Fitch Affirms Express Scripts' Ratings at 'BBB'; Outlook Stable

CHICAGO--(BUSINESS WIRE)--

Fitch Ratings has affirmed Express Scripts Holding Co.'s ESRX ratings at 'BBB'. The Rating Outlook is Stable.

A full list of rating actions, which apply to approximately $13.5 billion of debt at Dec. 31, 2014, follows at the end of this release.

KEY RATING DRIVERS

Market-Leading Scale: ESRX is the largest pharmacy benefit manager (PBM) and third-largest pharmacy operator in the U.S. Fitch expects such scale to continue enabling ESRX to negotiate favorable purchasing discounts and pricing rebates and to leverage its fixed costs associated especially with mail-order pharmacy.

Robust Cash Flows: Despite relatively low margins, stable and robust cash flows are driven by excellent working capital management and very efficient operations. Strong cash flows and a solid liquidity profile afford good ratings flexibility at current ratings in the event of leveraging M&A.

Historically an Active Acquirer: ESRX has been an active acquirer over the past decade, often employing large debt balances to fund deals. The possibility for large-scale M&A and accompanying leverage spikes, albeit lower now given ESRX's very large size, pressure the ratings somewhat. Notably, the firm has routinely executed on its outlined de-leveraging plans, reducing leverage appropriately within 12-18 months of each deal.

Increasing Competition, Consolidation: ESRX may experience some pricing pressure from new contracts and consolidating clients and competitors, including the announced merger of Catamaran Corp. and UnitedHealth's OptumRx, over the ratings horizon. Current trends supporting consolidation and alignment in many areas of healthcare are expected to continue for the foreseeable future.

Weak N-T, Better L-T Growth: ESRX's 2015 guidance for down to slightly flat adjusted script growth is better than 2014, but still weak. Nevertheless, Fitch believes ESRX's longer-term growth will fare more positively as the firm's leading scale benefits from reform tailwinds, specialty market growth, demographics, and ongoing cost containment efforts by payers leading to growing PBM volumes and utilization of more value-add services.

RATING SENSITIVITIES

ESRX has good flexibility at its current 'BBB' ratings, which contemplate gross debt/EBITDA of around 2x. Flexibility is afforded by a robust cash flow profile and steady industry demand.

Positive rating actions could accompany a shift in Fitch's expectations that ESRX would use its ample FCF to repay debt, rather than for shareholder payments, such that run-rate gross debt/EBITDA was maintained around 1.5x. Current cash generation is more than sufficient to operate with debt leverage lower than the 2x target over the ratings horizon.

A downgrade could be driven by the prioritization of cash flows for shareholder-friendly activities over debt repayment in the event of large-scale M&A or operational stress, resulting in debt leverage materially and durably above 2x. A possible stress scenario envisions the possibility of prolonged negative underlying script growth, possibly due to additional customer losses more severe than Fitch currently expects.

KEY ASSUMPTIONS

--Relatively flat script and top-line growth in 2015, with modest positive growth in 2016;

--Modest EBITDA margin expansion in 2015, resulting from gross margin compression offset by decreasing SG&A;

--Steady debt levels resulting in gross debt/EBITDA in the range of 1.8x-2.0x;

--Strong FCF in excess of $4.5 billion, mostly directed toward share repurchases in lieu of strategic M&A.

HIGHER LEVERAGE TARGET; EXPECTATION FOR STEADY DEBT DESPITE FCF

Management had indicated publicly that ESRX plans to operate with debt leverage around 2x going forward. This new target compares to a previous range of 1x - 2x, articulated up until around a year following the Medco-ESI merger. The firm's newfound scale and consistently strong cash generation do support incremental flexibility with respect to debt leverage, especially once integration and cost rationalization efforts are fully completed in 2015.

Importantly, Fitch believes ESRX remains committed to a solid IG rating and does not expect the firm to engage in activities that jeopardize the current 'BBB' ratings. Large M&A transactions are possible; though targets requiring debt-funding are not likely to be PBMs, due to ESRX's already very significant market position and the general non-existence of such targets of size. ESRX has proven its commitment to rapid de-leveraging following large deals.

