Fitch Rates HCA's Unsecured Notes Offering 'BB/RR4'
KEY RATING DRIVERS
Industry-Leading Financial Flexibility: 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 (operating cash flows less capital expenditures and distributions to minority interests).
Transition to Public Ownership Complete: The sponsors of a 2006 LBO previously directed HCA's financial strategy, but their ownership stake decreased steadily following a 2011 IPO and HCA has appointed four independent members to the 11-member board of directors (BOD), bringing the total to seven.
More Predictable Capital Deployment: Under the direction of the LBO sponsors, HCA's ratings were constrained by shareholder-friendly capital deployment, including lumpy special dividends and share repurchases. HCA has so far a more consistent and predictable approach to funding shareholder pay-outs under public ownership, although Fitch expects the company to continue to direct a substantial amount of cash to share repurchases.
Expect Stable Leverage: Fitch forecasts that HCA will produce discretionary FCF (operating cash flows less capital expenditures and distributions to minority interests) of about $1.9 billion in 2015 and will prioritize use of cash for organic investment in the business, acquisitions and share repurchases. Pro forma for the proposed note issue, HCA's gross debt/EBITDA of 3.8x is below the average of the group of publicly traded hospital companies, and Fitch does not believe that there is a compelling financial incentive for HCA to apply cash to debt reduction.
Secular Headwinds to Operating Outlook: Measured by revenues, HCA is the largest operator of for-profit acute care hospitals in the country, with a broad geographic footprint. The company benefited from this favorable operating profile during a period of several years of weak organic operating trends in the hospital industry. Although operating trends improved industrywide starting in mid-2014, secular challenges, including a shift to lower-cost care settings and insurer scrutiny of hospital care, are a continuing headwind to organic growth.
Expect Ongoing Tapering in 2H'15: Fitch expected slower organic growth in patient volumes in the for-profit hospital sector beginning in the second half of 2015 but also believes that the recent rebound in growth has some legs, and is unlikely to revert to the depressed levels experienced for much of 2010 - 2013. This is partly because the hospital industry seems to be finally emerging from a prolonged and delayed effect of the great recession. In addition, management initiatives to sustainably boost volumes in light of secular headwinds to utilization of inpatient hospital care will help sustain growth.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for HCA include:
--HCA's recently very strong organic patient volume growth (same hospital growth in adjusted admissions), supported by a ramp up of Affordable Care Act related benefits and improving economic conditions, tapers to a more normalized 2 - 3% in 2016;
--Modest Operating EBITDA margin compression of less than 100 bps in later 2015 through 2016, primarily the result of negative operating leverage as volume growth rates normalize and pricing trends remain stable;
--Fitch forecasts EBITDA of $7.9 billion and discretionary FCF of $1.9 billion in 2015 for HCA, with capital expenditures of about $2.3 billion. Higher capital spending is related to growth projects that support the expectation of EBITDA growth through the forecast period;
--The majority of discretionary FCF is directed towards share repurchases and acquisitions, and most debt due in 2015-2018 is refinanced resulting in gross debt/EBITDA of between 3.5x - 4.0x through the forecast period.
RATING SENSITIVITIES
Maintenance of a 'BB' IDR considers HCA operating with debt leverage sustained around 4.0x and with a FCF-margin of 4 - 5% or higher. A downgrade of the IDR to 'BB-' is unlikely in the near term, since these targets afford HCA with significant financial flexibility to increase acquisitions and organic capital investment while still returning a substantial amount of cash to shareholders through share repurchases.
An upgrade to a 'BB+' IDR would require HCA to maintain debt leverage of 3.0x - 3.5x. In addition to a commitment to operate with lower leverage, sustained improvement in organic operating trends in the hospital industry would support a higher rating for HCA. Evidence of an improved operating trend would include positive growth in organic patient volumes, sustained 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.
LIQUIDITY
At Sept. 30, 2015, HCA's liquidity included $588 million of cash on hand, $2.59 billion of available capacity on its senior secured credit facilities and LTM discretionary FCF of about $2.1 billion. HCA's EBITDA/gross interest expense is solid for the 'BB' rating category at 4.7x, and the company had an ample operating cushion under its bank facility financial maintenance covenant, which requires debt net of cash maintained at or below 6.75x EBITDA.
Fitch believes that HCA's favorable operating outlook and financial flexibility afford the company good market access to refinance upcoming maturities. Near-term debt maturities include $28 million of bank term loans and $150 million of HCA Inc. unsecured notes maturing in 2015 and $114 million bank term loans and $1 billion unsecured notes maturing in 2016, which are expected to be redeemed later this month.
FULL LIST OF RATING ACTIONS
Fitch currently rates HCA as follows:
HCA, Inc.
--IDR 'BB';
--Senior secured credit facilities (cash flow and asset backed) 'BB+/RR1';
--Senior secured first lien notes 'BB+/RR1';
--Senior unsecured notes 'BB/RR4'.
HCA Holdings Inc.
--IDR 'BB';
--Senior unsecured notes 'B+/RR6'.
The Rating Outlook is Stable.
Total debt of approximately $29.8 billion at Sept. 30, 2015 includes $8.3 billion of first-lien secured bank debt, $11.1 billion of first-lien secured notes, $8.9 billion of HCA Inc. unsecured notes, and $1 billion of Hold Co. unsecured notes. HCA's bank debt comprises approximately $5.7 billion in term loans maturing through June 2020. The company had full availability on its $2 billion capacity cash flow revolving loan and roughly $600 million availability on its $3.25 billion capacity asset-based revolving loan (ABL facility).
The secured debt rating is one notch above the IDR, illustrating Fitch's expectation of 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 Sept. 30, 2015, the subsidiary guarantors of the first-lien obligations comprised about 45% 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 2.5x at Sept. 30, 2015. 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 'BB-'. The bank agreements include a 3.75x first lien secured leverage ratio debt incurrence test.
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 Sept. 30, 2015, leverage at the HCA Inc. and HCA Holdings Inc. level was 3.6x and 3.7x, respectively.
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