NEW YORK–(BUSINESS WIRE)–Fitch Ratings has affirmed the ratings of McKesson Corp. (McKesson) and removed them from Rating Watch Negative as follows upon the Dec. 30 close of the US Oncology, Inc. (US Oncology) transaction:
–Issuer Default Rating (IDR) at ‘A-‘;
–Short-term IDR at ‘F2’;
–Commercial Paper at ‘F2’;
–Senior Unsecured Bank Facility at ‘A-‘;
–Senior Unsecured Notes at ‘A-‘.
Additionally, a rating of ‘A-‘ has been assigned to the company’s new short-term bridge facility. The proceeds from this facility, when drawn, are expected be used to fund a portion of the approximately $1.79 billion aggregate redemption payment for the notes currently outstanding at US Oncology Holding, Inc. and US Oncology, Inc. Consolidated debt at US Oncology as of Sept. 30, 2010 totaled approximately $1.62 billion.
The ratings apply to approximately $2.28 billion of debt at Sept. 30, 2010. The Rating Outlook is Stable.
The ratings reflect McKesson’s strong cash flow profile, stable operations, and appropriately low but stable margins, as well as the company’s position as the most diversified of the three largest drug distributors in the U.S. Fitch expects that McKesson and its drug distributor peers will benefit from increased profitability due to the large amount of U.S. branded pharmaceutical sales affected by the loss of patent protection over the next few years; that the company’s technology business will benefit from increased hospital capital spending in 2011-2012; and that there exists the potential for meaningful cost synergies and cross-selling opportunities associated with the successful integration of US Oncology. Furthermore, Fitch expects McKesson to continue demonstrating solid operational performance and to maintain strong liquidity measures over the rating horizon.
Rating concerns center on the integration risk and increased debt leverage associated with the US Oncology acquisition, as well as recent weakness in hospital capital spending and overall patient utilization.
In terms of debt leverage, measured as debt-to-EBITDA, Fitch believes the upper end of McKesson’s current ‘A-‘ rating category is approximately 1.2x-1.3x. Fitch anticipates that McKesson will operate in or near this range on a pro forma basis over the next 12-18 months, with moderate deleveraging occurring as a result of incremental EBITDA growth over the ratings horizon. Margin stability, illustrated by variability of fewer than 50 basis points, and material free cash flow generation continue to be viewed by Fitch as acceptable for McKesson’s current rating.
US Oncology Acquisition:
Fitch views the businesses of US Oncology and McKesson as generally complementary in nature and, as such, views the transaction as strategically sound. McKesson’s purchase of US Oncology improves the company’s share of the higher-growth, higher-margin, and somewhat fragmented specialty drug distribution market and further diversifies the company’s drug distribution business following the purchase of Oncology Therapeutics Network (OTN) in 2007. Fitch expects that the successful integration of US Oncology will allow McKesson to cross-sell legacy US Oncology’s and McKesson’s products and services more broadly, and that the combined company will be able to drive cost synergies through improving efficiencies and combining operations. As a result, Fitch expects the transaction to provide margin support for McKesson and the opportunity for future growth in the oncology drug distribution market.
Potential for Margin Expansion from Branded Drug Patent Expiries:
Over the next two years it is expected that approximately $40 billion worth of U.S. pharmaceutical sales will lose patent protection. Although top-line growth for drug distributors will likely be hampered by the conversion of a large portion of these branded drug sales to generic, Fitch expects generic substitution to contribute to stable to moderately improving margins for McKesson over the next two to three years.
Expected Growth in Hospital Capex:
Fitch expects McKesson’s technology segment to benefit from moderate growth in hospital capital spending as patient utilization of healthcare improves with the slow macroeconomic recovery. This segment could also see growth related to the expectation that healthcare providers will likely begin taking advantage of the Medicare and Medicaid Electronic Health Record (EHR) Incentives Program through the implementation of new EHR systems and the purchase of related products and services over the next couple of years. Although the technology segment has historically accounted for only approximately 3% of McKesson’s overall sales, growth in this higher-margin business should aid in supporting margins and increasing overall profitability.
Solid Liquidity and Strong Cash Flows Expected:
Fitch expects McKesson to maintain strong liquidity measures subsequent to its purchase of US Oncology, for which $415 million of cash was paid upfront. Liquidity is provided by a Fitch-estimated pro forma cash balance of $2-$3 billion, in addition to full availability under McKesson’s commercial paper program backed by its $1.3 billion bank facility maturing in June 2012 and full availability on its $1.35 billion receivables facility maturing in May 2011, as of Sept. 30, 2010. Additionally, strong operational cash flows, a modest dividend, and manageable capex requirements should drive solid FCF generation (defined as cash from operations minus capex minus dividends) of $1.3 billion-$1.5 billion for McKesson’s fiscal 2011 (ending March 31). Debt maturities, as of Sept. 30, 2010, and not including the debt held by US Oncology or the new bridge facility, were as follows: $400 million maturing in 2012, $500 million in 2013, $350 million in 2014, and approximately $1 billion thereafter.
Additional information is available at www.fitchratings.com.
Applicable Criteria and Related Research:
–‘Healthcare Stats Quarterly-Third Quarter 2010’ (Dec. 14, 2010)
–‘Corporate Rating Methodology’ (Aug. 16, 2010)
Applicable Criteria and Related Research:
Healthcare Stats Quarterly — Third-Quarter 2010
Corporate Rating Methodology