Financiere Top Mendel SAS Ratings Lowered To 'B' From 'B+' On Increased Financial Leverage; Outlook Negative

  • New ParentCo, a holding company sitting above Financière Top Mendel SAS, the parent company of France-based animal health company Ceva Sante Animale, issued equity and equity-like instruments as well as €600 million payment in kind (PIK) instrument to reshuffle its capital structure ownership and partially pay its shareholders.
  • After this transaction, S&P Global Ratings-adjusted debt to EBITDA excluding the noncommon equity (convertible bonds ORA/ORANBSA) will peak to 8.5x in 2020 before potentially falling to 8x in 2021.
  • We are therefore lowering our long-term issuer credit rating on Financière Top Mendel to 'B' from 'B+'; and the issue rating on the €2 billion term loan B to 'B' from 'B+', with the '3' recovery rating unchanged.
  • The negative outlook reflects our view that elevated financial leverage leaves limited leeway in case of unfavorable market development or unforeseen operating setback.
PARIS (S&P Global Ratings) March 26, 2020—S&P Global Ratings today took the rating actions listed above.
The shareholder payment increased financial leverage from an already-high level and leaves limited headroom for underperformance.  We forecast S&P Global Ratings-adjusted debt to EBITDA of 8.5x in 2020 and 8x in 2021. Our debt calculation includes €600 million of new PIK notes and excludes new convertible instruments (ORA/ORANBSA). Despite the deeply subordinated nature of the instruments and very restrictive payments conditions allowed under the senior facilities agreement, they do not fully comply with our criteria for equity-like treatment. Including the convertible bonds (ORA/ORANBSA) and including the PIK instrument, financial leverage would be about 12x. The term loan B matures in 2026 and the PIK notes in 2027. Consequently, there is no liquidity pressure nor refinancing at risk now, but we believe high leverage limit headroom for any unforeseen setback.
Ceva remains a fast-growing company but lacks a track record of positive free operating cash flow.   As of Dec. 31 2019, the company's sales reached €1.22 billion, up 14.6% from the previous year. Contribution from acquisitions IDT Biologika and Thunderworks was about €33 million and €9 million, respectively. Organic growth reached a strong 10.4%, not only from the recovery from the Biomune issue, which had an impact of €101 million on 2018 sales and €70 million on EBITDA in 2018, but also strong demand across all divisions. Poultry grew by 26% with a strong contribution from strategic vaccines such as Cevac Ibird, Vectormune ND, Ultifend IBD ND, and above all recovery of the autogenous vaccines (produced after identification and diagnosis of the disease serotype by a qualified veterinarian). Swine grew by 13% despite the impact from African Swine Fever (ASF) supported by Europe and other countries; ruminants grew by 7%; and companion animal, by 9%. Reported profitability fell slightly in 2019 to 22.9% vs. 23.5% in 2018 while reported EBITDA increased to €278.6 million from €250 million the previous year. Management's business plans assumes profitability improvement that should be driven by geo-expansions of products, strict operational expenditure control, and lower commercial expenses.
Despite EBITDA growth, free operating cash flow (FOCF) remains negative.   We estimate the outflow in 2019 to be negative €50 million-€ 70 million. Large capex and large working capital outflows have constrained FOCF over the years. The company's ability to generate meaningful FOCF will depend on its ability to accelerate EBITDA growth and to manage working capital and capex. We assume this would mostly materialize from 2021 onward.
At this stage, we take the view that ASF and COVID-19 will not jeopardize the company's growth, but uncertainties remain.  China is not a key market for Ceva, the country represents 3% of group sales, among which 1% only is produced locally. Still, the company estimated the impact from ASF in the country to €25 million on sales and €17 million on EBITDA. Nevertheless, potential substitution of swine meat by other proteins, in particular, poultry where the company is a leader, could offset potential decline in swine. The companion animal is likely to be the most affected segment as veterinary visits drop with confinement. However, we take the view that the majority (70%) of company's sales are linked to the food chain and most of growth is still driven by poultry. We also understand that the company is working on an action plan that includes costs savings from travel restrictions, IT, R&D, and potential capex postponement. We believe lower R&D would not result in lower revenue because growth should be driven by geographic extension of already approved products.
