October 24, 2017 / 4:25 PM / a year ago

Fitch Affirms Roche at 'AA'; Stable Outlook

(The following statement was released by the rating agency) LONDON, October 24 (Fitch) Fitch Ratings has affirmed Switzerland-based pharmaceutical company Roche Holding Ltd.'s Long-Term Issuer Default Rating (IDR) and senior unsecured debt rating at 'AA' with Stable Outlook. The Short-Term IDR has been affirmed at 'F1+'. A full list of rating actions is at the end of this commentary. The affirmation reflects Roche's industry-leading position in the global pharmaceutical industry, particularly in the high-margin oncology treatment and diagnostics sectors. Roche's drug pipeline is industry-leading in selected treatment areas, with a strong focus on biotech and innovation. Roche is currently focused on bringing its late-stage oncology pipeline to market, including combinations of treatments, which we expect to be a key growth driver for the group as it seeks to offset the loss of patents and an increase in competition for some of its key blockbuster drugs. We view Roche's strong focus on the growing but competitive field of oncology as constraining its business risk profile. Roche is diversifying into rare diseases and specialist treatments, but this will only develop over time. The ratings also reflect Roche's strong financial risk profile, underpinned by industry-leading margins and free cash-flow (FCF) generation, and moderate leverage. KEY RATING DRIVERS Strong, Stable Financial Profile: Roche's ratings reflect the group's conservative financial profile with funds from operations (FFO) adjusted net leverage forecast to remain at around 1.0x over our four-year rating horizon and FFO fixed charge cover exceeding 15x. These debt protection ratios support comfortably the 'AA' rating level and offer good financial flexibility. Despite the decline in FCF margins between 2013 and 2016 we expect steady profitability from mature drugs and controlled working capital, capex and dividend policy to drive FCF margins above 7.0% over the rating horizon. Innovation, Product Launches Drive Growth: Fitch's ratings assume that Roche will continue to generate revenue growth in the low single digits as new product launches offset headwinds from patent losses and increasing competition for some of Roche's existing blockbuster drugs. It has one of the strongest pipelines in the growing field of immuno-oncology (IO) with eight key read-outs expected over the next 12-18 months. Roche was not the first-to-market in the field of IO monotherapies, but we believe its broad research and combination options between its portfolio of new and existing drugs could create leading market positions in IO combination therapies. Softer Near-Term Profitability: Fitch assumes that Roche's profitability will be lower and affected by the changes in its drug portfolio. We expect margin pressure arising from biosimilar competition on existing drugs, which enjoy structurally high margins as they run at peak sales and benefit from economies of scale, as well as from investment in new launches to build up sales. Hence Fitch expects EBITDA margins will remain softer around 38% by end-2018 with our rating-case assumption of recovery towards by 40% relying on strong product launches, effective life-cycle management of existing off-patent drugs, as well as streamlining of the group's value chain and cost base. Positive Sector Trends, Increasing Value Focus: Fitch views fundamentals in the pharma and healthcare sectors as positive, with growing access to healthcare globally, an ageing population, an increase in chronic diseases, as well as innovation in specialist treatments. As a result, Fitch however also expects the focus on value in healthcare to increase, affecting industry growth and profitability. Pharma players will need to increasingly demonstrate the value of new treatments to payers in addition to medical efficacy. In our view, Roche has been at the forefront in discussing performance-based pricing models for new drugs, supported by its large amount of underlying performance data. Diagnostics Diversification: Fitch views Roche's diversification into diagnostics as a positive factor underpinning the company's strong business risk profile. This business has lower profitability and higher capital intensity than pharma, but it provides some diversity to earnings, emerging-market growth prospects, and R&D synergies with the pharmaceuticals division, focusing on developing drug personalisation. The division has experienced accelerated growth driven by new product launches and an increasing technology and IT content, offering data analytics and workflow solutions to its customers. DERIVATION SUMMARY Roche's rating of 'AA' remains well positioned in the Fitch rated global pharma universe, demonstrating similar size, financial leverage and debt service coverage ratios to its closest European peer