Roche (RHHBY) Ratings Affirmed by Fitch; Outlook Remains Stable

September 13, 2016 6:41 AM EDT
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Fitch Ratings has affirmed Roche Holding Ltd.'s (OTC: RHHBY) Long-Term Issuer Default Rating (IDR) at 'AA' with Stable Outlook. The Short-Term IDR has been affirmed at 'F1+'. A full list of rating actions is at the end of this commentary.

The affirmation reflects Roche's industry-leading position in the global pharmaceutical industry, particularly in the high margin oncology treatment and diagnostics. Roche's drug pipeline is industry leading in selected treatment areas, with a strong focus on biotech and innovation, and a satisfactory patent protection profile.

Roche is currently focused on bringing its late stage oncology pipeline to market, including combinations of treatments, which we expect to be a key growth driver for the group. Nevertheless, we view Roche's strong focus on the growing but competitive field of oncology as constraining its business risk profile, despite Roche's investment to also diversify into rare diseases and specialist treatment, which we expect will only develop over time. Fitch continues to view Roche's financial risk as strong, underpinned by industry leading margins, free cash flow (FCF) generation, and low leverage.

KEY RATING DRIVERS
Stable Financial Profile
Roche is operating within conservative financial policies with funds from operations (FFO) adjusted net leverage that we expect to peak at 1.1x in FY16 and FFO fixed charge cover above 13.0x. The group has significant financial flexibility in line with the 'AA' rating. Fitch expects FCF margins to trend towards 8.0% over the four-year rating horizon.

Product Launches, Profitability in Focus
Following a drop to 36.6% in FY15, Fitch expects Roche's EBITDA margin to return to around 40%, which is at industry leading levels and reflects the strong biotech and innovation content of its treatments. We observe currently slightly softer margins just below the company's 40% target given temporarily increased investment in new product launches as well as elevated R&D costs (Fitch expects 20% of sales) supporting the late stage R&D pipeline.

Given our expectation of gradually increasing competition from biosimilars after 2017 for some of Roche's core products, it will be critical for the company to deliver encouraging results for the R&D trials it is currently conducting in the new field of immuno-oncology. We expect more clarity when many of these trials will come to their conclusion in 2016 and 2017 and this will provide more guidance as to the evolution of Roche's sales.

Positive Sector Trends, Drug Pricing Debate
Fitch views secular trends in the pharma and healthcare sectors as supportive to the industry, with increasing access to healthcare globally, an ageing population, an increase of chronic diseases, as well as innovation in specialist treatments. However, we balance these favourable underlying industry trends with an increased focus on drug pricing and healthcare costs, particularly in the US market, and we expect a greater differentiation of pricing based on efficacy and innovation. In this context, we view Roche as a leader in specialist treatments and this positions it well to lead the intensifying debate around treatment costs.

Diagnostics Diversification
Fitch views Roche's diversification in diagnostics as a positive factor underpinning the company's strong business risk profile. Roche is a global market leader in in-vitro diagnostics, where it has around a 20% market share. In-vitro diagnostics account for 23% of group sales. This business has lower profitability and higher capital intensity compared to pharma, but it provides some diversity to earnings, emerging-market growth prospects, and R&D synergies with the pharmaceuticals division, focusing on developing drug personalisation.

KEY ASSUMPTIONS
Fitch's expectations are based on the agency's internally produced, conservative rating-case forecasts. They do not represent the forecasts of rated issuers individually or in aggregate. Key Fitch forecast assumptions are listed below.

- Sales over the four-year rating case are expected to grow by CAGR 3.7%, with pharmaceutical sales supported by recently launched and/or filed new treatments. We expect the Diagnostics division to have a more moderate growth profile, albeit supported by EM investments and a recent bolt-on acquisition widening the division's product offering.
- EBITDA margin returning towards 40.0% over the rating horizon supported by innovation and restructuring counterbalancing pricing pressures.
- R&D expense modelled at around 20% of sales to support the large late-stage pipeline.
- Moderate working capital absorption despite the new product launches.
- An annual bolt-on acquisition basket of CHF1.5bn with larger M&A treated as event risk; up to CHF1.0bn of annual share buybacks.
- Annual capex assumed at a maximum 8.6% of sales.

RATING SENSITIVITIES
Positive: Although not expected in the near term, future developments that could lead to positive rating action include sustained industry-leading profitability and cash flow generation with commitment to financial ratios in line with a higher rating category. These would be:
-FFO adjusted net leverage no greater than 0.5x on a sustained basis
-FFO fixed charge cover of 20x or above, on a sustained basis
-Increased product diversification, reducing Roche's reliance on its oncology offer

Negative: Future developments that could lead to negative rating action include:
-Significant pipeline setbacks and negative clinical trial results
-Major debt-financed acquisition or share buybacks, resulting in FFO adjusted net leverage above 1.5x on a sustained basis
-FFO fixed charge cover below 10x and FCF margin <5% on a sustained basis

LIQUIDITY
Roche's liquidity profile as of end-December 2015 comprised readily available cash of CHF9.2bn (Fitch defined), more than sufficiently covering short-term maturities of CHF6.2bn. Roche also has access to a USD7.5bn CP programme (of which CHF2.5bn were utilised at end-2015), which are supported by an existing committed bank facility of USD4.5bn and newly added committed bank facility of USD3bn, both of which were undrawn at end-2015. This strong liquidity profile underpins the 'F1+' Short-Term IDR.

FULL LIST OF RATING ACTIONS
Roche Holding Ltd.
Long-Term IDR: affirmed at 'AA'; Stable Outlook
Senior unsecured debt: affirmed at 'AA'
Short-Term IDR: affirmed at 'F1+'

Roche Holdings Inc.
Senior unsecured debt: affirmed at 'AA'

Roche Finance Europe BV
Senior unsecured debt: affirmed at 'AA'



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