NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed HCA Inc.'s (HCA) 'B+' Issuer Default Rating (IDR) and upgraded the unsecured notes rating to 'BB-' from 'B+'. The Rating Outlook is revised to Positive from Stable. A full list of ratings follows at the end of this release. The ratings apply to $28.2 billion of debt outstanding at June 30, 2013.
KEY RATING DRIVERS
--HCA has good headroom in credit metrics at the 'B+' rating category. Fitch forecasts total debt-to-EBITDA of 4.5x and EBITDA-to-gross interest expense of 3.5x at the end of 2013.
--HCA's financial flexibility has improved following the extension of its 2013 and 2016 debt maturity walls 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 $1.2 billion annually for HCA in 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. A demonstrated commitment to maintaining debt below 4.5x EBITDA would support a positive rating action.
SOLID FINANCIAL FLEXIBILITY
HCA has recently improved its balance sheet flexibility by extending near-term debt maturities, eliminating high coupon second lien secured notes from the capital structure, and securing a reduction in pricing on a cumulative $5.1 billion in bank loans. Near-term maturities remaining in the capital structure are manageable and include $341 million of bank term loans maturing in 2013 and $81 million of bank term loans and $621 million of HCA Inc. unsecured notes maturing in 2014.
At June 30, 2013, HCA's liquidity included $462 million of cash on hand, $3.0 billion of capacity on its bank facility revolving loans and latest 12 month (LTM) discretionary FCF 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 35% EBITDA cushion under its bank facility financial maintenance covenant, which requires debt net of cash maintained below 6.75x EBITDA.
Fitch's 2013 operating forecast for HCA projects the company generating $3.6 billion - $3.7 billion in cash from operations (CFO) and about $1.2 billion in discretionary FCF, assuming capital expenditures of $2.0 billion and minority distributions of about $400 million. This is an approximately $680 million drop versus the 2012 level, and is consistent with Fitch's forecast for the broader for-profit hospital sector in 2013.
Fitch expects a lower level of profitability and cash generation for most hospital companies in 2013, with operating trends influenced by various economic, policy and company specific headwinds. With respect to HCA, the absence of a one-time $270 million Medicare settlement received in 2012, higher capital expenditures and lower electronic health record (EHR) incentive payments in 2013 explain most of the drop in forecasted cash flow.
EVOLVING CAPITAL DEPLOYMENT STRATEGY
The sponsors of a 2006 LBO directed HCA's financial strategy for the last several years. Following a series of public equity offerings and a buyback of Bank of America's shares, HCA was no longer considered a controlled company as of February 2013, and must appoint a majority of independent directors during 2014. Four of the 14 current Board of Director members are independent. In addition, the company's CEO has announced plans to retire at the end of 2013. The CEO will stay on as Chairman of the Board and the current CFO will assume the CEO position.
Although Fitch does not expect a major departure in strategic direction under an independent board or different CEO, there may be some shifts in the company's capital deployment strategy. Under the direction of the LBO sponsors, HCA managed its capital structure in an aggressively shareholder-friendly manner, paying out $7.4 billion in special dividends since 2010 that were largely debt financed.
With the 2014 implementation of the coverage expansion elements of the Affordable Care Act (ACA) encouraging scale and consolidation in the hospital industry, Fitch thinks HCA is now more likely to prioritize acquisitions and capital investment as a use of cash as opposed to debt reduction or payments to shareholders. The company's recent acquisitions have been small though; the last large transaction was in late 2011 when HCA acquired the 40% remaining ownership interest in the Denver, CO HealthONE joint venture for $1.45 billion.
HCA could increase debt to fund further dividends to shareholders or acquisitions. The debt agreements do not significantly limit the ability to issue additional debt. The bank agreements include a 3.75x first lien secured leverage ratio debt incurrence test and a 6.75x net debt-to-EBITDA financial maintenance covenant. At 4.4x at June 30, 2013, debt leverage is consistent with that of HCA's peer companies. While discretionary 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.
HOSPITAL INDUSTRY OUTLOOK BOOSTED BY ACA
Fitch projects a positive benefit to the hospital industry's revenue and cash flow generation from the implementation of the ACA in 2014 - 2015. The initial benefits to the industry are the result of the coverage expansion elements of the legislation, including the individual mandate to purchase health insurance and expansion of Medicaid eligibility. An increase in the number of individuals with health insurance will lead to a drop in 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 private insurers in the subsequent years.
The start of the ACA coverage expansion coincides with a prolonged trend of weak organic patient volume growth in the hospital sector, which is partly explained by weak economic conditions and party by secular changes in the healthcare delivery system. As the largest operator of acute-care hospitals in the country, with a broad geographic footprint, HCA is in a decent position to capture market share to whatever extent the ACA results in a boost in patient volumes. However, almost half of HCA's revenues come from its hospitals in Florida and Texas, two states that appear unlikely to expand Medicaid eligibility in 2014. This will dampen the ACA's tailwind to revenue and EBITDA for HCA.
