NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BB+' rating to HCA Inc.'s (HCA) proposed $1.5 billion proposed senior secured notes. Fitch expects that the company will apply the proceeds of the proposed notes to refinance certain of its existing senior secured debt. A full list of ratings follows at the end of this release. The Rating Outlook is Stable. The ratings apply to $29 billion of debt outstanding at June 30, 2014.
KEY RATING DRIVERS
HCA's financial flexibility has improved significantly in recent years as a result of organic growth in the business as well as proactive management of the capital structure. The company has industry leading operating margins and generates consistent and ample discretionary FCF (CFO less capital expenditures and distributions to minority interests).
The sponsors of a 2006 LBO have directed HCA's financial strategy for the last several years, but their ownership has been steadily decreasing since a 2011 IPO and HCA recently appointed four new independent members to the 13-member board, bringing the total to seven.
Under the direction of the LBO sponsors, HCA's ratings were constrained by shareholder-friendly capital deployment; the company funded $7.4 billion in special dividends since 2010. Fitch thinks that HCA will have a more consistent and conservative approach to funding shareholder payouts under an independent board. At the same time, Fitch notes that the proposed refinancing will allow the company to operate under the more lenient terms of a recent amendment to the credit agreement restriction on dividends and share repurchases.
Fitch forecasts that HCA will produce discretionary FCF of $1.5 billion in 2014, and expects the company to prioritize acquisitions and capital investment as cash usages. At 4.1x, HCA's total debt-to-EBITDA is at the low end of the group of publicly traded hospital companies and Fitch does not believe that there is a compelling financial incentive for the company to apply cash to debt reduction.
HCA's organic growth in patient volumes has outpaced that of the broader for-profit hospital industry over the past several years. As one of largest operators of acute care hospitals in the country, with a broad geographic footprint, HCA is well-positioned to capture market share if patient volumes rebound in 2014 - 2015.
SOLID FINANCIAL FLEXIBILITY
HCA's balance sheet flexibility has recently improved due to the extension of some near-term debt maturities, the refinancing of relatively high coupon secured notes, and a reduction in pricing on a cumulative $5.1 billion in bank loans. Upcoming debt maturities include $81 million of bank term loans and $900 million of HCA Inc. unsecured notes maturing in 2015 and $1.2 billion bank term loans and $1 billion unsecured notes maturing in 2016. Fitch believes that HCA's operating outlook is amongst the best in the for-profit hospital industry, affording the company good market access to refinancing the 2015-2016 maturities.
Internal sources of liquidity could also address upcoming debt maturities. At June 30, 2014, HCA's liquidity included $658 million of cash on hand, $1.7 billion of capacity on its bank facility revolving loans and latest-12-month (LTM) discretionary FCF of about $1.4 billion. HCA's LTM EBITDA-to-gross interest expense was solid for the 'BB-' rating category at 3.9x 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.
Fitch's 2014 operating forecast for HCA projects the company generating $7.1 billion in EBITDA, $4.2 billion in cash from operations (CFO) and about $1.5 billion in discretionary FCF, assuming capital expenditures of $2.2 billion and minority distributions of about $480 million. This is an approximately $200 million increase versus the 2013 level of discretionary FCF, with growth provided by the combined effects of topline growth, slightly higher assumed profitability and lower cash interest expense following debt refinancing activity and reduction in pricing on the bank term loans.
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 share buybacks, the sponsors' ownership percentage dropped below 30% and SEC regulations required the company to appoint a majority of independent directors to the board during 2014. HCA has appointed four new independent members to the 13 member board, bringing the total number of independent directors to seven. In addition, the company's CEO retired at the end of 2013, retaining his role as chairman of the board. The former CFO assumed the CEO position and a new CFO was appointed from within the company. 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 health insurance coverage expansion elements of the Affordable Care Act (ACA) encouraging scale and consolidation in the hospital industry, Fitch believes 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 June 30, 2014, Fitch estimates the HCA has incremental secured first-lien debt capacity of about $8 billion and a 40% EBITDA cushion under the 6.75x consolidated leverage ratio test.
A recent amendment to the bank agreement loosened the limit on restricted payments (RP), including dividends and share repurchases, allowing unlimited RPs as long as total debt at the HCA, Inc. level is less than or equal to 4.25x EBITDA. At June 30, 2014, Fitch calculates leverage of 3.7x though the HCA, Inc. level. A more restrictive RP covenant under certain of the senior secured notes indentures places a stricter limit on RP capacity, preventing the company from operating under the more lenient terms of the amended covenant. Fitch expects the proceeds of the proposed notes will be used to refinance the notes that require the stricter covenant terms.
HOSPITAL INDUSTRY OPERATING TRENDS IMPROVING, ACA A BOOST, SECULAR HEADWINDS INTACT
The benefits of HCA's favorable business profile, with excellent scale and decent geographic diversification, are evident in recent operating trends, although the company has not been entirely resilient to headwinds to organic growth in the hospital sector. Facing a stiff comparison to a strong result in 2012 and weak growth in lower acuity service lines, HCA's organic patient volumes growth in 2013 was markedly softer than in recent periods, with same hospital adjusted admissions growing 0.1%. This weak volume metric still outperformed the peer group; same hospital adjusted admissions across the Fitch-rated group of for-profit hospital providers dropped 0.7% on average in 2013.
Operating trends were similarly weak in Q1'14, then improved drastically in Q2'14, with most companies reporting better organic volume growth, an improved payor mix with lower volumes of insured patients, and a higher acuity case mix, which is supportive of pricing growth and profitability. HCA reported organic volume growth of 2.2%. Drivers of the improved trend include general economic improvement in most geographies, the early influence of the insurance expansion elements of the ACA, as well as an ongoing skew toward a more acute (sicker) patient population. Fitch thinks that management initiatives to create growth in more profitable areas, including targeted expansion in outpatient services and more acute service lines, were also a factor.