A key risk could lay in the supply of the active pharmaceuticals ingredients (APIs).   Ceva relies on China and India for 70% of its APIs. Management highlights that it is mainly the pharmaceutical products (53% of the sales) that depends on these APIs, while exposure of the Biological products (47% of sales) is less important. Above all, according to management, the equivalent of two-to-five years' inventory on key APIs have been secured. This step came a few months ago given the situation in China at that time, when many plants were closing down due to new environmental requirements in the country. Given the magnitude of the COVID-19 pandemic, uncertainties are high and we will monitor the company's performance in this context.
We could revise our assessment of Ceva's earnings quality and stability if profitability were to deteriorate.  The size of the veterinary health market is estimated at €36 billion and has been growing at 5% per year. We believe Ceva has benefited from favorable market trends. Over the next 12-18 months, the company will have to demonstrate its ability to grow well above market, which will depend on the ramp-up of recently approved products and increase the return on R&D and capex. Our assessment of Ceva's competitive position remains supported by the company's sound performance, its leading position in the poultry's drug market (where it has a 17% market share in biologics and 9% globally, including bio and pharmaceutical drugs) and overall good geographic and product diversification. The group manufactures 3,500 products, with no exposure to single blockbusters, because the best-selling product represents less than 6.6% of total sales. The top 15 products (including versions approved in various countries) represent less than 40% of sales. Nevertheless, we see the company at the low end of the satisfactory business risk profile assessment because of limited scale, and small market share outside of the poultry segment. Ceva has a market share of 3% in each of the swine, ruminants, and pet segments. Profitability is lower compared with that of peers. Furthermore, in our opinion, the pipeline of new products in recent years have been limited. Still, the group has been investing 10% of its sales per year in R&D.
Over the next years, the company will mainly focus on geographical extension for existing products.   The company notably seeks to make Forceris a blockbuster. The drug, approved in April 2019, is an injectable combination of Gletofferon and Toltrazuril to treat coccidiosis (an intestinal disease) while protecting pigs from deficiency anaemia. In ruminants, the company should extend the sales of Zeleris (approved in 2017) used to treat cattle with bovine respiratory disease (BRD). Ceva forecasts that key launches should occur beyond 2025 except potentially for the PCV/MHYO for swine. PCV/MHYO is a combination of pneumococcal vaccine and vaccine against mycoplasma hyopneumoniae (M. hyo), which is considered a primary contributor to porcine respiratory disease.
The negative outlook reflects the increased risk that Ceva would not be able to achieve S&P Global Ratings-adjusted debt to EBITDA (excluding the convertible bonds) of close to 8x by 2021. We estimate that improvements in profitability will depend on the fast and successful uptake of products' geographical extensions, sound integration of IDT and Thunderworks, and fast delivery of synergies from distribution.
In our base-case scenario, we forecast the leverage ratio at about 8.5x in in 2020 and potentially improving to about 8.0x in 2021, thanks to strong organic growth and a gradual increase in the operating margin. Under this scenario, FOCF turns positive by 2021.
We would consider lowering the ratings if weaker-than-expected performance reduces Ceva's deleveraging prospects and its ability to achieve adjusted debt to EBITDA of about 8x and positive FOCF by year-end 2021. The most likely cause of would be inability to ramp up the sales of existing products or if envisaged operating efficiencies do not fully materialize, while the company continues to incur costs and working capital requirements.
We could revise the outlook to stable if Ceva deleverages faster than expected and the debt to EBITDA declines sustainably below 8x and FOCF is restored to comfortably positive levels. This can happen if the announced measures improve profitability and contain working capital requirements.
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