CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed Eli Lilly & Co. Inc.'s (Lilly) Long-Term Issuer Default Rating (IDR) at 'A' with a Stable Outlook. Fitch also affirmed the company's short-term IDR at 'F1'. The rating actions apply to roughly $7.8 billion of debt outstanding at Mar. 31, 2016. A full list of the rating actions is provided at the end of this release.
KEY RATING DRIVERS
--Lilly is facing a manageable patent expiry period, with roughly 22% of total sales at risk through 2018. Nearly half of those sales come from biologics, which generally experience relatively moderate sales decline once their patents expire.
--Fitch expects Lilly will return to top-line organic growth during 2016-2018 with the annualizing of patent expiries and continued strength in established and new products.
--Fitch believes Lilly's late-stage pipeline, particularly strong in treatments for diabetes and cancer, offers the company numerous opportunities to sustain longer-term growth.
--Lilly's leaner cost structure, growth of patent-protected products and new product launches should pave the way for margin expansion in 2016 as sales rebound.
--Fitch forecasts that Lilly will generate solid free cash flow (FCF; cash flow from operations minus capital expenditures and dividend payments) in 2016.
--The rating incorporates moderate share repurchases, targeted acquisitions and incremental dividend increases through the forecast period.
Manageable Patent Expiry Risk: Lilly faces patent expiries for Erbitux in February 2016 (3% of firm sales), Effient in October 2017 (2% of firm sales), Strattera in May 2017 (4% of firm sales), Cialis in November 2017 (12% of firm sales) and Forteo in December 2018 (7% of firm sales). However, Erbitux and Forteo are biologics, which generally lose sales to biosimilar competition at a much slower pace than small molecules (Cialis) do when experiencing generic competition. As such, Fitch views the company's patent expiry risk as manageable.
Lilly recently exited its significant patent expiry period which essentially began in 2014. Its largest selling drug, Cymbalta, lost U.S. patent protection in December 2013 and European patent protection in August 2014. Cymbalta accounted for roughly 24% of total company sales during 2013 and accounted for only 7% in 2015. Evista lost U.S. market exclusivity in March 2014 and now accounts for approximately 1% of total firm revenues. To date, no biosimilar competition to Humalog has entered the market, despite its May 2013 patent expiry.
Rebound With Patent-Protected Products: Fitch expects Lilly will return to top-line organic growth during 2016-2018, achieving annual sales in excess of $20 billion, including meaningful foreign exchange headwinds. In our view, currently marketed drugs including Cyramza (cancer), Trulicity (diabetes), Taltz (psoriasis), Jardiance (diabetes) and Tradjenta/Jandueto (diabetes), in aggregate, show reasonable intermediate-term growth potential.
Pipeline Underpins Long-Term Growth: Lilly has improved its growth prospects for the intermediate- to longer term, as it has been making significant progress in building its late-stage pipeline. The company has a number of late-stage drug candidates, and recently launched Basaglar (diabetes), Cyramza (cancer), Jardiance (diabetes), Portrazza (cancer), Trulicity (diabetes) and Taltz (psoriasis). Late-stage candidates include potential treatments for cancer, diabetes, lupus, depression, and rheumatoid arthritis. The company has partnered with Boehringer Ingelheim in its efforts to develop diabetes medications as well as evaluate therapy combinations in treating cancer.
Support for Margin Expansion: Lilly improved its EBITDA margin to 26% during the LTM ended March 31, 2016, versus 25.1% in the prior year period. A 220bps improvement in SG&A (as a percentage of sales) more than offset a 60bps decline in gross margin and a 90bps increase in R&D (as a percentage of sales). Fitch expects the company will continue to improve gross margins during the intermediate term through the growth in recently- or to-be-introduced, higher-margin products.
Growing FCF: Fitch forecasts higher FCF of approximately $800 million during 2016 as Lilly generates organic growth and improved margins. Expected cash flow from operations of roughly $4.2 billion should be sufficient to fund approximately $2.2 billion in cash dividends and $1.1 billion in capital expenditures. Fitch believes FCF will continue to grow from 2015 levels over the long run, as revenues and margins advance.
Share Repurchases to Continue: Fitch incorporates roughly $2 billion - $3 billion in aggregate share repurchases from now through 2018, funded with cash on hand. However, Fitch models only incremental dividend increases and targeted acquisitions during the same forecast period, which will not likely stress Lilly's balance sheet. We believe Lilly would moderate its share repurchases if it were to pursue somewhat more strategic acquisitions.
Fitch's key assumptions for Lilly's 'A'/Stable Outlook include:
--Moderate organic revenue growth, mostly offset by the negative effect of foreign exchange movements during 2016;
--Improving margins driven by favorable mix, including new product introductions and the achievement of meaningful cost reduction;
--Annual FCF (cash flow from operations minus capital expenditures minus dividends) of roughly $800 million during 2016;
--Leverage to remain below 1.6x during 2016.
While Fitch does not expect a positive rating action in the near term, future developments that may, individually or collectively, lead to a revision of the Rating Outlook to Positive or an upgrade in the intermediate term, include:
--Revenues continue to expand for patent-protected products, including Cyramza, Jardiance, Taltz, Tradjenta/Jandueto and Trulicity;
--The company attains adequate cost controls and integration synergies to generate sufficient profitability while limiting increases in debt to maintain leverage sustainably below 1.3x;
--Lilly deploys cash conservatively with a bias of using cash flow as opposed to debt issuance to fund transactions.
Future developments that may individually or collectively, lead to a Negative Outlook and/or a one-notch downgrade to 'A-'/'F2' include:
--Operational stress from factors including, but not limited to, patent expiries drive leverage durably above 1.7x;
--Inability to maintain relatively strong operations through the intermediate term, patent expiry period;
--FCF deteriorates without the expectation of a timely trend reversal.
Adequate Liquidity: Fitch assumes Lilly will maintain adequate liquidity, supported by FCF generation, balance sheet cash and availability on its revolving credit facility. At March 31, 2016, the company had approximately $3 billion of cash and short-term investments, $1.2 billion of unused committed bank credit facilities, and roughly $3.8 billion in noncurrent investments.
At March 31, 2016, Lilly had approximately $7.8 billion in debt outstanding. Fitch believes the company's long-term debt maturities are manageable with roughly $635 million maturing in 2017, $800 million in 2018, and $600 million in 2019. Fitch's forecast assumes that Lilly will refinance these maturities with new debt issuances.
FULL LIST OF RATING ACTIONS
Fitch has affirmed Eli Lilly & Co. Inc.'s ratings as follows:
--Long-Term IDR at 'A';
--Senior unsecured debt rating at 'A';
--Bank loan rating at 'A';
--Short-Term IDR at 'F1';
--Commercial paper rating at'F1'.
The Rating Outlook is Stable.
Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:
--Historical and projected EBITDA is adjusted to add back non-cash stock based compensation. During the LTM period ended Mar. 31, 2016, Fitch added back $231 million in non-cash stock based compensation to its EBITDA calculation.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
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