S&P Ratings News November 27, 2006, 6:47PM EST

European Pharma: A Report Card

S&P Ratings' rundown of the key players in the sector finds most in robust health

From Standard & Poor's RatingsDirect

The European pharmaceuticals sector is in robust good health in the latter part of 2006. The good product portfolios of patented drugs and limited immediate patent expirations among most rated companies have bolstered these outfits' operating cash flows and allowed them to further improve their net debt positions in the third quarter. The credit quality of rated companies has therefore further strengthened, even though many firms have increased dividend payments and share buybacks.

Nevertheless, some Big Pharma firms have suffered setbacks for drugs in the pipeline and withdrawals of initially hopeful drug candidates in recent quarters. Worst affected were Sanofi-Aventis and AstraZeneca; The former has suffered delays, patent challenges, or reimbursement issues on five drugs; the latter has seen three drug withdrawals.

Furthermore, some companies experienced delays or face nonreimbursement by public health authorities, in particular as a result of tightened regulatory efforts in some countries (Britain, France, and Germany). Regulation aims to enforce the prescription of generic instead of patented drugs, to keep down public health-care costs. Standard & Poor's Ratings Services considers, however, that this is not at an alarming level for the industry as a whole, as the late-stage pipeline for the sector still looks able to at least balance upcoming patent expirations and to some extent patent challenges.

The generally favorable business conditions for the sector during the year to date have not resulted in any rating upgrades during the period, as business profile scores were generally not significantly improved and most of the Big Pharma players already benefited from significant flexibility within the ratings.

Here is S&P Ratings' outlook for rated players in the European pharma sector (ratings are as of Nov. 27, 2006):

AstraZeneca (AZN)

Rating: AA+

AstraZeneca's currency-adjusted sales growth of 11% in the third quarter of 2006 continued to be significantly ahead of the industry average of 6% to 7%. Standard & Poor's expects the company to maintain above-average sales growth for the remaining quarter of 2006, based on high growth rates in its existing drug portfolio and overall limited visible patent risk. The company, however, is faced with a pipeline problem, as the group had to withdraw another potential blockbuster candidate (antistroke drug NXY-059) in the third quarter, following earlier withdrawals of Exanta and Galida in 2006.

The company's arrangements with Merck in the U.S. regarding termination of a joint venture are not likely to result in total payments higher than $3.3 billion by 2008, which should be made from the company's annual free cash flow of £6 billion. Higher cash flows in the third quarter enabled AstraZeneca to continue to improve its financial metrics, despite significantly higher payouts for dividends and share repurchases, compared with the third quarter of 2005. Following the change in top management, Standard & Poor's will monitor the company's potentially higher appetite for risk in the context of future acquisitions.

Bayer (BAY)

Rating: BBB+

Bayer's financial profile has been below average for four years and will remain depressed after the acquisition of Schering. In the second quarter of 2006, Bayer's cash flows continued to improve slightly, while management announced a new restructuring program for CropScience. The Schering acquisition and integration will be the main driver of group performance over the next few quarters, which will depress credit metrics owing to the up-front impact of the additional debt and despite the divestiture of the diagnostics business.

Fresenius Medical Care (FMS)

Fresenius AG

Rating: BB

Fresenius' and FMC's third-quarter results confirmed the ongoing strong growth trend throughout the group: Based on organic revenue growth of 9%, and despite a number of one-time tax and integration charges relating to the Renal Care acquisition, the group was once again in a position to raise its earnings forecast for 2006. Besides that, the group's earnings before interest, taxes, depreciation, and amortization (EBITDA) margin improved to 17% for the 12 months ending Sept. 30, 2006, compared with 16% at financial yearend 2005. We expect sales growth and operating margins to continue this positive trend over the coming quarters, which will also include Renal Care operations. The group's adjusted debt-to-EBITDA and adjusted funds-from-operations-to-debt ratios have improved to 4.5 times and 15% for Fresenius and 4.2 times and 13% for FMC, which compares with our ratio targets of 3.5 to 3.8 times and 17% for the end of 2007.

GlaxoSmithKline (GSK)

Rating: AA

Comparable sales growth for GSK pharmaceutical division moderated to 7% in the third quarter of 2006, after the previous quarter's 10%. While the group's U.S. sales continued to grow by 14% in the quarter, European sales were stable as a result of generic competition on a number of drugs. While profits remained strong in the third quarter of 2006, free cash-flow generation was hit by the £1.8 billion tax payment to Britain's Inland Revenue Service.

Despite negative news on the timing of new drugs' pending approval, we expect continued positive sales and free cash-flow performance in the coming quarters, based on the company's strong pipeline. Due to both the effects of the tax charge and the announced increased share-buyback program, however, Glaxo's formerly significant flexibility within the ratings has been reduced. On a last-12-month basis, however, the funds-from-operations (FFO)-to-net-debt ratio is still in excess of our guidance (100%). In the absence of a potential larger acquisition, we expect the company to stay comfortably within requirements.

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