Fitch Raises Outlook on Amgen (AMGN) to Stable; Notes Strong Operational Performance, Debt Reduction Goal

KEY RATING DRIVERS

--Amgen's recent operational strength contributed to reduced leverage of 2.9x at March 31, 2015, down from 4.1x at the end of 2013 driven by the acquisition of Onyx Pharmaceuticals (Onyx) in 4Q13. However, the May 2015 debt issuance to finance share repurchases resulted in pro forma leverage of 3.3x. Nonetheless, Fitch believes Amgen will achieve gross leverage of 3.0x by the end of 2015 through EBITDA growth, a level more commensurate with the current rating.

--Operating income during the year benefited from a change in the co-promotion agreement with Pfizer Inc. (Pfizer) pertaining to marketing of Enbrel in the U.S. and Canada. The royalty rate paid to Pfizer significantly fell at the end of 2013 which lead to a reduction in profit sharing and aided in increasing EBITDA margin by approximately 770 bps to 49.3% by the end of 2014. Further margin expansion is expected in 2015, driven by improving sales (including contributions from newer products), lower royalty payments to Pfizer, additional cost savings in general & administrative expenses and prioritization in research and development spending.

--Amgen took advantage of its improved performance by resuming share repurchase activity in the fourth-quarter 2014 and intends to buy back roughly $2 billion of its stock during 2015. Coupled with an increasing dividend, shareholder friendly actions will continue to pressure U.S. cash balances and gross debt leverage within the context of 2.5x - 3.0x.

--Growth of established products, progress with ramping up newer medicines and advancing pipeline projects should help to offset some of the risk of anticipated branded and biosimilar competition to Neulasta, Neupogen and Epogen. In addition, Fitch expects sales erosion for these biologic drugs to be less dramatic than for traditional small-molecule drugs facing generic competition.

--Amgen generates solid free cash flow (FCF) despite a rapidly rising dividend stream. FCF has remained above $4 billion annually since the initiation of a dividend in 2011 and was just above $6.0 billion for the LTM ended March 31, 2015, given the company suspended share repurchase activity as it integrated Onyx. Dividends have increased to $2.0 billion for the LTM as of March 31, 2015 from $500 million in 2011. Fitch still expects FCF margins to exceed 20% in 2015-2018 including annual increases to the dividend and a large interest expense tied to a persistently high debt balance.

PRESENTLY HIGH LEVERAGE

Amgen's gross debt leverage is high for the 'BBB' rating and is partly the result of the acquisition of Onyx in October 2013 that led to leverage of 4.1x at the end of 2013. The current leverage level of 3.3x, pro forma for the $3.5 billion May debt issuance to fund share repurchases, leaves no cushion within the 'BBB' rating category. In order to reduce ratings pressure, gross debt leverage would need to fall to around 3.0x by the end of 2015. Fitch thinks that this leverage target is achievable through EBITDA growth.

CONTINUED MARGIN IMPROVEMENT EXPECTED

Fitch expects Amgen's margins will continue to improve during the intermediate term. EBITDA margin improved during 2014 by roughly 770 basis points to 49.3%, aided by a reduction in selling, general and administration expense. The reduction is highly durable since it was largely due to the drop in royalty payments by Amgen to Pfizer associated with the start of a three-year phase out period for the co-promotion agreement of Enbrel in the U.S. and Canada. In addition, prioritization of product pipeline projects reduced research and development spending as a percentage of sales.

YOUNGER PORTFOLIO PRODUCTS GROWING

Newer therapies such as XGEVA (bone metastases), Prolia (osteoporosis), Nplate (thrombocytopenia), Vectibix (metastatic colorectal cancer) and Kyprolis (relapsed and refractory multiple myeloma) are posting strong double-digit growth, as good clinical experience drives increased acceptance in the medical community. While these four products accounted for only 17% of sales in the first quarter of 2015, their combined year-over-year growth in the quarter was 29%, compared to 9% for the remainder of the portfolio.

