Fitch Rates Eli Lilly's Notes Offering 'A'
KEY RATING DRIVERS
Fitch believes Lilly will maintain a credit profile supportive of its 'A' rating despite the increased debt (to help fund the NAH acquisition). However, Lilly will be left with only modest financial flexibility through 2015 given the expected increase in leverage during that period. Fitch's rating actions are based on the following:
--Fitch views the acquisition of NAH business as strategically sound, offering Lilly a broader product portfolio, greater geographic reach, top-line growth opportunities and potential cost savings.
--Lilly is nearing the end of its significant patent risk period that essentially began in 2014 with two of its top drugs, which accounted for roughly 26% of total firm sales, losing patent protection.
--Fitch expects Lilly will return to top-line organic growth during 2015-2016 with the annualizing of patent expiries and continued strength in established and new products such as Alimta, Cialis, Effient, Erbitux and Tradjenta/Jandueto.
--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 cost cutting measures have resulted in a leaner cost structure, paving the way for margin expansion in 2015-2016 as sales rebound.
--Fitch forecasts that Lilly will generate approximately \$1.1 billion to \$1.3 billion of free cash flow (FCF; cash flow from operations minus capital expenditures and dividend payments) in 2015.
--Relatively aggressive share repurchases from now through 2017 are incorporated in Fitch's forecast. However, cash dividend increases are expected to be modest and acquisitions targeted.
--Fitch expects Lilly to operate with leverage (total debt/EBITDA) of 1.5x-1.7x during 2015.
--Fitch assumes the company will maintain adequate liquidity during the upcoming patent cliff, supported by FCF generation, balance sheet cash, and availability on its revolving credit facility.
ANIMAL HEALTH ACQUISITION
Lilly completed its \$5.4 billion NAH acquisition in January 2015, which it funded with roughly \$3.4 billion of international cash and \$2 billion short-term debt. The acquisition moves Lilly near the top of the animal health market in terms of product categories and geographic presence. In addition, Novartis' animal health product pipeline is reportedly strong and will likely increase Lilly's long-term growth potential.
The newfound scale with its animal health business should also offer efficiency opportunities. Lilly has stated that it expects to achieve more than \$200 million in annual cost synergies within three years after the acquisition. While acquisition-related top-line synergies are more difficult to quantify and realize, Fitch believes there will be prospects for enhanced organic growth stemming from a broader product portfolio.
NEARING THE END OF PATENT CLIFF
Lilly is close to exiting its significant patent expiry period that 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. Evista lost U.S. market exclusivity in March 2014 and accounted for approximately 4% of total firm revenues.
REBOUND WITH PATENT-PROTECTED PRODUCTS
Fitch expects Lilly will return to top-line organic growth during 2015 - 2016, achieving annual sales of roughly \$20 billion including meaningful foreign exchange headwinds. Currently marketed drugs including Alimta (cancer), Cialis (erectile dysfunction), Effient (cardiac thrombosis), Erbitux (cancer) and Tradjenta/Jandueto (diabetes), in aggregate, have decent intermediate-term growth potential. These drugs, combined, generate roughly \$6.3 billion in annual revenues for Lilly and address large and growing treatment markets.
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 Cyramza (cancer)and Trulicity (diabetes). Late stage candidates include potential treatments for cancer, diabetes, lupus, psoriasis, high cholesterol, depression, and rheumatoid arthritis. The company has partnered with Boehringer Ingelheim in its efforts to develop diabetes medications.
EFFORTS TO SUPPORT MARGINS
Fitch expects Lilly to remain focused on controlling costs in order to support margins while balancing its need to invest in growth. As such, the company has remained steadfast in funding longer term growth by and prioritizing investing in research and development spending. In addition to costs, the growth in newer, higher-margin products supports the case for margin improvement beginning in 2015.
POSITIVE AND GROWING FCF
Fitch forecasts higher FCF of approximately \$1.1 billion to \$1.3 billion during 2015, as Lilly returns to a period of organic growth and improved margins. Expected cash flow from operations of roughly \$4.6 billion should be sufficient to fund approximately \$2.2 billion in cash dividends and \$1.2 billion in capital expenditures. Fitch believes FCF will continue to grow from 2014 levels over the long run, as revenues and margins recover.
RELATIVELY AGGRESSIVE CASH DEPLOYMENT
Fitch incorporates roughly \$4 billion in share repurchases from now through 2017 - 2018, funded with FCF and 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.
Fitch looks for Lilly to operate with debt leverage of 1.5x -1.7x during 2015. The forecasted increase in leverage over early 2014 stems from the increased debt that the company incurred to fund the acquisition of NAH in early 2015.
Fitch assumes Lilly will maintain adequate liquidity, supported by FCF generation, balance sheet cash and availability on its revolving credit facility. At Dec. 31, 2014, the company had approximately \$4.8 billion of cash and short-term investments, \$3.3 billion of unused committed bank credit facilities, and roughly \$4.6 billion in noncurrent investments. Lilly generated approximately \$1.0 billion in FCF during the LTM period.
In August 2014, the company refinanced its revolving bank credit facilities and entered into a \$1.20 billion credit facility with a five-year term and a \$2.00 billion credit facility with a 364-day term, both of which are available to support Lilly's commercial paper program. There were no amounts outstanding under the revolving credit facility during the year ended Dec. 31, 2014.
At Dec. 31, 2014, Lilly had approximately \$8.1 billion in debt outstanding. Fitch believes the company's long-term debt maturities are manageable with roughly \$8 million maturing in 2015, \$209 million in 2016, \$1.0 billion in 2017, \$203 million in 2018, and \$601 million in 2019. Fitch's forecast assumes that Lilly will refinance these maturities with new debt issuances.
Fitch's key assumptions for Lilly's 'A'/Stable Outlook include:
--Moderate organic revenue growth, which is mostly offset by the negative effect of foreign exchange movements during 2015;
--Improving margins driven by favorable mix, including new product introductions and the achievement meaningful cost reduction;
--Annual FCF (cash flow from operations minus capital expenditures minus dividends) of \$1.1 billion to \$1.3 billion during 2015;
--Leverage to decline below 1.7x by yearend 2015 through increased operational EBITDA ;
--No major business development initiatives that would meaningfully increase leverage during 2015.
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 in the intermediate term include:
--Revenues continue to expand for patent protected products, including Amyvid, Alimta, Cialis, Cyramza, Effient, Erbitux, Tradjenta/Jandueto and Trulicity;
--The company employs adequate cost controls and integration synergies to generate sufficient profitability while limiting increases in debt to maintain leverage sustainably below 1.3x;
--Cash is deployed conservatively, with the majority of the planned \$4 billion share repurchase program funded through cash flow as opposed to debt issuance.
Future developments that may, individually or collectively, lead to a Negative Rating Outlook and/or a one-notch downgrade to
--Operational stress from, but not limited to, patent expiries drives leverage durably above 1.7x;
--Inability to extract efficiencies from current operations as well as from the NAH acquisition;
--FCF deteriorates without the expectation of a timely trend reversal.
Fitch currently rates Eli Lilly as follows:
--Long-term IDR 'A';
--Senior unsecured debt rating 'A';
--Bank loan rating 'A';
--Short-term IDR 'F1';
--Commercial paper rating 'F1'.
The Rating Outlook is Stable.