Fitch Ratings has assigned a 'BBB' rating to Cardinal Health, Inc.'s (CAH) senior unsecured notes offering.

Fitch expects the net proceeds from the offering to fund the repayment of all of the aggregate principal amount outstanding of CAH's 3.08% senior notes due June 15, 2024 and its 3.5% senior notes due Nov. 15, 2024 at their respective maturities with any remaining proceeds to be used for general corporate purposes.

Fitch currently rates Cardinal's Long and Short-term Issuer Default Ratings 'BBB' and 'F2', respectively. The Rating Outlook is Positive, which reflects Fitch's expectation that CAH will operate with lower financial leverage through FY 2026 compared with the recent past. Fitch also expects CAH to report stronger earnings in the medical segment resulting from remedial actions to address inflation, demand trends and cost optimization.

Key Rating Drivers

Stable Pharmaceutical Segment: CAH's 'BBB' Long-Term IDR benefits from a stable pharmaceutical segment operating profile and good cash flow from operations. Cash generation is supported by steady pharmaceutical demand, increasing revenue and cash flow opportunities tied to specialty drugs and an oligopolistic drug-distribution industry in the U.S., despite the uncertainties tied to changing volumes and prices of generic drugs and regulatory pressures.

Fitch expects annual cash flow from operations (CFO) between $2.3 billion and $2.6 billion between fiscals 2024 and 2026, and FCF between $1.3 billion and $1.6 billion between fiscals 2024 and 2026, after assumed payments of $350 million per year related to opioid settlements. Fitch expects CAH will be able to expand CFO and FCF margins with continued focus on slowing growth in SG&A expenses.

Improved Leverage Profile: Fitch expects CAH's leverage profile to continue improving because of debt repayment and anticipated EBITDA growth. However, Fitch expects debt outstanding as of June 2023 to be refinanced as it comes due.

Fitch calculated CAH's EBITDA leverage at 2.7x-3.0x during fiscals 2019-2023 and projects it will be approximately 2.0x over fiscals 2024-2026. Overall, EBITDA will fluctuate at about $2.3 billion-$2.6 billion over the forecast (after Fitch-calculated opioid charges of $350 million per year) as a result of the frequency, timing and magnitude of specialty drug service growth; the effectiveness of pricing changes related to contract renewals; and branded and generic pharmaceutical manufacturer pricing changes.

Improving Outlook for Medical Segment: CAH's medical segment continues to experience weak financial results, primarily due to inflation and global supply chain constraints. However, performance could improve due to a credible improvement plan designed to address challenges, along with the design of accelerating Cardinal Health branded products, at-home solutions, OptiFreight Logistics, and focused cost management. In comparison to the past two years, Fitch is now modeling steading improvement in segment growth that will enhance consolidated EBITDA.

Customer Concentration: A significant portion of revenue for CAH and its peers in recent years came from a concentrated group of customers. In fiscal 2023, revenues related to CVS Health Corporation and OptumRx accounted for 25% and 16% of revenues, respectively.

CVS Health accounted for 23% of CAH's gross trade receivables at June 30, 2023. Sales through group purchasing organizations (GPOs), which act as agents that negotiate vendor contracts on behalf of their members, represented approximately 16% and 19% of revenues for fiscals 2023 and 2022, respectively. The trade receivable balances are with individual members of the GPOs, and credit risk is therefore spread throughout various members.

Fitch Litigation Assumptions: Fitch believes CAH has significant financial flexibility to settle the estimated liability of $6.5 billion associated with lawsuits and claims brought by states and political subdivisions related to the distribution of prescription opioid pain medications. Fitch anticipates the liabilities will be paid over 18 years rather than as lump sums, and Fitch treats these payments as a reduction to EBITDA (approximately $350 million/year) rather than incorporating the liability into CAH's adjusted debt.

New U.S. Drug Legislation: Fitch's assessment of the potential rating implications of the Inflation Reduction Act will initially center on branded pharma manufacturers with cash flow derived from the affected drugs. Global pharma companies generally maintain diversified product portfolios, which should minimize pricing pressure for any single drug. However, there could be limited offsets to declining revenue that could moderately affect pharma sector profitability and cash flow, which in turn could affect contracts manufacturers have with wholesalers such as CAH. Fitch has not adjusted its revenue or segment operating margin assumptions for CAH related to the new legislation.

Derivation Summary

The credit profiles of CAH and its peers, Cencora, Inc. (formerly AmerisourceBergen Corp. A-/Stable) and McKesson Corp. (MCK; A-/ Stable) benefit from stable operating profiles and consistent cash generation. Like its peers, CAH benefits from steady pharmaceutical demand and an oligopolistic position within the drug-distribution industry.

