Fitch Ratings has downgraded Cardinal Health’s credit risk rating to ‘BBB’ amid concerns that its debt-fueled expansion into medical devices could fail to deliver the expected results.
Cardinal has taken on around $9 billion of debt to fund activities including its $6.1 billion acquisition of Medtronic assets, leading Fitch to conclude it will remain too leveraged to have a ‘BBB+’ rating for an extended period of time.
Fitch thinks Cardinal’s medtech strategy is sound but warns the debt exposes the company to risks if it suffers setbacks, such as failing to realize the expected synergies from integrating the ex-Medtronic assets.
Cardinal, like other drug distributors, faces a challenge. As Fitch notes, opportunities to grow in the U.S. drug distribution space are limited, forcing Cardinal to look elsewhere for growth. Cardinal settled on medical devices and ex-U.S. sales as the answers to its problem. In 2015, Cardinal paid Johnson & Johnson $1.9 billion to buy Cordis. Last year, Cardinal followed up with a $6.1 billion deal to acquire Medtronic's patient care, deep vein thrombosis and nutritional insufficiency business.
Fitch thinks the strategy has merit, noting that “growth opportunities are more robust for the Cordis and related medical-surgical platforms” than for Cardinal’s drug distribution business. The strategy comes with risks, though. In May, Cardinal CEO Mike Kaufmann said infrastructure expansion triggered by the Cordis deal “has been more expensive than we thought.”
The infrastructure overspend is one of several problems Cardinal has run into in integrating Cordis and realigning its business around the new assets. Fitch did not refer to these problems directly but did note that payback from Cardinal’s deals “may be delayed in light of the significant integration cost,” adding that there is a possibility that the company “may not realize the synergies and benefits it expects.”
Other parts of Cardinal’s business also pose threats to the company. Fitch thinks pricing pressures in the generic drug market and opioid litigation settlements will drag on Cardinal in the years to come.
Cardinal got deeper into medtech to offset such headwinds but in doing so took on extra debt. Fitch thinks the debt is manageable and that Cardinal has adequate liquidity. The new ‘BBB’ rating, which indicates good credit quality, reflects Fitch’s belief Cardinal can manage the debt. Fitch classed Cardinal’s outlook as stable, suggesting neither a downgrade nor return to ‘BBB+’ are imminent.
The stable rating implies Cardinal may spend a long time, by its historic standards, at ‘BBB.’ Cardinal had an ‘A’ rating in the early 2000s. Fitch stripped Cardinal of that rating in 2004 but, while Cardinal has never since hit that high, it has rarely been as low as ‘BBB.’ The credit rating agency downgraded Cardinal to ‘BBB’ when it spun off CareFusion in 2009 but bumped it back up to ‘BBB+’ the following year.