Fitch Keeps Bayer on Rating Watch
London-based ratings agency Fitch said it is keeping Bayer’s long- and short-term Issuer Default Ratings (IDRs) of A/F1 on Rating Watch Negative (RWN) as well as the senior unsecured instrument and subordinated debt rated at A and BBB+ respectively. The forecast reflects the German company’s plan to take over US agrochemical company Monsanto for $66 billion.
Prior to the announcement of the Monsanto deal, Bayer was seen as continuing to enjoy a top-grade rating of A in all categories. The Fitch outlook takes into account that up to $47 billion of the takeover package is likely to be debt-financed. It has warned several times in the past that the costly deal could result in a downgrade of at least two notches.
Excluding the acquisition, Fitch says Bayer's credit profile is compatible with a long-term A IDR with a stable outlook on a standalone basis as the group has been deleveraging since its acquisition of US Merck’s consumer health business for $14 billion in 2014. The deleveraging has been driven by strong free cash generation, in combination with asset disposals and the use of hybrid debt to manage its financial risk profile, it notes.
The agency says the ratings outlook continues to reflect Bayer's strong market positions in different, uncorrelated, sectors, spanning pharmaceutical, consumer and animal health and crop science as well as the company’s 64% stake in its former engineering plastics business, Covestro, even if the latter is non-core and will be divested at some point in the future.
On the whole, Fitch believes the repositioning of Bayer's business model toward the life science sector will be positive, offering “sound organic growth opportunities,” as all of these sectors share a strong focus on R&D and will benefit from long-term positive economic and demographic trends.
Driven by pharma, the analysts formulating the ratings criteria expect Bayer's profitability to improve over a four-year rating horizon, with the EBITDA margin gradually trending toward 24% from 21% in 2015. Contributing to growth, they say, will be the “encouraging performance of new treatments in the pharma segment, which attract structurally higher margins.” The profitability outlook is also seen as being supported by the realization of cost synergies in the consumer health division and the currently satisfactory performance of Covestro.
On a less upbeat note, the ratings experts contend that Bayer has “under-delivered” on the revenue synergies expected from the Merck consumer health integration, due to the former US owner’s underinvestment in brands and R&D.
Looking at the impact of the Monsanto transaction on Bayer's business profile generally, Fitch says the outlook is “mixed.” With the deal, it remarks, the German group will shift from being a healthcare-oriented company with a below-average business risk toward a more cyclical agribusiness profile, although this will be balanced by better scale and diversification.
The agency sees Bayer as facing execution risks in delivering an ambitious integration plan while attempting to maintain its focus on capital allocation – this especially as the healthcare business, while offering growth and investment opportunities, is also subject to strong competition.
Finally, the company’s chances of maintaining an A rating could rise on a successful integration of Monsanto, in particular if it realizes the targeted €1.5 billion in cost synergies medium-term and keeps its dividend policy unchanged, Fitch says.