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Fitch Affirms Astrazeneca at 'A'; Stable Outlook
February 22, 2017 / 5:19 PM / 9 months ago

Fitch Affirms Astrazeneca at 'A'; Stable Outlook

(The following statement was released by the rating agency) LONDON, February 22 (Fitch) Fitch Rating has affirmed UK-based pharmaceutical company AstraZeneca PLC's (AZ) Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'A'. The Outlook is Stable. The rating remains underpinned by AZ's leading position in the global pharmaceutical sector, supported by a business risk profile characterised by scale, diversification, and focus on innovation. The group is accelerating the development of new treatments to counterbalance growing competition from generic drugs. As a result rating headroom is limited during the group's transformation phase. The Stable Outlook, however, reflects our expectation that the introduction of new treatments, particularly in the field of immuno-oncology, will return the company to growth over the next 18 months with restructuring aiding profitability and cash generation thus translating into mildly positive financial trends over 2017-2018. KEY RATING DRIVERS Limited Rating Headroom: We view the near-term financial profile of AZ as stretched compared with our rating sensitivities due to current pressures from intensifying generic competition, investment in its R&D base and front-loaded restructuring costs to protect profitability. Following the earnings diluting acquisitions of ZS Pharma and Acerta, we view financial leverage as temporarily not aligned with the 'A' IDR with funds from operations (FFO)-adjusted net leverage peaking at 3.4x at end-16 (2.6x in 2015), breaching our negative guideline of 3x. FFO fixed charge cover also dropped below the 6x negative guideline to 4.9x in 2016 from 6.4x in 2015. Growth, Margin Enhancement from 2018: Fitch expects financial metrics to remain stretched in 2017, which we view as a key transitional year to advance new treatments and of cost-cutting measures. This should support a return to growth, driving an improvement of financial metrics relative to rating sensitivities. Failure or delay to return the company towards profitable growth by 2018, as assumed in our rating case, will put pressure on the ratings and outlook in the absence of further capital preservation measures to protect its financial structure. Weak FCF Generation: Fitch's rating case assumes a prolonged period of negative free cash flow (FCF) generation to 2019 as a result of AZ's currently elevated investment levels and softer sales and profitability. Therefore restoring revenue growth is key to achieving the projected deleveraging and bringing debt protection levels back within our guidance for the rating. Additionally licensing and disposal of non-core drugs, subsidising some of the investments and restructuring will provide management with flexibility to manage this financial transition period. Patent Expiries Pressure Top Line: Fitch-defined 'sales-at-risk' from US, EU, Japan and China patent expiries up to end-2019 increased to 45% of 2016 sales (from 34% in 2015) and we view AZ as the European pharmaceutical company most exposed to generic competition in the Fitch-rated universe. AZ is, however, similarly affected by patent expiry as some of its US peers - AbbVie Inc, Amgen, BMS or Eli Lilly - with respective sales-at-risk of around 77%, 22%, 30% and 37% to end-2017. This demonstrates the increased near-term risk and volatility attached to the pharmaceuticals industry as it brings next-generation treatments to the market. Restructuring Easing Margin Pressures: During 2016, the company continued to expand its restructuring initiatives leading to further cash restructuring charges estimated by Fitch at USD1.5 billion p.a. over the next two years. AZ is targeting R&D site footprint changes to align with globally recognised bio-science clusters and further restructuring of SG&A activities. This should allow EBITDAR margin to grow above 30% beyond 2017, which would be healthy for the rating. Accelerating Investments: AZ's cash flow is being affected by significant upfront investments to facilitate the company's growth plans. In addition AZ's capex remains elevated (plateauing at 10.1% of total product sales in 2016) as the group continues to invest in its Cambridge headquarters and modernise its manufacturing sites with a focus on biologic agents. M&A to Bolster Science Base: Fitch views AZ's recent debt-funded acquisitions as being in line with the group strategic priorities to return to profitable growth from 2018, but which will add to near-term earnings erosion and stretch the financial profile. Recent transactions included ZS Pharma (for USD2.7 billion) to strengthen the respiratory drug pipeline, as well as a 55% stake in Acerta (USD1.5 billion payment deferred to 2018). Regulatory