Overview -- Switzerland-based pharmaceuticals and diagnostics group Roche Holding AG continues to display strong operating performance. -- We believe the group's financial policy has become more conservative because it has no large M&A ambitions. -- We are raising our long-term corporate credit rating on Roche to 'AA' from 'AA-' and are affirming the 'A-1+' short-term rating. -- The stable outlook reflects our view that the group's future performance will enable speedy deleveraging, aided by a supportive financial policy. Rating Action On Sept. 17, 2012, Standard & Poor's Ratings Services raised its long-term corporate credit rating on Switzerland-based pharmaceuticals and diagnostics group Roche Holding AG (Roche) to 'AA' from 'AA-'. At the same time, the 'A-1+' short-term rating was affirmed. The outlook is stable. Rationale The upgrade reflects that Roche has transitioned into the credit metrics compatible with higher ratings. The group has achieved continuous strong free cash flow generation, based on a portfolio of mature and growing products, basically not threatened by near-time patent expiries. Furthermore, the group's business profile is reinforced in our view by its continuing strong global lead in the oncology segment and by its promising late-stage pipeline also consisting of potentially meaningful non-oncology compounds. It also reflects our perception of management's more conservative financial policy following the Genentech minorities' buyout for $47 billion in 2009. Total financial debt was Swiss franc (CHF) 26.5 billion ($27.8 billion) on June 30, 2012. With its portfolio of leading oncology drugs and seven blockbuster drugs in total, thereof three drugs generating more than CHF5 billion in annual revenues, Roche's excellent business risk position becomes evident. Consequently, EBITDA margins in the pharmaceutical division rose to 48% in 2012, from 47% a year ago, and to almost 43% on a group level--including the weaker-margin diagnostics division--from about 42% in 2011. These are excellent results in a peer group context, which should not be significantly threatened in the near future, thanks to Roche's superior patent expiry profile relative to its peers. Our comparatively robust revenue growth assumption of about 4% for the group's pharmaceuticals division is mainly based on this. In addition, we believe Roche will likely be able to generate positive sales growth in the wider future, also as a result of innovative drugs launched in the past, such as Lucentis (against macular degeneration) or with respect to its well-filled pipeline. We view management's financial policy now as having become more conservative than in earlier years, such as in 2009, which culminated in the large-scale Genentech transaction. Meanwhile, Roche's credit metrics have recovered and we understand it is unlikely that large mergers and acquisitions will be undertaken within our two-year ratings horizon. Coupled with a relatively modest dividend allocation and no share buybacks, Roche's discretionary cash flow is stronger than that of most of its peers, which generally make use of both shareholder remuneration instruments. Thus, based on the group's ample free cash generation of more than CHF10 billion annually, we believe Roche can deleverage relatively speedily over the next couple of years. Liquidity The short-term rating is 'A-1+'. We view Roche's liquidity as "strong" under our criteria and calculate that liquidity sources should exceed liquidity needs by a factor of 1.8x over the next 12 months. On June 30, 2012, the group had more than CHF7 billion in available cash and marketable securities, stripping out about CHF2 billion to account for restricted cash elements, thereby comfortably exceeding short-term maturities of only CHF5.4 billion at the same date. In addition, the group had undrawn committed credit lines exceeding EUR3 billion at the end of June 2012. Furthermore, the group's strong liquidity profile is also supported by Roche's having achieved free operating cash flow before acquisitions and dividends of almost CHF10 billion in the last 12 months to June 30, 2012, which is about the same level as in 2010, and compares well against peers. Outlook The stable outlook reflects Roche's well entrenched market positions, both in pharmaceuticals and diagnostics. It also reflects our expectation that the group will predominantly use its enhanced free cash flow-generating capabilities for debt reduction in 2012 and beyond. We therefore expect management to abstain from large debt-funded acquisitions. We consider a sustainable pension-adjusted funds from operations-to-net-debt ratio of 60% and rising further to be consistent with the current ratings. Moreover, the ratings provide some flexibility for potential midsize acquisitions. We would consider a positive rating action if Roche were to achieve a nearly net cash position and demonstrate a sustainable commitment to a financial policy commensurate with a higher rating. Conversely, a large debt-funded acquisition could trigger a downgrade. Related Criteria And Research All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated. -- Key Credit Factors: Business And Financial Risks In The Global Pharmaceutical Industry, Jan. 22, 2009 -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Upgraded; Ratings Affirmed To From Roche Holding AG Corporate Credit Rating AA/Stable/A-1+ AA-/Stable/A-1+ Genentech Inc. Corporate Credit Rating AA/Stable/NR AA-/Stable/NR Senior Unsecured AA AA- Upgraded To From Roche Finance Europe B.V. Senior Unsecured(2) AA AA- Roche Holdings Inc. Senior Unsecured(2) AA AA- Roche Kapitalmarkt AG Senior Unsecured AA AA- 1 issue(1) 3 issues(2) (1)Guaranteed by Roche Holding AG (2)Guaranteed by Roche Holding Ltd. 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