Fitch Rates Express Scripts Bonds 'BBB'; Outlook Stable

CHICAGO--()--Fitch Ratings has assigned a 'BBB' rating to the new bonds issued by Express Scripts Holding Co. (NYSE: ESRX). The Rating Outlook is Stable.

Proceeds will be used to refinance upcoming maturities, including the $1.5 billion of bonds due May 2016, and for general corporate purposes. This refinancing of upcoming maturities with incrementally larger issuances is in line with Fitch's expectations for ESRX.

A full list of ratings, which apply to approximately $15.6 billion of debt at Dec. 31, 2015, follows at the end of this release.

KEY RATING DRIVERS

Market-Leading Scale: ESRX is the largest pharmacy benefit manager (PBM) and third-largest pharmacy operator in the U.S. Fitch expects such scale to continue enabling ESRX to negotiate favorable purchasing discounts and pricing rebates and to leverage its fixed costs associated particularly with mail-order pharmacy.

Robust Cash Flows: Despite relatively low margins and recent volume declines, stable and robust cash flows are driven by excellent working capital management and efficient operations. Strong cash flows and a solid liquidity profile provide flexibility at current ratings in the event of leveraging M&A or further contract losses.

Better L-T Growth: Fitch believes ESRX's longer-term underlying growth will fare better as the firm's leading scale benefits from reform tailwinds, specialty market growth, demographics, and ongoing cost containment efforts by payers leading to growing PBM volumes and utilization of more value-add services. Recent growth has been weak, as contract losses have contributed to a roughly 25% decline in adjusted claims volume compared to that of ESRX and Medco combined in 2011, just before the completion of their merger.

Increasing Competition, Client Consolidation: Underlying growth and margin dynamics face the risk of pricing pressure and possible large customer losses in light of recent large-scale payer consolidation. The future of ESRX's contract with Anthem, its largest customer, is at this time unknown given Anthem's currently pending acquisition of Cigna. The deal could produce the largest health insurer in the U.S., possibly with the scale supportive of a strategy to bring its PBM functions in-house.

Historically an Active Acquirer: ESRX has been an active acquirer over the past decade, often employing large debt balances to fund deals. The possibility for large-scale M&A and accompanying leverage spikes, albeit lower now given ESRX's very large size, pressure the ratings somewhat. Notably, the firm has routinely executed on its outlined de-leveraging plans, reducing leverage appropriately within 12-18 months of each deal.

RATING SENSITIVITIES

ESRX has decent flexibility at its current 'BBB' ratings, which contemplate gross debt/EBITDA of around 2x. Flexibility is afforded by robust cash flows, market share leadership, and steady industry demand.

Positive rating actions could accompany a shift in Fitch's expectations that ESRX would use its ample free cash flow (FCF) to repay debt rather than for shareholder payments, such that run-rate gross debt/EBITDA was maintained at around 1.5x. Current cash generation is more than sufficient to operate with debt leverage even lower than this target over the ratings horizon.

Negative rating actions could be driven by the prioritization of cash flows for shareholder-friendly activities over debt repayment in the event of large-scale M&A, debt-funded share repurchase, or operational stress, resulting in debt leverage materially and durably above 2x. A possible stress scenario envisions customer losses more severe than Fitch currently expects without a corresponding reduction in absolute debt balances.

KEY ASSUMPTIONS

--Modestly positive underlying script and top-line growth in 2016, offset by Coventry roll-offs, due to slowing customer churn post-integration of ESRX and Medco operations. ESRX is expected to grow at least in line with the overall PBM market, likely in the low single digits, for the foreseeable future.

--Margin expansion is expected in 2016-2017 due to the ramping nature of ESRX's contracts and SG&A rationalization post-merger. Margins will also be supported by generic conversions and growing opportunities around specialty drugs.

--Relatively steady debt levels on a moderately growing EBITDA figure resulting in moderate de-leveraging. Fitch does not think ESRX has incentive to operate with lower debt levels, though the firm certainly could use FCF to repay debt as it comes due. Debt leverage around 2x is expected over the ratings horizon.

--Strong FCF of $4.5 billion or more annually, driven by strong working capital efficiency, stable and efficient operations, and the remaining impact of synergy capture. Most FCF is expected to be used for share repurchase, in lieu of M&A.

LIQUIDITY

Solid Liquidity, Strong Cash Flows: ESRX maintains a solid liquidity profile, supported by steady and robust cash generation. Cash and equivalents and committed revolver availability at Dec. 31, 2015 were approximately $3.2 billion and $2 billion, respectively. Fitch considers all cash readily available because of ESRX's revolver availability and strong cash conversion cycle. FCF in fiscal 2015 exceeded $4.5 billion. Strong cash flows are driven by excellent working capital management and steady and efficient operations.

Well-Laddered, Manageable Maturities: The firm's debt maturity schedule is well-laddered and manageable, especially given its strong cash flow profile. No more than $4.2 billion is due in any one year (2017), compared to annual forecast FCF of around $5 billion. Nevertheless, Fitch expects ESRX to refinance most debt maturities, thereby growing absolute debt balances with EBITDA, in favor of directing FCF toward M&A and shareholders.

Fitch rates ESRX as follows:

Express Scripts Holding Company

--Long-term IDR 'BBB';

--Senior unsecured bank facility 'BBB';

--Senior unsecured notes 'BBB'.

Express Scripts, Inc.

--Senior unsecured notes 'BBB'.

Medco Health Solutions, Inc.

--Senior unsecured notes 'BBB'.

The Rating Outlook is Stable.

Date of Relevant Rating Committee: Nov. 23, 2015

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Additional Disclosures

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=999795

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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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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
Megan Neuburger, CFA
Managing Director
+1 212-908-0501
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
Megan Neuburger, CFA
Managing Director
+1 212-908-0501
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com