OREANDA-NEWS. Fitch Ratings has affirmed Priory Group No. 3 plc (Priory)'s Long-term Issuer Default Rating (IDR) at 'B+'. The Outlook is Stable. Fitch has also affirmed Priory's super senior revolving credit facility (RCF), senior secured notes and senior notes at 'BB+'/'RR1'.

The rating affirmation reflects Priory's steady financial performance, despite some moderate downward pressure on profit margins linked to ongoing sector-wide pricing pressure, high dependence on National Health Service (NHS) & local authorities funding and moderate execution risks as the group adjusts to transfer of patients from residential to day care in its Education and Children Services segment and focuses on private patient growth. We expect profitability to remain under pressure due to increasing regulatory scrutiny and rising staff costs driven by a living wage increase and a national shortage of nurses. However such pressures will be more muted than its peers given Priory's exposure to high acuity care services, which commands more resilient pricing.

Positively, the ratings take into account Priory's leading position in the independent UK health and social care market, strong brand, reputation for high-quality care and experienced management. It also reflects mildly improving credit metrics resulting from net lease-adjusted debt reduction from the sale and leaseback of six acute psychiatric hospitals completed a year ago with proceeds applied to partial debt redemption.

KEY RATING DRIVERS

Steady Growth in Challenging Sector
Priory continues to deliver a steady operating performance, despite challenging conditions in the sector. Priory's business model is robust relative to its peers, underpinned by management's proactive approach in responding to challenges, including increasing costs, regulation and structural changes in local authority spending, such as the move from residential education to day care. Fitch believes Priory is well placed to manage these challenges due to its leading market position as the UK's largest provider of independent acute mental health care, strong brand and good reputation and relationship with commissioners and the NHS.

High but Sustainable Leverage
Fitch expects funds from operations (FFO) adjusted gross leverage to decrease mildly to just under 5.0x (4.5x net of unrestricted cash) by 2017 from 5.1x at end-2014 and FFO fixed charge cover to improve to around 2.25x from 1.7x. Priory's strengthened balance sheet follows the sale and leaseback of six acute psychiatric hospitals completed in December 2014, with proceeds applied to partial debt redemption, in spite of a corresponding higher lease charge - which Fitch capitalises at a multiple of 8x to derive a debt-like figure in its leverage computation.

Priory's financial leverage is considered sustainable due to Priory's resilient business model and satisfactory financial flexibility, evidenced by our expectation of free cash flow (FCF) improving towards the mid-single digit of sales by 2017. Refinancing risk is manageable for Priory's senior secured notes in 2018, consistent with an IDR of 'B+', hence the Stable Outlook.

Supportive Long-term Fundamentals
We continue to believe that Priory is well placed to benefit from the outsourcing of high-acuity patients by the NHS in the long term. We expect future volumes to offset pricing pressure stemming from fee negotiations with the NHS over the near- to medium-term as a result of budget constraints. The impact of the National Living Wage is not expected to be material for the group.

Moderate Execution Risk
Fitch considers the underlying execution risk inherent in Priory's expansion plans to be moderate. The group will continue to prioritise growth opportunities where demand is strong and where it can achieve higher growth than the wider market, namely in private outpatients and new autism services. Fitch believes these targeted growth areas will not affect Priory's business risk profile materially.

Strong Asset Coverage
The proportion of freehold and long-leasehold properties in Priory's asset portfolio remains high at 79%. Fitch estimates the value of such assets in a liquidation scenario will remain sufficient to ensure outstanding recoveries for all creditors, including unsecured noteholders, leading to a 'BB+'/'RR1' rating on Priory's debt instruments. Our view on recoveries for the unsecured noteholders is supported by the lack of structural subordination and the creditor-friendly UK jurisdiction, where any liquidation of the assets would be most likely.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
-Recurring number of patients
-Mildly improving occupancy rates
-Limited daily fee improvement
-Mild pressure on EBITDAR margin towards 26% (2014: 27.6%)
-No significant acquisitions

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
-- FFO lease-adjusted gross leverage below 4.5x (or 4.0x net of unrestricted cash) on a sustained basis;
--FFO fixed charge cover above 2.5x on a sustained basis;
--Improvement in EBITDAR margin towards 30% or FCF margin of 5% (2014: 0.4%) on a sustained basis.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
--FFO lease-adjusted gross leverage above 6.0x (or 5.5x net of unrestricted cash) on a sustained basis;
--FFO fixed charge cover below 2.0x on a sustained basis;
--Permanently weak FCF resulting from further price and cost pressure.

LIQUIDITY

Fitch expects liquidity to stay satisfactory, supported by stable FCF from 2015 and remaining access to GBP27m of a committed GBP70m senior secured RCF expiring in 2017, which can be used for capex of up to GBP50m.

The debt structure provides financial flexibility as the maturities are back-ended. Debt includes GBP386m senior secured notes due February 2018 and GBP175m senior notes due February 2019.

FULL LIST OF RATING ACTIONS
Priory Group No.3 plc
--Long-term IDR affirmed at 'B+'; Stable Outlook
--Super senior RCF affirmed at 'BB+'/'RR1'/100%'
--Senior secured notes affirmed at 'BB+'/'RR1'/100%'
--Senior notes affirmed at 'BB+'/'RR1'/100%'