The ratings apply to approximately
KEY RATING DRIVERS
The Negative Outlook mainly reflects that leverage (total debt/EBITDA) has remained above 1.5 times (x) since Merck's
Fitch expects that Merck will continue to favor share repurchases over deleveraging, acknowledging the possibility of further debt-funded stock buybacks. Notably, the company has roughly
Sales at-risk to patent expiries have declined to roughly 20% of total firm sales. Roughly one-third of those sales are generated by biologics, which tend have significantly less market share erosion in the face of generic (biosimilar) than do traditional small molecule drugs.
Merck has made progress in building its late-stage pipeline. The company has approximately 20 new molecular entities (NMEs) in phase 3 development or registration.
Merck initiated a restructuring program in
Fitch believes the rumored sale of the company's consumer business would be strategically sound, as it would increase the company's focus on its core mission of developing and marketing innovative medicines. However, unless the company were to use some of the proceeds to pay down debt, the incremental loss of diversification and EBITDA would be incrementally negative for Merck's credit rating.
Fitch expects modest growth for Merck's Januvia/Janumet franchise, as the market becomes increasingly crowded with new entrants. Although, the growth in the number of diabetic patients and some share gains from older generic treatment modalities should offset the competitive headwind.
Fitch forecasts that Merck will generate
Debt Financed Share Repurchases
Fitch expects that Merck will continue with shareholder friendly actions during the near term, some of which may be funded by debt. Merck purchased
Patent Exposure Easing
The company faces significant number of patent expiries during the next two years. However, roughly only 20% of total firm sales are at risk. In addition, Remicade and PEG-Intron, which account for about 6.2% of total firm, are biologics and tend not to experience the rapid sales loss to generic competition as do traditiona, one small molecule pharmaceuticals.
Expanding Late Stage Pipeline
Fitch expects Merck to continue to build its late-stage pipeline, despite the company's intention to narrow its focus its focus on R&D projects. The company's late stage pipeline is broad with new molecular entities (NMEs) to treat cancer, bacterial and viral infections, diabetes, cardiovascular disease, central nervous system disorders, osteoporosis, allergies and other maladies.
While the majority of these projects are internally developed, Merck has partnered with other innovator firms to take advantage of technological advancements that were discovered externally. The landscape for drug development is expanding, particularly as more is learned about how genetics influence the development, prevention and treatment of disease.
Cost Cutting Continues
Merck will sell some real estate, move its corporate headquarters and continue to work towards improving the efficiency of its manufacturing and supply network. The restructuring program is expected to be substantially completed by the end of 2015. Estimated pre-tax restructuring costs are approximately
Consumer Business Possibly for Sale
Fitch believes the sale of Merck's consumer products business would be a net negative for the company's credit profile, with the expectation that the proceeds of the sales would not be used for debt reduction. While the consumer business accounts for roughly 4% of total firm sales, Fitch estimates the segment's contribution to the firm's total EBITDA is less than that. Regardless, we believe the negative effects of a less diversified product portfolio and a lower base of profitability will more than offset the benefits to the firm from increasing its focus on its core competency of drug development and marketing in the near term.
Fitch expects that the growing number of diabetic patients and continued market share gains from some older generic diabetes treatments will more than offset the increasing number of competitors in the diabetes treatment market, resulting in relatively soft sales growth for Januvia/Janumet, Merck's largest selling franchise. Growth has slowed in recent years due to competition (DPP-4 inhibitors, SGLT2 inhibitors, GLP-1 agonists) entering the diabetes market. In addition, concerns over the safety of these drugs(DPP-4 inhibitors) have been a headwind to growth, although the
Solid Free Cash Flow Expected
Fitch forecasts that Merck will continue to generate significantly positive free cash flow generate, including expected 2014 FCF of
Fitch looks for Merck to maintain adequate liquidity through strong FCF generation and ample access to the credit markets. FCF for the LTM ending
Fitch would consider revising the Rating Outlook to Stable if Merck pursued a capital deployment strategy that maintained gross debt leverage below 1.5X during the long term, including managing through operational stress such as patent expiries and clearly taking a more conservative approach to its use of debt. In addition, the company must demonstrate long-term positive sales growth through demand for core drug products and uptake of new medicines.
Rating pressure would stem from total debt leverage remaining above 1.5x in the intermediate term. The high leverage would likely be driven by incremental borrowing to fund acquisitions or share repurchases. Leverage pressure could also result from operational weakness due to an inability to achieve in achieving cost containment targets or generating sales growth despite is improving patent risk profile and expanding late-stage pipeline. In addition, Fitch anticipates that FCF would be constrained in this scenario.
Fitch has affirmed the follow ratings for Merck:
--Long-term Issuer Default Rating (IDR) at 'A+';
--Senior unsecured debt rating at 'A+';
--Bank loan rating at 'A+';
--Short-term IDR at 'F1';
--Commercial paper rating at 'F1'.
The Rating Outlook on the long-term ratings remains Negative.
Additional information is available at 'www.fitchratings.com'.
--'Corporate Rating Methodology' (
--'Rating Pharmaceutical Companies - Sector Credit Factors' (
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Rating Pharmaceutical Companies
Source: Fitch Ratings
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