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Fitch Rates Johnson & Johnson's Notes Offering 'AAA'; Outlook Stable
February 28, 2017 / 4:41 PM / 9 months ago

Fitch Rates Johnson & Johnson's Notes Offering 'AAA'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, February 28 (Fitch) Fitch Ratings has assigned a 'AAA' rating to Johnson & Johnson's (JNJ) senior unsecured notes offering. The proceeds will be used for general corporate purposes. The Rating Outlook is Stable. KEY RATING DRIVERS Actelion Acquisition: JNJ will acquire Actelion Ltd. (Actelion) for $30 billion cash. The transaction will be funded using off shore cash. Actelion will spin off its Research and Development (R&D) business as a separate publicly-traded (Switzerland) company immediately prior to the completion of the acquisition. JNJ will receive 16% of the R&D NewCo shares, with the option to acquire an additional 16% through a convertible note. Actelion generated roughly $1.8 billion in revenues during the first nine months of 2016. Fitch views the transaction as strategically sound, as JNJ will gain a number of approved and in-development therapies. The acquisition gives JNJ five currently-marketed therapies (Opsumit, Tracleer, Uptravi, Veletri and Ventavis) for the treatment of pulmonary hypertension and two currently-marketed specialty products, Valchlor gel (cutaneous T-cell lymphoma) and Zavesca (Gaucher disease in the U.S./Nieman-Pick disease in Europe). JNJ also receives three pipeline products: ponesimod (in phase 3 development for the treatment of multiple sclerosis), cadazolid (in phase 3 development for the treatment Clostridium difficile-associated diarrhea) and an option on ACT-132577 (in phase 2 development for the treatment resistant hypertension). The 16% stake in the R&D NewCo also provides for potential longer-term financial benefits through passive stock price appreciation and/or future R&D collaborations. Innovation-Driven Growth Despite Headwinds: Fitch expects that JNJ will continue to generate moderate intermediate-term top-line organic growth, despite facing a number of challenges during 2017 and beyond. The company continues to bring innovative new products to market and expand the utilization of established products and franchises. Nevertheless, unfavorable foreign exchange rates and competition in select franchises dampened reported sales growth during 2016. Remicade faced biosimilar competition in Europe during 2015 and in the U.S. in late-2016. The negative effect on sales has been moderate so far. JNJ pursues innovation across all three of its business segments, which provides it with favorable long-term growth prospects, as well as opportunities to support margins. R&D intensity is greatest in its biopharmaceutical business, followed by the medical device segment. The company also pursues collaborations and outright acquisitions to supplement its internal new product development efforts. This strategy has produced a significant number of innovative, value-added medical therapies and products. While the consumer business is not as R&D intensive, innovation is still a key component in defending and advancing JNJ's franchises in this segment. Broad Portfolio Mitigates Risk: JNJ operates with three business segments and a large diversified product portfolio, reducing its operational and financial reliance on any individual product. It employs a decentralized business model with its various franchises to promote receptivity to their respective markets, while maintaining a strong cultural-centric philosophy driven by its longstanding credo. The company develops and manufactures consumer healthcare-related products, medical devices and pharmaceutical/biologic therapies. Its diverse business model also enables JNJ to pursue a broad array of treatment advancements that offer growth opportunities. JNJ's largest selling product, Remicade, accounts for roughly 9.7% of sales. It is also a biologic, which typically faces patent slopes as opposed to patent cliffs like traditional, small-molecule drugs. This dynamic mitigates the risk of generic/biosimilar competition. The next three largest products, in total, account for less than 10% of company sales, so Fitch views the company's patent expiration risk as manageable. Free Cash Flow (FCF) for Growth and Shareholder Returns: Fitch looks for JNJ to produce strong annual FCF (operating cash flow minus capital expenditures minus dividends) 2017 of $7 billion-$8.5 billion. Moderate organic sales growth and incrementally improving margins, aided by an improving sales mix and a continued focus on costs, should support solid cash flow from operations, offset by manageable capital expenditures and dividends. Fitch expects JNJ will prioritize cash deployment for dividends, internal/external growth opportunities and then for share repurchases. JNJ will likely remain acquisitive, focusing on targets or products that offer innovation and growth in the health care sector. Fitch expects the company to finance its transactions within the context of its 'AAA' credit profile. Shareholder-focused activities, such as dividend increases and share repurchases will presumably continue, and Fitch believes the company will finance these primarily with FCF. Current Leverage/Limited Flexibility: Fitch believes JNJ will operate with leverage consistent with its 'AAA' rating and with solid liquidity supported by significant cash balances and ample access to credit markets. However, current leverage of 1.0x leaves the company little flexibility to take on additional debt. JNJ holds the vast majority of cash outside of the U.S. However, the company periodically uses some of its OUS cash and short-term investments to fund targeted and larger acquisitions, as evidenced by the announced acquisition of Actelion. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for JNJ's 'AAA' rating include the following: --Low- to mid-single-digit revenue growth in 2017; --Incremental margin improvement driven by favorable product mix and an ongoing focus on cost control during the near term; --Annual FCF of $7 billion to $8.5 billion during 2017; --Leverage to range between 0.8x and 1.0x with moderately increasing levels of debt; --Capital deployment priorities focused on dividend and then balanced between acquisitions and share repurchases, with the mix depending on the availability and valuation of strategically appropriate targets. RATING SENSITIVITIES While Fitch does not anticipate a downgrade during its rating horizon, a negative rating action could occur if some combination of deteriorating operational performance and leveraging transactions stress the company's credit profile. Fitch believes the company's broadly diversified health care related franchises make it more likely that a negative rating action would be prompted by a leveraging transaction, as opposed to operational stress. Three of the key rating metrics for JNJ's 'AAA' rating that Fitch believes investors should consider are the following: --Total debt/FCF of 3.0x (reported Oct. 2, 2016 at 5.2x); --Total debt/EBITDA of 1.0x (reported Oct. 2, 2016 at 1.1x); --Net debt of $4 billion-$5 billion (reported Oct. 2, 2016 at a net cash position of $13.3 billion). LIQUIDITY Solid Liquidity: JNJ has significant liquidity and access to the credit markets. Moderate growth and relatively stable margins enabled the company to generate roughly $5.1 billion of FCF during the latest 12 month (LTM) period ended Oct. 2, 2016. JNJ had approximately $40.4 billion in cash plus short-term marketable securities (STMS) and access to $10 billion in short-term borrowings on Oct. 2, 2016. FULL LIST OF RATINGS Fitch currently rates Johnson & Johnson as follows: --Issuer Default Rating (IDR) 'AAA'; --Senior unsecured debt 'AAA'; --Subordinated debt 'AAA'; --Short-Term IDR 'F1+'; --Commercial paper 'F1+'. The Rating Outlook is Stable. Contact: Primary Analyst Bob Kirby, CFA Director +1-312-368-3147 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst Megan Neuburger Managing Director +1-212-908-0501 Committee Chairperson Peter Molica Senior Director +1-212-908-0288 Media Relations: Elizabeth Fogerty, New York, Tel: +1 (212) 908 0526, Email:; Hannah James, New York, Tel: + 1 646 582 4947, Email: Additional information is available on Date of Relevant Committee: Jan. 26, 2017 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected EBITDA is adjusted to add back non-cash stock based compensation. In 2015, Fitch added back $874 million in non-cash stock based compensation to its EBITDA calculation. 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