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Rating action

Scope Ratings has today affirmed its A-/Stable issuer rating on German diversified Merck KGaA as well as on its wholly owned financing subsidiaries Merck Financial Services GmbH and EMD Finance LLC. The agency also affirmed the A- senior unsecured debt rating as well as the BBB subordinated debt rating. The short-term rating for Merck KGaA of S-1 was also affirmed.

Rating rationale

The rating affirmation reflects Scope’s unchanged view of Merck’s credit-supportive business risk profile, which consists of the mostly stable and cash-generative business models of its three critically sized divisions. In addition, Scope continues to see the group’s diversified structure as reflecting the owning family’s commitment to achieving balanced cyclicality exposure.

Merck’s Healthcare division is still transitioning to a new growth phase. It therefore depends, to some extent, on the continued stability of its mature product portfolio until its promising pipeline and newly approved drugs are performing fully. Management continues to expect an additional contribution of EUR 2bn from newly approved and to-be-approved drugs’ revenues in the period to 2022. So far, the recent sales generation of key drug Bavencio (anti-PD-L1), jointly developed and marketed with Pfizer Inc, has been rather modest. To date, the drug is approved for a number of indications with lower revenue potential (bladder cancer [second-line treatment], Merkel cell carcinoma, and renal cell carcinoma). While approval for the potentially much more sizeable first-line treatment of bladder cancer was already received for the US in June 2020, European approval is still outstanding.

Avelumab is currently being developed in four Phase 2 and 3 projects. Sales of Merck’s new multiple sclerosis drug Mavenclad have ramped up successfully, following US approval in early 2019. This was a major breakthrough, which opened up blockbuster potential for the drug. In a crowded multiple sclerosis product market, the drug is likely to generate more than EUR 500m in revenues in 2020. Scope sees this as a real achievement, although sales generation was significantly held back by the coronavirus crisis in the second quarter of 2020. Scope believes there is additional blockbuster potential in Merck’s pipeline for bintrafusp alfa (oncology, anti-PD-L1), which is currently in six Phase 2 developments.

The other Merck group divisions have developed differently in the last twelve months. While Life Science managed to perform very strongly after the integration of Sigma Aldrich (acquired in 2015), both in terms of sales growth and margin expansion, the Performance Materials division was held back by the ongoing decline in profitability caused by competitive pressure in the liquid displays sub-division. As there is no growth potential for this former Merck flagship anymore, it is being managed for cash generation after a significant restructuring in the past 18 months. Declining liquid displays profits have been effectively mitigated by the acquisition of Versum, a producer of electronic materials, which has been acquired and integrated successfully. This transaction was of high strategic importance for two reasons: i) it immediately and effectively balanced the lost liquid displays profits; and ii) it provided a new platform, which should allow Merck to benefit from future growth in the semiconductor solutions industries. Scope continues to assess Merck’s business risk profile at A.

Scope’s assessment of Merck’s financial risk profile reflects the continued expectation that management will be both able and willing to reduce debt regularly in the coming years. This ability has been evidenced by the swift deleveraging following sizeable takeovers in the past (serono, Millipore, Sigma Aldrich). After the Versum acquisition, management announced a focus on costs after 2019, including R&D as well as sales and marketing expenditures. As 2019 credit metrics were negatively affected by the acquisition debt for Versum (only one quarter of Versum cash flows was consolidated that year), metrics were not fully comparable. In 2020, Scope expects group credit metrics to have recovered somewhat compared to the year before. This is due to the full inclusion of Versum and an expected recovery in demand for individual drugs in the second half of the year, following a weaker first half as a result of Covid-19. Despite this, Scope expects key credit metrics to almost reach the agency’s ratio guidelines for the ratings: funds from operations (FFO)/Scope-adjusted debt (SaD) of about 30% and an adjusted EBITDA/SaD of about 2.5x by the end of the year. In addition, Scope expects the Healthcare division to deliver on its pipeline from 2021. The agency’s base case scenario assuming a metrics recovery is also supported by management’s strong ratings commitment and by the fact that larger acquisitions have been ruled out until the end of 2020. Further support is provided by the fact that Merck has prevailed in the US litigation against Biogen Idec, which saves more than EUR 300m in potential damage payments.

Outlook and rating-change drivers

The Stable Outlook reflects Scope’s expectations of SaD/EBITDA of 2.5x and FFO/SaD of 30%-35%, which are indicative for the current rating and Outlook and translate into a financial risk profile assessment in the BBB category.

A higher rating could be triggered by both an improved business risk assessment if the Healthcare division performs well in the future (connected to a faster ramp-up of Bavencio sales) and a sustained improvement in credit metrics beyond the levels detailed previously (significantly below 2.5x for SaD/ EBITDA and above 35% for FFO/SaD, on a sustained basis).