PIPELINE PROGRESS

Amgen has also experienced a number of successes in advancing products through its pipeline. The company received FDA approval for Blincyto (acute lymphoblastic leukemia) in December 2014 and Corlanor (heart failure) in April 2015. Repatha (hyperlipidemia) was recommended by the FDA advisory committee to be approved by the FDA in June 2015 and talimogene (melanoma) was recommended for approval by the advisory board in April of this year. These drugs all have the potential to improve outcomes in a number of patients that currently face suboptimal treatment options.

INTELLECTUAL PROPERTY CHALLENGES

The base patent for Neulasta in the U.S. expires in October 2015, and in Europe it expired in February 2015. International patents for Sensipar lapse in October 2015. In addition, the European patent for the second-generation erythropoietin medicine, Aranesp expired in August 2014. Collectively, these maturing pharmaceuticals represent roughly 30% of total firm revenues at risk to branded or biosimilar competition.

Amgen has already lost patent protection in the U.S. for Epogen and Neupogen. Through the long term, Teva's branded medication and Sandoz's recently-approved biosimilar therapy will take share directly from Neupogen and to a lesser extent Neulasta, Amgen's long acting filagrastim treatment. However, the competing products will not benefit from interchangeability with the originator biologics, requiring the competitors to spend on marketing and selling. Stiff price competition will be less likely for Amgen. In addition, Amgen's On-Body injector for Neulasta could help fend off biosimilar competition.

KEY ASSUMPTIONS

Fitch expects mid-single digit organic growth driven by increased competitive pressure for some of the more established products offset by uptake of new product commercialization.

Fitch forecasts EBITDA of $11 billion and free cash flow (FCF; CFO less capital expenditures and dividends) of about $6 billion for Amgen in 2015. Fitch expects Amgen's operating EBITDA margin to improve in 2015 versus 2014. This is driven by a focus on cost reduction and an improving product mix.

Capital expenditures are forecasted at $800 million in 2015. The company deploys cash for mainly share repurchases; total leverage is maintained at a level commensurate with the 'BBB' rating.

RATING SENSITIVITIES

Positive: Future developments, individually or collectively, that may lead to positive rating action include the following:

--An upgrade of the ratings is not likely in the near-term given currently high leverage;
--An upgrade could occur if the company maintained leverage in the 2.2x to 2.6x range and operational performance remained strong.

Negative: Future developments, individually or collectively, that may lead to negative rating action include the following:

--An expectation for gross debt leverage maintained durably above 3.0x after 2015 would likely result in a Negative Outlook or a one-notch downgrade;

--Progress toward the target could be hindered by financial decisions that include debt-financed share repurchases, dividends or acquisitions. In addition, leverage improvement could be jeopardized by operational stress that decreases profitability, greater-than-expected biosimilar and brand name drug competition and/or unsuccessful commercialization of the late-stage research pipeline.

ADEQUATE LIQUIDITY

Amgen has a solid liquidity profile. The biggest concern is the increasing amount of the cash balances held overseas, given this cash will not likely be repatriated and debt will be needed to finance shareholder friendly actions domestically. Fitch forecasts FCF to remain above $6 billion annually, representing FCF margins of around 30% through 2018, despite a growing dividend that has increased to $2.0 billion for the latest 12 months (LTM) as of March 31, 2015 (currently $0.79 per share per quarter), from $500 million in 2011 ($0.28 per share per quarter). FCF was $6 billion for the LTM as of March 31, 2015.

The company also had cash and short-term investments of $27 billion on March 31, 2015 of which only $2.5 billion resides domestically according to Amgen reports. Growth in the amount of cash held overseas raises concern that dividends and share repurchases will require debt funding, driving higher gross leverage.

Additional liquidity comes from full availability of a recently amended and extended $2.5 billion credit facility that matures on July 30, 2019. The facility backstops an untapped $2.5 billion commercial paper program providing additional financial flexibility.

FULL LIST OF RATING ACTIONS

Fitch affirms Amgen's ratings as follows:

--IDR at 'BBB';
--Senior unsecured debt at 'BBB';
--Bank loan at 'BBB';
--Short term IDR at 'F2';
--Commercial paper at 'F2'.

The Rating Outlook is Stable.