TEXT-Fitch revises Merck & Co rating outlook to positive

(The following statement was released by the rating agency)

Oct 5 - Fitch Ratings has affirmed Merck & Co.'s (Merck)ratings as follows:

--Long-term Issuer Default Rating (IDR) at 'A+';--Senior unsecured debt rating at 'A+';--Bank loan rating at 'A+';--Short-term IDR at 'F1';--Commercial paper rating at 'F1'.

The ratings apply to approximately $21.5 billion in outstanding debt includingthe recent $2.5 billion debt issuance. The Rating Outlook is revised to Positivefrom Stable.

Margins Steady Through Patent Cliff:

Merck has successfully managed through a very long period of key drug patentexpirations that will ease over the next year after annualizing the loss ofmarket exclusivity for its bestseller Singulair that started in August. Costsavings programs initiated since 2008 have supported margins in light of apatent cliff dating back to 2006. Since 2006, three of Merck's top-5 sellingpharmaceuticals - Zocor, Fosamax, and Cozaar/Hyzaar - each of which generated atleast $3 billion in annual sales - have lost market exclusivity.

Merck maintained EBITDA margin above 30% during this period, with the exceptionof 2010, when there were cost pressures related to the integration ofSchering-Plough. In the first half of 2012, the EBITDA margin rose to 39.3%,from 37% in the same period in 2011, driven primarily by the savings initiativesthat lowered SG&A by 5.5% and cost of goods sold by 1.2%. Fitch sees EBITDAmargin compressing in the second half of 2012 due to pressure on gross profit ashigh-margin Singulair sales dramatically decline, outweighing the company'srecent success in its cost reduction program. However, Fitch expects EBITDAmargin to be maintained above 30% at the end of 2012 supported by restructuringactions that will continue through 2013.

Revenue Pressures Easing:

Fitch believes that Merck's revenue decline due to expiring drug patents willpeak in 2013 driven by rapidly eroding sales of its bestseller Singulairfollowing the commercialization of multiple generic drugs in August. Excludingthe loss of Singulair, Merck is subject to patent lapses that represent 16.9% ofoverall revenues over the next three-year horizon, including the potentialexpiration of Remicade internationally. The figure shows a moderation from 30%exposure at the end of 2009. Pressure on top-line performance also arises fromthe anticipated dissolution of Merck's commercialization agreement withAstraZeneca that will erase over $1 billion in annual sales in 2012 to 2013, inFitch's estimation.

An upgrade is contingent on Merck's ability to generate sales growth afterreaching a projected floor in 2013. Fitch recognizes that demand for the currentdiversified product portfolio, and commercialization of a broad late-stageresearch program could offset the pressures from drug patent expirations overthe long term.

Fitch presently anticipates compound annual growth (CAGR) in 2012-2016 for theoverall company of 0.99%. Key growth drivers are the Januvia franchise,Isentress, Zetia, and the vaccine portfolio. Fitch sees much improved CAGR of2.26% during 2013-2016, once the company has lapped the patent loss ofSingulair. Uptake of new drug approvals from the late-stage R&D program areanticipated to contribute around 1% growth annually in 2014-2016, depending onMerck's success in filing seven potential therapeutics with drug regulators bythe end of 2013.

Leverage Improvement From EBITDA Expansion:

Strong EBITDA growth bolstered by the contribution from Schering-Plough andrestructuring programs has led to a reduction in debt leverage since the end of2009. Gross debt leverage and adjusted debt leverage have fallen to 1.1 times(x) and 1.3x, respectively, for the latest 12 months (LTM) ending June 30, 2012from 2.1x and 2.2x, respectively, in 2009 following the merger with ScheringPlough. The drop in leverage resulted mostly from EBITDA growth rather than areduction in outstanding debt. EBITDA more than doubled to $17.4 billion from$8.5 billion, strongly driven by margins expansion to 36.1% from 31%, duringthat time frame.

Fitch currently sees total debt leverage staying below 1.3x (pro forma for therecent issuance of $2.5 billion), which, if sustained, could support a one-notchupgrade of the IDR to 'AA-'. Fitch's total debt leverage forecast assumes thatthe company will refinance $6 billion of debt maturing in 2013-2015 given theabsence of a commitment to deploy capital toward debt reduction.

Steady Free Cash Flow:

Merck generated free cash flow of $6.1 billion in the LTM period ending June 30,2012, in line with Fitch's expectation of annual free cash flow in excess of $5billion. Restructuring costs, higher capital spending, and pressured earningsfrom rapidly declining Singulair revenues will dampen cash flow in 2012 leadingto free cash flow of $5 billion (yielding free cash flow margin of 10.7%) thisyear. Free cash flow will remain above $5 billion annually with free cash flowmargin sustained above 10% through 2014. The free cash flow forecast includes anexpectation of an increasing dividend and higher capital spending.

Merck's strong liquidity is supported by cash and short-term investments of$17.5 billion and $4.1 billion of long-term investments on June 30, 2012. Inaddition, Merck had full capacity under a five-year $4 billion revolving creditfacility due May 2017. The company has ample liquidity to address upcoming debtmaturities of $1.8 billion in 2013, $2.1 billion in 2014, and $2.1 billion in2015.

What Could Trigger A Rating Action:

Positive rating action would follow sustained gross debt leverage in the rangeof 1.0x to 1.3x over the next 12-18 months, which indicates that Mercksuccessfully traversed its long-running patent expiration period. In addition,Merck must demonstate positive sales growth, through demand for core drugproducts and uptake of new medicines, subsequent to a trough in 2013.

Rating pressure would stem from a rise in total debt leverage above 1.5x in theintermediate term. The increase in total debt leverage could result fromoperational weakness due to inability in achieving cost containment targets orgenerating sales growth despite the imminent end of the company's patent cliff.A leveraging transaction could lead to higher leverage prompting negative ratingaction.

(Caryn Trokie, New York Ratings Unit)

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