and Political Uncertainties Increasing: Fitch expects the focus on value in healthcare to increase as the debate over drug pricing intensifies. Healthcare costs have played a significant role in the recent US presidential election, and political uncertainty around healthcare funding is growing under the new US administration, in turn increasing political and regulatory risk in the sector. In Europe, the UK's decision to leave the EU could disrupt the strong UK life science sector. DERIVATION SUMMARY Following AZ's downgrade to 'A' in December 2015 from 'A+' reflecting elevated business and financial risks resulting from the acceleration of investments in AZ's science base, at a time of growing near-term top-line pressures associated with the loss of patents on key drugs, sales-at-risk from patent expiries and FCF margins are therefore below the standards of 'A' rated peers. In addition FFO adjusted net leverage and FFO fixed charge cover are temporarily below 'A' rated peers. However, size and market position is aligned with 'AA' peers while R&D product pipeline is showing a positive trajectory at the current rating level. KEY ASSUMPTIONS Fitch's expectations are based on the agency's internally produced, conservative rating case forecasts. They do not represent the forecasts of rated issuers, individually, or in aggregate. Key Fitch forecast assumptions include: -Top line expected to contract around 6% in 2017, driven by growing competition from generic key drugs (Nexium, Crestor, Symbicourt, and Seroquel), before growth resumes from 2018 as pipeline launches overcome compensate generic competition, in addition to growth from licensing revenues; -Licensing revenues peaking at USD2 billion p.a. in 2017-18 before easing to USD1.5 billion in 2019-2020; -EBITDA-margin to bottom out at around 29% before gradually recovering towards 35% over the next four years; -R&D spend peaking at around 26% of sales in 2017 before gradually easing towards 22% over the next four years; -Continued focus on working capital leading to an assumed inflow of USD500 million inflow p.a; -Investment in the business with capex (associated with investment in manufacturing sites and development of the Cambridge headquarters) remaining high at 10% of sales in 2017 before gradually reducing to 5%, which we consider as a more sustainable level; -Cash restructuring of around USD1.5 billion p.a. over 2017-18 and USD1 billion p.a. over 2019-2020; -Disposal of product rights of USD3.7 billion in 2017 and USD3 billion in 2018 before gradually easing; no strategic or bolt-on acquisition expected; -ZS Pharma acquisition (USD2.7 billion) completed in 2016; Acerta majority stake cash outflow USD2.5 billion in 2016 and USD1.5 billion in 2018; the additional option to acquire full control for USD3 billion is conservatively expected to be exercised by 2020; -Lower cash taxes in 2016 considered exceptional due to transfer pricing arrangements between Canadian, British and Swedish tax authorities; -Unchanged dividends in line with 2015 levels. -No share buy backs factored into our forecasts. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -Failure to mitigate near-term top-line erosion with new product developments and to return to growth path as per guidance, leading to further pressure on the business risk profile. -Major debt-financed acquisitions or higher-than-expected shareholder distributions resulting in FFO-adjusted net leverage above 3.0x or FFO fixed charge cover of below 6x on a sustained basis. Future Developments That May, Individually or Collectively, Lead to Positive Rating Action -Successful product launches supporting revenue growth and restoring EBITDA margin comfortably above 30%, supporting positive FCF generation and leading to FFO adjusted net leverage trending around 2.0x and FFO fixed charge cover comfortably above 8x on a sustained basis. LIQUIDITY Adequate Liquidity: Fitch assesses AZ's liquidity as adequate with readily available cash at USD4.5 billion at end-2016 (as defined by Fitch after assuming USD500 million restricted/non-readily available cash) and undrawn committed term bank facilities of USD3 billion maturing in 2020, which are not subject to financial covenants. Existing liquidity is more than sufficient to cover near-term maturities of USD2.3 billion in 2017. Contact: Principal Analyst Quentin Dumouilla Analyst +44 20 3530 1790 Supervisory Analyst Frank Orthbandt Director +44 20 3530 1037 Fitch London 30 North Colonnade London E14 5GN Committee Chairperson Pablo Mazzini Senior Director +44 20 3530 1021 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: Summary of Financial Statement Adjustments - Fitch adjusts for leases capitalised applying a capitalisation factor of 8.0x to arrive at a debt-equivalent figure for the computation of leverage metrics. 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