Moody's Investors Service today affirmed CVS Health (NYSE: CVS) Baa1 senior unsecured rating following its announcement that it will be acquiring the pharmacy and clinic business of Target Corporation in a transaction valued at $1.9 billion. CVS Health will finance this acquisition with debt. At the same time, CVS Health lowered its level of expected share repurchases in 2015 by $1 billion. CVS Health now expects to make about $5 billion of share repurchases in 2015. The rating outlook remains stable.

The following ratings are affirmed:

Senior unsecured notes at Baa1

Commercial Paper rating at Prime-2

Senior unsecured shelf at (P) Baa1

RATINGS RATIONALE

The affirmation acknowledges that the acquisition of the Target pharmacy and clinic business provides CVS with an earnings growth opportunity. It increases CVS's presence in important new markets including Seattle, Denver, Portland, and Salt Lake City. It also enhances its existing presence in other market's such as Phoenix. Target's pharmacy business currently significantly underperforms CVS's pharmacy business on both a revenue per location and EBIT margin basis. We believe CVS will be able to bring its industry operating expertise to this new channel which will allow it to driver further profitability largely through a more efficient operating structure. However, we believe it may be challenging for CVS to achieve a high level of revenue growth from the Target pharmacy business as we believe consumers still have a preference to fill their prescriptions in smaller more convenient locations. A consumer trend that has benefitted the CVS retail locations for a number of years. However, CVS will now be able to add the Target locations to its maintenance choice program.

The incremental debt associated with the Target acquisition along with the previously announced $13 billion of debt that will be raised as a part of the Omnicare acquisition will result in CVS Health's debt to EBITDA exceeding its 2.7 times rent adjusted debt to EBITDAR target. It will also result in its debt to EBITDA (as adjusted by Moody's for operating leases) to exceed Moody's current 3.25 times debt to EBITDA downward rating trigger.

The affirmation acknowledges that we believe that CVS Health's increase in leverage is temporary and that over time CVS Health will bring its debt to EBITDA back in line with its leverage target and below Moody's downward rating trigger. CVS Health has reduced the level of its share repurchases which Moody's views as a sign of its commitment to reduce its debt to EBITDA. CVS estimates that the two transactions will result in its debt to EBITDA reaching 3.2 times. Using CVS Health's method of calculating debt to 8 times rent to EBITDAR, we estimate that CVS Health's debt to EBITDA will fall to 2.9 times at December 2017. Using Moody's approach which adjusts for operating leases using the present value approach, we forecast that CVS Health's debt to EBITDA will peak at 3.5 times for the year ended December 2015 before falling to 3.1 times at December 2017.

The affirmation incorporates that CVS Health has a history of making debt financed acquisitions and that the Baa1 rating had factored in the risk that CVS Health was highly likely to continue that practice. Given the timing of the two acquisitions so closely together and the incremental debt raised to finance both acquisitions, CVS Health is now weakly positioned in the Baa1 rating category.

A key underpinning of CVS Health's Baa1 senior unsecured rating is its strong market position in two industry sectors with solid fundamentals given their focus on providing prescription drugs. CVS Health is a solid number two player in both its retail pharmacy division and its pharmacy services division. It also acknowledges Omnicare's market position as the leading provider of pharmacy services to the long term sector. The retail pharmacies, pharmacies services in long term care facilities, and the pharmacy services division will all benefit from broad demographic trends which will continue to drive increasing usage of prescription medication. In addition, the rating balances the strength of the retail pharmacy division and the expected high growth of specialty pharmacy with the high price competition and contract renewal risk associated with its pharmacy benefit management company (PBM).

The rating also reflects CVS Caremark ability to manage on going reimbursement pressures while maintaining fairly consistent operating margins. The Baa1 considers CVS Health's clearly stated financial policy including its 2.7 times leas adjusted debt to rent adjusted EBITDA target, targeted 35% dividend payout ratio in 2018, and good liquidity.

The stable outlook acknowledges that we expect CVS Health to hold off on any further acquisitions for the next twelve to eighteen months. It also reflects that over time, we expect CVS Health will bring its debt to EBITDA back in line with its leverage target and below our current downward rating trigger. The stable outlook acknowledges that while credit metrics will weaken as a result of the acquisition, the weakening will only be temporary and that debt to EBITDA will return to levels appropriate for the Baa1 rating. It also acknowledges that despite the incremental debt, EBITA to interest expense will remain in line with a Baa1 rating.

Ratings could be upgraded should CVS Caremark's operating results continue on their current trend and CVS Caremark would to revise its financial policy such that its leverage target would be at or below 2.5 times, while maintaining retained cash flow to net debt above 25% and EBITA to interest expense above 6.0 times.

Ratings could be downgraded should the integration of the two acquisitions not go smoothly, should operating performance decline or financial policy become more aggressive such that debt to EBITDA were to remain above 3.25 times or EBITA to interest expense were to fall below 5.0 times.