CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed Merck & Co.'s (Merck) long-term ratings, including the Issuer Default Rating (IDR) at 'A+'. The Rating Outlook remains Negative. In addition, Fitch has affirmed the company's short-term ratings at 'F1'. A full list of rating actions follows at the end of this release.
The ratings apply to approximately $24.6 billion in outstanding debt.
KEY RATING DRIVERS
The Negative Outlook mainly reflects that leverage (total debt/EBITDA) has remained above 1.5 times (x) since Merck's $5 billion, largely debt-funded share repurchases in second-quarter of 2013. While leverage has declined to 1.65x from its peak of 1.92x at June 30, 2013, it remains higher than what Fitch would expect for an 'A+' credit rating for this issuer.
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 $10.4 billion remaining on its existing repurchase authorization.
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 October 2013, which Fitch expects will be supportive to margins during the intermediate term. The company will focus on costs in a number of areas including manufacturing, general administration and research & development.
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 $5.8 billion - $6.1 billion in FCF during 2014 as improving margins offset soft revenue.
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 $5.3 billion (net of issuances) of its common stock during 2013, compared to $1.3 billion during 2012. The repurchases were executed under a $15 billion program authorized in May 2013 and a previously authorized program. The company has approximately $10.4 billion remaining under the May 2013 share repurchase program. The repurchases were funded, in large part, with debt issuances.
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
In October 2013, Merck initiated a new global restructuring program, in an effort to sharpen its global commercial and research & development focus. The company expects to reduce its total workforce by approximately 8,500 positions, including those in sales, administration and research & development.
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 $2.5 billion - $3 billion, of which two-thirds will be cash-related.
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.
More Competition for Januvia/Janumet
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 FDA recently reaffirmed their safety regarding pancreatitis and pancreatic cancer.
Solid Free Cash Flow Expected
Fitch forecasts that Merck will continue to generate significantly positive free cash flow generate, including expected 2014 FCF of $5.8 billion - $6.1 in FCF during 2014. Improving margins driven by an improving sales mix and strong cost control should more than offset the negative effect that expected soft top-line growth will have on cash generation.
Adequate Liquidity
Fitch looks for Merck to maintain adequate liquidity through strong FCF generation and ample access to the credit markets. FCF for the LTM ending Dec. 31, 2013 was $8.35 billion. At the end of the period, Merck had approximately $17.5 billion in cash plus short-term investments and full availability on its $4 billion revolver, maturing in May 2017.
At Dec. 31, 2013, Merck had roughly $24.6 billion in debt outstanding, with $4.7 billion maturing in 2014, $2 billion in 2015, $2.3 billion in 2016 and $1 billion in 2017. Fitch expects near- to mid-term maturities will be satisfied primarily through refinancing in the public debt markets.
RATING SENSITIVITIES
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.
RATING ACTIONS
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'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 12, 2013);
--'Rating Pharmaceutical Companies - Sector Credit Factors' (Aug. 9, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139
Rating Pharmaceutical Companies
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684459
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=827681
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