Fitch Ratings has affirmed Roar BidCo AB's (Recipharm) Long-Term Issuer Default Rating (IDR) at 'B'.
The Outlook is Stable. Fitch has also affirmed the senior secured rating on Recipharm's term loan B (TLB) at 'B+' with a Recovery Rating of 'RR3'.
Recipharm's 'B' rating reflects its leading position in the non-cyclical and structurally growing contract development and manufacturing organisation (CDMO) market, where it is well-placed to capture growth opportunities due to its geographically-diversified production facilities and established and sticky customer base with high barriers to entry. However, the rating is constrained by temporarily high leverage due to inflation headwinds and challenging operating environment in its biologics business divisions.
The Stable Outlook is supported Recipharm's ability to grow organically in 2023-2025, with EBITDA leverage improving to 6.5x after 2024. We also believe that current profitability pressures will gradually ease in 2023, on the back of contract renegotiations and operational efficiencies.
Key Rating Drivers
Performance Bottoms Out: We project Recipharm will rebuild profitability over 2023 and estimate that EBITDA will reach around EUR185 million (Fitch-defined EBITDA margin of 14.2%) after a significant operating underperformance in 2022, which closed with EBITDA of EUR144 million (12.2% Fitch-defined margin). This operational improvement reflects a new commercial manufacturing agreement in the advanced delivery systems division, pricing improvements across product divisions and cost-cutting initiatives, the benefits of which have been partially reflected in 1H23 performance.
The Stable Outlook is largely driven by the continuation of this profitability rebound, after Recipharm's underperformance in 2022 against our forecast due to a slower-than-expected inflation pass through, pandemic-related earnings reducing in the steriles division, a termination of a key customer contract and weak demand in its biologics division.
High Execution Risks: Fitch sees meaningful execution risks, given the broad number of issues being addressed by management, such as development of the biologics division, cost-cutting initiatives and somewhat constrained ability to immediately pass through cost increases.
The 'B' rating is predicated on the ongoing sector recovery and management's ability to deliver cost efficiencies. We have revised our forecast EBITDA margin in 2024-2027 to 16%-17%, from about 18% previously. A faster-than-expected biologics business ramp-up would be an upside to Fitch's updated forecast. Failure to improve EBITDA margins above 16% from 2024, leading to neutral or volatile free cash flow (FCF) generation, would put the ratings under pressure.
Tight Rating Headroom: Recipharm's ratings have materially reduced headroom, reflected in negative but improving FCF and EBITDA leverage projected at 8.4x at end-2023 and 7.0x in 2024, temporarily exceeding our sensitivities. Nevertheless, we believe the underlying business remains robust, evidenced by high capacity utilisation and deleveraging potential. We expect an improvement of EBITDA leverage to below 6.5x after 2024, as inflationary pressures ease and the group's cost base is addressed.
Investments in Growth: Management plans to spend about EUR90 million-EUR100 million a year total capex over 2023-2024 to expand capacity and meet long-term demand, which we project will be funded mostly with internal cash flow and some balance sheet cash. In 2022, Recipharm invested equity to expand biologics production capacity (Recibiopharm). These investments are significant and the biologics division remains loss-making over 2023-2024, but Fitch believes they are necessary and will position Recipharm for growth in areas that are aligned with anticipated demand driven by cell- and gene-therapies.
Revenue Visibility, Established Market Position: The rating remains supported by Recipharm's strong revenue visibility and high barriers to entry, particularly in more complex product areas where the manufacturing process is harder to replicate. Setting up a contract manufacturer requires significant capex, as well as technological knowledge, regulatory approvals and time to build reputation. CDMO reliability is key for pharma companies as switching suppliers can be high-risk and time-consuming. These factors, combined with the long life-cycle of pharma products (typically over 10 years), translate into high revenue visibility for Recipharm with a record of maintaining its customer base, translating into the underlying resilience of its business model.
Positive Long-term Structural Drivers: We forecast that overall market demand will continue to grow in the mid-single-digit percentages, with higher pricing in more technologically complex product areas, which will support Recipharm's deleveraging. The global CDMO market, estimated at around EUR90 billion, is supported by a growing trend of pharmaceutical companies outsourcing production (opting for more asset-light business models to focus on core activities, R&D, marketing and sales), as well as long-term macro drivers of an ageing population, growing healthcare demand and new drug development.
Fragmented Market, Large-Scale Customers: The CDMO market is fragmented, with the 10 largest manufacturers accounting for less than 20% of the overall market. Although Recipharm is the fourth-largest CDMO globally in sales, it still represents only 1%-2% of the total global market. Large global pharma customers typically have strong bargaining power in new contract negotiations, especially in high-volume generics. This likely caused the slower-than-expected inflation pass through in 2022.
In our view, Recipharm's strategic focus on faster-growing, more technologically innovative advanced delivery systems, plus sterile and development services (representing 55% of sales) continues to somewhat offset these risks.
