December 5, 2017 / 9:51 PM / a year ago

Fitch Rates AmerisourceBergen's Senior Notes 'A-'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, December 05 (Fitch) Fitch Ratings has assigned an 'A-' rating to AmerisourceBergen's (ABC) sale of $750 million senior notes due 2027 and $500 million senior notes due 2047. Proceeds are expected to be used to finance the acquisition of H.D. Smith for $815 million in cash and to redeem 4.875% senior notes due Nov. 15, 2019, and for general corporate purposes. See key terms of the notes below the list of rating actions. Fitch has affirmed ABC's Long-Term Issuer Default Rating (IDR) at 'A-'. The Outlook is Stable. Fitch also affirmed ABC's Short-Term IDR at 'F2'. A full list of ratings follows at the end of the release. The ratings apply to approximately pro forma $4.3 billion of debt at Sept. 30, 2017. The Rating Outlook is Stable. KEY RATING DRIVERS Stable Operations, Low Margins: ABC's credit profile benefits from a stable operating profile and consistent cash generation. Strong ratings are supported by steady pharmaceutical demand, an oligopolistic drug distribution industry in the U.S. and relative insulation from most drug pricing and regulatory pressures, despite very low margins. ABC's long-term relationship with Walgreens provides an added element of meaningful stability and growth. Solid Liquidity, Cash Generation: ABC maintains a solid liquidity position, supported by strong cash flows and strong access to capital markets. Fitch expects annual FFO and FCF to exceed $2 billion and $1 billion, respectively, but notes that FCF can be affected by large working capital swings inherent to large healthcare distributors. Narrow Focus, Business Concentration: ABC's business is narrowly focused on the distribution of pharmaceutical products and related services. Furthermore, about 45% of sales are to the firm's two largest customers: Walgreens Boots Alliance Corp. (BBB/Stable) and Express Scripts Holding Corp. (BBB/Stable). Close Alignment with Walgreens: Fitch views Walgreens as a strong long-term partner for ABC, particularly as the firm is expected to drive industry-leading organic growth and bring additional distribution volumes to ABC through its announced transactions with Rite Aid Corp. (B/Stable ) and Prime Therapeutics. Fitch expects the proportion of revenues ABC sources from Walgreens will trend higher over the near term. Low U.S. Growth, Event Risk: Fitch believes there are low growth opportunities in the traditional U.S. drug distribution space. Growth opportunities are more robust for the company's global commercialization and animal health businesses, but represent a relatively small portion of ABC as a whole. As a result, and now more so considering ABC's alignment with Walgreens, Fitch expects ABC to pursue both organic and inorganic growth in service-related and non-U.S. markets over the intermediate to longer term. DERIVATION SUMMARY ABC's 'A-' Long-term Issuer Default Rating reflects its solid position as one of the largest global pharmaceutical distributors, stable operating profile and consistent cash generation. Fitch believes that AmerisourceBergen will maintain a commitment to maintaining gross leverage at or below 1.4x over the near term and FCF/debt at or above 20%, except for the year following debt-funded acquisitions. The credit profiles of ABC and its peers, Cardinal Health (BBB+/Negative) and McKesson Corp. (BBB+/Stable) benefit from secular trends such as an aging U.S. population and increased use of generic prescription drugs and drug therapies; however, drug distributors face headwinds in the form of declining generic drug prices and slower brand drug inflation over the medium term. ABC has some customer concentration risk; its top two customers, Walgreens Boots Alliance and Express Scripts, accounted for 30% and 15% of revenues, respectively for the fiscal year ended Sept. 30, 2017. KEY ASSUMPTIONS Fitch's Ratings Case forecast incorporates the following assumptions: -- Top-line growth of approximately 8% in 2017 and 7% in 2018. The year 2018 benefits from growth at Walgreens and the addition of new volumes in connection with the JV between Walgreens and Prime Therapeutics. Fitch assumes the addition of new business from legacy Rite Aid stores beginning in fiscal 2018, less the impact of store divestitures. Fiscal 2018 also includes the renewal of Express Scripts contract, with no material change in terms. Some growth could shift to 2017 from 2018 depending on the timing and pacing of ABC providing service to legacy Rite Aid stores. -- Declining to flat EBITDA margins for the forecast period. Margins are pressured in 2018-2019 from repricing associated with renewed contracts with Kaiser Permanente and Compliant Pharmacy Alliance Cooperative (CPA), from lower branded-price inflation expectations, continued generic price deflation, and from a growing proportion of sales to Walgreens, albeit at lower margins. Growth at MWI, PharMEDium and in specialty, as well as improving generic purchasing scale through the addition of Rite Aid and Prime Therapeutics volumes offset these pressures somewhat. -- FCF of approximately $1 billion-$1.5 billion in both 2018 and 2019. Margin pressures contribute to FFO that grows more slowly than the top line. Capex declines in 2018 (~$325 million) and the impact of certain working capital concessions related to a large customer and increase in merchandise inventories reduce FCF. -- Gross debt/EBITDA increasing to 1.7x in 2018 following the recent acquisition and senior notes offering, but stepping down to 1.4x at fiscal year end 2019 with amortization of debt and modest EBITDA growth. Discretionary FCF is more than sufficient to repay debt over the next three fiscal years. Fitch assumes ABC will refinance debt maturities through 2021. Remaining capital is expected to be used for bolt-on M&A, common stock dividends and share repurchase activity. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action ABC currently has limited flexibility at its current ratings. Maintenance of the 'A-' long-term rating considers gross debt/EBITDA of 1.4x by year-end 2019 and maintenance of FCF/to debt above 25%. Gross debt/EBITDA is expected to trend above 1.4x in 2018 following the acquisition of H.D. Smith, but consistent FCF applied to debt reduction in 2019-2021 is expected to bring leverage at or below Fitch's expectations. Fitch notes that ABC's leverage has moved higher over the past two years because of acquisitions and several large charges to operating income (lawsuits, warrant expense). However, ABC is expected to maintain a commitment to operating with low debt leverage and responsible allocation of capital, with strong cash generation. An upgrade to 'A' is not expected over the ratings horizon. Fitch believes ABC's management would need to commit to operating with gross debt leverage below 0.8x, accompanied by increased profit margins and to maintain FCF/ debt at or above 25%. Fitch does not expect ABC to commit to operating with such low leverage or to enhance profit margins in the near to intermediate term. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action A downgrade to 'BBB+' would likely be the result of a change in the firm's current capital deployment strategy, resulting in gross debt/EBITDA sustainably above 1.4x and FCF/debt durably below 20%. Negative rating actions are not expected to directly result from recent shifts in the industry's competitive and pricing dynamics, namely lower branded price inflation and key contract renewals, but may lead to erosion of the aforementioned metrics over the medium term. However, ABC's 'A-' IDR could be pressured by a significant leveraged acquisition, customer losses, heightened competition or a combination of all of these factors. LIQUIDITY ABC has access to a large amount of internal liquidity, in addition to solid access to the capital markets. Contractual debt maturities are manageable and well-laddered. FCF is expected to range from $1 billion to $1.5 billion in 2018 and 2019, which adequately covers debt maturities over the same period. Fitch expects that ABC will continue to maintain approximately $1 billion of cash available during the forecast period. As of Sept. 30, 2017 and 2016, ABC's cash and cash equivalents held by foreign subsidiaries were $995.7 million and $582.9 million, respectively, and are generally based in U.S. dollar-denominated holdings. ABC has disclosed that it expects its cash and cash equivalents held by foreign subsidiaries will grow. Amounts held outside of the U.S. are generally utilized to support non-U.S. liquidity needs, including future acquisitions of non-U.S. entities, although a portion may from time to time be subject to short-term intercompany loans to U.S. subsidiaries. Fitch does not expect ABC to repatriate cash in foreign subsidiaries to the U.S. in the near term. FULL LIST OF RATING ACTIONS Fitch has assigned the following rating: AmerisourceBergen Corporation --Long-term senior unsecured note 'A-'. Fitch affirms AmerisourceBergen Corporation as follows: --Long-Term IDR at 'A-' --Short-Term IDR at 'F2' --Commercial Paper at 'F2' --Senior unsecured bank facility at 'A-' --Long-term senior unsecured notes at 'A-' The Rating Outlook is Stable. The 2027 and 2047 notes are unsecured and will rank equal in right of payment with all of ABC's other existing and future unsecured and unsubordinated indebtedness, and senior to any of its future indebtedness, if any, that expressly provides for its subordination to the notes. In the event that the acquisition of H.D. Smith is not completed on or before May 20, 2018, or, if prior to such time the acquisition is terminated, other than in connection with the consummation of the acquisition and is not otherwise amended or replaced, ABC will be required to redeem the 2047 notes, in whole but not in part, at a redemption price equal to 101% of the aggregate principal amount thereof, plus accrued and unpaid interest to the redemption date. ABC must offer to repurchase the notes at a price equal to 101% of the principal amount of the notes to be purchased, plus accrued and unpaid interest, if any, upon the occurrence of certain change of control triggering events. In addition, ABC may redeem the notes in whole or in part at any time at the applicable redemption price, plus accrued and unpaid interest to the redemption date. Contact: Primary Analyst Patrick Finnegan, CFA Senior Director +1-646-582-4620 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Bob Kirby, CFA Director +1-312-368-3147 Committee Chairperson Britton Costa, CFA Senior Director +1-212-908-0524 Date of Relevant Rating Committee: Dec. 4, 2017 Summary of Financial Statement Aside from financial adjustments customary to U.S. Corporates (removal of non-cash expenses, such as stock-based compensation expenses, from EBITDA calculation), Fitch notes that EBITDA has been adjusted to add back reported LIFO expense figures. 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