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Fitch Affirms Teva's Ratings at 'BBB+'; Outlook Stable

[December 17, 2014]

Fitch Affirms Teva's Ratings at 'BBB+'; Outlook Stable

Fitch Ratings has affirmed the ratings of Teva Pharmaceutical Industries Limited (Teva) and its subsidiaries at 'BBB+'. The Rating Outlook is Stable.

A full list of rating actions, which apply to approximately $10.65 billion of debt at Sept. 30, 2014, follows at the end of this release.

KEY RATING DRIVERS

-- Teva is the world's largest generic drug manufacturer and a top-20 global pharmaceutical company. Such scale, combined with good product and geographic diversification (except Copaxone), provides the firm with strong positions in most relevant pharmaceutical markets and superior flexibility with which to expand into emerging markets.

-- The risk remains that Teva's top-selling drug, Copaxone (approx. 20% sales; approx. 50% operating profit before G&A expenses), could face generic competition in the U.S. at any time and by May 2015 in most of Europe. However, this risk has been mitigated by Teva's successful conversion of nearly two-thirds of U.S. patients to a new formulation with less frequent dosing.

-- A significant reduction in working capital is driving stronger cash generation in 2014 than Fitch originally expected, despite significant non-recurring cash outflows for legal settlements and restructuring. Better cash flows have allowed the firm to reduce gross debt-to-EBITDA to below 2x at Sept. 30, 2014. Fitch expects solid free cash flow (FCF) of $2.5 billion - $3 billion in 2015.

-- Management's tone toward capital deployment has become more aggressive over the course of 2014, as the firm has outlined up to $2.3 billion in shareholder payments in 2015. Public comments support Fitch's expectation for Teva's M&A activity to be elevated in 2015-2016 in order to fill its medium-term growth gaps and to build out its CNS/pain and respiratory portfolios.

-- Fitch expects overall weak medium-term organic growth, as most of Teva's key specialty products are set to face generic competition over the next few years. Certain products currently in R&D could contribute to better growth in 2017 and beyond - but probably not early enough to offset expected losses in the meantime.

-- Teva's accelerated restructuring program (targeting $2 billion in annual cost savings) is on track and showing early signs of success. The firm's renewed commitment to its generics business, narrowed focus on CNS/pain and respiratory in the specialty segment, and recent and expected steps to improve its corporate governance should also contribute to improving operations over the ratings horizon.

-- Near-term generic drug industry growth may appear somewhat stagnant compared to the unprecedented but now-subsiding generic wave of 2011-2014. Business mix decisions may also reduce top-line growth but support profitability in 2015-2016. Fitch expects aging populations in developed markets and increasing access to healthcare in emerging markets will support solid base business growth for Teva and its peers over the ratings horizon.

RATING SENSITIVITIES

Teva has good flexibility at its current 'BBB+' ratings, likely sufficient for the firm to engage in targeted M&A while also funding its outlined shareholder payouts for 2015. Maintenance of Teva's 'BBB+' ratings will require gross unadjusted debt-to-EBITDA of 2x-2.5x over the ratings horizon, with continued execution of the firm's restructuring program and expected associated improvements in profit margins. Temporary increases in debt leverage to fund M&A will be appropriate at the 'BBB+' level, so long as the firm is committed to de-leveraging back to below 2.5x within 12-18 months.

Though debt leverage has moderated in 2014 and could continue to decline in 2015, Fitch does not expect positive ratings momentum in the near term. Declining sales, management's more aggressive stance toward capital deployment, and Fitch's belief that M&A could be material in the aggregate during 2015-2016 support this view.

Negative ratings pressure could result from a failure to execute on the firm's ongoing cost restructuring efforts and/or more aggressive shareholder-friendly payouts requiring debt funding. Notably, a downgrade is not expected to be caused by the launch of generic competition to Copaxone 20mg in the U.S.

COPAXONE LOSSES MITIGATED BY GENERIC DELAY, 40MG CONVERSION

Fitch views the pending launch of an AB-rated generic version of Copaxone 20mg as the key risk to Teva's credit profile, albeit already incorporated in the current 'BBB+' ratings. Copaxone represents about 20% of Teva's overall revenues (U.S. Copaxone sales are about 15% of total sales) and about half of the company's operating profit before G&A expenses. About three-quarters of Copaxone sales are generated in the U.S., where the drug lost market exclusivity in May 2014. Corresponding market exclusivity will expire in most European markets in May 2015.

The FDA has yet to approve a generic version of Copaxone 20mg, and several factors that will materially affect the pace and severity of potential profit losses are still unknown. These include the timing of FDA's potential approval of an AB-rated generic, market acceptance of a generic Copaxone once one is launched, and the outcome of the pending U.S. Supreme Court case. Fitch also notes that Teva has successfully backstopped a significant portion of potential losses to generic competition by switching almost two-thirds of its patients to a new three-times-weekly (3xW) version of Copaxone.