Those strengths are somewhat offset by weak performance, albeit improving within the medical segment; persistent, restructuring, litigation and regulatory costs; and ongoing changes in the U.S. healthcare environment that may dampen funding for the products and services CAH and peers provide.

CAH's leading competitors, Cencora and MCK exhibited lower financial leverage and higher profitability in recent years and Fitch expects them to do so over the medium term. Both Cencora and MCK developed or acquired significant capabilities to service pharmaceutical manufacturers of specialty drugs, which is one of the fastest growing and profitable areas of pharmaceutical distribution. CAH plans to expand its capabilities in this area, which has the potential for improved profitability relative to peers.

Fitch believes the guarantee from CAH of Allegiance Corporation's debt signals strong legal, operational and strategic linkages between the two entities, which allows for the subsidiary debt to be rated 'BBB', the same as the parent company debt.

The 'F2' Short-Term IDR is supported by the company's good financial flexibility, financial structure and operating environment. CAH's financial structure subfactor of 'a-', financial flexibility subfactor of 'bbb+' with very comfortable liquidity of 'a', and a well-spread maturity schedule of long-term debt all support the 'F2' Short-Term IDR. The 'F2' rating also benefits from committed revolving credit facilities that back-stop CP issuance.

Key Assumptions

Pharmaceutical segment revenue CAGR of approximately 8%-9% through 2026, and medical segment revenue CAGR of approximately 3% through 2026;

EBITDA margins remain near 1.00% over the forecast;

Litigation settlements and legal expenses of approximately $350 million per year through fiscal 2026 are charged to EBITDA;

Working capital is assumed to be net positive over the forecast at approximately $400 million per year;

Capex of approximately $500 million per year and common dividends of approximately $500 million per year over the forecast;

Share repurchases assumed by Fitch at approximately $1 billion per year in fiscals 2024-2026;

Acquisitions are not assumed;

All debt is assumed to be refinanced over the forecast at rates between 5.0% and 5.5%.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

EBITDA leverage (after opioid payments) expected to remain below 2.5x;

FCF (after opioid payments)/debt expected to remain above 20%.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A deepening of recent shifts in the industry's competitive and pricing dynamics, such as lower than expected brand name product inflation, higher than expected margin compression or generic price erosion; and reduced profitability related to key contract revisions;

Debt-funded acquisitions, share buybacks, material operational issues, declining revenues or evidence of material margin pressure leading to an expectation of EBITDA leverage (after opioid payments) remaining above 3.0x;

FCF (after opioid payments)/debt expected to remain below 15%.

Liquidity and Debt Structure

Ample Liquidity: Fitch believes CAH has ample sources of liquidity based on cash on hand and committed credit facilities; and projected FCF is expected to comfortably cover working capital needs, capex, contractual obligations, dividends and potential litigation settlement payments.

CAH has near full availability under its $2 billion revolving credit facility (RCF) due in February 2028, plus approximately $1 billion in undrawn capacity under a committed receivables sales facility program due in September 2025. The RCF also backs CAH's $2 billion CP program. The revolving credit and committed receivables sales facilities require CAH to maintain a consolidated net leverage ratio of no more than 3.75 to 1. As of Dec. 31, 2023, CAH was in compliance with this financial covenant.

The CP program and receivables sales facility program balances were zero as of Dec. 31, 2023. Fitch anticipates CAH will utilize the CP program and receivable sales facility less as long as interest rates remain higher compared with the recent past.

Laddered Maturities: Fitch projects FCFs and cash balances will be more than adequate to fund near-term maturities and opioid settlement payments. Debt maturities are manageable and well-laddered with a total of $4.7 billion of debt maturities as of Dec. 31 2023. All debt is assumed to be refinanced after fiscal 2023 at rates between 5.0% and 5.5%.

Issuer Profile

Cardinal Health, Inc. (CAH) is a globally integrated healthcare services and products company providing pharmaceuticals and medical products along with customized solutions for hospitals, healthcare systems, pharmacies, ambulatory surgery centers, clinical laboratories, physician offices and patients in the home.

Summary of Financial Adjustments

Fitch has adjusted EBITDA to reflect reported merger and integration expenses, litigation expenses, impairments, state opioid assessments and other charges and credits that are deemed non-recurring.

Date of Relevant Committee

11 August 2023

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

CAH has an ESG Relevance Score of '4' for Customer Welfare - Fair Messaging, Privacy & Data Security due to its exposure to loss contingencies related to opioid litigation that affects U.S. pharmaceutical distributors, which has a negative impact on the credit profile, and is relevant to the rating, in conjunction with other factors.

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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