McKesson (MCK) Ratings Affirmed by Moody's

Moody's Investors Service, ("Moody's") today affirmed McKesson Corporation's (NYSE: MCK) Baa2 senior unsecured debt ratings and its Prime-2 short term rating. This action follows news that the company plans to contribute most of its information technology (IT) business to a newly formed joint venture (JV) with Change Healthcare, Inc. (B2 Corporate Family Rating). Change Healthcare is a healthcare software company owned by Blackstone and Hellman and Friedman. McKesson's rating outlook remains stable. However, Moody's noted that this development is credit negative because it will reduce McKesson's diversification profile and its profitability.
Ratings affirmed: McKesson Corporation: Baa2 senior unsecured rating Prime-2 short term rating McKesson Canada Corporation Prime-2 short term rating

The rating outlook on all ratings is stable.

RATINGS RATIONALE

"McKesson's proposed JV transaction and plans to exit its IT business will reduce its financial flexibility," said Diana Lee, a Moody's Senior Credit Officer. Moody's estimates that McKesson's pro-forma debt/EBITDA, excluding profits that will be contributed to the JV and including the Rexall transaction, will be around 2.5 times. McKesson's debt/EBITDA at March 31, 2016 was about 2.0 times.

McKesson and Change Healthcare intend to take steps to launch an IPO in the months following the formation of the JV, which the companies anticipate will occur in the first half of calendar 2017. The JV will initially have a material amount of debt, and be highly leveraged. Moody's believes that the JV debt will be non-recourse to McKesson. At some point subsequent to the planned IPO, McKesson expects to exit its investment in a tax efficient manner. Until that time, however, Moody's believes that there is some risk that -- while not contractually obligated to do so -- McKesson would voluntarily step in to provide financial support to the JV if the JV was unable to service its own debt. The degree to which Moody's will consider the JV's debt as a financial burden when assessing McKesson's credit strength will be based on the JV's financial strength and its ability to service its own debt. Although McKesson will own about 70% of the JV, it will share control with its partner.

Over the coming months, McKesson will also close on its Rexall pharmacy deal, which is likely to result in additional borrowings. There is also a possibility that McKesson will lose its Rite Aid contract if Walgreens Boots Alliance completes its merger with Rite Aid. However, McKesson has about $4.0 billion of cash and strong cash flow, which the company could use to reduce its debt levels. In addition, the JV will dividend about $1.25 billion to McKesson at close.

McKesson's Baa2 rating reflects its significant revenue base and position as one of the nation's leading drug distributors. The rating also reflects relatively thin operating margins that are subject to pressure as well as relatively high customer concentration. McKesson will maintain moderate leverage, aided in part by its strong cash flow. The three largest US drug distributors -- including McKesson -- will benefit from arrangements with retail pharmacies to increase scale in purchasing generic drugs. McKesson's focus on retail pharmacies outside the US adds greater geographic and business line diversity, but also risks of operating in highly regulated markets.

The stable outlook reflects Moody's belief that McKesson will sustain moderate leverage, even if it loses its contract with Rite Aid. The outlook also reflects Moody's expectation that McKesson will pursue a prudent approach to funding future acquisitions because it will have less ability to take on additional debt at the current rating level. If the company engages in additional debt-financed acquisitions, loses a key customer, or does not improve profitability, the ratings could be downgraded. If Moody's believes that debt/EBITDA will be sustained above 2.5 times, the ratings could be downgraded. If McKesson can realize margin improvement, aided by synergies, and is able to sustain debt/EBITDA below 2.0 times, the ratings could be upgraded.

The principal methodology used in these ratings was that for the Distribution & Supply Chain Services Industry published in December 2015. Please see the Ratings Methodologies page on www.moodys.com for a copy of this methodology.

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