Fitch Affirms AmerisourceBergen at 'A-'; Outlook Revised to Stable

Fitch Ratings has affirmed the ratings of AmerisourceBergen Corp. (NYSE: ABC), including the Long-Term Issuer Default Rating (IDR) at 'A-'. The Rating Outlook is revised to Stable from Negative.

A full list of rating actions, which apply to approximately $4.2 billion of debt outstanding at Sept. 30, 2016, follows at the end of this release.

KEY RATING DRIVERS

Stable Operations, Low Margins

The credit profiles of ABC 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 relative insulation from most drug pricing and regulatory pressures, support strong ratings despite very low margins. ABC's long-term relationship with Walgreens provides an added element of meaningful stability and growth.

De-Leveraging Expected in 2017

Fitch expects debt repayment in 2017 will reduce gross debt/EBITDA to 1.4x. This de-leveraging follows a lengthened period of heightened leverage subsequent to $2.65 billion of debt issued during fiscal 2014-2015 for ABC's special share repurchase program and the acquisitions of MWI and PharMEDium. Gross debt/EBITDA was 1.8x at Sept. 30, 2016.

Solid Liquidity, Cash Generation

ABC maintains a solid liquidity position, supported by strong cash flows and strong access to capital markets. Fitch expects annual funds from operations (FFO) and free cash flow (FCF) to exceed $2 billion and $1 billion, respectively, but notes that FCF can be affected by large working capital swings inherent to large healthcare distributors.

Narrow Focus, Business Concentration

ABC's business is narrowly focused on the distribution of pharmaceutical products and related services. Furthermore, nearly half of sales are to the firm's two largest customers: Walgreens Alliance Boots Corp. (Walgreens; 'BBB'/Outlook Stable) and Express Scripts Holding Corp. (Express Scripts; 'BBB'/Outlook Stable).

Close Alignment with Walgreens

Fitch views Walgreens as a strong long-term partner for ABC, particularly as the firm is expected to drive industry-leading organic growth and bring additional distribution volumes to ABC through its announced transactions with Rite Aid Corp. (Rite Aid; 'B'/Watch Positive) and Prime Therapeutics. Fitch expects the proportion of revenues ABC sources from Walgreens will trend toward the mid- to high-30% range by 2018-2019 from nearly 30% in fiscal 2016.

Limited U.S. Growth, Event Risk

Fitch believes there are limited growth opportunities in the traditional U.S. drug distribution space. Growth opportunities are more robust for the MWI and PharMEDium platforms, but represent a relatively small portion of ABC as a whole. As a result, and now more so considering ABC's alignment with Walgreens, Fitch expects ABC to pursue both organic and inorganic growth in service-related and non-U.S. markets over the intermediate-to-longer term.

RATING SENSITIVITIES

ABC currently has limited flexibility at its current ratings. Maintenance of the 'A-' long-term ratings consider gross debt/EBITDA of 1.4x or below following debt reduction in fiscal year-end 2017, accompanied by steady FFO in excess of $1 billion annually and stable or improving margins.

Fitch notes the period of heightened leverage expected to resolve in 2017, which has been longer than usual, may run into fiscal 2018. However, ABC's historical commitment to operating with low debt leverage and responsible allocation of capital, with strong cash generation and a growing long-term partner in Walgreens, support the current 'A-' ratings.

An upgrade to 'A' is not expected over the ratings horizon. Because of the business's very low margins, Fitch believes ABC's management would need to commit to operating with gross debt leverage below 0.8x, accompanied by increased profit margins likely the result of diversifying away from its largest and lowest-margin customers. Fitch does not expect ABC to commit to operating with such low leverage or to enhance profit margins in the near-to-intermediate term.

A downgrade to 'BBB+' would likely be the result of a change in the firm's current capital deployment strategy, resulting in gross debt/EBITDA sustainably above 1.4x, or one veers from ABC's traditional commitment to its core drug distribution business. Negative rating actions are not expected to explicitly result from recent shifts in the industry's competitive and pricing dynamics - namely lower branded inflation and key contract renewals.

KEY ASSUMPTIONS

Fitch's Ratings Case forecast incorporates the following assumptions:

Top Line Growth of 7% in 2017 and 12% in 2018:

2017 benefits from market-leading growth at Walgreens and the addition of new volumes in connection with the JV between Walgreens and Prime Therapeutics. Fitch assumes the addition of new business from legacy Rite Aid stores beginning in fiscal 2018, less the impact of store divestitures (assume approximately 1,000 stores). Fiscal 2018 also assumes renewal of Express Scripts contract with no material change in terms. Some growth could shift to 2017 from 2018 depending on the timing and pacing of ABC's providing service to legacy Rite Aid stores.