A negative rating action could be the result of a more aggressive financial policy – which Scope does not foresee – or a sustained negative departure from the ratio levels commensurate with the present ratings (SaD/EBITDA of above 2.5x and FFO/SaD of below 30%).

Long-term and short-term debt ratings

Senior unsecured debt is rated at the same level as the issuer rating, in line with Scope’s corporate methodology.

The short-term rating of S-1 reflects Merck’s sound credit quality and is supported by adequate internal liquidity.

Stress testing & cash flow analysis
No stress testing was performed. Scope performed its standard cash flow forecasting for the company.

Methodology
The methodology used for these ratings and rating outlooks (Corporate Ratings published on 26 February 2020 and Pharmaceuticals published on 10 January 2020) are available on https://www.scoperatings.com/#!methodology/list.
Information on the meaning of each rating category, including definitions of default and recoveries can be viewed in the “Rating Definitions - Credit Ratings and Ancillary Services” published on https://www.scoperatings.com/#!governance-and-policies/rating-scale. Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definitions of default and rating notations can be found at https://www.scoperatings.com/#governance-and-policies/rating-scale. Guidance and information on how Environmental, Social or Governance factors (ESG factor) are incorporated into the rating can be found in the respective sections of the methodologies or guidance documents provided on https://www.scoperatings.com/#!methodology/list.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The rated entity and/or its agents particpated in the rating process.
The following substantially material sources of information were used to prepare the credit rating: the rated entity, public domain and Scope internal sources.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds on which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH, Lennéstraße 5, D-10785 Berlin, Tel +49 30 27891-0.
Lead analyst Olaf Toelke, Managing Director
Person responsible for approval of the rating: Philipp Wass, Executive Director

The Merck KGaA issuer rating/outlook was first released by Scope on 19 October 2016. The rating/outlook were last updated on 22 October 2019.
The Merck KGaA short-term rating was first released by Scope on 19 October 2016. The rating was last updated on 22 October 2022 2019.
The Merck KGaA senior unsecured debt rating/outlook was first released by Scope on 19 April 2018. The rating was last updated on 22 October 2019.
The Merck KGaA subordinated debt rating/outlook was first released by Scope on 19 April 2018. The rating was last updated on 22 October 2019.
The Merck Financial Services GmbH issuer rating/outlook was first released by Scope on 19 April 2018. The rating was last updated on 22 October 2019.
The Merck Financial Services GmbH senior unsecured debt rating/outlook was first released by Scope on 19 April 2018. The rating was last updated on 22 October 2019.
The Merck Financial Services GmbH subordinated debt rating/outlook was first released by Scope on 19 April 2018. The rating was last updated on 22 October 2019.
The EMD Finance LLC issuer rating/outlook was first released by Scope on 19 April 2018.The rating was last updated on 22 October 2019.
The EMD Finance LLC senior unsecured debt rating/outlook was first released by Scope on 19 April 2018. The rating was last updated on 22 October 2019.
The EMD Finance LLC subordinated debt rating/outlook was first released by Scope on 19 April 2018. The rating was last updated on 22 October 2019.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings.

Conditions of use / exclusion of liability
© 2020 Scope SE & Co. KGaA and all its subsidiaries including Scope Ratings GmbH, Scope Analysis GmbH, Scope Investor Services GmbH and Scope Risk Solutions GmbH (collectively, Scope). All rights reserved. The information and data supporting Scope’s ratings, rating reports, rating opinions and related research and credit opinions originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data. Scope’s ratings, rating reports, rating opinions, or related research and credit opinions are provided ‘as is’ without any representation or warranty of any kind. In no circumstance shall Scope or its directors, officers, employees and other representatives be liable to any party for any direct, indirect, incidental or other damages, expenses of any kind, or losses arising from any use of Scope’s ratings, rating reports, rating opinions, related research or credit opinions. Ratings and other related credit opinions issued by Scope are, and have to be viewed by any party as, opinions on relative credit risk and not a statement of fact or recommendation to purchase, hold or sell securities. Past performance does not necessarily predict future results. Any report issued by Scope is not a prospectus or similar document related to a debt security or issuing entity. Scope issues credit ratings and related research and opinions with the understanding and expectation that parties using them will assess independently the suitability of each security for investment or transaction purposes. Scope’s credit ratings address relative credit risk, they do not address other risks such as market, liquidity, legal, or volatility. The information and data included herein is protected by copyright and other laws. To reproduce, transmit, transfer, disseminate, translate, resell, or store for subsequent use for any such purpose the information and data contained herein, contact Scope Ratings GmbH at Lennéstraße 5 D-10785 Berlin. Scope Ratings GmbH, Lennéstraße 5, 10785 Berlin, District Court for Berlin (Charlottenburg) HRB 192993 B, Managing Director: Guillaume Jolivet.