Novartis ('AA'/Negative). Roche enjoys a stronger financial profile than Novartis, expressed by higher profitability and superior credit metrics, However, its business risk profile remains less diversified, owing to is predominant focus on innovative pharma, and within this segment on oncology as its dominant treatment area. The narrower focus of its business risk profile is counterbalanced by the strong scientific content of its treatments - Roche is the leading pharma biotech company in Europe - as well as its market-leading position in oncology treatments, which are near-term growth drivers in the pharma industry. Sanofi SA (AA-/Negative) is smaller in size and diversified into more mature treatment areas such as diabetes, and consumer health with further strategic activity expected. The one notch rating differential between Roche and Sanofi is also supported by its more conservative financial profile. Other global peers such as the UK's AstraZeneca (A-/Negative), GSK (A/Stable), Pfizer (A+/Negative) and Merck & Co (A/Stable) of the US, are differentiated by size, business model, profit margins and - most importantly - financial leverage, with all of these entities in the 'A' rating category having FFO net adjusted leverage above 2.0x against Roche's projected level of around 1.0x. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - group sales in 2017 expected to grow around 5%, followed by more modest growth assumptions of 2.5% pa to the end of the rating horizon in 2020; - softer EBITDA margins projected in the near term due to new drug launches, increasing biosimilar competition and greater price sensitivity resulting in 38% margin floor (by end-2018) moving towards 39% in FY20, supported by innovation and restructuring; - R&D expense modelled at around 20% of sales to support the large late-stage pipeline; - moderate working-capital absorption despite the new product launches; - annual capex at around 9.0% of sales; - annual bolt-on acquisition basket of CHF2.0 billion with larger M&A treated as event risk; - up to CHF1.5 billion of annual share buybacks (Fitch's modelling assumption). RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action As Roche's business risk currently undergoes structural changes as new oncology treatments are currently introduced to the market, we do not expect a rating upgrade in the near-future. However, future developments that could lead to positive rating action in future include: - increased product diversification, reducing Roche's reliance on oncology - sustained industry-leading profitability and cash-flow generation - commitment to financial ratios in line with a higher rating, for example FFO adjusted net leverage no greater than 0.5x and/or FFO fixed charge cover above 20x on a sustained basis Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Significant pipeline setbacks and negative clinical trial results, leading to continuing erosion of sales and profitability - FCF margin under 5% on a sustained basis - Major debt-financed acquisition or share buybacks, or steady operating underperformance resulting in FFO adjusted net leverage above 1.5x on a sustained basis -FFO fixed charge cover below 10x LIQUIDITY Strong Liquidity: Roche's liquidity profile as of half-year 2017 comprised readily available cash of CHF5.1 billion (Fitch defined and adjusted by CHF1.8 billion for restricted cash, investments with maturities between three and 12 months and intra-year working-capital swings), sufficiently covering short-term maturities of CHF4.4 billion. Roche also has access to a USD7.5 billion CP programme (of which CHF1.9 billion was utilised at mid-2017), supported by a committed USD7.5 billion bank facility as an undrawn back-up. This strong liquidity profile underpins the 'F1+' Short-Term IDR. FULL LIST OF RATING ACTIONS Roche Holding Ltd. Long-Term IDR: affirmed at 'AA'; Stable Outlook Senior unsecured debt: affirmed at 'AA' Short-Term IDR: affirmed at 'F1+' Roche Holdings Inc. Senior unsecured debt: affirmed at 'AA' Roche Finance Europe BV. Senior unsecured debt: affirmed at 'AA' Contact: Principal Analyst Xavier Taule Flores Analyst +34 93492 9513 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: Adrian Simpson, London, Tel: +44 203 530 1010, Email: adrian.simpson@fitchratings.com. Summary of Financial Statement Adjustments - Fitch has adjusted the debt by adding 8x annual operating lease expense related to an estimate of long-term assets of CHF281 million in 2016. Despite being based in Switzerland, the lease capitalisation multiple of 8x reflects Roche's asset base spread in various countries. Reported cash and cash equivalents have been adjusted by CHF1.8 billion to reflect restricted cash, cash invested between three and 12 months as well intra-year working-capital swings. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. 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