Universal Health (UHS) Ratings Affirms by Fitch Amid Recent Review; Outlook Remains Stable
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Fitch Ratings has affirmed the ratings of Universal Health Services, Inc. (NYSE: UHS), including the Issuer Default Rating (IDR) at 'BB+' and the senior secured credit facility and senior secured bond ratings at 'BBB-/RR1'. The Rating Outlook is Stable.
A full list of rating actions, which apply to approximately $3.6 billion of debt outstanding at June 30, 2016, is found at the end of this release.
KEY RATING DRIVERS
Low Debt Leverage: Gross debt/EBITDA of 2.1x at June 30, 2016 is the lowest among Fitch-rated hospital companies, driven by management's more conservative balance sheet management and M&A strategy. Fitch expects UHS to operate with gross debt/EBITDA below 3x over the ratings horizon, with temporary increases for moderate-sized M&A possible.
Solid Cash Flows: Cash flows are solid, with LTM FCF of nearly $680 million at June 30, 2016, supported by the more profitable behavioral health business and improved acute care volumes in favorable markets. Improving cash generation will be more closely tied to success in growing outpatient capabilities over the ratings horizon.
Diversification, Stability from Behavioral Health: UHS' behavioral health business provides increased business and revenue diversification, as well as improved longer-term financial stability and profitability. Good organic growth in the mid-single digits and moderately improving profit margins are expected over the ratings horizon. Recent acquisitions are in line with Fitch's expectation that opportunities to expand the behavioral health segment will be a primary focus of capital deployment for UHS.
Leading Acute Care Results: UHS' acute care segment continues to outperform its peers, with both volumes and pricing growth being sustained in the mid-single digits. Fitch expects UHS to continue reporting volumes and pricing metrics that are among the best in the industry, due in large part to its strong market shares in favorable urban markets where volumes tend to be weighted toward a higher-acuity patient mix.
Dynamic Operating Environment: Fitch expects 2016 to be less favorable for UHS and its for-profit acute care hospital peers, as volumes shift toward lower-cost outpatient facilities and are compared to an exceptional 2015. Hospital industry management teams are contending with a very dynamic operating environment due to the evolution of payment schemes, developing trends around care coordination, and other regulatory reforms influencing organic operating trends.
--Revenue growth in the high-single digits, with roughly equal contributions from each of acute care, behavioral health, and acquisitions in 2016.
--Slower organic growth in 2017-2018 due to secular headwinds facing the acute care industry.
--Stable to modestly improving operating EBITDA margins, facing headwinds in 2017 and beyond, primarily due to negative operating leverage as particularly inpatient volume growth rates normalize versus the higher level seen in 2014-2015.
--The majority of discretionary FCF directed towards share repurchases and acquisitions, resulting in gross debt/EBITDA around 2x-2.5x through the forecast period.
Maintenance of a 'BB+' IDR will require a continued demonstrated commitment to operating with debt leverage below 3x, with FCF-to-adjusted debt of 8% or higher. UHS has good flexibility at the current 'BB+' level to consummate debt-funded M&A, especially as it supports longer-term growth in light of prevailing trends in U.S. healthcare (i.e. care coordination, physician employment, outpatient service lines, etc.).
A downgrade of UHS' IDR to 'BB' could result from pressured margins and cash flows - or a large, leveraging transaction - that results in debt leverage expected to be sustained above 3x and/or FCF-to-gross adjusted debt below 8%. Margin and cash flow pressures of this magnitude are not likely to occur abruptly, but could materialize due to severe pricing pressures or unfavorable large-scale reform of Medicare and/or Medicaid programs.
With the potential for the company to continue participating in industry consolidation through debt-financed transactions, an upgrade would be considered should the company publicly commit to operating with leverage under 2.5x on a sustained basis. Given industry consolidation trends and the significantly higher leverage profiles of UHS's peers, Fitch does not anticipate UHS making a public leverage commitment to support an investment grade profile. Furthermore, Fitch notes that the risks around reimbursement and other regulatory factors associated with healthcare providers in the U.S. - and UHS's reliance on government payers - is a material risk for UHS and its peers going forward.
Manageable Debt Maturities: Recent refinancing of the bonds due 2016 has extended the nearest maturity to the end of 2018 when the A/R facility expires. The following year, $300 million of senior secured bonds and the $1.9 billion of term loans come due.
Sufficient Available Liquidity: Though UHS does not usually carry large amounts of cash ($56 million at June 30, 2016), it maintains an $800 million revolver, of which $751 million was available at June 30, 2016. UHS also maintains a $400 million A/R facility, of which $120 million was available at June 30, 2016. The entire amount of cash is considered 'readily available'. UHS typically uses its revolver and A/R facility to fund working capital and other operational needs, more recently refinancing outstanding amounts with longer-dated debt.
Cash Directed Toward Deals: Fitch expects UHS to continue the more aggressive acquisition strategy evidenced in 2014-2016 - though still more conservative than most of its peers - as consolidation continues among healthcare providers. Management has commented that it is beginning to see the pipeline of possible deals increase. Physician employment and expansion into non-acute/ambulatory sectors are likely to continue representing strategic uses of cash for the sector going forward.
The secured debt rating remains one notch above the IDR, illustrating Fitch's expectation for superior recovery prospects in the event of default. Furthermore, Fitch believes UHS has good financial flexibility at the 'BB+' IDR, illustrated by relatively low secured debt leverage, supporting the one notch uplift.
The incurrence of material additional secured debt that pushed secured debt leverage toward 2.5x-3x could support consideration of downgrading the secured debt ratings by one notch, to 'BB+'.
FULL LIST OF RATING ACTIONS
--Long-Term IDR at 'BB+';
--Senior secured credit facility at 'BBB-/RR1';
--Senior secured bonds at 'BBB-/RR1'.
The Rating Outlook is Stable.
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