Derivation Summary
Fitch rates Recipharm according to its global Generic Rating Navigator. Under this framework, Recipharm is supported by resilient demand, continued outsourcing and high entry barriers, with high switching costs and strong revenue visibility. The rating is constrained by its overall limited scale in a fragmented and competitive CDMO market with high financial leverage.
We regard capital-and asset-intensive businesses, such as European Medco Development 3 S.a.r.l. (Axplora, B-/Stable), Financiere Top Mendel SAS (Ceva Sante, B+/Stable), F.I.S. Fabbrica Italiana Sintetici S.p.A. (FIS, B/Stable) and privately rated CDMOs, as the closest peers to Recipharm as they all rely on ongoing investments to grow at or above market and to maintain operating margins. However, Recipharm has stronger profitability and scale than most privately-rated CDMO peers. It also has a stronger business profile, focused on prescription-drug manufacturing, steriles and delivery systems with intellectual property rights.
Recipharm's and Ceva Sante's scale and diversification support higher debt capacity than the more specialised Axplora, which has similar levels of financial leverage but with a lower rating. Recipharm has lower FCF generation than Ceva Sante (partly owing to higher capex) and higher financial leverage hence the one-notch differential between the two.
Recipharm has larger scale and better profitability than FIS. Nevertheless, the latter's modest leverage with an estimated EBITDA leverage of about 5.0x in 2023 versus 8.4x in 2023 at Recipharm warrants the same rating.
Key Assumptions
Fitch's Key Assumptions Within Our Rating Case for the Issuer
Revenue growth of around of 10.5% in 2023, 8.5% in 2024 and mid-to-high-single digits a year to 2027
EBITDA margin of 14.2% in 2023 due to the loss-making biologics division and cost inflation, before gradually increasing to 16-17% in 2024-2027
Capex intensity of 6.5%-7.0% of sales in 2023-2024, before returning to normalised levels of 5.5%-6.0% to 2027
Annual working-capital outflows of EUR20 million-EUR30 million a year in 2023-2024 and EUR10 million a year thereafter
No large debt-funded M&A or shareholder distributions to 2027
Key Recovery Assumptions
Our recovery analysis assumes that Recipharm would be reorganised as a going-concern (GC) in bankruptcy rather than liquidated.
The EUR164 million (unchanged from last update) GC EBITDA reflects stress assumptions from weak operating performance with regulatory issues or increased competition leading to deteriorating margins. The assumption also reflects corrective measures taken in reorganisation to offset the adverse conditions that trigger the default.
We continue to apply an enterprise value (EV) multiple of 6.0x to the GC EBITDA to calculate a post-reorganisation EV. The choice of this multiple is based on positive market fundamentals, strong revenue visibility with long-term customer contracts and high switching costs, but also some traits of commoditisation within solids.
Recipharm's SEK3 billion (EUR250 million equivalent) revolving credit facility (RCF) is assumed to be fully drawn upon default. It has around EUR26 million equivalent of prior-ranking local facilities and EUR100 million non-recourse factoring facility, 50% out of which will remain available at distress, as Fitch estimates. The RCF and EUR1,115 million first-lien TLB rank pari-passu between themselves, and senior to a GBP228 million second-lien term loan in the debt waterfall.
Assuming a 10% administrative claim, the allocation of value in the liability waterfall results in recoveries corresponding to 'RR3' for the first-lien RCF and TLB. This indicates a 'B+' instrument rating for the first-lien TLB with a waterfall-generated recovery computation of 59% (previously 62%) based on current metrics and assumptions.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Larger scale, increased high-tech offering or increased geographical diversification while maintaining EBITDA margin above 20% on a sustained basis
EBITDA leverage below 5.0x on a sustained basis, supported by commitment to conservative financial policies
Mid-single digit FCF margin
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Weak operating performance, product or regulatory issues or change in M&A or investment discipline leading to weaker EBITDA margin
Prospects of EBITDA leverage remaining above 6.5x after 2024
EBITDA interest coverage below 2.0x on a sustained basis
Neutral to negative FCF margin, reducing liquidity headroom
Liquidity and Debt Structure
Liquidity Remains Satisfactory: As of end-June 2022, cash on balance sheet of EUR92 million (including about EUR27 million that Fitch treats not readily available) was complemented by about EUR175 million funds available under its SEK3 billion RCF (about EUR250 million) and EUR100 million non-recourse factoring facility. We believe the group's liquidity position is adequate to cover higher interest costs as well as its ambitious investment plans, which include capacity enhancement investments.
Although our assessment of liquidity is satisfactory, we expect weaker cash flows, with negative FCF in 2023-2024 before it returns to break-even in 2025 as operating profitability is restored and capex intensity eases. The group has a manageable debt maturity profile with its first-lien TLB maturity in February 2028.
Issuer Profile
Recipharm, headquartered in Stockholm and founded via a management buy-out from Pharmacia in 1995, is one of the five largest pharmaceutical CDMO globally.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.
RECIPHARM AB (PUBL) 