EBITDA Margin Flat to Down Modestly in 2017 and 2018:

Margins are pressured in 2017-2018 from repricing associated with renewed contracts with Kaiser Permanente and Compliant Pharmacy Alliance Cooperative (CPA), from lower branded price inflation expectations, from fewer generic conversion opportunities, and from a growing proportion of sales to Walgreens. Growth at MWI, PharMEDium, and in specialty, as well as improving generic purchasing scale through the addition of Rite Aid and Prime Therapeutics volumes, should help to offset these pressures somewhat.

FCF of Approximately $1 billion in Both 2017 and 2018:

Margin pressures contribute to FFO that grows more slowly than the top line. Elevated capex in 2017 (approximately $500 million) offsets remaining tax benefits associated with deductible warrant expense, and the impact of certain working capital concessions under ABC's extended contract with Walgreens tamps down FCF somewhat.

Gross debt/EBITDA lingering at 1.4x at fiscal year-end (FYE) 2017, stepping down to 1.1x at FYE 2018.

Discretionary FCF is more than sufficient to repay the $600 million notes due 2017 and remaining term loans ($700 million) with cash over 2017-2018. Fitch assumes ABC will refinance debt maturities thereafter. Remaining capital is expected to be used for bolt-on M&A and share repurchase activity.

LIQUIDITY & DEBT STRUCTURE

Higher Current Debt Balances for Special Share Repo, M&A

Total debt of $4.2 billion at year-end 2016 is temporarily elevated due to debt-funding of a special dilution-offsetting share repurchase program and M&A worth more than $5 billion in 2015-2016. Fitch granted ratings flexibility to ABC for the $600 million of three-year notes due 2017 due to their specified and temporary use for offsetting dilution associated with the expected exercise of warrants by Walgreens in 2016 and 2017.

Debt Repayment Required for De-Leveraging

In order to achieve the target of 1.4x gross debt/EBITDA by FYE 2017, Fitch estimates that ABC will need to reduce its debt balances by approximately $800 million in 2017. This assumption is based on an expectation for EBITDA margin pressure yielding EBITDA of around $2.36 billion.

Maturities Manageable, Well-Laddered

Contractual debt maturities are manageable and well-laddered. Fitch expects ABC to prepay its term loans in order to even better disperse debt repayment. Fitch forecasts debt repayment of $800 million in 2017 and $500 million in 2018. Debt maturities thereafter are expected to be refinanced.

Cash Flows Weakened by Working Capital Concessions, CapEx

FCF is expected to be depressed in fiscal 2017 and 2018 compared to 2015 and 2016 due to i) longer payment terms under an extended contract with Walgreens, ii) Fitch's expectations for higher inventory balances during the onboarding of Rite Aid and Prime Therapeutics, iii) elevated capex (around $500 million) in 2017 as ABC complete work on new distribution centers and IT upgrades, and iv) less benefit from additional volumes of generic pharmaceuticals, mostly to Walgreens, experienced in 2015-2016. (Generic drugs usually carry more favorable working capital terms than branded drugs.)

Strong Internal Liquidity

Internal liquidity at Sept. 30, 2016 comprised $2.7 billion of cash ($583 million held outside the U.S.), an undrawn $1.4 billion unsecured revolver due Nov. 2020, and a $1.45 billion accounts receivable facility due November 2018. Fitch considers all of ABC's U.S. cash as readily available. Although subject to large working capital-related swings, the firm has access to a large amount of internal liquidity, in addition to good capital markets access. Management has shared that it likes to keep roughly $1 billion to $1.2 billion of cash on the balance sheet for flexibility.

FULL LIST OF RATING ACTIONS

Fitch affirms the following ratings:

AmerisourceBergen Corp.

--Long-Term IDR at 'A-';

--Short-Term IDR at 'F2';

--Senior unsecured bank facility at 'A-';

--Senior unsecured notes at 'A-';

--Commercial paper at 'F2'.

The Rating Outlook is revised to Stable from Negative.

Date of Relevant Rating Committee: Dec. 15, 2016

Aside from financial adjustments customary to U.S. Corporates (removal of non-cash expenses, such as stock-based compensation expenses, from EBITDA calculation), Fitch notes that EBITDA has been adjusted to add back reported LIFO expense figures.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1016685

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1016685

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https://www.fitchratings.com/regulatory

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