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Fitch Rates Walgreens Boots Alliance, Inc. $1B Unsecured Term Loan 'BBB'

NEW YORK, Sep 01, 2016 (BUSINESS WIRE) -- Fitch Ratings has assigned a 'BBB' rating to Walgreens Boots Alliance, Inc.'s (WBA) $1 billion unsecured term loan. The loan is structured in two $500 million tranches, with one maturing in March 2017 and the other maturing one year following the date of the close of the Rite Aid Corporation (Rite Aid) acquisition, pending regulatory approval. Proceeds will be used to partly fund the company's acquisition of Rite Aid. Fitch rates WBA's Long-Term Issuer Default Rating (IDR) 'BBB'/Stable Outlook. A full list of ratings follows at the end of this release.

Of the total $17 billion purchase price for Rite Aid, Fitch estimates WBA will fund the acquisition with $14.6 billion of debt, including the assumption of $2.3 billion of Rite Aid's existing unsecured debt. As WBA has obtained $6 billion in term loans and $6 billion of unsecured notes, the company will need to raise another $0.3 billion in financing. WBA has disclosed that this could include bank financing, commercial paper and/or private debt placement.

The 'BBB' rating incorporates WBA's leading position and increasing market share in the growing drugstore category. WBA's ample free cash flow (FCF) provides it the financial flexibility to invest strategically in its business and new opportunities while managing its balance sheet. The debt-financed Rite Aid acquisition offers WBA the ability to strengthen its competitive position and generate significant procurement and cost synergies.

While incremental debt is expected to yield elevated leverage at 4.2x on a pro forma basis, Fitch expects WBA to return adjusted leverage to its historical low-3.0x levels by fiscal 2019 (August). Concerns include ongoing pressure on U.S. pharmacy reimbursement rates, WBA's under-penetration in the U.S. specialty pharmacy business, and integration risks with Rite Aid.


Since Walgreen Co. (WAG) completed its merger with Alliance Boots to form WBA on Dec. 31, 2014, the combined entity has developed a holistic strategy to grow its presence in the U.S. healthcare market. The company has undertaken a number of strategic priorities to drive the business, including the following:

--AmerisourceBergen Corp. (ABC) Long-Term Relationship: In March 2013, WAG and wholesaler ABC announced a 10-year agreement (extension of three years announced on May 5, 2016) to source all drugs through a newly formed strategic partnership which would enable sharing of synergies by layering ABC's generic volume into WBA. Previously, WAG sourced branded pharmaceuticals through Cardinal Health Inc., specialty pharmaceuticals through ABC and generics directly from manufacturers.

Management also believed an economic interest in ABC was important and structured warrants and an open-market purchase program. As of August 2016, WBA owns 24% of ABC at a cost of approximately $3.1 billion after exercising its final warrants for $1.2 billion (announced August 25, 2016).

--Rite Aid Purchase: In October 2015, WBA announced the proposed purchase of Rite Aid, designed to add to the company's national retail coverage and purchasing scale. Rite Aid - which has approximately 6% share of the U.S. prescription market - has strong presence in key markets where Walgreens has lower market share such as California and the Northeast. The company is also targeting $1 billion in cost synergies, including leveraging scale in sourcing and eliminating duplicative corporate expenses. Fitch has modelled synergies approaching $750 million by fiscal 2019. The transaction is expected to close in the second half of calendar 2016.

--Cost Structure Opportunities: The company has identified $1.5 billion in cost reduction opportunities primarily in the Walgreens U.S. business (up from $1 billion initially identified in June 2012 at the announcement of the WAG/Alliance Boots partnership) and plans to complete the program by the end of fiscal 2017. Key areas of focus have included retail footprint optimization, headquarters rationalization and store operations efficiencies.

In terms of the front-end, which represents around 30% of enterprise sales volume (three-quarters via Walgreens stores in the U.S.), WBA has a multifaceted strategy. First, new management sees an opportunity to improve basic operations such as inventory management and shrink reduction. Second, management believes Walgreens has historically been overly focused on promotions, with many loss leaders driving down margins. WBA has been reducing promotions and relying more on strong operations and its Balance Rewards loyalty program to drive sales. Third, WBA plans to revitalize its beauty offering in the U.S., using elements of the successful Boots model including owned brands such as No 7, Soap & Glory and Botanics. Fitch views as positive efforts to drive installed loyalty programs as a means to improve customer stickiness.


Category Growth and Competitive Resilience

WBA benefits from share gains in its U.S. pharmacy business (approximately 50% of total company sales), with the industry expected to grow 1%-2% annually each in volume and pricing. The industry has benefitted from an aging U.S. population, enrollment increases due to the Affordable Care Act, and prescription price increases, particularly for specialty pharmaceuticals.

Unlike many other retail categories, Fitch views pharmacies as having limited competition from new formats given fixed-price contracts and pharmacist supply constraints. Mail-order, which emerged as a major threat to retailers over the past several decades, appears to have peaked, particularly given '90-day at retail' offers across the industry as well as a number of branded drugs shifting to over-the-counter.

There has been significant pharmacy reimbursement pressure due to shifts to managed care from cash over the 1990s through mid-2000s and growth in Medicaid/Medicare over the last few years, and this pressure is expected to continue over the next few years as payers strive to contain healthcare costs. Economics of scale are critical to negotiate better pricing on pharmaceutical purchases to help offset some of the reimbursement pressure. As a result, Fitch expects WBA will continue to drive U.S. share gains with volume growth in the 2%-3% range while overall industry grows at 1%-2%.

Front-end sales have grown in the low-single digits in recent years, and have shown resilience to competition from channels including discounters and online. Fitch believes that WBA's low front-end ticket (less than $10 in most cases)...