Growth in profitability in the quarter illustrated the power of operating leverage for the hospital industry. Along with the generally improved operating trends, profitability increased for most for-profit hospital companies in Q2'14 versus the year ago period. Excluding supplemental Medicaid payments received in Q2'14, HCA's operating EBITDA margin expanded 30 bps versus the prior year period, to 20.6%. While these results are encouraging, it difficult to determine how much of the recent gains in profitability will be sustainable. There are secular headwinds to growth that remain intact, including general pressure on payment rates and actions by patients and payors to limit relatively expensive hospital care in less acute situations. Therefore, Fitch does not expect the industry to maintain all of the profitability gains realized in Q2'14, with operating margins at the end of 2014 projected to track only slightly better than 2013 levels.
Maintenance of a 'BB-' IDR contemplates HCA operating with total debt-to-EBITDA below 4.5x, and with a FCF-margin of 4% or higher. A downgrade of the IDR to 'B+' is unlikely in the near term, since these targets afford HCA with significant financial flexibility to increase acquisitions and organic capital investment, which Fitch thinks will be the priorities for capital deployment going forward.
HCA's ratings could be upgraded if the company maintains total debt leverage below 4.0x. In addition to a commitment to operate with lower leverage, improvement in organic operating trends in the hospital industry would support a higher rating for HCA. Evidence of an improved operating trend would include sustained positive growth in organic patient volumes, improvement in the payor mix with fewer numbers of uninsured patients and correspondingly lower bad debt expense, and limited concern that profitability will suffer from drops in reimbursement rates.
DEBT ISSUE RATINGS
Fitch rates the following:
--Issuer Default Rating (IDR) 'BB-';
--Senior secured credit facilities (cash flow and asset backed) rated 'BB+';
--Senior secured first lien notes rated 'BB+';
--Senior unsecured notes rated 'BB-' .
HCA Holdings Inc.
--Senior unsecured notes rated 'B'.
Total debt at June 30, 2014 was approximately $29 billion and includes a senior secured bank credit facility consisting of approximately $5.5 billion in term loans maturing through May 2018, a $2 billion capacity cash flow revolving loan and a $2.5 billion capacity asset backed revolving loan (ABL facility), $11 billion of first-lien secured notes, $7.2 billion of HCA Inc. unsecured notes, and $2.5 billion of HCA Holdings, Inc. unsecured notes.
The secured debt rating is two notches above the IDR, illustrating Fitch's expectation for superior recovery prospects in the event of default. The first-lien obligations, including the bank debt and the first-lien secured notes, are guaranteed by all material wholly owned U.S. subsidiaries of HCA, Inc. that are 'unrestricted subsidiaries' under the HCA Inc. unsecured note indenture dated Dec. 16, 1993. Because of restrictions on the guarantor group as stipulated by the 1993 indenture, the credit facilities and first-lien notes are not 100% secured. At June 30, 2014, the subsidiary guarantors of the first-lien obligations comprised about 49% of consolidated total assets. The ABL facility has a first-lien interest in substantially all eligible accounts receivable (A/R) of HCA, Inc. and the guarantors, while the other bank debt and first-lien notes have a second-lien interest in certain of the receivables.
The HCA Inc. unsecured notes are rated at the same level as the IDR despite the substantial amount of secured debt to which they are subordinated, with secured leverage of 2.7x at June 30, 2014. Fitch often notches ratings on unsecured debt obligations below the IDR level when secured debt leverage is greater than 2.5x. However, the strength and stability of HCA's cash flows supports an expectation of at least average recovery for these lenders relative to historical rates in an event of default, resulting in a rating at the same level of the IDR. If HCA were to layer more secured debt into the capital structure, such that secured debt leverage is greater than 3.0x, it could result in a downgrade of the rating on the HCA Inc. unsecured notes, to 'B+'.
The HCA Holdings Inc. unsecured notes are rated two-notches below the IDR to reflect the substantial structural subordination of these obligations, which are subordinate in right of payment to all debt outstanding at the HCA Inc. level. At June 30, 2014, leverage at the HCA Inc. and HCA Holdings Inc. level was 3.7x and 4.1x, respectively.
Applicable Criteria and Related Research:
--'U.S. Healthcare Stats Quarterly (First-Quarter 2014)' (July 7, 2014);
--'Hospitals Credit Diagnosis' (June 30, 2014);
--'High-Yield Healthcare Checkup' (April 4, 2014);
--'2014 Outlook: U.S. Healthcare' (Nov. 25, 2013);
--'U.S. Leveraged Finance Spotlight Series: HCA Holdings, Inc.' (Nov. 7, 2013);
--'For-Profit Hospital Insights: Fitch's Annual Review of Bad Debt Accounting Policies and Practices' (Oct. 24, 2013);
--'Margin Preservation Strategies: Different Angles (U.S. Hospitals and Health Insurers)' (Oct. 1, 2013);
--'The Affordable Care Act and Healthcare Providers: Assessing the Potential Impact' (May 1, 2013);
--'Corporate Rating Methodology' (May 28, 2014).
Applicable Criteria and Related Research:
U.S. Healthcare Stats Quarterly (First-Quarter 2014)
Hospitals' Credit Diagnosis (Promising Early Experience Under Affordable Care Act)
High-Yield Healthcare Checkup: Comprehensive Analysis of High-Yield U.S. Healthcare Companies
2014 Outlook: U.S. Healthcare - Secular Challenges Require a Compelling Value Proposition
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
For-Profit Hospital Insights: Fitch's Annual Review of Bad Debt Accounting Policies and Practices
U.S. Leveraged Finance Spotlight Series: HCA Holdings, Inc.