OREANDA-NEWS. Fitch Ratings affirms Eli Lilly & Co. Inc.'s (Lilly) long-term Issuer Default Rating (IDR) at 'A'. In addition, Fitch affirms the company's short-term IDR at 'F1'. The Rating Outlook is Stable. The rating actions apply to roughly \$7.6 billion of debt outstanding at Dec. 31, 2014. A full list of the rating actions is provided at the end of this release.

KEY RATING DRIVERS

--Fitch views the acquisition of Novartis' Animal Health (NAH) business as strategically sound, offering Lilly a broader product portfolio, greater geographic reach, top-line growth opportunities and potential cost savings.

--Lilly is nearing the end of its significant patent risk period that essentially began in 2014 with two of its top drugs, which accounted for roughly 26% of total firm sales, losing patent protection and now accounting for only 7% of firm sales.

--Fitch expects Lilly will return to top-line organic growth during 2015-2016 with the annualizing of patent expiries and continued strength in established and new products such as Alimta, Cialis, Effient, Erbitux and Tradjenta/Jandueto.

--Fitch believes Lilly's late-stage pipeline, particularly strong in treatments for diabetes and cancer, offers the company numerous opportunities to sustain longer-term growth.

--Lilly's leaner cost structure, growth of patent-protected products and new product launches should pave the way for margin expansion in 2015-2016 as sales rebound.

--Fitch forecasts that Lilly will generate approximately \$400 million to \$600 million of free cash flow (FCF; cash flow from operations minus capital expenditures and dividend payments) in 2015.

--Relatively aggressive share repurchases from now through 2017 are incorporated in Fitch's forecast. However, cash dividend increases are expected to be modest and acquisitions targeted.

--Fitch expects Lilly to operate with leverage (total debt/EBITDA) of 1.5x-1.7x during 2015.

--Fitch assumes the company will maintain adequate liquidity during the forecast horizon, supported by FCF generation, balance sheet cash, and availability on its revolving credit facility.

ANIMAL HEALTH ACQUISITION GOOD FIT
Lilly completed its \$5.4 billion NAH acquisition in January 2015, which it funded with roughly \$3.4 billion of international cash and \$2 billion in debt. The acquisition moves Lilly near to the top of the animal health market in terms of product categories and geographic presence. In addition, Novartis' animal health product pipeline is reportedly strong and will likely increase Lilly's long-term growth potential.

The newfound scale with its animal health business should also offer efficiency opportunities. Lilly has stated that it expects to achieve more than \$200 million in annual cost synergies within three years after the acquisition. While acquisition-related top-line synergies are more difficult to quantify and realize, Fitch believes there will be prospects for enhanced organic growth stemming from a broader product portfolio.

PATENT RISK EASING
Lilly is close to exiting its significant patent expiry period that essentially began in 2014. Its largest selling drug, Cymbalta, lost U.S. patent protection in December 2013 and European patent protection in August 2014. Cymbalta accounted for roughly 24% of total company sales during 2013 and accounted for only 7% in 2015. Evista lost U.S. market exclusivity in March 2014 and accounted for approximately 4% of total firm revenues, declining to 2% of firm revenues in 2014. To date, no biosimilar competition to Humalog has entered the market, despite its May 2013 patent expiry.

REBOUND WITH PATENT-PROTECTED PRODUCTS
Fitch expects Lilly will return to top-line organic growth during 2015-2016, achieving annual sales of roughly \$19 billion to \$21 billion including meaningful foreign exchange headwinds. Currently marketed drugs including Alimta (cancer), Cialis (erectile dysfunction), Effient (cardiac thrombosis), Erbitux (cancer) and Tradjenta/Jandueto (diabetes), in aggregate, have decent intermediate-term growth potential. These drugs, combined, generate roughly \$6.3 billion in annual revenues for Lilly and address large and growing treatment markets.

IMPROVING PIPELINE
Lilly has improved its growth prospects for the intermediate-to-longer term, as it has been making significant progress in building its late-stage pipeline. The company has a number of late-stage drug candidates and recently launched Cyramza (cancer)and Trulicity (diabetes). Late stage candidates include potential treatments for cancer, diabetes, lupus, psoriasis, high cholesterol, depression, and rheumatoid arthritis. The company has partnered with Boehringer Ingelheim in its efforts to develop diabetes medications.

