Medika, Medical intertrade, Oktal pharma, Phoenix Farmacija – Weak liquidity and high refinancing risks limit pharma distributors’ credit ratings

CreditAnalyst.eu (“CAeu”) assigned first-time credit ratings to the four leading Croatian pharma distributors – Medika, Medical intertrade, Oktal pharma, and Phoenix Farmacija.

Rating rationale

The assigned ratings remain largely depressed and highly limited due to weak liquidity caused by slow collection of receivables. Pharma distributors are in a difficult market position, as primarily state-owned market players do not pay their obligations on time and thus generate a chain of non-payments or payments severely exceeding common trading terms. All pharma distributors depend on tolerance of drug suppliers / manufacturers, and a change in the suppliers’ credit policies could quickly and adversely affect the distributors’ liquidity. On a standalone basis, all four pharma distributors are not able to cover their debt from operating cash flows. In a worst-case scenario, the suppliers’ application of more aggressive collection methods could lead to defaults.

Although there are differences in credit profiles among the four companies, they all display the following similar key credit risks and strengths.

Key credit risks constraining the pharma distributors’ ratings:

Long receivables collection, which causes (i) weak liquidity paired with high refinancing risk, (ii) consistently negative FCF, and (iii) dependence on suppliers to finance further growth.

Croatian pharma distributors finance their long receivables days fully on the back of drug suppliers, which leads to nominally balanced operating cycle. However, due to the untenable length of the operating cycle components, working capital is the key negative contributor in their credit analysis. Average receivables days amount to 125-160 days, while distributors’ payments to suppliers are normally longer and amount to 150-190 on average. Both metrics significantly exceed the legally defined 60 days. Such conditions severely impair pharma distributors creditworthiness, as they: (i) strain distributors’ liquidity position as cash and available credit lines are not sufficient to cover the short-term debt, which represents high refinancing risk amid lack of suitable tangible collaterals, (ii) cause consistently negative FCF, as suppliers’ financing is effectively debt, and (iii) healthy organic growth is dependent on the suppliers’ willingness to support further growth in a highly illiquid market conditions. We treat trade payables in excess of 90 days as debt, which adds a significant burden to the leverage metrics of all pharma distributors.

Low margin industry pressured by strong competition and high regulation.

Pharma distribution is generally a low-margin business, requiring large scale for sustainable profit generation. This is reflected in low-to-mid single digit EBITDA margin. Tough competition between the four leading players and high market regulation in terms of drug prices limit distributors’ space for error.

Pharma distributors’ weak business diversification.

All four companies have weakly diversified operations. Namely, only Oktal pharma and Medika benefit from some business diversification, as they have invested in vertical integration into pharmacy chains. However, the effect is limited as the share of pharmacy sales contributes only 10-12% to total sales. On the other side, Medical intertrade’s presence in the manufacturing segment via its company Yasenka has not yet yielded meaningful results. Phoenix Farmacija focuses on distribution, however, it can lean on its group’s solid business and geographic diversification. Generally, reliance on the domestic market is high, with some customer concentration risk, as the major of key customers have the same owner (the State), do business within the same framework, have similar demand drivers, etc.

Key credit strengths supporting the ratings:

Strategic importance of the drug supply for the functioning of the national health system, which, in case of wider financial issues in the sector, could lead to government interventions.

Given the importance of each of the companies, should any of them enter into difficulties, the government might intervene by either accelerating its payments which will depend on the available cash in the State’s treasury (the more likely scenario) or by directly supporting a company (the less likely scenario and applicable only for some companies). Alternatively, some companies could opportunistically initiate the prebankruptcy settlement procedure, which would allow them to continue doing business, yet with a questionable outcome for their creditors.

Moderate industry risk due to low cyclicality and relatively high barriers to entry, supported by steady growth in drug consumption.

Pharma distribution industry leans on the pharmaceutical industry, which generally exhibits low cyclicality. The barriers to entry are relatively high due to the time needed to build relationship with drug suppliers and customers, often dependent on the public procurement procedures. The market is also highly concentrated with Medika leading the rankings in terms of sales, followed by the remaining distributors with almost equal market share. Another favourable factor for pharma distributors is the continuous growth in drug consumption, visible from the sales CAGR of 8,3% over the 2015-2020 period. However, the pharma distributors’ business is highly dependent on the government spending, which can negatively impact the distributors’ sales level in case of purchasing power decline and implementation of budgetary savings measures.

Factors that could lead to the rating changes

Factors that could lead to upgrades:

• Rating upgrades are not likely in the short-term. The main pre-condition for an upgrade is the improvement in working capital, which is possible only through a comprehensive restructuring of the national health system which would result in its sustainability and stabilised payment frequency. Recent speculations of the state budget adjustment resulting in a likely reduction of debt towards pharma distributors is credit positive, yet deemed unsustainable in absence of a major restructuring.

Factors that could lead to downgrades:

• Unwillingness of drug suppliers to finance further growth, including potential drug delivery limitations.
• Increased pressure from drug suppliers to shorten payables days, which could result in application of more aggressive collection methods, leading to potential defaults in a worst-case scenario.

Company profiles

Medika

Medika is the leading pharma distributor in Croatia, with sales of HRK 4,13bn in FY2021. Medika Group consists of the main holding and operating company Medika d.d., and a leading pharmacy chain Ljekarne Prima Pharme. Medika’s largest shareholder is Auctor d.o.o. with a stake of 48%. The company’s is listed on the Zagreb Stock Exchange, and its market cap amounted to HRK 912m as of June 2^nd, 2022.

Medical intertrade

Medical intetrade is a domestic group consisting of Medical intertrade d,o.o. (the holding and main operating company), Yasenka d.o.o., Medical intetrade d.o.o. Sarajevo (BiH) and Medical intetrade d.o.o. Trzin (Slovenia). The Group’s sales amounted to HRK 2,07bn in FY2020. The specific of the Medical intertrade group is that it does not include the pharmacy business, which has been separately owned by the same owner as the Group, Mrs Jasenka Joukhadar.

Oktal pharma

Oktal pharma is a group consisting of numerous companies in Croatia and the neighbouring countries, with the holding and main operating company Oktal pharma d.o.o. and a pharmacy chain Ljekarne Vaše zdravlje being the major contributors to the Group’s sales, which amounted to HRK 2,22bn in FY2020.

Phoenix Farmacija

Phoenix Farmacija is a wholly-owned subsidiary of the Germany-based Phoenix Pharma SE, the leading European pharma distributor and pharmacy chain operator. The company’s sales amounted to HRK 2,45bn in the financial year ended in January 2022.  The Phoenix Group is currently rated BB+ by S&P.

Disclaimer: CreditAnalyst.eu Corporate Credit Rating is not a credit rating defined according to the regulation applicable to external credit rating agencies. As CreditAnalyst.eu is not a regulated credit rating agency, it provides exclusively private credit ratings.