DBRS Confirms McKesson at A (low) and R-1 (low), Trend Stable

DBRS has today confirmed the Issuer Rating of McKesson Corporation (McKesson or the Company), along with its Senior Unsecured Debt rating at A (low) and McKesson Canada’s Commercial Paper at R-1 (low), all with Stable trends. The confirmation reflects McKesson’s solid operating performance, along with its consistent growth and strong free cash flow generation through Q3 F2013. The ratings continue to be supported by McKesson’s efficient operations and its market position as the largest distributor of pharmaceutical and health-care products in North America. The ratings also reflect constantly evolving government regulations, high levels of competition in a typically low-margin industry and risks associated with growth.

McKesson’s earnings profile remained strong through Q3 F2013 as the Company continued to leverage its strong market position and efficient operations, while continuing its record of steady growth (organically and through acquisitions). Revenues increased modestly to $123.5 billion for the LTM ended Q3 F2013, driven primarily by higher prices and rising drug utilization in the Distribution Solutions segment. EBITDA margins remained relatively flat, as higher gross profit margins were largely offset by higher operating costs. As a result, EBITDA increased to nearly $2.9 billion for the LTM ended Q3 F2013, versus $2.7 billion in F2012.

McKesson’s financial profile remains adequate for the current rating category, based on its strong free cash flow generating capacity and acceptable leverage level. Cash flow from operations continued to track operating income through Q3 F2013, while capex declined moderately based on lower property additions and capitalized software. Dividends paid remained relatively flat versus the previous year, resulting in free cash flow before changes in working capital of over $2.05 billion in the LTM ended Q3 F2013 (versus $1.98 billion at year-end F2012).

After a significant use of cash to fund changes in working capital in the LTM ended Q3 F2013, the Company continued to apply free cash flow toward investment for growth and share repurchases. As such, after pre-funding an upcoming $500 million maturity, the Company’s gross balance sheet debt increased to nearly $4.5 billion at Q3 F2013 versus approximately $4 billion at year-end F2012, resulting nevertheless in relatively stable credit metrics; that is, lease-adjusted debt-to-EBITDAR of 1.83x for the LTM ended Q3 F2013, versus 1.77x at the end of F2012.

Going forward, DBRS believes that McKesson will maintain an earnings profile consistent with the current rating category, based on its strong market position and solid industry fundamentals. DBRS expects revenues will increase in the mid-single-digit range over the near to medium term, based primarily on higher organic volumes and acquisitions. EBITDA margins should remain relatively stable over the near to medium term as demand grows for lower-price but higher-margin generics and the higher-margin Technology Solutions segment continues to grow. As such, DBRS believes McKesson’s EBITDA could reach the $3 billion level in the near to medium term.

DBRS expects McKesson will maintain a financial profile commensurate with the current rating category going forward, despite its announced agreement in Q3 F2013 to acquire PSS World Medical Inc. (PSS), a transaction valued at approximately $2.1 billion (including the assumption of debt) and expected to close in Q4 F2013. Cash flow from operations should continue to track operating income, rising toward the $2.75 billion level in F2014 and F2015. Capex requirements are expected to be in the $400 million to $500 million range, based on recent acquisitions and new investments. McKesson’s policy of modest dividend increases as earnings and cash flow grow is expected to continue, which should result in free cash flow before changes in working capital in the $1.5 billion to $2.0 billion range. The Company’s acquisition of PSS is expected to be funded using a combination of cash on hand, free cash flow generated, incremental debt and the assumption of approximately $480 million of debt. DBRS believes that McKesson will continue to use cash on hand and free cash flow to complete small tuck-in acquisitions and to increase returns to shareholders (i.e., dividend increases and share repurchases). Should the Company use debt for such purposes, DBRS expects that it should be of a magnitude that maintains credit metrics at levels acceptable for the current rating category. As such, while DBRS expects that balance sheet debt will remain somewhat elevated, credit metrics, including lease-adjusted debt-to-EBITDAR, are expected to remain fairly steady, on a pro forma basis, subsequent to the closing of the acquisition of PSS. Should credit metrics deteriorate (i.e., with lease-adjusted debt-to-EBITDAR meaningfully above 2.0x for an extended period of time) due to weaker-than-expected operating performance or more aggressive-than-expected financial management, the ratings could be pressured.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating Companies in the Merchandising Industry, which can be found on our website under Methodologies.