COST CONTROL BODES WELL FOR LONGER-TERM MARGIN EXPANSION
Lilly has been effective in reducing costs during 2014, as it reduced spending in SG&A by 7% and R&D by 15% compared to 2013. Much of the decrease was driven by reducing resources needed to support Cymbalta and Evista, as well as prioritizing research and development projects. In addition to costs, the growth in newer, higher-margin products supports the case for margin improvement beginning in 2015.

POSITIVE AND GROWING FCF
Fitch forecasts higher FCF of approximately \$400 million to \$600 million during 2015, as Lilly returns to a period of organic growth and improved margins. Expected cash flow from operations of roughly \$4 billion should be sufficient to fund approximately \$2.2 billion in cash dividends and \$1.3 billion in capital expenditures. Fitch believes FCF will continue to grow from 2014 levels over the long run, as revenues and margins recover.

RELATIVELY AGGRESSIVE CASH DEPLOYMENT
Fitch incorporates roughly \$4 billion in share repurchases from now through 2017-2018, funded with FCF and cash on hand. However, Fitch models only incremental dividend increases and targeted acquisitions during the same forecast period, which will not likely stress Lilly's balance sheet.

NAH ACQUISITION DRIVEN LEVERAGE
Fitch looks for Lilly to operate with debt leverage of 1.5x-1.7x during 2015. The forecasted increase in leverage over early 2014 stems from the increased debt that the company incurred to fund the acquisition of NAH in early 2015. Fitch does not expect the company to reduce debt levels during the forecast period.

ADEQUATE LIQUIDITY
Fitch assumes Lilly will maintain adequate liquidity, supported by FCF generation, balance sheet cash and availability on its revolving credit facility. At Dec. 31, 2014, the company had approximately \$4.8 billion of cash and short-term investments, \$3.2 billion of unused committed bank credit facilities, and roughly \$4.6 billion in noncurrent investments. Lilly generated approximately \$1 billion in FCF during the LTM period.

In August 2014, the company refinanced its revolving bank credit facilities and entered into a \$1.20 billion credit facility with a five-year term and a \$2.00 billion credit facility with a 364-day term, both of which are available to support Lilly's commercial paper program. There were no amounts outstanding under the revolving credit facility during the year ended Dec. 31, 2014.

At Dec. 31, 2014, Lilly had approximately \$7.6 billion in debt outstanding. Fitch believes the company's long-term debt maturities are manageable with roughly \$2.7 billion maturing in 2015, \$209 million in 2016, \$1 billion in 2017, \$204 million in 2018, and \$601 million in 2019. Fitch's forecast assumes that Lilly will refinance these maturities with new debt issuances.

KEY ASSUMPTIONS:

Fitch's key assumptions for Lilly's 'A'/Stable Outlook include:

--Moderate organic revenue growth, which is mostly offset by the negative effect of foreign exchange movements during 2015;
--Improving margins driven by favorable mix, including new product introductions and the achievement meaningful cost reduction;
--Annual FCF (cash flow from operations minus capital expenditures minus dividends) of \$400 million to \$600 million during 2015;
--Leverage to remain below 1.7x during 2015;
--No major business development initiatives that would meaningfully increase leverage during 2015.

RATING SENSITIVITIES

While Fitch does not expect a positive rating action in the near term, future developments that may, individually or collectively, lead to a revision of the Rating Outlook to Positive in the intermediate term include:

--Revenues continue to expand for patent protected products, including Alimta, Cialis, Cyramza, Effient, Erbitux, Tradjenta/Jandueto and Trulicity;

--The company employs adequate cost controls and integration synergies to generate sufficient profitability while limiting increases in debt to maintain leverage sustainably below 1.3x;

--Cash is deployed conservatively, with the vast majority of the remaining \$3.7 billion share repurchase authorization funded with cash flow as opposed to debt issuance.

Future developments that may, individually or collectively, lead to a Negative Rating Outlook and/or a one-notch downgrade to 'A-'/'F2' include:

--Operational stress from, but not limited to, patent expiries drives leverage durably above 1.7x;

--Inability to extract efficiencies from current operations as well as from the NAH acquisition;

--FCF deteriorates without the expectation of a timely trend reversal.

Fitch has affirmed Eli Lilly's ratings as follows:

--Long-term IDR at 'A';
--Senior unsecured debt rating at 'A';
--Bank loan rating at 'A';
--Short-term IDR at 'F1';
--Commercial paper rating at'F1'.

The Rating Outlook is Stable.