S&P Lowers Outlook on Community Health Systems (CYH) to Negative
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S&P Global Ratings affirmed its 'B' corporate credit rating on Community Health Systems Inc. (NYSE: CYH) and revised the rating outlook to negative from stable. Our issue-level ratings on Community Health are unchanged.
"Our rating action follows Community's preannouncement of very weak third-quarter operating results, characterized by declining margins and weakening adjusted admissions trends, even when compared to a disappointing prior year third quarter," said S&P Global Ratings credit analyst Shannan Murphy. Moreover, the company has recently announced that it is reviewing strategic alternatives, and is speaking to a number of parties, including financial sponsors, who may be interested in purchasing all or a portion of the company's assets. While we continue to believe that the company can address some of its capital structure issues through cost cutting and planned and pending asset sales, we believe that there is a meaningful risk that the company is unable to execute on these plans.
While many peer acute-care hospital operators reported soft same-facility adjusted admissions in the third quarter, Community's 1.5% decrease in same-facility adjusted admissions was weaker than expected, especially when compared to a poor prior year comparison. In addition to declining volumes, the company was unable to achieve targeted cost reductions in the quarter, which contributed to significant margin erosion, with margins down about 170 basis points on a sequential basis, off weak second-quarter levels.
Our negative rating outlook on Community reflects our view that credit risk has escalated over the past few months, reflecting both Community's operating issues and its strategic review process. Based on recent trends, we believe that Community is likely to generate only marginally positive free cash flow over the next several quarters, and debt leverage is likely to be sustained near 7x. However, we recognize that the company plans to address at least some of its capital structure issues through cost restructuring and planned and pending asset sales, though we now see execution risk associated with this strategy as higher given recent operating performance.
We could lower the rating if Community is unable to stabilize its operations and generate at least $100 million to $200 million in positive recurring cash flow. We could also lower the rating if we believe the company will be unable to address its covenant issues (either through improving its operating performance or getting an amendment) such that it can continue to access its revolver, given working capital swings inherent in the business.
If we become more confident that the company can stabilize its operations and generate modest positive recurring free cash flow, we could revise the outlook back to stable. In our view, this would require the company to stabilize EBITDA margins at around 12.5%-13% on an unadjusted basis (just below the level in 2015).
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