DBRS Places Shoppers Drug Mart Under Review with Negative Implications

DBRS has today placed the long- and short-term ratings of Shoppers Drug Mart Corporation (Shoppers or the Company) Under Review with Negative Implications. The rating action is based on the Ontario provincial government’s recently announced plan to alter the Ontario Drug Benefit Program, making changes that are harsher than previously expected by DBRS. The resulting impact on Shoppers’ business model, including its over 600 pharmacies in Ontario, could become material starting later this year and into 2011.

In particular, DBRS notes that the four-year plan proposes to phase in the following:

1) A reduction in generic prescription drug prices under the Ontario Drug Benefit Program from the current 50% of the equivalent brand to 25%.
2) A reduction in generic prescription drug pricing in the private sector over a multi-year period.
3) Elimination of certain payments from generic manufacturers to pharmacies (professional allowances).
4) Prohibiting Ontario pharmacies from selling generic drugs that they may choose to manufacture themselves.

To offset the foregoing, the government has offered to take the following measures:

1) Provide pharmacies an extra $1.00 in dispensing fees per prescription.
2) Compensate pharmacists for additional services.
3) Pay a special premium to rural pharmacies.

DBRS will assess the implications of the Ontario government’s plan, with any potential modifications, once it is finalized and in place. Because Shoppers has a national operation, DBRS also remains concerned about the effect that Ontario’s plan may have on other provinces as they, in turn, put in place regulations to manage their health-care costs.

During this period, DBRS plans to meet with the Company to review its plans on how it can mitigate the impact of the government’s proposed plan. The generic prescription segment of Shoppers’ revenue and earnings in Ontario is material and it will be important to see where savings can be made to support the Company’s financial profile. A key metric will be the debt-to-EBITDAR ratio, which could rise well above 3.0 times. Cash flow-to-debt will also be considered, along with free cash flow to see if it remains positive.

While many details are not yet available, DBRS’s initial view is that Shoppers has the ability to retain its financial and credit strength to the degree that it is able to maintain investment-grade ratings that are within a notch of current rating levels.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Merchandisers, which can be found on our website under Methodologies.

This is a Corporate rating.