Fitch's base case assumptions currently include generic competition in most European markets in ay 2015 and in the U.S. in September 2015. Importantly, Fitch believes an earlier generic launch in the U.S. can be accommodated for by the current 'BBB+' ratings.

BETTER CASH GENERATION USED TO PAY SHAREHOLDERS

Management's tone toward capital deployment has become more aggressive over 2014, but is not a material concern for Fitch at the current 'BBB+' ratings. Teva's cash generation in 2014 is outpacing Fitch's expectations, despite more than $1.3 billion of non-recurring cash outflows for litigation settlements and restructuring, largely due to a drastic reduction in working capital. This increased cash flow has allowed Teva to repay about $1.4 billion of debt in the first nine months of 2014, resulting in debt leverage of 1.8x at Sept. 30, 2014.

The prolonged delay of a generic Copaxone approval/launch is also supporting a better cash forecast in 2015. Management has publicly outlined that it intends to deploy up to $2.3 billion, or about half of the firm's projected 2015 cash from operations, in the form of dividends and share repurchases. Fitch forecasts about $1 billion to $1.5 billion will be left (after roughly $800 million in capex) for M&A and debt repayment. Fitch expects that Teva will adjust its plans, if necessary, as details pertaining to the launch of a generic Copaxone 20mg become available or as M&A targets surface over the course of 2015.

IMPROVING BUSINESS FUNDAMENTALS

Fitch continues to expect Teva to be successful in achieving its cost savings targets, as early signs of success are evident in better margins, particularly for the generics business, in 2014. Achieving these cost savings will be important to offset lost EBITDA from Teva's declining specialty drug portfolio. Fitch expects cost savings to support flat EBITDA on a 6% revenue decline in 2015.

Teva also took steps in 2014 to address shareholders' corporate governance concerns, including the publication of certain management compensation details, the reduction of board of director (BOD) seats, allowing the new CEO to retain his BOD seat, and announcing the planned retirement of Philip Frost, Teva's current BOD chairman and one of the firm's largest shareholders.

WEAK MEDIUM-TERM GROWTH OUTLOOK, PORTFOLIO FOCUS TO DRIVE M&A

Fitch expects Teva to engage in what could be material amounts of aggregate M&A in 2015-2016. Targets will likely include specialty pharma firms with marketed or late-stage products focusing on CNS/pain or respiratory indications, regional generic or branded generic firms, or companies with compelling biosimilar capabilities. Management has stated that deals of all sizes are possible, including both bolt-ons and more transformational transactions.

In addition to Copaxone, most of Teva's other branded drugs are set to face generic competition in 2015-2017. Not all sales will be lost upon generic launch, however, due to certain settlement provisions (ie, ProAir with Perrigo) and new formulations (ie, liquid version of Treanda). New drug launches expected over this time horizon, including hydrocodone ER (2015) and Reslizumab (2016), will add new sources of revenue, but will not be sufficient to offset these losses. Fitch forecasts sales of Teva's currently marketed specialty products to decline at a CAGR of 12% (9% excluding Copaxone) over 2015-2017.

Generic sales are expected to decline in 2015, albeit primarily due to FX and business mix decisions; so profitability is likely to improve despite a declining top-line. Going forward, growth in North America and Western Europe will probably be flat to modestly declining, with better prospects in regions like Latin America and Southeast Asia (ex-Japan), especially for branded generic offerings. Teva's presence in many of these higher-growth regions is currently limited. Demographic and economic trends will nevertheless support opportunities for base business growth for Teva and its peers going forward, as IMS Health projects that more than half of pharma spending growth will come from generics in 2015-2018.

STRONG LIQUIDITY, WELL-LADDERED DEBT MATURITIES

Teva has historically maintained a strong liquidity profile, consisting of more than $1 billion of cash on hand ($1.47 billion at Sept. 30, 2014) and a $3 billion unsecured revolver due 2018 (undrawn at Sept. 30, 2014). Fitch deems these sources of liquidity as sufficient in light of the risk of large litigation-related and other non-recurring cash outflows inherent to the business profiles of pharmaceutical manufacturers.

Teva successfully lengthened and spread its debt maturity profile in 2011-2012 by refinancing much of the debt associated with the 2011 Cephalon and Taiyo acquisitions. Annual debt maturities in 2015-2018 of at most $1.3 billion are manageable for the firm and expected to be refinanced as they come due. Fitch notes that Teva may redeem its $1 billion of notes due 2015, depending on M&A activity.

Fitch has affirmed Teva's ratings as follows:

Teva Pharmaceutical Industries Limited

-- IDR at 'BBB+'.

Teva Pharmaceuticals USA, Inc.

-- Senior unsecured bank facility at 'BBB+'.

Teva Pharmaceutical Finance Company LLC