FLAT SCRIPTS IN 2015 BETTER THAN 2014, BUT MAY REFLECT WEAKNESS

ESRX is expecting organic adjusted prescriptions to be flat to slightly down in 2015, despite favorable underlying industry tailwinds (increasing coverage, demographics, increased access to Hepatitis C treatments, and some key generic conversions). Fitch estimates modestly positive top-line growth of 1% in 2015.

In general, Fitch believes ESRX competitive strengths remain ahead of these players due to its much greater scale - leading to lower drug acquisition costs and greater rebates - and the combination of legacy ESI's focus on behavioral consumer science and legacy Medco's forte in clinical expertise. Some incremental share loss is possible over the next couple years, but Fitch expects ESRX to grow in the low-single digits, at least in line with the industry as a whole, over the medium- to longer-term.

Negative script growth in 2014 illustrated greater contract losses than Fitch had previously expected subsequent to the Medco deal and associated platform migrations. Fitch acknowledges the growing competitive threat of ESRX's much-smaller peers, including Catamaran, and especially given the announced merger between UnitedHealth's OptumRx and Catamaran.

SPECIALTY, GENERICS OFFER STRONG GROWTH PROSPECTS

ESRX and its peers will benefit from industry tailwinds over the medium-term. Key generic conversions, the continued high growth of specialty drugs (including very expensive Hepatitis C indications), and the expectation for biosimilars in 2015-2016 provide compelling growth drivers over the ratings horizon. PBMs' business models are such that they generally earn higher margins when their clients reduce costs, and each of the aforementioned areas offer opportunities for client cost reductions.

The growing specialty drug market in particular offers a compelling growth and margin expansion for ESRX and its peers. Very expensive Hepatitis C drugs have received a lot of press in recent months, particularly with respect to ESRX's actions to exclude Gilead's top-selling Sovaldi and Harvoni products from their national formularies in favor of Abbvie's Viekira Pak. Pricing pressure made possible by product competition, capitalized on by the largest PBMs, will drive increased patient access to these highly efficacious drugs in 2015.

MAIL STILL A PLATEAU, MEDIUM-TERM OPPORTUNITY

Fitch believes that mail-order pharmacy services could provide upside to current forecasts over the medium- to longer-term. Though currently plateaued at around 30%, home delivery utilization could rise as the growing numbers of retirees, who usually take a larger number of maintenance medicines, are increasingly tech-savvy. Mail-order services offer significant costs savings to PBMs and their clients, supporting the view that ESRX and its peers will drive increasing mail-order penetration over time.

Fitch has affirmed Express Scripts' ratings as follows:

Express Scripts Holding Company

--Long-term IDR at 'BBB';

--Unsecured bank facility at 'BBB';

--Unsecured notes at 'BBB'.

The Rating Outlook is Stable.

Express Scripts, Inc.

--Long-term IDR at 'BBB';

--Unsecured notes at 'BBB'.

The Rating Outlook is Stable.

Medco Health Solutions, Inc.

--Long-term IDR at 'BBB';

--Unsecured notes at 'BBB'.

The Rating Outlook is Stable.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014);

--'Fitch Rates Express Scripts' Proposed Bond Offering 'BBB'; Outlook Stable' (June 2, 2014);

--'2015 Outlook: U.S. Healthcare' (Dec. 4, 2014);

--'Navigating the Drug Channel: PBMs in Flux' (Mar. 27, 2012);

--'Trekking the Path to Biosimilars: The Destination' (Oct. 4, 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

2015 Outlook: U.S. Healthcare (The Value Debate Intensifies While Aggressive M&A Continues)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=824368

Navigating the Drug Channel: Pharmacy Benefit Managers (PBMs) in Flux

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=674982

Trekking the Path to Biosimilars -- The Destination

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=719802

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=982144

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