NEW YORK--()--Fitch Ratings has assigned a 'B-/RR6' to HCA Holdings Inc.'s (HCA) $1 billion proposed senior unsecured notes. A full list of ratings is shown below. The Rating Outlook is Stable, and the ratings apply to $27 billion of debt outstanding at Sept 30, 2012. Fitch expects that the company will use the proceeds of the proposed notes to fund a special dividend payment to shareholders in Q4'12.
The ratings reflect the following main credit factors:
--HCA has good headroom in credit metrics at the 'B+' rating category. Pro forma for the proposed notes issuance, Fitch forecasts total debt-to-EBITDA of 4.5x and EBITDA-to-gross interest expense of 3.5x at the end of 2012.
--HCA's financial flexibility has improved following the extension of the bulk of its 2013 debt maturity wall and refinancing of high coupon second lien secured debt at lower rates.
--Fitch expects continued solid discretionary free cash flow (FCF; cash from operations less capital expenditures and distributions to minority interests) of about $1.4 billion annually for HCA in 2012-2013.
--While strong cash generation could support debt pay down, Fitch does not believe that there is compelling financial incentive for the company to apply cash to debt reduction.
--HCA's debt agreements do not significantly limit the company's ability to undertake leveraging transactions, and the ratings are constrained by the prospect for debt funding of additional shareholder dividends and share repurchases. A demonstrated commitment to maintaining debt below 4.5x EBITDA over the next 12-18 months could support a positive rating action.
SOLID FINANCIAL FLEXIBILITY
HCA's liquidity profile is basically solid following the refinancing of the bulk of the company's 2013 debt maturities. Over the past 18 months, HCA improved its balance sheet flexibility by extending its bank debt maturity wall and refinancing its relatively high coupon second lien secured debt at lower rates. Most recently, the company used a portion of the proceeds of its October 2012 $1.25 billion secured notes issue to pay down its 2013 bank term loan B-1 maturity. Near-term maturities remaining in the capital structure include $384 million of bank term loan and $1 billion of HCA Inc. unsecured notes maturities in 2013 and $81 million of bank term loan and $621 million of HCA Inc. unsecured notes maturities in 2014.
Fitch believes the company has the financial flexibility necessary to address its near-term maturities, with ample sources of liquidity and solid demonstrated capital market access. At Sept. 30, 2012, HCA's liquidity included $472 million of cash on hand, $3.2 billion of capacity on its bank facility revolving loans and latest 12 month (LTM) FCF (cash from operations less capital expenditures, dividends and distributions) of about $ 1.1 billion. HCA's LTM EBITDA-to-gross interest expense was solid for the 'B+' rating category at 3.5x, and the company had about a 40% EBITDA cushion under its bank facility financial maintenance covenant, which requires debt net of cash maintained below 6.75x EBITDA.
CASH GENERATION OUTLOOK
Fitch's 2012-2013 operating forecast for HCA projects the company generating $3.7 billion-$3.8 billion in cash from operations (CFO) and about $1.4 billion in FCF before dividends assuming capital expenditures of $1.8 billion and minority distributions of about $420 million. Excluding a 1Q'12 $982 million special dividend payment, FCF before dividends would have been nearly $2.1 billion in the LTM period ended Sept. 30, 2012.
Versus the $2.1 billion of pre-dividend FCF generated in the LTM, Fitch's more conservative forecast is driven primarily by higher capital expenditures and cash taxes. In 2011, FCF was boosted by a favorable $800 million swing in cash tax payments versus 2010, mostly due to tax refunds related to settlements that are not expected to reoccur. Also, CFO was boosted by $270 million in 2Q'12 as a result of a settlement from the federal government related to historical Medicare payment rates. CFO was higher than normal across the hospital industry in the first half of 2012 as a result of these one-time payments.
AGGRESSIVE CAPITAL DEPLOYMENT CONSTRAINS RATINGS
Including the proposed $987 million dividend to be paid by HCA Holdings Inc., the company will have funded three special dividend payments in a cumulative amount of nearly $3.2 billion during 2012. The funding of the dividends has contributed to higher debt leverage. Fitch projects total debt to EBITDA of 4.5x at the end of 2012 assuming a total debt level of $28.9 billion, which is $1.9 billion above the Dec. 30, 2011 level. Due to growth in EBITDA however, the pro forma leverage ratio is only slightly higher than the Dec. 31, 2011 level of 4.4x.
