The ratings apply to approximately
KEY RATING DRIVERS
-- The oligopolistic nature of the U.S. drug distribution industry and steady pharmaceutical demand contribute to exceptionally stable operating profiles for Cardinal and its peers, excluding recent contract switches. Drug distribution, though low margin, is relatively insulated from pricing and regulatory pressures faced by other areas of healthcare in the U.S.
-- Margins and cash flows continue to benefit from the mostly durable effects of the generic wave, which is set to ramp up again in calendar 2014-2015. Cardinal's joint venture (JV) with CVS Caremark Corp. (CVS) and the anticipated introduction of biosimilar drugs to the U.S. drug channel should further support margins beginning in 2015-2016.
-- Overall industry trends, including brand-to-generic conversions, favorable drug pricing, and base business growth, are offsetting the Fitch-estimated
-- Cardinal's material underrepresentation in the specialty drug distribution space relative to its peers could hinder intermediate-term growth and profitability. The acquisition of
-- Fitch expects Cardinal to generate cash sufficient to fund operations, shareholder payouts, targeted M&A, and debt service. Solid liquidity is supported by relatively large available cash balances, and only
Maintenance of a 'BBB+' IDR will require debt leverage generally maintained below 1.7x, accompanied by continued robust cash flows and stable or growing margins over the ratings horizon (excluding the impact of the lost Walgreens contract). Liquidity should be adequate to fund targeted M&A that bolsters the firm's intermediate-term growth outlook; but there is currently limited room for additional long-term debt at the 'BBB+' ratings.
An upgrade to 'A-' is not anticipated in the intermediate term. Upward ratings migration could result from a demonstration of and commitment to operating with debt leverage below 1.2x-1.3x, combined with responsible M&A activity that contributes to an overall improved intermediate-term growth outlook. A sustained commitment to Cardinal's core distribution business will also be necessary to support the consideration of an upgrade.
A downgrade to 'BBB' could result from a leveraging transaction that causes debt leverage to increase to above 1.7x for materially more than 12-18 months. Debt-funded shareholder-friendly activities could also precipitate a negative rating action. The development of a material competitive gap between Cardinal and its peers, possibly arising from the firm's lagging position in specialty distribution, could also pressure ratings.
MODESTLY GROWING EBITDA DESPITE SIGNIFICANT CONTRACT LOSSES
Despite the very low-margin nature of the aforementioned contracts and the now decreased customer concentration, the removal of such a large amount of drug volumes is a moderate credit negative. Cardinal will no longer benefit from the operating stability and superior growth prospects generally associated with these drug channel participants. Furthermore, the removal of such a large amount of volumes will lessen Cardinal's ability to leverage the largely fixed cost structure inherent in drug distribution.
Fitch believes Cardinal has adjusted appropriately thus far and will continue to review and optimize its cost structure as it annualizes the Walgreens contract expiration so as to limit the credit impact of these developments.
INTERMEDIATE-TERM GROWTH CONCERNS; OFFSET SOMEWHAT BY MEDICAL STRATEGY
Fitch remains concerned about Cardinal's intermediate-term growth profile, primarily due to the company's significant under-representation in specialty drug distribution. Cardinal's lagging position in this important growth market could become more glaring after the bulk of the generic wave has washed through the channel and biosimilars begin to gain market acceptance in 2016 and beyond. Fitch is not convinced that Cardinal's current strategy will take a significant share of the specialty distribution market over the ratings horizon.
Fitch estimates AmerisourceBergen Corp. (ABC), McKesson Corp. (McKesson), and Cardinal control approximately 55%, 25%, and 5% of the specialty drug distribution (primarily to care providers) market in the U.S., respectively.
Cardinal's 2013 acquisition of
On balance, Fitch thinks Cardinal will pursue these opportunities responsibly and that most transactions will be funded with cash on hand. Success in this area could alleviate Fitch's intermediate-term growth concerns over time. Fitch views certain tenets of Cardinal's outlined strategy for growing its Medical segment cautiously though, depending on the pacing thereof. Specifically, Fitch is wary of new types of business risk that could accompany potential acquisition targets (i.e. product liability with manufacturing).
JV WITH CVS TO DRIVE COST SAVINGS; DIFFERENTIATED FROM PEERS
The 10-year joint venture Cardinal announced with CVS Caremark Corp. (CVS) in
The CVS/Cardinal JV will become the largest purchaser of generic drugs in the U.S., and the second-largest in the world. The JV is similar in principle to the other scale-aggregating deals executed over the last 12 months, though it lacks the equity ownership components of the other two. Fitch expects the benefits of increased scale to be recognized more or less in proportion to the purchasing power of each entity over the course of the next few years. The longer-term implications of the various degrees of business integration are at this time difficult to measure and predict.
GOOD LIQUIDITY, CASH FLOWS; MANAGEABLE DEBT MATURITIES
Fitch expects Cardinal's liquidity to remain strong over the ratings horizon, bolstered in the near term by a significant cash inflow from working capital associated with the expired WAG contract. Cash flows will remain robust, with annual free cash flow (FCF) forecasted to exceed
Debt maturities are manageable, with only
Fitch has affirmed Cardinal's ratings as follows:
-- Long-term IDR at 'BBB+';
-- Senior unsecured bank facility at 'BBB+';
-- Senior unsecured notes at 'BBB+';
-- Short-term IDR at 'F2';
-- Commercial paper at 'F2'.
Fitch has also assigned a long-term IDR of 'BBB+' to
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' (
--'U.S. Healthcare Stats Quarterly - Third-Quarter 2013' (
--'Trekking the Path to Biosimilars - The Destination' (
--'Vital Signs - Currents in the Drug Channel' (Podcast) (
--'Navigating the Drug Channel - Drug Distributors: A Deeper Dive' (
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
U.S. Healthcare Stats Quarterly -- Third-Quarter 2013
Trekking the Path to Biosimilars -- The Destination
Navigating the Drug Channel -- Drug Distributors: A Deeper Dive
Source: Fitch Ratings
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