NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings of Community Health Systems, Inc., (CHS) including the 'B+' Issuer Default Rating (IDR). The Rating Outlook is revised to Stable from Negative. The ratings apply to $16.8 billion of debt outstanding at June 30, 2015. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
SPIN OFF FAVORABLE TO BUSINESS PROFILE
CHS has announced plans to spin off 38 of the company's 193 acute care hospitals as well as Quorum Health Resources, LLC, a hospital management and consulting business. The transaction is expected to occur in the first quarter of 2016 (1Q16). The terms of CHS's debt agreements permit the company to spin off operations comprising up to 15% of the company's EBITDA; the assets to be spun off represent $255 million or about 9% of trailing 12 months (TTM) EBITDA.
Fitch believes the transaction will improve CHS's business profile. The remaining group of hospitals is substantially more profitable and is located in larger markets that Fitch believes have better organic growth potential. Loss of business or geographic diversification is not a major concern with this transaction since the company will still be of a substantial size relative to hospital industry peers, with about 160 hospitals located across 22 states.
Additionally, the transaction may result in cash proceeds to CHS that would provide an opportunity to pay down debt. The company currently has about $7 billion of pre-payable secured term loans outstanding. The terms of CHS's debt agreements do not require that the proceeds from a spin off transaction be used to reduce debt, but the pro forma secured net leverage ratio cannot exceed the ratio immediately prior to the transaction, implying that the loss of EBITDA will require some amount of secured debt reduction. At June 30, 2015, Fitch calculates net secured leverage of about 3.3x.
LEVERAGE STUBBORNLY HIGH BUT IMPROVING
CHS's leverage has been elevated since the 2014 acquisition of rival hospital operator Health Management Associates (HMA), in a deal that added about $7 billion of debt to the capital structure and pushed leverage to greater than 6.0x. CHS's leverage dropped below 6.0x in 1Q15 for the first time since the HMA purchase, due to a combination of growth in EBITDA and scheduled term loan amortization. Fitch now expects that the company's leverage ratio will be durably maintained below 6.0x
OPERATING TRENDS LAG INDUSTRY BUT GAP CLOSING
Prior to the HMA acquisition and early in the integration process, CHS's patient volume trends lagged industry peers and weighed on top-line growth and margins. Although a performance gap remains relative to peers in the first half of 2015 (1H15) volume growth, CHS has made progress in this area, posting an improvement in volumes along with the rest of the for-profit hospital industry beginning in the 2H14. The economic recovery taking hold in more markets, investments in higher-growth service lines and expansion of health insurance under the Affordable Care Act (ACA) are supporting better growth despite ongoing secular headwinds.
PROGRESS IN RESOLVING LEGAL ISSUES
CHS has been dealing with government investigations and lawsuits related to the issue of short-stay hospital admissions. CHS made progress in resolving the legal issues facing the legacy CHS hospitals during 2014, which did not involve financial fines significant enough to threaten financial flexibility or require major operational changes that would influence future revenue and EBITDA growth.
Fitch's key assumptions within the rating case for CHS include:
--Spin-off of Quorum Health Corporation occurs as planned in 1Q16;
--Sustained positive top-line organic growth of low single digits annually, driven primarily by pricing increases, although the trend in patient volume growth is not expected to reverse to the poor levels experienced in 2013 and early 2014;
--Operating EBITDA margins sustained above 15% and slightly expanding in 2015-2017, aided by the spin-off of the group of less profitable hospitals;
--CFO generation of $1.6 billion-$1.8 billion annually;
--No substantial debt repayment in 2015-2017;
--Capital expenditures of $1 billion-$1.1 billion annually in 2015-2017.
Maintenance of the 'B+' Issuer Default Rating (IDR) considers CHS maintaining total debt to EBITDA below 6.0x, an operating EBITDA margin of at least 14% and a free cash flow (FCF) margin of at least 2%. Fitch thinks maintaining leverage at this level is achievable even if total debt levels are not substantially reduced after the planned spin-off in early 2016. A sustained trend of positive organic revenue growth as seen in the first half of 2015 would also support maintenance of the rating.
A downgrade could result from leverage above 6.0x and an FCF margin below 2%. Risks to the operating outlook include the inability to achieve projected cost synergies and implement operational improvements at the HMA hospitals, lack of progress towards resolution of HMA's legal issues, and a reversal of the improving trends in patient volumes. An upgrade of the ratings is unlikely in the near term, but could occur if Fitch believes leverage is likely to be durably maintained at or near 4.5x.
CHS's liquidity profile is decent, with no major areas of concern. The company has adequate cushion under the bank facility financial maintenance covenants, and cash from operations is fairly robust and is expected to be stable. At March 31, 2015, sources of liquidity included cash on hand of $222 million, latest 12 months (LTM) FCF of $563 million and availability on the revolving credit facilities of $932 million. Fitch projects that the company will maintain a 3% FCF margin, with FCF generation of about $600 million annually. Near-term debt maturities are manageable with the next large maturity occurring in 2018.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Community Health Systems, Inc.:
--IDR at 'B+'.
CHS/Community Health Systems, Inc.:
--IDR at 'B+',
--Senior secured credit facility at 'BB/RR2';
--Senior secured notes at 'BB/RR2';
--Senior unsecured notes at 'B+/RR4';
The Rating Outlook is revised to Stable from Negative.
The 'BB/RR2' rating for CHS's secured debt (which includes the bank term loans, revolver and senior secured notes) reflects Fitch's expectations for 83% recovery under a hypothetical bankruptcy scenario. The 'B+/RR4' rating on CHS's $6.2 billion senior unsecured notes rating reflects Fitch's expectations for principal recovery of 49%.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 12 Jun 2015)
Dodd-Frank Rating Information Disclosure Form