The ratings assume that the company will continue to fund a high level of dividends and potentially share repurchases in 2013. The debt agreements at the HCA Inc. level, including the bank agreement and bond indentures, provided limited capacity for restricted payments that was mostly exhausted after this year's second dividend payment in November 2012. However, additional capacity for restricted payments at the HCA Inc. level will build based on 50% of net income. The proposed dividend will be funded at the HCA Holdings, Inc. level.
At the pro forma 4.5x level, HCA's debt leverage is basically consistent with its peer companies. While FCF generation could support debt pay down, Fitch does not believe that there is compelling financial incentive for the company to significantly reduce its debt balances, so it expects that any further leverage reduction will come from incremental growth in EBITDA. A commitment to maintaining debt below 4.5x EBITDA over the next 12-18 months despite ongoing shareholder friendly cash deployment could support an upgrade of the Issuer Default Rating (IDR) to 'BB-'.
HOSPITAL INDUSTRY OPERATING OUTLOOK
Organic top-line trends in the for-profit hospital sector have recently been weak, and Fitch does not see a near-term catalyst for improvement. The most important drivers of the trend are high unemployment and government pricing pressure, exacerbated by the implementation of Medicare payment reforms required by the Affordable Care Act (ACA). Management's cost-cutting efforts and low inflation in labor and supply costs are supporting the industry's profitability.
HCA's organic patient volume trends were stronger than that of the broader for-profit hospital sector in 2011 and the first nine months of 2012. However, a shift to patients with less profitable government health insurance coverage has recently been a headwind to the company's topline growth and profitability. Fitch's 2013 operating outlook for HCA projects little growth in EBITDA versus 2012. This is due to the combined effects of a slightly lower profitability caused by continued mix shift to less profitable Medicaid and uninsured patient volumes, a lower amount of government high tech incentive payments and the absence of a one-time $170 million boost to Q1'12 EBITDA through Medicare settlement payments. Fitch expects low-to-mid single digit organic topline growth for HCA in the near term. This is mostly contributed through growth in patient volume since pricing is expected to continue to be strained.
Fitch projects a positive benefit to the hospital industry's revenue, EBITDA and FCF from the implementation of the ACA in 2014-2015. The initial benefits to the industry are the result of the health insurance coverage expansion elements of the ACA. An increase in the number of individuals with health insurance will lead to a reduced level of uncompensated care and associated bad debt expense for hospital providers, as well as an increase in the organic volume of patients. The positive boost to financial trends is likely to erode over time as hospital providers experience lower payment rates from both government and commercial insurers in the subsequent years.
DEBT ISSUE RATINGS AND RECOVERY ANALYSIS
Fitch currently rates HCA as follows:
--Senior secured credit facilities (cash flow and asset backed) 'BB+/RR1' (100% estimated recovery);
--Senior secured first lien notes 'BB+/RR1' (100% estimated recovery);
--Senior secured second lien notes 'BB+/RR1' (100% estimated recovery);
--Senior unsecured notes 'B+/RR4' (44% estimated recovery).
HCA Holdings Inc.
--Senior unsecured notes affirmed at 'B-/RR6' (0% estimated recovery).
In November 2010, HCA reorganized by creating a holding company structure. Under this structure, HCA Holdings Inc. is the parent company, and HCA Inc. is its wholly owned subsidiary. HCA Inc. owns substantially all of the company's hospital operating subsidiaries. The only debt that is currently outstanding at the HCA Holdings Inc. level is the $1.525 billion 7.75% senior notes due 2021. These notes are unsecured and are not guaranteed by the operating subsidiaries. These notes are therefore structurally subordinate in right of payment to all debt outstanding at the HCA Inc. level.
The debt issue ratings are based on a distressed recovery scenario which assumes that value for HCA's creditors will be maximized as a going concern (rather than a liquidation scenario). Fitch estimates a post-default EBITDA for HCA of $3.9 billion, which is a 40% haircut from the LTM EBITDA level of $6.5 billion. A 40% haircut represents roughly the level of EBITDA decline that would trip the 6.75x net leverage bank facility financial maintenance covenant.
Fitch then applies a 7.0x multiple to post-default EBITDA, resulting in a post-default EV of $27.2 billion for HCA. The multiple is based on observation of both recent transactions/takeout and public market multiples in the healthcare industry. Fitch significantly haircuts the transaction/takeout multiple assigned to healthcare providers since transactions in this part of the healthcare industry tend to command multiples of closer to 7.0x versus the 9.74x healthcare sector transaction multiple 10-year low.
