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Fitch Rates McKesson's EUR and GBP Notes 'BBB+'; Outlook Stable
February 13, 2017 / 2:18 PM / 10 months ago

Fitch Rates McKesson's EUR and GBP Notes 'BBB+'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, February 13 (Fitch) Fitch Ratings has assigned 'BBB+' ratings to the EUR and GBP denominated senior unsecured notes issued by McKesson Corp. (NYSE: MCK). A full list of ratings follows at the end of the release. KEY RATING DRIVERS Stable Operations, Low Margins The credit profiles of MCK and its peers benefit from stable operating profiles and consistent cash generation. Steady pharmaceutical demand, an oligopolistic drug distribution industry in the U.S. and, for the most part, in Western Europe, and relative insulation from most drug pricing and regulatory pressures, support strong ratings despite very low margins. Increased Competitive Pressures The recent repricing of certain independent pharmacy GPO contracts in 2016 represent another weakening of MCK's competitive positioning, albeit also affecting MCK's peers, following key losses in calendar 2015 (or pending losses) as many of its largest customers (Rite Aid, Omnicare, Target, OptumRx) were involved in key M&A transactions. This weakened positioning is most evident in MCK's generic sourcing scale, which Fitch now estimates as lagging that of both Walgreens-AmerisourceBergen and CVS Health-Cardinal Health and, in Fitch's view, contributed to the generic sourcing JV with Wal-Mart rather than Wal-Mart simply becoming a party to MCK's generic purchasing. Leading Market Positions MCK is expected to continue to hold top market positions (#1 or near #2) in pharmaceutical and non-acute care medical distribution, including of specialty pharmaceuticals, in both the U.S. and Canada. The firm's European business is also market-leading in distribution and pharmacy operations. Solid Liquidity, Cash Generation MCK maintains a solid liquidity position, supported by strong cash flows and strong access to capital markets. Fitch expects annual FFO and FCF to exceed $3 billion and $2 billion, respectively, but notes that FCF can be affected by large working capital swings inherent to large healthcare distributors. Non-U.S. Operations More Risky Fitch generally sees non-U.S. drug channels, particularly in Europe, as less stable and higher risk than in the U.S., especially given the diversity of regulatory and reimbursement systems. But inorganic growth opportunities are more prevalent in markets outside the U.S., so MCK's presence in Europe is important for long-term growth prospects. RATING SENSITIVITIES Maintenance of MCK's 'BBB+' IDR considers gross debt/EBITDA generally in the range of 1.4x to 2x, with continued strong and steady cash flows, accompanied by stable or modestly expanding underlying margins. Cash flows and liquidity are strong for the rating category. Flexibility is expected to be ample but limited in calendar 2017. Negative rating actions are not expected to explicitly result from recent shifts in the industry's competitive and pricing dynamics - namely lower branded inflation and key contract losses/revisions - though MCK's margins could be pressured compared to peers. A downgrade to 'BBB' could be driven by material debt-funded acquisitions or share repurchases, or more significant margin pressures than are currently expected, resulting in gross debt/EBITDA expected to be sustained at or above 2x. Cash generation and liquidity in a reasonable stress scenario could still support absolute debt repayment, so a downgrade would most likely be tied to management's capital deployment decision-making. A positive rating action is not currently anticipated over the ratings horizon. Fitch does not expect MCK to reduce gross debt/EBITDA to 1.4x or below, although cash generation and internal liquidity are expected to be more than sufficient to do so. KEY ASSUMPTIONS Fitch's Ratings Case forecast incorporates the following assumptions: Top line growth of 4% in fiscal 2017 and a decline of 2% in 2018. Growth in 2017 is supported by the expanded Albertsons contract, recent acquisitions, specialty, and stability in med-surg, offset by lost business (OptumRx, Omnicare generics, Target generics). Revenue decline of 2% in fiscal 2018 is mostly the result of the expected loss of Rite Aid distribution volumes gradually in the first half of the fiscal year, offset by the addition of Walmart generics. Fitch forecasts assume both the loss of Rite Aid and the addition of Wal-Mart generics in MCK's fiscal 1Q'2018. Fitch may revise this assumption as updated terms and likelihood of the Walgreens / Rite Aid transaction crystallize. Ramping margin pressures in fiscal 2017 to 2018 Margin pressure is most acute from lower branded price appreciation and heightened competitive pressures particularly among independent pharmacy customers, leading to double-digit EBITDA margin declines (rate of change) in both fiscal 2017 and 2018. Continuing margin pressures in fiscal 2018 are offset somewhat by ongoing cost reduction programs, and upside is possible depending on the timing and pacing of Wal-Mart generics onboarding. FFO Approximating $3 in Fiscal 2017 and 2018 FFO to be generated from projected cash flow from operations of $4 billion and $3.2 billion, respectively. An expectation for a meaningfully positive working capital benefit, especially in 2017, supports cash generation despite declining absolute EBITDA. Notably, working capital is subject to large day-to-day swings which could cause FCF to fluctuate. Cash flows will be aided over in coming years from proceeds related to the divestiture of certain technology businesses ($1.25 billion expected in fiscal 2017 from initial transaction). Relatively Steady Debt Balances, Yielding Gross Debt/EBITDA Around 1.9x in 2017 to 2018 Fitch does not expect MCK to use FCF for meaningful long-term debt reduction over the ratings horizon, instead allocating the majority of discretionary FCF to M&A and share repurchase activity. LIQUIDITY MCK maintains a strong liquidity position. The firm's new $3.5 billion revolver, which replaced its previous revolvers and A/R facilities, provides ample liquidity for working capital and other temporary financing requirements and backup to MCK's commercial paper program. Fitch assumes major drug distributors seek to keep $1 billion to $2 billion of cash available for day-to-day operations. All U.S. cash ($0.6 billion) is considered Readily Available. Access to external liquidity is adequate. Well-Laddered Maturities Debt maturities are relatively well-laddered and manageable, with proceeds from the offering available to fund recent and upcoming debt maturities. FCF is expected to routinely outpace debt maturities, leaving flexibility for M&A or share repurchase activity. FULL LIST OF RATINGS Fitch currently rates MCK as follows: --Long-term IDR 'BBB+'; --Short-term IDR 'F2'; --Senior unsecured bank facility 'BBB+'; --Senior unsecured notes 'BBB+' --Commercial Paper 'F2'. Contact: Primary Analyst Britton Costa, CFA Director +1-212-908-0524 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Bob Kirby, CFA Director +1-312-368-3147 Committee Chairperson David Peterson Senior Director +1-312-368-3777 Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: Date of Relevant Rating Committee: Dec. 15, 2016 Additional information is available at No material financial statement adjustments were made other than those customary within U.S. Corporates (i.e. the removal of non-cash and non-recurring expenses, such as stock-based compensation expense, from the calculation of EBITDA). Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016) here Additional Disclosures Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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