DBRS Confirms McKesson Corporation at A (low), R-1 (low), Trends Stable

DBRS has today confirmed the Senior Unsecured Debt rating of McKesson Corporation (McKesson or the Company) at A (low) and the Commercial Paper rating of McKesson Canada at R-1 (low), both with Stable trends. McKesson continues to benefit from its market position as the largest distributor of pharmaceutical and health-care products in North America and its efficient operations, despite constantly evolving government regulations and high levels of competition in a typically low-margin industry.

McKesson’s revenue increased by nearly 4.6%, to $117 billion, from the previous year in the last twelve months (LTM) ended Q2 F2012. In the first half of F2012, revenue increased by 9%, based on market growth in the Company’s Distribution Solutions segment along with the inclusion of the US Oncology Inc. (US Oncology) business, acquired on December 30, 2010. Despite efforts to improve operating margins, the EBITDA margin remained flat as a result of higher operating expenses and litigation costs. As such, EBITDA for the LTM ended Q2 F2012 increased nearly 4% from the previous year to $2.4 billion.

In terms of financial profile, McKesson continues to benefit from its strong free cash flow generating capacity. The financial profile remains acceptable for the current rating category after settling at a higher level after the acquisition of US Oncology. Cash flow from operations for the LTM ended Q2 F2012 increased approximately 7.4% versus F2011, to nearly $2.2 billion. Higher capex as a result of the acquisition of US Oncology, and regular dividend increases, resulted in free cash flow before changes in working capital of over $1.5 billion for the LTM ended Q2 F2012.

The acquisition of US Oncology, along with smaller acquisitions, combined with share repurchases to result in an increase in gross debt of nearly $1.7 billion during the LTM ended Q2 F2012. As such, gross lease-adjusted debt-to-EBITDAR rose from a low of 1.2 times (x) in F2010 to 1.9x in F2012.

Going forward, DBRS expects McKesson to maintain a stable earnings profile based on its strong market position and beneficial industry fundamentals. Top-line revenue should increase in the mid-single-digit range over the near to medium term, based primarily on growing volumes and minor acquisitions. Margins are expected to benefit in the near to medium term from a shift toward higher-margin generic drugs and growth in the higher-margin Technology Solutions business. As such, DBRS expects McKesson’s EBITDA to grow to levels above $2.5 billion in the near to medium term.

McKesson is expected to boost its cash flow generated from operations, as calculated by DBRS prior to changes in working capital, to between $2.2 billion and $2.5 billion, and this level should continue to grow with earnings in the medium term. Capex requirements are expected to increase and remain high between $400 million and $500 million as acquisitions are completed and new investments in the Distribution Solutions and Technology Solutions segments are made. DBRS expects that the Company’s dividend policy should remain consistent, with dividends raised moderately in the near to medium term. As such, DBRS expects free cash flow before changes in working capital to be in the range of $1.5 billion to $1.75 billion. DBRS expects the Company to remain acquisitive in nature, likely completing smaller, tuck-in type acquisitions on an opportunistic basis. McKesson is expected to use free cash flow and cash-on-hand to complete additional share repurchases. Should the Company choose to use debt for such purpose, DBRS expects that it should be of a magnitude that maintains credit metrics close to current levels. Credit metrics should therefore remain fairly steady, although weaker-than-expected operating performance or financial management that is more aggressive than expected that results in weaker credit metrics could pressure the current ratings.

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

The applicable methodology is Rating the Consumer Products Industry, which can be found on our website under Methodologies.