Fitch Ratings has affirmed the Long- and Short-Term Issuer Default Ratings (IDRs) of AmerisourceBergen Corporation (ABC) at 'A-'/'F2'.
The Rating Outlook is Stable. The ratings apply to approximately $6.7 billion of debt outstanding as of Sept. 30, 2021.
The affirmation reflects ABC's consistent FCF generation and ample financial flexibility. The acquisition of Alliance Healthcare provides ABC with an extension of its core business in established and emerging markets, while also enhancing its scale and margin profile. Those benefits are somewhat offset by the incremental business and financial risks related to the Alliance Healthcare acquisition, but are expected to be managed closely by ABC's senior management.
Key Rating Drivers
Alliance Acquisition-A Good Start: ABC's acquisition of Alliance, which closed in June 2021 performed in line with Fitch's forecast for fiscal 2021 and is expected to continue to do so over the near term. The acquisition is expected to strengthen ABC's global platform of higher margin services to pharmaceutical manufacturers. In addition, the acquisition will result in an extension of the strategic and operational partnership between ABC and Walgreens Boots Alliance (WBA), which is expected to produce growth and efficiency through exclusive distribution agreements and deeper collaboration through sourcing and distribution logistics.
Leverage Picture: Fitch believes that ABC has demonstrated a commitment to deleveraging over the past two years and will maintain that commitment to achieve credit metrics consistent with the 'A-' IDR over the near to medium term with earnings growth and debt paydown. ABC has already reduced debt in fiscal 2021 greater than Fitch anticipated and is on track to reduce debt by another $2 billion over the next two fiscal years. During this period, Fitch anticipates that company may repurchase some shares or make 'tuck-in' acquisitions with FCF in excess of the amounts earmarked for debt reduction.
Stable Operations, Expanding Margins: ABC's credit profile benefits from a stable operating profile and consistent cash generation. Strong ratings are supported by steady pharmaceutical demand, an oligopolistic drug distribution industry in the U.S. and relative insulation from most drug pricing and regulatory pressures, despite very low reported margins. ABC's long-term relationship with WBA provides an added element of meaningful stability and growth. The addition of Alliance Healthcare and the growing contribution from World Courier and MWI Animal Health are expanding margins.
Unremarkable Pandemic Effects: ABC has navigated the increased operational and financial challenges presented by the coronavirus pandemic exceptionally well. ABC continues to report strong operating income growth driven by a portfolio of businesses, but especially from its specialty distribution operations. In addition, businesses like World Courier have been successful in providing its expertise to manufacturers needing solutions to problems created by the pandemic and MWI continues to experience strong growth in the companion animal market as consumers maintain their focus on their pet's health.
Solid Liquidity, Cash Generation: ABC maintains a solid liquidity position, supported by an expected CFO of approximately $2.4 billion and FCF of approximately $1.5 billion (after assumed opioid payments of $350 million) for fiscal 2022 and strong access to capital markets. Fitch notes that FCF can be affected by large working capital swings inherent to large healthcare distributors and potential future litigation settlements. Cash generation is expected to be sustained or grow because of the aforementioned growth opportunities, especially in its specialty distribution operations.
Customer Concentration: ABC's trade accounts receivables are exposed to credit risk. Revenue from the various agreements and arrangements with its largest customer in the fiscal year ended Sept. 30, 2021, WBA, accounted for approximately 31% of revenue and represented approximately 38% of accounts receivable (approximately $7 billion), net of incentives. Express Scripts, Inc., the second largest customer in the fiscal year ended Sept. 30, 2021, accounted for approximately 12% of revenue and represented approximately 6% of accounts receivable. Fitch notes that the allowances for returns and credit losses has remained relatively stable for the three years ended Sept. 30, 2021.
Close Alignment with WBA: Fitch views WBA as a long-term partner for ABC; in connection with the Alliance acquisition, WBA and ABC have announced a series of strategic initiatives designed to further integrate and align their relationship that is expected to focus on opportunities to further collaborate on sourcing, logistics and distribution. Examples include enhanced private label offerings, expanded Front of Store assortment for ABC and joint delivery operations. These initiatives are expected to produce additional meaningful EBITDA over the next five years.
Opioid Litigation: On July 21, 2021, ABC, McKesson Corporation and Cardinal Health, Inc. announced that they had negotiated a comprehensive proposed settlement agreement that, if all conditions are satisfied, would result in the resolution of a substantial majority of opioid lawsuits filed by state and local governmental entities. In connection with the litigation, ABC previously reported in its Form 10-K for fiscal year-end 2020 a pre-tax charge of $6.6 billion and recorded an additional $147.7 million charge in the fiscal year ended Sept. 30, 2021.
Fitch's believes that ABC has significant financial flexibility at its current rating level and, inclusive of the incremental debt related to the Alliance acquisition, to deal with the estimated opioid settlements. Early indication is that cash settlements will be paid over a period of years rather than as lump sums, which Fitch has assumed to be approximately $350 million per year. For purposes of forecasting financial data and credit metrics, Fitch treats the estimated payments as a reduction in EBITDA (and FCF), instead of explicitly incorporating the liability into ABC's debt metrics.
Derivation Summary
ABC's 'A-' Long-Term IDR reflects its solid position as one of the largest global pharmaceutical distributors, stable operating profile and consistent cash generation. Fitch believes that ABC will return gross leverage (total debt/operating EBITDA) to, or below 2.0x and FCF/debt to 20%, or higher over the medium term. Those strengths are somewhat offset by the business and financial risks of the Alliance acquisition, generic pharmaceutical pricing pressure, increased challenges related to the coronavirus pandemic, regulatory costs and the potential for material cash settlements tied to the opioid crisis.
