Fitch Rates Cardinal Health's $1.5B Bond Issuance 'BBB+'; Outlook Stable

CHICAGO--()--Fitch Ratings has assigned a 'BBB+' rating to the $1.5 billion bond issuance by Cardinal Health, Inc. (Cardinal; NYSE: CAH). Proceeds are expected to be used to help fund recently announced acquisitions, including the $1.9 billion acquisition of Cordis from Johnson & Johnson (NYSE: JNJ) and the $1.1 billion purchase of the Harvard Drug Group (Harvard). Cash on hand will fund the remainder of the acquisition costs.

Cardinal's acquisition of Harvard has strong strategic merit, although it incrementally reduces the firm's ratings flexibility over the next 12-24 months. Harvard adds $450 million of revenues to Cardinal, weighted toward the distribution of generic drug products to smaller independent pharmacies and hospitals. Synergy opportunities center on Cardinal's ability to source generic drugs more cheaply than Harvard but present relatively small benefit compared to Cardinal as a whole.

A full list of Cardinal's ratings, which apply to approximately $4 billion of debt at March 31, 2015, is provided at the end of this release.

KEY RATING DRIVERS

--The oligopolistic nature of the U.S. healthcare distribution industry and steady pharmaceutical demand contribute to exceptionally stable operating profiles for Cardinal and its peers. Drug distribution, though low margin, is relatively insulated from pricing and regulatory pressures faced by other areas of healthcare in the U.S.

--Fitch thinks Cardinal's financing plans for the purchase of Cordis and Harvard are responsible at the current 'BBB+' ratings. However, the firm will have no flexibility to incur additional long-term debt over the next 12-24 months. Fitch forecasts gross debt/EBITDA to moderate to around 1.7x by the end of 2016, with business growth and synergy capture driving de-leveraging.

--Margins and cash flows continue to benefit from the mostly durable effects of the generic wave, albeit offset more recently by margin-dilutive Hepatitis C therapies. The addition of Cordis, along with Cardinal's generic drug procurement joint venture (JV) with CVS Caremark Corp. (NYSE: CVS) and the anticipated introduction of biosimilars to the U.S. drug channel should support margins in fiscal 2015-2016.

--Fitch remains concerned that Cardinal's underrepresentation in the specialty drug distribution space relative to its peers could hinder future growth and profitability. Cardinal's presence in China and recent moves in its medical business, including the Cordis acquisition, could offset this concern somewhat. But these areas also represent forms of operating (e.g. product liability, geographical) and execution risk.

--Generic conversions, favorable drug pricing, new customer wins, and base business growth are offsetting the now-annualized lost contracts with Express Scripts, Inc. (NASDAQ: ESRX; 'BBB', Outlook Stable) and Walgreens Boots Alliance, Inc. (NASDAQ: WBA). Strong top-line growth with prospects of moderate margin expansion will drive growing cash generation over the ratings horizon.

--Solid liquidity is supported by relatively large available cash balances, an undrawn $1.5 billion revolver, and a $950 million A/R facility. Annual free cash flow (FCF) is expected to exceed $1 billion. The firm's recent refinancing activity resulted in no more than $400 million of debt due in any of the next four fiscal years.

RATING SENSITIVITIES

Maintenance of a 'BBB+' IDR considers gross debt/EBITDA generally maintained below 1.7x, accompanied by continued robust cash flows and stable or growing margins over the ratings horizon.

Liquidity should be adequate to fund targeted M&A and the firm's shareholder payouts. But given the long-term debt funding of the Cordis and Harvard acquisitions, there will be no room for additional long-term debt at the 'BBB+' ratings for the next 12-24 months. Reported gross debt/EBITDA is expected to moderate to around 1.7x by year-end 2016, in support of current ratings.

Failure to achieve expected synergies and EBITDA growth could result in a Negative Rating Outlook or downgrade during this timeframe. A downgrade to 'BBB' could also result from debt-funded shareholder-friendly activities or material operational snafus, particularly related to Cardinal's somewhat untested Medical segment strategy. Evidence or anticipation of material pricing pressure greater and more direct than currently expected could also pressure ratings.

An upgrade to 'A-' is not anticipated in the near to intermediate term. Upward ratings migration could result from a demonstration of and commitment to operating with debt leverage below 1.2x-1.3x, combined with responsible M&A activity that contributes to an overall improved intermediate-term growth outlook. A sustained commitment to Cardinal's core distribution business will also be necessary to support the consideration of an upgrade.

FULL LIST OF RATINGS

Fitch currently rates Cardinal as follows:

--Long-term IDR 'BBB+';

--Short-term IDR 'F2';

--Senior unsecured bank facility 'BBB+';

--Senior unsecured notes 'BBB+';

--Commercial paper 'F2'.

The Rating Outlook is Stable.

Date of Relevant Rating Committee: March 2, 2015

Additional information is available on www.fitchratings.com

Related Research:

--'Fitch Affirms Cardinal Health at 'BBB+' on Cordis Acquisition; Outlook Stable' (March 3, 2015);

--'Fitch Rates New Cardinal Bonds 'BBB+'; Outlook Stable' (Nov. 7, 2014);

--'Fitch Affirms Cardinal Health at 'BBB+'; Outlook Stable' (Feb. 12, 2014);

--'2015 Outlook: U.S. Healthcare - The Value Debate Intensifies While Aggressive M&A Continues' (Dec. 4, 2014);

--'Trekking the Path to Biosimilars - The Destination' (Oct. 4, 2013);

--'Vital Signs - Currents in the Drug Channel' (Podcast) (April 25, 2013);

--'Navigating the Drug Channel - Drug Distributors: A Deeper Dive' (April 24, 2013).

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosures

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=986474

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Contacts

Fitch Ratings
Primary Analyst
Jacob Bostwick, CPA
Director
+1-312-368-3169
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Greg Dickerson
Director
+1-212-908-0220
or
Committee Chairperson
Michael Weaver
Managing Director
+1-312-368-3156
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Jacob Bostwick, CPA
Director
+1-312-368-3169
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Greg Dickerson
Director
+1-212-908-0220
or
Committee Chairperson
Michael Weaver
Managing Director
+1-312-368-3156
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com