Fitch Ratings affirms CVS's long-term Issuer Default Rating at BBB+, with stable outlook, reflecting company's relatively steady credit metrics, strong liquidity position
January 14, 2014
– Fitch Ratings has affirmed and withdrawn the following ratings for CVS Caremark Corp. (NYSE: CVS):
--Long-term Issuer Default Rating (IDR) at 'BBB+';
--Senior unsecured bank facilities at 'BBB+';
--Senior unsecured notes at 'BBB+';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
The Rating Outlook is Stable.
Fitch is discontinuing the ratings, which are uncompensated.
KEY RATING DRIVERS
The affirmations reflect the company's relatively steady credit metrics and strong liquidity position. Fitch expects CVS to manage its credit profile and capital allocation within the context of maintaining its publicly stated adjusted debt/EBITDA (including NPV of lease obligations) ratio of 2.7 times (x). The ratings also consider CVS's strong positioning in all prescription distribution channels, with a #2 market position in the retail segment and pharmacy benefit management (PBM) and a #1 position in the fast-growing specialty pharmacy business, making it the largest provider of prescriptions in the U.S. with a 21% share of 2012 prescription volume.
The company is well positioned to drive continued market share gains and capitalize on favorable industry trends for prescription growth such as the aging population and expansion of coverage to the uninsured, the continued growth in higher-margin generics and mid-teens growth in specialty pharmacy over the next five years. Of concern are the ongoing cyclical pressures on the industry resulting in soft front end sales, the industry-wide pressure on pharmacy pricing and reimbursement rates in both the retail and PBM businesses, and any potential hit to profitability from regulatory issues. Ongoing healthcare reform initiatives could pressure reimbursement rates but be positive for prescription volume over the intermediate term as the Affordable Care Act is implemented.
CVS and Cardinal Health recently announced an agreement to jointly source their generics and also announced a three-year extension through June 2019 of Cardinal Health's existing pharmaceutical distribution agreements with CVS Caremark. The U.S.-based joint venture is expected to be operational as soon as July 1, 2014, and will have an initial term of 10 years. In order to reflect an equitable 50/50 joint venture, the agreement includes a quarterly payment of $25 million over the life of the agreement from Cardinal Health to CVS Caremark. The payments have an estimated after-tax present value of $435 million. Fitch expects large pharmacy chain, distributors and service providers to continue to find ways to partner together to leverage their buying scale and distribution networks. This was also evidenced by the announcement of a strategic relationship in March 2013 between Walgreens and Alliance Boots with AmeriSourceBergen to collaborate on global supply chain opportunities.
Retail EBIT Margins Expected to be up Modestly in 2014-2015
The retail segment which accounts for approximately 70% of operating profit continues to perform well in spite of near-term cyclical pressures and the company continues to lead the drug retail sector in sales productivity and other operating metrics. It has had a successful track record in integrating large-scale retail acquisitions over the past 10 years, while maintaining a healthy level of growth and improving profitability on an organic basis.
As large-scale retail acquisition opportunities are limited going forward, share gains will depend on: generating above-average organic growth; store closings or share losses by weaker independents and regional chains; and small market fill-in acquisitions and prescription file buys. Fitch expects retail top-line growth to be in the 3% - 4% range going forward with comparable store sales growth in the 2% - 2.5% range and square footage contribution in the 1% - 1.25% range. Operating profit growth is expected to be 9% in 2013 and in the mid-single digits in 2014 - 2015, which assumes flat to a modest increase in gross margin, due to the ongoing benefit of branded to generic conversions offset by reimbursement pressure on the prescription side. As a result, retail EBIT margins are expected to increase modestly over the next 2 - 3 years on an expected base of 9.4% to 9.5% in 2013.
PBM EBIT Margin Expand In 2013; Expected to be Flat in 2014/2015
CVS has seen positive momentum in its PBM segment since 2011 from a top line perspective with strong business wins that were accretive in 2012, including the ramp up of Aetna and the UAM acquisition which contributed $5.5 billion in incremental revenue in 2012. The company has won approximately $25 billion in net new business over the past three years. Revenues have grown in the mid-20% range in 2011 - 2012 and are expected to grow in the 4% to 6% in 2013 to 2015. CVS recently announced the acquisition of Coram LLC (Coram), the specialty infusion services and enteral nutrition business unit of Apria Healthcare Group Inc. for approximately $2.1 billion. Coram is expected to generate approximately $1.4 billion in revenues during the first 12 months following the close of the deal (expected end of 1Q'14) and will further strengthen CVS's leadership position in the specialty pharmacy market where it controls about 20% of the market with 2013 estimated revenue of $20 billion.
Pharmacy services EBIT margin are expected to expand to 4% from 3.6% in 2013 after four years of decline, as the company integrates large scale contracts such as Aetna Inc. and is realizing benefits from the streamlining initiatives that it put in place in late 2009 to deliver over $1 billion in cost savings from 2011 - 2015.
Overall EBIT Growth of Mid-Single Digits; Strong FCF
Fitch expects total EBIT growth including retail to be in the mid-single digit over the next 24 months, after growing 11%-12% in 2013. CVS continues to generate strong free cash flow (FCF) providing the company with significant financial flexibility. Fitch expects $3.3 billion to $3.5 billion in annual FCF (after dividends which are expected to grow in the 20% to 25% range annually, as the company targets a payout ratio of 25% to 30% by 2015, and before any sales leaseback transactions) over the next few years. Fitch expects FCF will primarily be used toward share buybacks ($4 billion to $5 billion annually), and any bolt-on acquisitions within the context of maintaining adjusted debt/EBITDAR at 2.7x. The company's liquidity is also supported by various credit facilities that support its $3.5 billion commercial paper program.
CVS had $10 billion in debt outstanding at Sept. 30, 2013. CVS recently issued $4 billion of debt (staggered maturities of 3, 5, 10, and 30 years) to fund the $2.1 billion acquisition of Coram and to pay down commercial paper borrowings (which stood at $814 million on Sept. 30, 2013). The company has debt maturities of $550 million each in 2014 and 2015 and $1.2 billion in 2016, which Fitch expects will be refinanced.
For business questions, please contact Tiffany Co, Chicago, Tel: +1-312-368-3185.
Additional information is available at 'www.fitchratings.com'. The issuer did not participate in the rating process other than through the medium of its public disclosure.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 5, 2013);
--'Evaluating Corporate Governance' (Dec. 12, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Evaluating Corporate Governance
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