S&P: 6 factors affecting pharma credit ratings

About 89 percent of the credit rating changes in the pharmaceutical industry in the last five years have been downgrades, according to a new report from S&P Global Ratings.  

While many pharmaceutical companies have rating stability due to strong profitability, hefty barriers to competition and insensitivity to economic cycles, S&P changed the industry outlook to negative, meaning more downgrades may occur in the future — especially as pressure heightens in the U.S. to lower drug costs.

As pressures mount against the industry, S&P worked to identify key factors that lead to both positive and negative rating changes for pharmaceutical companies. S&P reviewed 46 credit rating changes from 2008 and 2018 to understand the key factors. The credit agency analyzed 27 downgrades and 19 upgrades.

Here is a breakdown of those factors:

1. M&A activity. M&A accounted for 21 of the 46 rating changes, making it the most common driver of rating changes for the pharmaceutical industry. About 70 percent, or 19 of the 27 downgrades, were due to M&A activity. In comparison, just two of the 19 upgrades resulted from M&A. While M&A doesn't guarantee a downgrade, acquisitions at high EBITA multiples and financed with debt can increase the debt leverage.  

  • "To be blunt, the increased financial leverage of debt-financed acquisitions for investment-grade ratings nearly always outweighs the benefits such deals provide to a company's business," the report said.
  • 2. Operating performance change accompanied by material change in credit ratios. The second most common cause of a rating action, attributed to nine of the 46 analyzed rating changes, was an operating performance change alongside a change in credit ratios. This factor resulted in five downgrades and four upgrades. The operational improvements were often a result of success with significant product launches,  improved prospects in the late-stage pipeline, successful integration and restructuring efforts and sustained double-digit revenue growth. Operational deterioration, on the other hand, related to patent expirations, product safety concerns or failures in the product pipeline. 

    3. Operating performance change without credit measure change. This factor accounted for seven rating changes, including two downgrades and five upgrades. Pharmaceutical companies that saw rating improvements saw several things, such as a track record of effective integrations, products with expanded indications, or rising incidence of a certain disease. Conversely, operational deterioration resulted from halted products.

    4. Change in credit measures and financial policy. This factor resulted in five upgrades. S&P found that if a company changed its credit measures and financial policy, for example, by altering its leverage targets or the company's tolerance to raise leverage above those targets, it helped influence rating actions. "A view that a company has a more conservative financial policy than suggested by current credit measures can support a higher rating. And likewise, a company that shows an appetite for higher debt leverage than current credit measures suggest could be subject to a lower rating," the report says. 

    5. Change in business stability. Three rating actions, two upgrades and one downgrade, were attributed to a change in business stability, which considers long-term profitability of a drugmaker. To analyze this factor, S&P considers product, therapeutic and geographic concentration as well as resilience to economic cycles, market position and track record. 

    6. Change in business stability and leverage. Accounting for one credit rating upgrade was a change in business stability and leverage. The upgrade resulted from a solid operating performance, increasingly diverse product portfolio as well as the drugmaker's conservative debt leverage.

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