Fitch Affirms Express Scripts at 'BBB'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed the 'BBB' ratings of Express Scripts Holding Co. and its subsidiaries (NYSE: ESRX). The Rating Outlook is Stable.

A full list of rating actions, which apply to approximately $15.6 billion of debt at Sept. 30, 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 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 performance has been weak, as contract losses have contributed to a roughly 25% decline in adjusted claims volume compared to that of both ESRX and Medco 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

-- Flat script- and top-line growth in 2015 and modest positive 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.

-- Modest margin expansion in 2015-2016, as better profitability from specialty drug volumes is offsetting margin pressure from new customer contracts. 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 in 2015-2016 by generic conversions and growing opportunities around specialty drugs.

-- Relatively steady debt levels on a moderately growing EBITDA figure resulting in moderate de-leveraging. We do not think ESRX really 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. No working capital impact is forecast given the very large day-to-day fluctuations inherent in operating a large mail-order pharmacy.

LIQUIDITY

Solid Liquidity, Strong Cash Flows

ESRX maintains a solid liquidity profile, supported by steady and robust cash generation. Cash and equivalents and revolver availability at Sept. 30, 2015 were approximately $438 million and $2.2 billion, respectively. Fitch considers all cash readily available because of ESRX's revolver availability and its negative cash conversion cycle. FCF on an LTM basis 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 $4.5 billion to $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.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

Express Scripts Holding Company

-- IDR at 'BBB';

-- Sr. unsecured bank facility at 'BBB';

-- Sr. unsecured notes at 'BBB'.

Express Scripts, Inc.

-- Sr. unsecured notes at 'BBB'.

Medco Health Solutions, Inc.

-- Sr. unsecured notes at 'BBB'.

Fitch has also withdrawn the following ratings, due to the cross-guarantees present within the capital structure providing linkage of debt issues to the IDR assigned at Express Scripts Holding Company:

Express Scripts, Inc.

-- IDR 'BBB'.

Medco Health Solutions, Inc.

-- IDR '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

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=995285

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=995285

Endorsement Policy

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:
Sandro Scenga, +1 212-908-0278
sandro.scenga@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:
Sandro Scenga, +1 212-908-0278
sandro.scenga@fitchratings.com