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Credit Outlook Summary

Core Content

This document is a credit outlook report from Moody's, dated 3 July 2017, analyzing the credit implications of recent corporate and banking events. It provides insights into how various business decisions and regulatory changes impact the creditworthiness of companies and financial institutions.

Main Points

Corporates

• Walgreens and Rite Aid Merger Termination:

  • The termination of the merger is credit positive for Walgreens, as it reduces debt burden and financial leverage.
  • The new asset purchase agreement does not require additional debt, with a pro forma debt/EBITDA ratio expected to be $3.6x - 3.8x for fiscal 2017, versus $4.5x under the original merger plan.
  • The transaction is expected to generate $400 million in synergies and reduce debt further through accumulated cash.
  • The merger termination is credit negative for McKesson, as it will lose fewer stores to Walgreens, and credit neutral for Cardinal Health due to the loss of potential sales to Fred's Inc.

• UPS Pension Freeze:

  • The plan to freeze pension benefits for non-union employees starting in 2023 is credit positive, as it reduces future pension obligations and cash outflows.
  • This move will reduce pressure on operating earnings and cash flow, and the company is expected to shift to a defined contribution plan, reducing long-term cash requirements.
  • The pension freeze is part of a broader strategy to improve earnings and free cash flow, though its benefits will materialize in 2023.

• HC2 Tack-on Offering:

  • The $38 million tack-on offering increases leverage, with the adjusted leverage ratio expected to reach $8.0x and interest coverage around $1.0x in 2017.
  • The offering is credit negative due to the deterioration of credit metrics, though the rating and outlook remain unchanged.
  • HC2's liquidity is expected to be sufficient, with a buffer above the minimum requirement, but the company faces challenges in reducing leverage below $6.5x.

• Nestlé Share Buybacks:

  • Nestlé's planned share buybacks of CHF20.0 billion over three years are credit negative, as they will reduce retained cash flow and funds from operations to net debt ratios.
  • The buybacks are expected to lower the retained cash flow to net debt ratio to 25% in 2019 and 2020 from 31.3% in 2016, and the funds from operations to net debt ratio to 45% from 65%.
  • Despite this, Nestlé's credit strength is supported by its business risk profile and predictable cash flows, and its credit metrics in 2020 are expected to remain stronger than some peers.

• Philips Acquisition and Buyback:

  • The acquisition of Spectranetics and a share buyback programme are credit negative, as they increase leverage to $2.5x.
  • The acquisition is not compelling due to Spectranetics' recent losses, but it fits into Philips' product spectrum.
  • Philips has access to liquidity and a new revolving credit facility, which may help manage the increased leverage.

• Seizure of Sistema's Stake in MTS:

  • The seizure of Sistema's 31.76% stake in MTS is credit negative for Sistema, as it limits its rights over MTS and reduces dividend income.
  • MTS' credit quality remains neutral, as it is not affected by the seizure and continues to operate with stable credit metrics.
  • MTS is the largest integrated telecommunications operator in Russia, with significant revenue and EBITDA, and its dividend policy is already at 100% of IFRS net profit.

Banks

• Guatemala and Panama's Tax Transparency Improvements:

  • The OECD raised the ratings of Guatemala and Panama to "Largely Compliant", which is credit positive for local banks.
  • These improvements reduce risks in correspondent banking relationships and lower external refinancing risks.
  • The ratings are still provisional, and the improvement is significant compared to other Latin American countries.

• Europe's Ban on MMF External Support:

  • The new regulation prohibiting money market funds from receiving external support in stressed conditions is credit positive for European banks.
  • It reduces reputational risks and limits contagion effects between MMFs and banks.
  • The regulation also introduces minimum liquidity requirements and stress-testing obligations, enhancing MMF resilience.

• UK's Countercyclical Capital Buffer:

  • The strengthening of the countercyclical capital buffer is credit positive for UK banks, as it enhances their capital resilience and regulatory compliance.

• Switzerland's Gone-Concern Capital Rules:

  • The proposed gone-concern capital rules for D-SIBs are credit positive, as they improve capital adequacy and risk management practices.

• Commerzbank and National Bank of Greece:

  • Commerzbank's lower restructuring charges and higher capital ratio are credit positive.
  • The National Bank of Greece's sale of a stake in its insurance subsidiary is credit positive, as it improves liquidity and reduces leverage.

Key Information

• Credit Implications:

  • The document highlights how corporate actions and regulatory changes can positively or negatively impact credit metrics.
  • It emphasizes the importance of leverage, debt/EBITDA ratios, and free cash flow in assessing creditworthiness.

• Regulatory Impact:

  • Regulatory changes, such as the OECD's tax transparency improvements and Europe's MMF rules, are generally credit positive for banks.
  • These changes reduce risks and enhance capital resilience, which is beneficial for financial institutions.

• Corporate Strategy:

  • Corporate strategies like share buybacks and acquisitions are analyzed for their impact on financial leverage and creditworthiness.
  • Companies are expected to manage their financial policies carefully to maintain credit stability.

• Liquidity and Capital Management:

  • Liquidity levels and capital management are critical in determining credit outcomes.
  • Companies with strong liquidity buffers are better positioned to manage debt and maintain credit ratings.

• Industry Outlook:

  • The drugstore and pharmaceutical industries are expected to face challenges due to reimbursement rates and competitive pressures, but are supported by long-term demographic trends.
  • The food and beverage industry, including Nestlé, is expected to see slower growth due to market conditions.

Conclusion

The document outlines a range of credit implications across different sectors and regions, emphasizing the importance of financial policies, regulatory changes, and industry dynamics in assessing creditworthiness. While some corporate actions and regulatory updates are credit positive, others, such as share buybacks and leveraged acquisitions, are credit negative. The overall outlook suggests that companies and banks need to manage their leverage and liquidity carefully to maintain stable credit metrics.