News Column

Fitch Downgrades McKesson's L-T Rating to 'BBB+'; Outlook Negative

February 11, 2014

Fitch Ratings has downgraded the long-term ratings of McKesson Corp. (NYSE: MCK), including the long-term Issuer Default Rating (IDR), to 'BBB+' from 'A-'.

The Rating Outlook is Negative.

A full list of rating actions follows below.

The rating actions follow the close of MCK's agreements with Franz Haniel & Cie GmbH (Haniel) and Elliott Fund Management (Elliott) to acquire the firms' respective stock and convertible bond holdings of Celesio AG (Celesio). These transactions are valued at approximately EUR3.7 billion (US$5.1 billion).


-- MCK's acquisition of Celesio is strategically sound, though moderate event risk remains as to the subsequent steps in the acquisition process. Increased scale from the deal will allow MCK to drive cost savings, particularly related to generic drug sourcing, and future growth.

-- Fitch expects MCK's post-deal capital structure to include a materially increased amount of long-term debt. Pro forma debt-to- EBITDA could exceed 2.5x, but MCK's strong cash generating ability should allow for de-leveraging to around 2x by fiscal year-end 2016. Liquidity is expected to remain strong.

-- U.S. drug distributors maintain exceptionally stable operating profiles and consistent and strong cash generation, owing to steady pharmaceutical demand and generally oligopolistic markets. Margins and cash flows continue to benefit from the mostly durable effects of the unprecedented generic wave, which is set to ramp up again in calendar 2014.

-- Fitch sees the European drug channel as somewhat less stable and efficient, and generally higher risk, than the U.S. market due to increased competitive/regulatory pressures. MCK's acquisition of Celesio adds incremental but manageable business risk related to operating a new business line (retail pharmacy) and engaging new geographies (Europe, Brazil).

-- MCK holds top U.S. market positions in specialty drug distribution, medical-surgical distribution, and healthcare IT, as well as drug distribution in Canada. These businesses will support intermediate-term growth and profitability and, in addition to measured expansion in other non-U.S. markets, are likely to represent areas in which MCK will pursue future growth opportunities.


Maintenance of a 'BBB+' IDR will require MCK to direct sufficient cash flows toward debt repayment such that debt-to-EBITDA of 2x or below is achieved over the next 24-30 months. Long-term funding plans have not been made available, but Fitch expects MCK's significant cash generating ability, enhanced by the addition of Celesio in the intermediate term, to be sufficient to achieve this target. Fitch forecasts cumulative free cash flow (FCF; cash from operations minus capital expenditures minus dividends) to exceed $4.5 billion in fiscal 2015-2016 for the combined firm.

Ratings flexibility will be limited during the de-leveraging timeframe. Significant M&A activity or the resumption of large- scale share repurchases in the next 2-3 years could contribute to downward ratings pressure, to the extent that such actions restrict MCK's ability to repay debt maturities as they come due. The addition of more long-term debt than currently expected could also pressure the 'BBB+' ratings.

A positive rating action is not anticipated in the near-to- intermediate term.

The Negative Outlook represents the large amount of de- leveraging necessary to support the 'BBB+' ratings, plus uncertainty related to the longer-term post-deal capital structure. Furthermore, some event risk remains surrounding future acquisition-related transactions and processes. Significant setbacks in any of these areas requiring the use of material amounts cash or external financing could contribute to negative ratings pressure.


Fitch views the acquisition of Celesio by MCK as strategically sound, as it offers the potential for better buy-side drug pricing and additional growth opportunities outside the largely penetrated U.S. market. The realization of these benefits, however, is likely to take several years. Fitch sees relatively few financial synergies in the near term.

The combination of MCK and Celesio is differentiated from the scale-plays engaged by other drug channel participants. Both of MCK's competitors, AmerisourceBergen Corp. (ABC) and Cardinal Health, Inc. (Cardinal), have entered into drug purchasing joint ventures with other drug channel participants - ABC with Walgreen Co. and Alliance Boots GmbH, and Cardinal with CVS Caremark Corp. Thus, these firms must share the benefits of increased scale, namely buy-side cost savings on the purchase of generic drugs. Conversely, MCK will retain all the benefit of expected cost savings, but will also bear fully the risks associated therewith. The overall relative benefits of these differing globalization/scale-enhancing schemes cannot yet be ascertained and will take some time to be fully realized.


