Fitch: McKesson's 'BBB+' Ratings Unchanged On Rexall, Oncology Acquisitions

CHICAGO--(BUSINESS WIRE)--

The ratings for McKesson Corp. MCK, including the 'BBB+' Long-term Issuer Default Rating (IDR), are unchanged by the firm's recently announced acquisitions of the Canadian drugstore chain Rexall Health for approximately CAD 3 billion ($2.2 billion), and Vantage Oncology LLC (Vantage Oncology) and Biologics, Inc. (Biologics) for $1.2 billion.

A full list of ratings, which apply to outstanding debt of approximately $8.1 billion at Dec. 31, 2015 (net of $600 million of notes which matured March 1, 2016), follows at the end of this release.

DEALS FUNDED IN LINE WITH CURRENT RATINGS

Fitch expects these transactions, as well as the closing of MCK's acquisition of UDG Healthcare, to be funded in a manner that is consistent with the current 'BBB+' Long-term and 'F2' Short-term ratings. The need for incremental debt issuance will be limited by the use of cash balances held both in and outside the U.S., supported by strong FCF approaching $2.4 billion in fiscal 2016. Pro forma gross debt/EBITDA is not expected to exceed 2x for more than a short period of time.

TRANSACTIONS STRATEGICALLY SOUND, BUT NOT WITHOUT SOME CONCERNS

MCK's recently announced M&A is supportive of the firm's strategic positioning, particularly in light of recently negative pharmaceutical distribution contract developments due to customer M&A. The acquisition of Rexall in particular will provide overall margin support and help to offset some of the profitability volumes lost in calendar 2015 (Omnicare, Target) and expected to be lost in calendar 2017 (Rite Aid). The deal also further solidifies MCK's leadership position in pharmaceutical distribution and pharmacy services in Canada.

Fitch also notes the long-term significance of MCK's building position in oncology and other specialty distribution and provider services. The acquisitions of Vantage Oncology and Biologics should support MCK's US Oncology and other specialty pharmaceutical distribution and services business, bolstering an already strong source of longer-term growth and margin support. Fitch agrees with many industry participants that forecast specialty pharmaceuticals and the support services associated therewith to represent some of the fastest-growing areas of healthcare over the medium- to longer-term.

However, Fitch notes that MCK's ownership of one of the largest pharmacy chains in Canada and a large specialty pharmacy in the U.S. could create at least the appearance of competitive conflicts of interest among MCK and its other pharmacy customers. Historically, pharmaceutical wholesalers and pharmacies have not shared ownership interests, and MCK management has stated publicly that it would not seek to compete directly with its customers. That said, this concern may prove unfounded over the medium-term, particularly in light of the oligopolistic nature of pharmaceutical distribution in the U.S. and Canada, the trend toward consolidation in virtually every area of the pharmaceutical supply channel (the Canadian market is already more vertically integrated than the U.S. market), and the fact that the largest pharmacy chains are today owned by the largest pharmaceutical wholesalers in Europe.

MCK's ownership of pharmacies in North America furthermore follows the precedent being set by other recent industry developments, including the ownership of AmerisourceBergen Corp. ABC by Walgreens Boots Alliance Corp. WBA that is expected to grow into the mid- to high-20% range over calendar 2016 - 2017.

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 Canada, 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.

De-leveraging Complete Post-Celesio: Fitch expects MCK to complete its post-Celesio de-leveraging in fiscal 2016, with the repayment of its $600 million of notes due March 2016. Cash flows are expected to outpace debt maturities, but further debt repayment is not expected, resulting in gross debt/EBITDA between 1.7x and 2.0x over the ratings horizon.

Weakened Competitive Positioning: MCK's competitive positioning will become somewhat weakened following key transactions involving four of its largest customers in calendar 2015 (Rite Aid, Omnicare, Target, OptumRx). This weakened positioning is most evident in MCK's generic pharmaceutical sourcing scale, which Fitch expects will lag that of both Walgreens-AmerisourceBergen and CVS Health-Cardinal Health, but still among the strongest in the world.

Non-US Operations More Risky: Fitch generally sees the European drug channel as less stable and higher risk than in the U.S., especially given the diversity of its 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 margins. Cash flows and liquidity are strong for the rating category. However, ratings flexibility with respect to debt leverage will be limited in fiscal 2017 and into 2018, depending on the pace of EBITDA growth associated with acquired businesses and the use of cash flows for debt repayment, if any.

Negative rating actions are not expected to explicitly result from recent shifts in the industry's competitive landscape, namely M&A among MCK's largest customers resulting in key contract losses/revisions, though margins could be pressured compared to peers. A downgrade to 'BBB' could be driven by additional material debt-funded acquisitions or share repurchases, operational or integration-related snafus, or more significant margin pressures than currently expected.

A positive rating action is not currently anticipated over the ratings horizon, as Fitch does not expect MCK to reduce gross debt/EBITDA to 1.4x or below.

STRONG LIQUIDITY POSITION

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. Management also seeks to keep ample cash on hand for day-to-day operations. Access to external liquidity is adequate.

Non-controlling owners have the right to put their Celesio stock to McKesson at EUR 22.99, per the German courts. The maximum redemption value of these put options at Sept. 30, 2015 was $1.26 billion, meaning MCK could be required to pay up to $1.26 billion to acquire the remaining 24% of Celesio at any time, as directed by non-controlling shareholders. Although this risk remains, it is mitigated by McKesson's rebuilt liquidity position and the low probability that a large portion of the non-controlling shareholders would put their stock simultaneously.

Debt maturities are well-laddered and manageable, with no more than $1.6 billion due in any one year (2017). FCF is expected to routinely outpace debt maturities, leaving flexibility for M&A or share repurchase activity. However, this flexibility will be limited in fiscal 2017 and possibly into 2018 because of recently announced M&A transactions. Fitch expects debt maturities to be refinanced, including by the issuance of non-US debt obligations, from fiscal 2017 onward.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for MCK include:

--Revenues up in the low-single digits in 2016-2017, owing to the expanded contracts with Rite Aid and Albertsons, solid growth in specialty, and stability in med-surg, offset by currency headwinds at Celesio and lost business (OptumRx, Omnicare generics, Target generics). Acquired businesses are expected to contribute growth rates that exceed those of MCK's underlying pharmaceutical distribution business.

--Modest overall margin pressures in fiscal 2016-2017 from lost generic distribution contracts and less opportunity from generic price appreciation spreads, offset in part by the acquisition of higher-margin businesses in fiscal 2017.

--FCF approaching $2.4 billion in 2016 and at least $2.5 billion, depending on working capital dynamics, in fiscal 2017. FCF is expected to be utilized primarily for M&A, with remaining discretionary cash flows used for share repurchases. Most debt is expected to be refinanced upon maturity.

--Fitch forecasts assume MCK continues serving Rite Aid under the recently expanded distribution contract through MCK's fiscal 2017.

Fitch rates McKesson Corp. as follows:

--Long-term IDR 'BBB+';

--Short-term IDR 'F2';

--Senior unsecured bank facility 'BBB+';

--Senior unsecured notes 'BBB+';

--Commercial paper 'F2'.

The Rating Outlook is Stable.

Date of Relevant Rating Committee: 20 January 2016

Additional information is available on www.fitchratings.com

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