HCA's organic revenue growth has outpaced that of the broader for-profit hospital industry since early 2012. Operating concerns center on a deteriorating patient payor mix with shifts to less profitable government volumes. Growth in pricing has recently lagged the broader industry for HCA and other urban market hospital companies (Tenet, Universal Health Services) as a result of the higher volumes of Medicaid and uninsured patient volumes, although HCA did post improved growth in pricing of 2.9% in Q2'13.
With LTM debt-to-EBITDA of 4.4x and EBITDA-to-gross interest expense of 3.5x, HCA's credit metrics are strong relative to the 'B+' IDR. A one-notch upgrade to 'BB-' will require HCA to maintain debt below 4.5x EBITDA. In addition, the following factors would support an upgrade:
--More information on how HCA intends to manage capital deployment under an independent board and new CEO.
--Sustained improvement in organic operating trends, in particular a continuation of the stronger growth in pricing seen in Q2'13.
--Better clarity on the effects of the ACA on operating results. Fitch believes that the coverage expansion elements of the ACA will be a tailwind to revenue and EBITDA growth starting in 2014, but there is still considerable uncertainty about the magnitude of the influence.
A downgrade of the ratings is not likely in the near-term but could result from debt above 5.0x EBITDA and interest coverage below 3.0x EBITDA because of a stressed operating scenario and aggressive capital deployment. Fitch sees the most likely driver of a stressed operating scenario as continued weakness in payments due to ongoing strained government payor reimbursement coupled with persistent shift in HCA's mix of patients to those with less profitable Medicaid coverage, as well as uninsured patients.
DEBT ISSUE RATINGS AND RECOVERY ANALYSIS
Fitch has taken the following actions on HCA's ratings:
--IDR affirmed at 'B+';
--Senior secured credit facilities (cash flow and asset backed) affirmed at 'BB+/RR1' (100% estimated recovery);
--Senior secured first lien notes affirmed at 'BB+/RR1' (100% estimated recovery);
--Senior unsecured notes upgraded to 'BB-/RR3' (65% estimated recovery).
HCA Holdings Inc.
--IDR affirmed at 'B+';
--Senior unsecured notes affirmed at 'B-/RR6' (0% estimated recovery).
The upgrade of HCA Inc. unsecured notes is based on improved recovery prospects for bondholders. The recovery ratings are based on a financial distress 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. This represents a haircut to recently announced hospital industry transaction multiples (Tenet Healthcare Corp. to purchase Vanguard Health Systems in a deal valued at 7.9x LTM EBITDA and Community Health Systems' offer to acquire Health Management Associates for 8.2x LTM EBITDA).
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. Fitch assumes that HCA would fully draw the $2.0 billion available balance on its cash flow revolver and 50% of the $2.5 billion available balance on its asset backed lending facility.
The 'BB+/RR1' rating for HCA's secured debt (which includes the bank credit facilities and first lien notes) reflects Fitch's expectations for 100% recovery under a bankruptcy scenario. The 'BB-/RR3' rating on the HCA Inc. unsecured notes rating reflects Fitch's expectations for recovery of 65%. The 'B-/RR6' rating on the HCA Holdings, Inc. unsecured notes, including the proposed notes, reflects expectation of 0% recovery.
Based on Fitch's current recovery assumptions, HCA has capacity to issue up to an additional $1.2 billion of secured debt without diminishing recovery prospects for the HCA Inc. unsecured note holders to below the 'RR3' recovery band of 51%-70%. 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+/RR4. 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. At June 30, 2013, total first lien debt equals $17.5 billion and 2.7x debt-to-EBITDA. Based on $6.5 billion in LTM EBITDA, Fitch estimates total first lien secured debt capacity of $24.4 billion, implying additional first lien capacity of about $6.9 billion.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 15, 2013);
--'Hospitals Credit Diagnosis' (June 27, 2013);
--'The Affordable Care Act and Healthcare Providers: Assessing the Potential Impact' (May 1, 2013);
--'High-Yield Healthcare Checkup' (Jan. 30, 2013);
--'2013 Outlook: U.S. Healthcare' (Nov. 29, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Effective from 8 August 2012 - 5 August 2013
Hospitals Credit Diagnosis (Implications of the ACA Slowly Taking Shape)
The Affordable Care Act and Healthcare Providers (Assessing the Potential Impact)
High-Yield Healthcare Checkup: Comprehensive Analysis of High-Yield U.S. Healthcare Companies
2013 Outlook: U.S. Healthcare -- Navigating a Dynamic Operating and Regulatory Environment