Fitch Rates McKesson's Proposed Senior Unsecured Notes 'A-'

CHICAGO--()--Fitch Ratings has assigned an 'A-' rating to McKesson Corporation's (McKesson) planned issuance of $900 million of new senior unsecured notes. Proceeds will be used to repay amounts drawn on the company's bridge facility to finance the purchase of PSS World Medical Inc. (PSS World) in February 2013.

A full list of McKesson's ratings is provided at the end of this release. The Rating Outlook is Stable.

KEY RATING DRIVERS

--Fitch believes the recently closed acquisition of PSS World is strategically sound and was financed responsibly, though temporarily pushing reported debt leverage outside the range appropriate for McKesson's 'A-' ratings. EBITDA growth and the recent repayment of maturing notes are expected to cause debt leverage to moderate to 1.4 times (x) or below by the end of McKesson's fiscal 2014 (March 31).

--Steady pharmaceutical demand and the oligopolistic market position support a stable operating profile. Fitch expects U.S. drug distributors to continue strengthening their position within the drug channel over the rating horizon.

--The branded patent cliff is driving solid growth in McKesson's appropriately low margins. Fitch forecasts EBITDA margin expansion of 7-10 basis points (bps) in McKesson's fiscal 2013, though increased pricing pressure is possible over the ratings horizon.

--McKesson's strong market positions in specialty drug distribution, non-acute medical-surgical distribution, and healthcare IT will support intermediate-term growth and profitability. Given the lack of opportunities in pure U.S. drug distribution, Fitch expects McKesson to explore growth opportunities in these areas.

--Robust cash flows and solid capital market access contribute to a strong liquidity profile. Fitch forecasts funds from operations (FFO; cash from operations before working capital) to exceed $2 billion in 2014 and 2015.

RATING SENSITIVITIES

Maintenance of an 'A-' IDR will require debt-to-EBITDA leverage generally below 1.4x. Continued strong and steady funds from operations (FFO), accompanied by expected margin expansion driven by the tailwinds propelling the industry (i.e. the generic wave and specialty pharma market growth), are also expected at the current rating levels.

A negative rating action could result from a material debt-funded acquisition leading to sustained leverage above 1.4x. Fitch does not expect McKesson to engage in M&A activity outside the company's core businesses, but a move into a non-adjacent product space or geography could also threaten the current 'A-' ratings. Debt-funded shareholder friendly activities would likely pressure ratings as well.

A positive rating action is not expected over the ratings horizon. Fitch believes McKesson would need to commit to and demonstrate the ability to sustain debt leverage below 0.8x to achieve an 'A' rating. Margin expansion and robust cash flows would also be required to support this rating action.

PSS WORLD DEAL FINANCED CONSISTENT WITH 'A-' RATINGS

Fitch believes that McKesson's financing of its $2.1 billion acquisition of PSS World was executed in a manner consistent with the company's 'A-' ratings. Fitch forecasts that debt leverage (debt-to-EBITDA) will be 1.4x or below by the end of McKesson's fiscal 2014. However, rating flexibility may be limited in the interim.

Fitch views the deal as strategically sound. Increased scale provides the company with additional negotiating power with suppliers and provides the opportunity to further leverage fixed costs. McKesson and PSS World are currently two of the largest distributors of medical-surgical supplies to non-acute care providers in the U.S. The two businesses together generate more than $5 billion in annual revenues.

STEADY PHARMA DEMAND, OLIGOPOLY PROVIDE EXCEPTIONAL STABILITY

McKesson and its peers in the drug distribution industry continue to exhibit exceptionally stable operations and financial performance. Despite weak macroeconomic conditions and moderately decreased utilization of healthcare overall, core business growth at McKesson has remained largely in-step with or ahead of broader market growth. Organic low-single digit growth is driven by consistent demand for pharmaceuticals and is realized relatively uniformly, since the largest three drug distributors account for approximately 95% of the market.

The drug distribution industry is in a position to maintain good operating stability through the ratings horizon and beyond. The industry's very slim margins make it an unlikely target for extra taxes and fees (like those imposed on the pharma and medical device sectors). Furthermore, the industry excels in adding value to the drug channel through the supply chain management and other services it offers to both its upstream and downstream customers. Fitch expects distributors to continue to build additional value-adding services that will further entrench their position in the drug channel.

STRONG MARGIN EXPANSION FROM GENERICS, PRICING PRESSURE POSSIBLE

McKesson and its peers are benefitting from the unprecedented wave of branded drug patent expirations, especially in McKesson's fiscal 2013 and 2015. Most drug channel participants, including distributors, earn higher margins - though less revenues - on the sale of lower-cost generic drugs. Fitch forecasts revenue growth to be relatively flat and EBITDA margin expansion of 7-10 bps in MCK's fiscal 2013, driven primarily by generic conversions. Fiscal 2014 will likely see higher organic top-line growth but less margin expansion.

