that FFO adjusted net leverage could approach 3.0x in FY18 due to the decline in FFO driven by lower pharma margins. Fitch's base-case forecast is that net leverage will stay around the 3.0x level over the rating horizon despite a recovery in margins and low-single-digit revenue growth. This is based on Fitch's expectation of a continuation of GSK's generous dividend policy leading to slightly negative FCF generation from 2018 onwards, and Fitch's assumption that Novartis' put option will be exercised in FY18 and settled by GSK in equal instalments over a four-year period. M&A Ambitions: The value of Novartis' stake is assumed at GBP8.5 billion, in line with GSK's balance sheet provision in 3Q17. Management has stated its intention to increase the scale of its Consumer Healthcare business through acquisitions, but Fitch would treat any additional medium-size or large acquisition, including a potential obligation to buy out Pfizer's 12% stake in its ViiV business, as event risk. Significant Financial Flexibility: GSK has a high degree of flexibility with regard to some of the negative drivers for the financial risk profile, particularly with regard to the generous shareholder remuneration, the timing and structure of the exit of minorities and of potential acquisitions, and possible divestments of non-core assets and partial IPOs of businesses. Strong Market Position and Diversification: GSK operates a diversified business model spanning a broad portfolio of treatment areas, with industry-leading positions in respiratory, HIV, vaccines and consumer-healthcare products. GSK also enjoys a diversified geographical mix with and an industry-leading presence in emerging markets. As part of its recent portfolio reorganisation, GSK exited the increasingly competitive oncology treatment area to concentrate on its enlarged vaccines and consumer-health operations, which Fitch expects will benefit from economies of scale and growth opportunities in developing markets. Positive Sector Trends: Fitch views certain secular trends in the pharma- and healthcare sectors as positive, with increasing access to healthcare globally, an ageing population, an increase in chronic diseases, as well as innovation in specialist treatments. Nevertheless, the focus on delivering value to patients and healthcare systems will accelerate the industry-wide review of pricing models in favour of performance-based pay. Fitch however believes that truly innovative and differentiated drugs will continue to attract premium prices and good market access as evidenced by GSK's strong growth of its anti-viral business. DERIVATION SUMMARY GSK's rating of 'A' remains well positioned in the global pharma universe, with a similar size compared to its higher-rated peer Sanofi (AA-/Negative) and with scale advantages over UK peer AstraZeneca (A-/Negative). GSK's EBITDA and FFO margins are in line with its UK peer AstraZeneca and its American peer Eli Lilly (A/Stable), lower than those of higher-rated peers Roche (AA/Stable), Novartis (AA/Negative), Sanofi (AA-/Negative) and Pfizer (A+/Negative), and stronger than those of its European peer Bayer (A/RWN). Its financial profile has improved in FY16 and FY17 YTD. Its FFO adjusted net leverage is now in line with that of American peers Pfizer (A+/Negative), and Merck & Co (A/Stable), but still higher than higher-rated European peers. Its FFO fixed charge coverage is lower than that of other 'A' and 'A+' rated pharma peers. GSK's slightly negative FCF generation caused by its generous dividend policy is unusual in the 'A' category and compares negatively with the FCF generation of other European and American pharma peers in the 'A' category. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer are listed below. - Fitch expects revenue growth to slow down between FY18-22 projecting an average sales growth of 2.5% (after sales growth expected to reach around 8% in FY17). We expect positive growth effects from new product launches to be counterbalanced by increasing biosimilar competition for GSK's key drug Advair. We expect pressure on GSL's profitability to increase, modelling a group EBITDA margin of just below/around 27% over the period FY18-FY20, caused by increasing competition and pricing pressure for some of GSK's key drugs. - Pharma R&D expense (excl. Consumer Health) modelled at unchanged level of around 15% of pharma-only sales. - Moderate working-capital outflows in line with sales growth. - Stable dividend until 2020, causing slightly negative FCF generation over the four-year rating horizon. - Bolt-on acquisitions to be financed with disposal of non-core businesses. - Consumer healthcare put option exercised by Novartis in FY18, but paid for by GSK in four equivalent yearly instalments. No buyout of the ViiV minorities over the four-year rating horizon. This buyout or indeed any other large scale M&A would be treated as event risk. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Inability to defend its top-line growth and its profitability following the expiration of key products and despite restructuring efforts - Major debt-financed acquisitions, share buybacks and/or minority payouts, which result in FFO adjusted net leverage above 3.0x on a continuing basis - FFO fixed charge cover below 5.0x on a continuing basis - FFO/sales below 20% and continued negative FCF driving a weakening of debt protection ratios Future Developments That May, Individually or Collectively, Lead to Positive Rating Action Fitch views an upgrade to 'A+' unlikely over the rating horizon. However future developments that may, individually or collectively, lead to positive rating action include: - successful product launches leading to a stable, predictable top-line performance and sustainable improvement in profitability; - capital allocation and financial policies in line with a higher rating level, including shareholder returns, M&A and payouts to minorities; - FFO adjusted net leverage trending towards 2.0x and FFO net fixed charge cover above 8x on a continuing basis; - FFO/sales above 25% and FCF/sales in the mid-single digits. LIQUIDITY Adequate Liquidity: At FYE16 GSK had readily available cash (as defined by Fitch) of GBP4.5 billion and undrawn committed credit facilities of GBP4.4 billion, which covered the GBP4.1 billion of short-term debt. By September 2017 GBP2.2 billion of this short-term debt due in 2017 has been already refinanced. Undrawn credit facilities included a GBP1.9 billion committed facility maturing in in September 2021 and a USD2.5 billion 364-day facility. In addition, GSK has a USD10 billion (GBP8.1 billion) US commercial paper programme, from which USD1.4 billion had been issued in December 2016. FULL LIST OF RATING ACTIONS GlaxoSmithKline PLC -Long-Term IDR: affirmed at 'A'; Stable Outlook -Senior unsecured debt: affirmed at 'A' GlaxoSmithKline Capital Inc. -Senior unsecured debt: affirmed at 'A' GlaxoSmithKline Capital PLC -Senior unsecured debt: affirmed at 'A' Contact: Principal Analyst Xavier Taule Flores Analyst +34 93492 9513 Supervisory Analyst Frank Orthbandt Director +44 20 3530 1037 Fitch London 30 North Colonnade London E14 5GN Committee Chairperson Giulio Lombardi Senior Director +39 02 8790 87214 Summary of Financial Statement Adjustments Fitch adjusts its debt by capitalising annual lease payments using the factor 8x. 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