Fitch applies a waterfall analysis to the post-default EV based on the relative claims of the debt in the capital structure. Administrative claims are assumed to consume $2.7 billion or 10% of post-default EV, which is a standard assumption in Fitch's recovery analysis. Also standard in its analysis, Fitch assumes that HCA would fully draw the $4.5 billion available balance on its bank facility revolvers in a bankruptcy scenario and includes that amount in the claims waterfall.
The 'BB+/RR1' rating for HCA's secured debt (which includes the bank credit facilities, the first and second lien notes) reflects Fitch's expectations for 100% recovery under a bankruptcy scenario. The 'B+/RR4' rating on the HCA Inc. unsecured notes rating reflects Fitch's expectations for recovery of 44%. The 'B-/RR6' rating on the HCA Holdings, Inc. unsecured notes, including the proposed notes, reflects expectation of 0% recovery. The recovery estimates are pro forma for the company's Q4'12 debt financing activities.
Based on Fitch's current recovery assumptions, HCA has capacity to issue up to an additional $1.1 billion of secured notes without diminishing recovery prospects for the HCA Inc. unsecured note holders to below the 'RR4' recovery band of 31%-50%. Should the company increase the amount of secured debt in the capital structure by more than that amount, Fitch would likely downgrade the HCA Inc. unsecured notes by one-notch, to 'B/RR5. The ratings on the secured debt and HCA Holdings Inc. unsecured notes would not be affected.
HCA has good incremental capacity for additional secured debt issuance under its debt agreements. The only limit on secured debt is a 3.75x first lien leverage ratio test in the bank agreements. First lien debt includes the bank debt and the first lien secured notes. Pro forma for the Q4'12 debt financing activities, total first lien debt equals $17.4 billion and 2.7x debt-to-EBITDA.
Based on $6.5 billion in LTM EBITDA, Fitch estimates total first lien secured debt capacity of $24.3 billion, implying additional first lien capacity of about $6.9 billion.
At Sept. 30, 2012, the company had $3.2 billion of capacity under the $4.5 billion in total revolver commitments. Since Fitch assumes that HCA would fully draw its credit revolvers in a distressed scenario, any revolver draws on the will not influence the recovery bands or debt issue ratings.
WHAT COULD TRIGGER A RATING ACTION
An upgrade of the ratings would be supported by total debt maintained below 4.5x EBITDA and interest coverage above 3.5x EBITDA over the next 12-18 months. Drivers of a positive rating action would include a commitment to maintenance of credit metrics at these levels despite the company's recently shareholder friendly capital deployment activities.
A downgrade of the ratings could result from debt above 5.0x EBITDA and interest coverage below 2.5x EBITDA. This could result from a combination of a stressed operating scenario and aggressive capital deployment. Fitch sees the most likely drivers of a stressed operating scenario for HCA as ongoing weakness in payments. This could be the result of ongoing strained state Medicaid funding in its largest states (about half of revenues come from its 75 hospitals in Texas and Florida) coupled with persistent shift in its mix of patients to those with less profitable Medicaid coverage as well as uninsured patients.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'2013 Outlook: U.S. Healthcare' (Nov. 29, 2012);
--'HCA, Inc. Spotlight Series' (Oct. 24, 2012);
--'Hospitals Credit Diagnosis' (Sept. 18, 2012);
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Fitch 50 - Structural Profiles of Fifty Leveraged Credits' (July 26, 2012);
--'For-Profit Hospital Quarterly Diagnosis - First Quarter 2012' (June 6, 2012);
--'Leverage Finance Annual Manual for the Americas' (May 1, 2012).
Applicable Criteria and Related Research:
U.S. Leveraged Finance Spotlight Series: HCA Holdings, Inc.
Hospitals Credit Diagnosis: Operating Trends Remain Weak but Solid Liquidity Supports Credit Profiles
Corporate Rating Methodology
Fitch 50 -- Structural Profiles of 50 Leveraged Credits - Amended
For-Profit Hospital Quarterly Diagnosis
Leveraged Finance Annual Manual for the Americas
2013 Outlook: U.S. Healthcare -- Navigating a Dynamic Operating and Regulatory Environment