OREANDA-NEWS. Fitch Ratings has affirmed the ratings for McKesson Corp. (NYSE: MCK), including the Issuer Default Rating (IDR) at 'BBB+' and the Short-term IDR at 'F2'. The Rating Outlook is Stable.

A full list of rating actions, which apply to approximately $9.4 billion of debt outstanding at Sept. 30, 2015, follows at the end of this release.

KEY RATING DRIVERS

STABLE OPERATIONS, LOW MARGINS

The credit profiles of MCK and its peers benefit from stable operating profiles and consistent cash generation. Steady pharmaceutical demand, an oligopolistic drug distribution industry in the U.S. and, for the most part, in Western Europe, and relative insulation from most drug pricing and regulatory pressures, support strong ratings despite very low margins.

DE-LEVERAGING NEARLY COMPLETE

Fitch expects MCK to complete its post-Celesio de-leveraging in fiscal 2016, with the repayment of its $600 million of notes due March 2016. Cash flows are expected to outpace debt maturities, but further debt repayment is not expected, resulting in gross debt/EBITDA between 1.5x and 2.0x over the ratings horizon.

WEAKENED COMPETITIVE POSITION

MCK's competitive positioning will become somewhat weakened following key transactions involving four of its largest customers in calendar 2015 (Rite Aid, Omnicare, Target, OptumRx). This weakened positioning is most evident in MCK's generic sourcing scale, which Fitch expects will lag that of both Walgreens-AmerisourceBergen and CVS Health-Cardinal Health, but still among the strongest in the world.

NON-US OPERATIONS MORE RISKY

Fitch generally sees the European drug channel as less stable and higher risk than in the U.S., especially given the diversity of its regulatory and reimbursement systems. But inorganic growth opportunities are more prevalent in markets outside the U.S., so MCK's presence in Europe is important for long-term growth prospects.

RATING SENSITIVITIES

Maintenance of MCK's 'BBB+' IDR considers gross debt/EBITDA generally in the range of 1.4x to 2x, with continued strong and steady cash flows, accompanied by stable or modestly expanding margins. Cash flows and liquidity are strong for the rating category.

Negative rating actions are not expected to explicitly result from recent shifts in the industry's competitive landscape - namely M&A among MCK's largest customers resulting in key contract losses/revisions - through margins could be pressured compared to peers. A downgrade to 'BBB' could be driven by material debt-funded acquisitions or share repurchases, or more significant margin pressures than currently expected.

A positive rating action is not currently anticipated over the ratings horizon. Fitch does not expect MCK to reduce gross debt/EBITDA to 1.4x or below, though cash generation will likely be sufficient to repay debt maturities in fiscal 2017-2018 if the firm chose to do so.

STRONG LIQUIDITY POSITION

MCK maintains a strong liquidity position. The firm's new $3.5 billion revolver, which replaced its previous revolvers and A/R facilities, provides ample liquidity for working capital and other temporary financing requirements. Management also seeks to keep ample cash on hand for day-to-day operations. Access to external liquidity is adequate.

Non-controlling owners have the right to put their Celesio stock to McKesson at EUR 22.99, per the German courts. The maximum redemption value of these put options at Sept. 30, 2015 was $1.26 billion, meaning MCK could be required to pay up to $1.26 billion to acquire the remaining 24% of Celesio at any time, as directed by non-controlling shareholders. Although this risk remains, it is mitigated by McKesson's re-built liquidity position and the low probability that a large portion of the non-controlling shareholders would put their stock simultaneously.

Debt maturities are well-laddered and manageable, with no more than $1.6 billion due in any one year (2017). FCF is expected to routinely outpace debt maturities, leaving flexibility for M&A or share repurchase activity. Fitch expects debt maturities to be refinanced, including by the issuance of non-US debt obligations, from fiscal 2017 onward.

CUSTOMER CONSOLIDATION SHIFTS COMPETITIVE POSITIONING

MCK's contracts with four of its largest seven customers were negatively affected by M&A in 2015. These customers include Rite Aid, Omnicare, Target, and OptumRx. While MCK has shared publicly that it will retain branded distribution for Omnicare and Target, the firm will lose the higher-margin generic drug distribution business it had only recently won with Omnicare. Fitch assumes MCK will also eventually lose its Rite Aid business, as well. Most importantly, MCK will no longer be able to include those companies' generic drug acquisition volumes in its generic drug sourcing venture. Consequently, Fitch estimates MCK's generic drug buying power - which continues to be an increasingly important competitive positioning facet in recent years - will lag that of its primary competitors. Still, McKesson remains one of the world's largest purchasers of generic drugs and could still offer value to pharmacies that currently source generics on their own.

If there is a silver lining to the aforementioned M&A-driven losses, it is that MCK remains more in control of its own organic growth and business decisions than its peers. Whereas AmerisourceBergen and Cardinal Health have large sales concentrations and are dependent on their partners, Walgreens and CVS Health, respectively, for their generic sourcing, McKesson remains independent with superior business diversification. MCK also leads its peers with respect to organizing its independent pharmacy customers, with its several banners and franchise brands in Canada and its more than 4,000 pharmacy-strong HealthMart offering in the U.S. McKesson's position in Europe should also lend itself to growth opportunities in the medium-term.

IMPACT OF CONSOLIDATING GENERIC DRUGMAKERS

Consolidation, while present in nearly every area of healthcare, is especially torrid among manufacturers of generic drugs. Most notably, Teva Pharmaceutical Industries Ltd., the world's largest generic drugmaker, agreed in July 2015 to acquire the generic drug business of Allergan plc, also a top-4 global generic drugmaker. The effect of this very large-scale merger is at this time uncertain, as Fitch tends to think there is a point of diminishing returns as it pertains to generic drug pricing negotiations. However, the continued consolidation of mid-tier generic drug firms may incrementally push back on more favorable pricing and/or working capital terms achieved recently by the world's largest buying consortiums.

KEY ASSUMPTIONS

--Revenues up low-single digits in 2016-2017, owing to the expanded contracts with Rite Aid and Albertsons, solid growth in specialty and stability in med-surg, offset by currency headwinds at Celesio and lost business (OptumRx, Omnicare generics, Target generics).
--Modest overall margin pressures in fiscal 2016-2017 from lost generic distribution contracts and less opportunity from generic price appreciation spreads.
--FCF exceeding $2 billion annually, utilized for M&A that resembles the recent Sainsbury's and UDG deals, with remaining discretionary cash flows used for share repurchases.
--The repayment of $600 million of notes due March 2016, with the refinancing of debt maturities thereafter.
--Fitch forecasts assume MCK continues serving Rite Aid under the recently expanded distribution contract through MCK's fiscal 2017.

Fitch affirms the following:

McKesson Corp.
--Long-term IDR at 'BBB+';
--Short-term IDR at 'F2';
--Senior unsecured bank facility at 'BBB+';
--Senior unsecured notes 'BBB+';
--Commercial paper at 'F2'.

The Rating Outlook is Stable.