Baxter International Inc.’s BAX senior unsecured ratings of A3 were recently downgraded to Baa2 by credit rating agency Moody’s MCO, reflecting apprehensions over the upcoming split of the company into two separate entities. However, Moody’s has maintained Prime-2 short term ratings on Baxter and is likely to rate Baxalta Baa2.
Credit rating downgrade from a reputed agency like Moody’s has its implications as it limits borrowing capacity. The rating downgrade follows Baxter’s recent (May 19) disclosure related to the capital structure and financial details of both the companies. The spilt process is set to be complete by mid-2015 (Jul 1, 2015).
At the time of the initial announcement (Mar 2014), Moody’s had slashed Baxter’s rating outlook to negative from stable, but maintained A3 and Prime-2 ratings. However, in March, this year, Moody’s put both the ratings under review owing to concerns over Baxter’s business model and leverage issues.
Notably, Baxter’s bioscience division currently contributes a significant portion to the company’s sales and profits (36.2% of revenues in the first quarter of 2015). Also, many of the company's key pipeline products are from its bioscience segment. Thus, Moody’s believes that the separation would be a material event for the company.
Per Moody’s, the recent downgrade takes into account Baxter's smaller, lesser diverse, and lower margin business as well as its high leverage (total debt of $10 billion as of Mar 31, 2015), which is not sufficient for maintaining the A3 rating. However, Moody’s believes that Baxter will be able to de-leverage over the next 18-20 months.
The credit rating agency expects Baxter to lower its leverage from an initial figure of 4.5x debt/EBITDA (post split) to 3.0x during this period. The expectation is based on lower debt, which Baxter plans to achieve by using the $4 billion cash dividend it will receive from Baxalta. Baxter will also retain an approximately 19.5% equity stake in Baxalta, which it plans to contribute to its domestic pension plan.
Moreover, improving top-line growth driven by synergies from the Gambro acquisition and margin expansion along with lower debt can improve Baxter’s leverage to 2.5x debt/EBITDA, which per Moody’s will propel a rate upgrade. On the other hand, debt-financed acquisitions, aggressive share buybacks and/or leverage above 3.0x debt/EBITDA can call for a further downgrade.
In this regard, we note that Moody’s regarded Baxter’s recent acquisition of Oncaspar oncology product portfolio from Sigma-Tau Finanziaria as credit negative. This was due to the fact that the deal was partially debt-funded. Moody’s also noted that 9x sales multiple were quite high for the product category.
Meanwhile, Baxalta’s Baa2 rating primarily reflects a dominant position in hemophilia drugs. The company’s presence in orphan drugs, strong margins and moderate leverage (2.7x at the time of spin) are other criterions.
Baxalta’s targeted gross debt/EBITDA multiple of 2.0 times is quite good according to Moody’s. However, high dependence on ADVATE and risks related to the split are primary headwinds.
Stocks to Consider
Currently, Baxter carries a Zacks Rank #3 (Hold). Better-ranked stocks in the medical products industry include Hospira HSP and Vascular Solutions VASC. Both the stocks sport a Zacks Rank #1 (Strong Buy).
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