2017 credit ratios
Merck had a mixed past year. On the one hand, its Performance Materials division – specifically its liquid crystals sub-division – suffered from adverse pricing and market share losses. In addition, foreign exchange movements had a negative effect on revenues and multiple-sclerosis drug Rebif suffered from a more competitive environment. On the other hand, the weaker US dollar had a positive effect on financial debt and the group’s free cash flow generation was again sufficient to allow for stronger deleveraging than Scope had expected. While adjusted 2017 EBITDA was slightly lower in a year-on-year comparison, Merck reported higher operating cash flows in 2017 (due to lower non-cash corrections and lower deferred tax liabilities compared to 2016). This resulted in free cash flow generation of about EUR 1.7bn in 2017, only marginally weaker than in 2016. After deducting dividends and (net) acquisitions, Merck generated discretionary cash of EUR 0.9bn in 2017, giving rise to a net financial debt reduction of about EUR 1.4bn in 2017 which was slightly higher than our estimate of EUR 1.2bn. The impact on key credit metrics was somewhat negative overall but not decisively so, in our view, or in the context of the ratings:

• Funds from operations (FFO) to Scope-adjusted debt (SaD) of 27% (25% in 2016, Scope expected 32%)
• SaD to Scope-adjusted EBITDA of 2.7x (2.9x in 2016, Scope expected 2.5x)
• Free cash flow (FCF) to SaD of 17% (21% in 2016, Scope expected 22%)

2018 looks like another mixed year
According to management guidance, 2018 will be another mixed year. This is largely based on flat Healthcare division performance as it can be assumed that demand for Rebif in particular will continue to decline in line with the interferon market while initial sales of newly approved drugs Bavencio (immuno-oncology) and Mavenclad (multiple sclerosis) will contribute to results on a twelve-months basis. Performance Materials is expected to have another down year in 2018 as management is addressing the more competitive landscape, especially for display materials. Life Sciences is likely to continue following the positive trend seen in 2017 with increases expected in both sales and operating profits for 2018. In total, we believe that group profits will probably decline modestly (single digit, compared to 2017). There are good chances of more profitable growth in 2019, in our view, especially in Healthcare, assuming a more sizeable contribution from Bavencio and Mavenclad as well as a stabilisation in liquid crystals performance.

Rating implications
Scope believes that 2018 is likely to result in a stronger improvement in credit metrics, assuming support from a potential disposal of consumer health activities. Management had announced good progress in the evaluation of “strategic options” for the business. This could more than counterbalance another year of operational headwinds and allow management to continue its confirmed deleveraging focus in 2018. Based on Merck’s track record of a conservative financial policy, we do not expect a special dividend to be announced in connection with the likely consumer health disposal. Thus, our ratio guidelines (FFO/ SaD >30%, SaD/ EBITDA <2.5) are likely to be met in 2018.

This publication does not constitute a credit rating action. For the official credit rating action release click here. On 19 October 2016, Scope assigned Merck KGaA an issuer rating of A-. Senior unsecured debt issued by the company is rated A-. The short-term rating is S-1. The Outlooks are Stable.