Fitch believes most of the margin expansion as a result of branded-to-generic conversions is durable, as several of the most-prescribed medications in the U.S. have recently been or soon will be converted to generic. Generic penetration in the U.S. is likely to remain at or above 80% for many years to come.

Fitch believes margins could be pressured by additional pricing pressure within the drug channel over the next several years. Especially in light of legislated healthcare reform, it is possible that third-party payors will begin to focus more intently on profits associated with specialty and, to a lesser extent, generic drugs. Drug distributors, while not immune, are well-insulated from these types of pressures.

SOLID PRESENCE IN SPECIALTY, MED-SURG, AND HIT

Traditional drug distribution in the U.S. is an industry that is mostly consolidated and characterized by steady growth in the low-single digits. This activity accounts for roughly 80% of MCK's overall revenues. The remaining 20% comes from the company's strong market positions in the distribution of specialty pharmaceuticals and med-surg supplies and in healthcare information technology (HIT). McKesson is one of only a handful of companies with a significant share of these relatively fragmented markets.

As a result, Fitch believes McKesson is uniquely positioned to benefit from growth opportunities related to its ancillary businesses as those markets grow and consolidate over time. To that end, Fitch expects McKesson to continue consummating small, tuck-in acquisitions in especially the med-surg and HIT spaces. In general, the company approaches M&A opportunistically and responsibly.

ROBUST CASH FLOWS AND SOLID LIQUIDITY

MCK's stable margins and good asset management contribute to stable and strong cash generation measures. FFO for the LTM period ended Dec. 31, 2012 was a robust $2.86 billion. Free cash flow (FCF; cash from operations less dividends and capital expenditures) for the same period was muted by a negative working capital swing and large cash payouts in relation to the Average Wholesale Price (AWP) litigation but was still nearly $1 billion.

The company maintains a very strong liquidity profile. At Dec. 31, 2012, McKesson had $2.7 billion of cash on hand ($1.5 billion OUS), as well as full availability of its $1.3 billion revolver due September 2016 and its $1.35 billion accounts receivable facility due May 2013. The revolver provides 100% support for the company's commercial paper program.

Debt maturities are well-laddered and mature as follows: $350 million in fiscal 2014; $1.1 billion in 2016; $500 million in 2017; and $2 billion thereafter. McKesson issued $900 million of notes in November 2012 to prefund the $500 million of notes which were repaid in March 2013 and to refinance $400 million of notes that were repaid in February 2012. Fitch expects McKesson to refinance future debt maturities as they come due.

Fitch rates McKesson as follows:

--Long-term Issuer Default Rating (IDR) 'A-';

--Short-term IDR 'F2';

--Unsecured bank facility rating 'A-';

--Unsecured notes rating 'A-'

--Commercial paper 'F2'.

The Rating Outlook is Stable.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria & Related Research:

--'Corporate Rating Methodology' (Aug. 8, 2012);

--'Short-Term Ratings Criteria for Non-Financial Corporates' (Aug. 9, 2012);

--'Fitch Affirms McKesson's Ratings at 'A-'; Outlook Stable (Dec. 5, 2012)

--'2013 Outlook: U.S. Healthcare - Navigating a Dynamic Operating and Regulatory Environment' (Nov. 29, 2012);

--'Fitch Rates McKesson's Proposed Senior Unsecured Notes 'A-' (Nov. 29, 2012);

--'Fitch: McKesson's Ratings Initially Unchanged by PSS World Acquisition Announcement (Oct. 25, 2012);

--'Navigating the Drug Channel - Drug Distributors: A Deeper Dive' (March 13, 2012).

Applicable Criteria and Related Research

Corporate Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684460

Short-Term Ratings Criteria for Non-Financial Corporates

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685553

2013 Outlook: U.S. Healthcare -- Navigating a Dynamic Operating and Regulatory Environment

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=695570

Navigating the Drug Channel -- Drug Distributors: A Deeper Dive

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=673889

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Contacts

Fitch Ratings
Primary Analyst
Jacob Bostwick, CPA, +1-312-368-3169
Associate Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Bob Kirby, CFA, +1-312-368-3147
Director
or
Committee Chairperson
Michael Weaver, +1-312-368-3156
Managing Director
or
Media Relations
Brian Bertsch, +1-212-908-0549
brian.bertsch@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Jacob Bostwick, CPA, +1-312-368-3169
Associate Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Bob Kirby, CFA, +1-312-368-3147
Director
or
Committee Chairperson
Michael Weaver, +1-312-368-3156
Managing Director
or
Media Relations
Brian Bertsch, +1-212-908-0549
brian.bertsch@fitchratings.com