MCK and its peers in the drug distribution industry continue to exhibit exceptionally stable operations and financial performance. Despite still weak macroeconomic conditions and moderately decreased utilization of healthcare in the U.S., core business growth at MCK has remained largely in-step with or ahead of broader market growth. Organic long-range growth in the low-single digits is driven by consistent demand for pharmaceuticals and is realized relatively uniformly, given the largely oligopolistic market.

Fitch expects the U.S. drug distribution industry to maintain good operating stability. The industry's very slim margins make it an unlikely target for extra taxes and fees (like those recently imposed on the pharma and medical device sectors in the U.S.). Distributors excel in adding value to the drug channel through the supply chain management and other services they offer to both upstream and downstream customers.

The Celesio transaction will provide MCK with significant new exposure to the European drug distribution and pharmacy markets. Fitch sees the European drug channel as relatively less stable and efficient than that found in the U.S. Furthermore, Fitch believes risks related to drug pricing and reimbursement are greater for drug channel participants in Europe than in the U.S., especially given that regulatory and reimbursement constructs generally vary from country to country. The opportunity for increasing generic penetration in most markets could provide upside, however, over the ratings horizon.


MCK and its peers - both in the U.S. and in Europe - continue to benefit from the unprecedented wave of branded drug patent expirations in calendar 2012-2014. Most drug channel participants, including distributors, earn higher margins - though less revenues - on the sale of lower-cost generic drugs. Fitch believes much of the margin expansion MCK and its peers have achieved in recent years is durable.

Further margin growth is expected to benefit from the introduction of biosimilars to the U.S. drug channel, as well as from new branded biologic drugs, as the pace of traditional branded- to-generic conversions slows post-2015. Fitch believes biosimilars could represent an even more compelling margin expansion opportunity for drug distributors than traditional generics in the intermediate- to-longer term.


Traditional drug distribution in the U.S. is a consolidated industry characterized by steady growth in the low-single digits. Traditional drug distribution accounts for roughly 80 percent of MCK's overall revenues. The remaining 20 percent comes from the company's leading market positions in the distribution of specialty pharmaceuticals and of med-surg supplies, and in healthcare information technology (HIT). MCK is one of only a handful of companies with a significant share of these relatively fragmented markets.

As a result, Fitch believes MCK is uniquely positioned to benefit from growth opportunities related to its ancillary businesses as those markets grow and consolidate over time. To that end, Fitch expects MCK to continue consummating small, tuck-in acquisitions in especially the med-surg and HIT spaces.


MCK's stable margins, efficient operations, and good asset management contribute to stable and strong cash generation measures. Funds from operations (FFO) and FCF for the latest 12 months (LTM) period ended Dec. 31, 2013 were $3.1 billion and $2 billion, respectively. The firm's solid liquidity position also includes a $1.3 billion unsecured revolver due September 2016 and a $1.35 billion accounts receivable facility due November 2014. Cash on hand as of Dec. 31, 2013 was $2.4 billion ($1.5 billion held outside the U.S.).

Debt maturities are estimated as follows: $350 million for the remainder of fiscal 2014; $1.1 billion in 2016; $980 million in 2017 (including EUR 350 million of Celesio bonds); $1.2 billion in 2018 (including EUR 500 million of Celesio bonds), and $2.4 billion thereafter.

Fitch has downgraded the following ratings of MCK:

-- Long-term IDR to 'BBB+' from 'A-';

-- Unsecured bank facility to 'BBB+' from 'A-';

-- Unsecured senior notes to 'BBB+' from 'A-'.

Fitch has affirmed the following ratings of MCK:

-- Short-term IDR at 'F2';

-- Commercial paper at 'F2'.

The Rating Outlook is Negative.

Additional information is available at ''.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' (Aug. 5, 2013);

--'U.S. Healthcare Stats Quarterly - Third-Quarter 2013' (Jan 2,);

--'2014 Outlook: U.S. Healthcare - Secular Challenges Require a Compelling Value Proposition' (Nov. 25, 2013);

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

--'Vital Signs - Currents in the Drug Channel' (Podcast) (April 25, 2013);

--'Navigating the Drug Channel - Drug Distributors: A Deeper Dive' (April 24, 2013).

Applicable Criteria and Related Research:

U.S. Healthcare Stats Quarterly - Third-Quarter 2013

Additional information is available at ''.

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