Moody's Drops Credit Rating of Pharma Industry

Oct 17, 2007

Last week, Moody's Investors Service announced that the financial outlook of the entire pharmaceutical industry has dropped from stable to negative.

The main driver for the decline: anticipated patent expirations between 2010 and 2012. "Companies are facing a pretty major loss of cash flow that they need to offset with either a new product or with acquisitions," Michael Levesque, a credit analyst with Moody's, told Pharm Exec on Tuesday.

Moody's said that the regulatory climate is becoming more challenging for drug companies, pointing a finger at the anemic rate of recent FDA approvals. "Historically, drug companies have maintained very solid balance sheets and high levels of cash, and we think that over the next few years, they might spend that cash on acquisitions," Levesque said. "That could positively affect shareholders—but for bondholders, it's more likely to have a negative effect."

Levesque explained that this announcement is not a downgrade as some media outlets reported. "We downgrade ratings of individual companies, but an industry outlook is simply modified," Levesque said. "Every industry has an outlook that changes from time to time. It can't be positive every year, so this is not unusual."

Moody's rates 21 individual pharma companies (including Johnson & Johnson, Lilly, and Merck) and applies to each company a rating that looks forward approximately 18 months. It also studies and ranks the industry as a whole.

Although pharma now has a negative standing, many individual companies are highly rated and have good access to capital markets and relatively low-cost financing.

Moody's will rank pharma again in six months, but with the patent expirations on the horizon, expect the downward trend to continue for the next few years, says Levesque.

"Right now, there is a lot of event risk with mergers and acquisitions," Levesque said. "If we reach a point where we feel that those events are much less likely to occur, then we could move pharma to a more stable outlook. We'd have to feel that companies are prepared for patent expirations and aren't making big acquisitions to offset the exposure."

In the last 12 months, the biggest action was placed on Pfizer, whose AAA credit ranking dropped one point to Aa1. In prior years, Merck dropped three notches, and BMS was fell five points over time.

Levesque said, "This isn't a dire situation—the industry still remains profitable and is generating strong cash flow—it is a caution that the high ratings might come down."