Assessing What Happens If Fitch Sacks Mylan

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About: Mylan N.V. (MYL)
by: Shock Exchange
Summary

MYL's revenue and EBITDA are in decline.

Generics is experiencing a diminution in pricing power. This does not bode well.

I estimate MYL's debt/run rate EBITDA is at 4.9x, approaching junk status.

Fitch Ratings recently revised MYL's outlook to negative. A downgrade could cause MYL's debt to fall to junk status. Sell MYL.

Mylan corporate logo. Source: Bloomberg Mylan corporate logo. Source: Bloomberg

Mylan's (NASDAQ:MYL) revenue and operating income are in rapid decline. Its $14 billion debt load makes the decline even more problematic. Fitch Ratings recently revised Mylan's outlook to negative and implied a downgrade could leave the company's debt with a junk rating:

Fitch Ratings has affirmed Mylan's long-term Issuer Default Rating ("IDR") at 'BBB-' and its short-term IDR at 'F3'. The Rating Outlook is revised to Negative from Stable. The ratings apply to approximately $14 billion of debt as of March 31, 2019. (In the event of a downgrade of the IDR, Fitch expects that the short-term ratings would be reduced to 'B'.)

The Outlook revision reflects Fitch's expectation that Mylan's gross leverage may remain elevated over the near term because of slower than expected revenue growth, cash generation and debt reduction. The Outlook revision does not reflect potential event risk related to loss contingencies associated with legal proceedings or potential changes in the company's capital structure resulting from its previously announced strategic review.

Mylan's weighted average interest rate is less than 4%, which I would consider cheap. A ratings downgrade could cause its next debt raise to be at much higher interest rates, amplifying its interest costs. It could also hurt sentiment for the stock.

Mylan's Debt Could Be Entering Junk Territory

Fitch appears to be spot on in giving Mylan a negative outlook. In my opinion, the company's $14 billion debt load is at or near junk status. Based on Mylan's estimated run rate EBITDA of $2.8 billion (Q4 2018 and Q1 2019 annualized), its debt/EBITDA would be around 4.9x. Debt/EBITDA at 5.0x or higher is often considered junk status.

Mylan credit metrics at Q1 2019 Mylan's debt was as low as $6 billion at year-end 2015. The company acquired Swedish drug maker Meda in 2016 for $7.2 billion. From 2015 to year-end 2016, the company's debt increased to $15.2 billion, driven by the Meda acquisition.

Over the past few years, pricing for the generics drug market has sharply deteriorated. In North America, large institutions have wielded their buying power to garner cheaper prices. Faster approval of new drugs by the FDA has heightened competition. EpiPen, formerly a cash cow, has also seen its revenue fall due to competition and regulatory scrutiny. Mylan's Q1 2019 revenue and EBITDA fell by 7% and 19%, respectively. Its $542 million EBITDA represented a margin of 22%, down 300 basis points versus the year-earlier period.

Run rate EBITDA is Q4 2018 EBITDA and Q1 2019 EBITDA annualized. This could be considered robust, given that Q1 2019 EBITDA declined Q/Q by over 35%. In Q1 2019, R&D and SG&A expenses were a combined 31% of revenue. Mylan could potentially cut into these expenses, yet there is no guarantee it could achieve the EBITDA reported in Q4 2018. That is a long-winded way of saying, over time, its run rate EBITDA could decline, and its credit quality could deteriorate further.

Conclusion

Mylan's EBITDA has been in free fall. A ratings downgrade could be next. Sell MYL.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.