S&P Raises Outlook on Cardinal Health (CAH) to Stable Following FY14 Outperformance
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Standard & Poor's Ratings Services revised its outlook on Dublin, Ohio-based Cardinal Health (NYSE: CAH) to stable from negative and affirmed the 'A-' corporate credit rating. We also affirmed the 'A-2' commercial paper rating.
The rating affirmation and outlook revision follows a fiscal 2014 performance that exceeded our expectations. In particular, the revenue decline of almost 10% was better than the 15% decline we forecasted, which contributed to higher levels of EBITDA, free cash flow, and on-hand cash. The better than expected performance, and corresponding strong credit metrics, reinforces our perception of business risk and conservative financial policies after two major contract losses (Express Scripts in 2012 and Walgreens in 2013).
"Cardinal Health remains one of the three largest drug distributors," said credit analyst Michael Berrian. "The company has size and scale, and its market position is strong, evidenced by the recent extension of the CVS contract to 2019, in conjunction with the generic sourcing joint venture that began on July 8, 2014. We continue to assess Cardinal Health's business risk profile as "satisfactory"."
The stable outlook reflects our expectation that Cardinal will grow revenues at a low single-digit rate, in line with the industry, and continue to generate strong cash flow. Although we do not expect any debt repayments, we do expect leverage will stay at 1x or less given modest EBITDA growth.
Downside scenario
We could lower the rating if incremental debt, or the use of on-hand cash, totaling roughly $1.5 billion, to fund an acquisition or share repurchase results in leverage increasing to more than 1.5x. We could also lower the rating in the more unlikely event the company is unable to sustain modestly higher margins resulting in leverage also increasing to, and being sustained at, more than 1.5x over the next two years. This could occur if gross margins decline to 5.5% or less and would result from price pressure in the pharmaceutical distribution business or lower revenues in the higher margin medical products supply business.
Upside scenario
Given the concentration in pharmaceutical distribution, an upgrade is unlikely, barring a major diversifying acquisition that improves its satisfactory business risk profile while keeping leverage at 2x or less.
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