The credit profiles of ABC and its peers, Cardinal Health (BBB/Stable) and McKesson Corp. (BBB+/Stable) benefit from secular trends, such as an aging U.S. population, increased use of generic prescription drugs and drug therapies. However, drug distributors face headwinds in the form of declining generic drug prices and slower brand drug inflation over the medium term. ABC has some customer concentration risk; its top two customers, WBA and Express Scripts, accounted for 31% and 12% of total consolidated revenues, respectively, for the fiscal year ended Sept. 30, 2021.
The 'F2' Short-Term IDR is supported by the company's solid financial flexibility, financial structure and operating environment. ABC enjoys a financial structure subfactor of 'a-' and a financial flexibility subfactor of 'a-'. However, its liquidity score on a pro forma basis after the completion of the Alliance acquisition is expected to constrain the short-term rating at the baseline level. ABC has a good operating environment of 'aa' given the primary locales in which it is expected to operate. All of these factors support the 'F2' short-term rating.
Key Assumptions
Fitch's Key Assumptions Within its Rating Case for the Issuer Include:
Top-line CAGR of approximately 5% over the forecast period supported by growth in sales of specialty products, COVID treatments and overall market growth principally driven by increased drug utilization trends. In addition, the pace of growth may vary depending on the increase in the number of generic and biosimilar therapies that will be available over the next few years and the rate of conversion from brand to generic drugs and biosimilars and the related price inflation or deflation in various drug categories.
Coronavirus pandemic continues to have relatively modest effects on business continuity and costs; consolidated EBITDA margins remain relatively stable and expand somewhat as a result of the addition of Alliance Healthcare and higher margin growth from MWI, specialty drugs and continued generic purchasing scale.
Additional collaborative activities between ABC and WBA are expected to enhance EBITDA over the forecast period;
Gross debt/EBITDA falls below 2.0x by fiscal year end 2023 with both repayment of debt and EBITDA growth;
Discretionary FCF and available cash are sufficient to repay debt over the next three fiscal years;
Capex of approximately $500 million per year over the forecast period;
Material litigation settlement payments of $350 per year; and
Fitch assumes ABC will repay debt maturities in 2022 and 2023 of at least $1 billion. Remaining capital is expected to increase cash balances that may be used for additional debt reduction, share repurchases, bolt-on M&A or increased common stock dividends.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Management commitment to operating with lower financial leverage compared to the recent past;
Total debt/operating EBITDA at or below 1.5x accompanied by increased profit margins;
FCF/ debt maintained at or above 25%.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
ABC is either unable or unwilling to sustain credit metrics for debt/EBITDA of 2.0x or lower and FCF/Debt of 20% or higher, respectively, by fiscal year end 2023 following its acquisition of Alliance;
Negative rating action could result from changes to the industry's competitive structure, caused by new entrants, heightened credit risk related to a key customer or higher than expected litigation costs.
In general, Fitch has tolerance for an issuer to remain above its negative rating sensitivity for an 18-24 month period after a leveraging event, assuming a commitment to a credible plan to reduce debt, which Fitch believes exists for the Alliance acquisition.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Good Liquidity: ABC has access to a large amount of internal liquidity, in addition to borrowing facilities in the form of revolving credit and accounts receivable securitization facilities. In addition, ABC has shown solid access to the capital markets through both the CP market and long-term debt sales.
Fitch notes that there was no CP outstanding at Sept. 30, 2021, but that intra-period borrowings can result in the use of material amounts of CP to cover working capital swings. In addition, ABC has access to a committed multicurrency revolving credit facility due November 2026 of $2.4 billion and a receivables securitization facility due November 2024 of $1.45 billion, $350 million of which was outstanding at Sept. 30, 2021.
ABC has a large pool of unrestricted cash as of Sept. 30, 2021 of approximately $2.5 billion. The balance of unrestricted cash is forecast to double by the end of the forecast period without any other material uses, such as debt repayment (including opioid liabilities), share repurchases or acquisitions.
Laddered Maturities: ABC has a flexible maturity schedule of long-term debt; FCF and available cash are expected to be sufficient to meet all maturities over the forecast horizon even after material litigation payments. Following the Alliance acquisition, ABC is expected to focus its capital deployment on debt reduction and pay down approximately $1.0 billion of debt in both fiscal years 2022 and 2023.
Issuer Profile
AmerisourceBergen is one of the largest global pharmaceutical sourcing and distribution services companies, helping both healthcare providers and pharmaceutical and biotech manufacturers improve patient access to products and enhance patient care.
Summary of Financial Adjustments
Fitch has adjusted historical and forecasted EBITDA to reflect an estimated charge for opioid litigation settlements and legal expenses; historical EBITDA has been adjusted to remove merger and integration expenses, restructuring costs, impairments, gains from anti-trust legal settlements and LIFO inventory related adjustments.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
AmerisourceBergen Corp. has an ESG Relevance Score of '4' for Customer Welfare - Fair Messaging, Privacy & Data Security due to its exposure to loss contingencies related to opioid litigation that affects U.S. pharmaceutical distributors, which has a negative impact on the credit profile, and is relevant to the rating[s] in conjunction with other factors.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
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