News Column

Fitch Upgrades Universal Health Services to 'BB+'; Outlook Revised to Stable

June 24, 2014

CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has upgraded the ratings of Universal Health Services, Inc. (NYSE: UHS) as follows:

-- Issuer Default Rating (IDR) to 'BB+' from 'BB';

-- Senior secured bank facility rating to 'BBB-' from 'BB+';

-- Senior secured notes rating to 'BBB-' from 'BB+';

-- Senior unsecured notes rating to 'BB' from 'BB-'.

The Rating Outlook has been revised to Stable from Positive.

The ratings apply to approximately $3.2 billion of debt outstanding at March 31, 2014.

KEY RATING DRIVERS

-- UHS has continued to demonstrate a commitment to debt repayment, resulting in debt-to-EBITDA of 2.3x at March 31, 2014 compared to 4.9x (reported) at Dec. 31, 2010. Fitch expects UHS to operate with debt leverage between 2.25x and 3x over the ratings horizon.

-- Unlike many of its peers, UHS has not engaged in large-scale acquisitions since its $3.1 billion purchase of PSI in 2010. Fitch expects UHS to pursue moderate-sized, targeted acquisitions over the ratings horizon. The 'BB+' ratings provide ample flexibility for UHS to incur additional debt to participate in the ongoing consolidation of the U.S. healthcare provider space.

-- Cash flows are strengthening on a stabilizing acute care business, better margins due to lower uncompensated care, and growing behavioral health operations. Fitch anticipates that UHS will generate solid free cash flow (FCF) of $550 million-$700 million in 2014-2015, compared to $477 million for the latest 12 month (LTM) period ended March 31, 2014.

-- UHS behavioral health business accounts for more than half of UHS overall revenues, providing business and revenue diversification as well as improved financial stability and profitability. Good organic growth in the mid-single digits, driven by mental health parity rules and UHS' capacity growth initiatives, and moderate margin improvement are expected over the ratings horizon.

-- UHS' same-hospital admissions were flat in 2013, better than the 2% and 2.2% declines in 2012 and 2011, respectively, and stronger than many of its for-profit peers. Fitch expects moderately negative to possibly flat acute care inpatient admissions growth to be indicative of stable markets for the foreseeable future. Pricing metrics continue to remain stable as lingering unfavorable payor mix has been offset by relatively strong commercial reimbursement rate increases.

-- Fitch views the Affordable Care Act (ACA) as a net positive for UHS and its hospital operator peers. Net revenue growth from declining uncompensated care, on a fairly constant cost base, will drive an increase in absolute profits during 2014-2015. Fitch thinks it is likely, however, that profit gains will begin to erode in later years due to an overall constrained healthcare reimbursement environment.

RATING SENSITIVITIES

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. Fitch notes that UHS' has good flexibility at the current 'BB+' ratings to consummate debt-funded M&A, especially as it supports longer-term growth in light of prevailing trends in healthcare (i.e. integrated care delivery, physician employment, outpatient service line expansion, 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 occur abruptly, but could materialize due to severe pricing pressures or unfavorable large-scale reform of Medicare and/or Medicaid programs. Fitch thinks the availability of single M&A transactions that could drive a downgrade is limited.

An upgrade of UHS' IDR to 'BBB-' is unlikely in the near-to-intermediate term, as Fitch views the risks around reimbursement and other regulatory factors associated with healthcare providers in the U.S. - and UHS' reliance on government payers - as material going forward. Furthermore, UHS' current ratings and credit metrics provide the firm with flexibility to participate in the consolidation of the healthcare provider space, which Fitch expects to continue through the intermediate term.

DILIGENT DEBT REPAYMENT, MEASURED M&A STRATEGY CONTRASTS WITH PEERS

Most large acute care hospital operators have been active acquirers and aggressive in recruiting physicians and expanding outpatient service line offerings over the last few years. UHS has instead directed the majority of its FCF toward debt repayment. Debt-to-EBITDA has declined to 2.3x at March 31, 2014 from nearly 5x (reported) at year-end 2010.

Each of UHS' acquisitions over the past four years has been of behavioral health targets, including the $500 million acquisition of Ascend Health Corporation in October 2012. Going forward, most targets are likely to be small, with purchase prices of less than $100 million. Fitch does not expect UHS to engage another transformational deal - like the 2010 PSI acquisition - over the ratings horizon, partly because deals of that nature are largely unavailable.

STRENGTHENING CASH FLOWS, CAPITAL DEPLOYMENT STRATEGY SOMEWHAT UNCERTAIN

Fitch forecasts FCF of more than $550 million in 2014, compared to $456 million in 2013, primarily due to higher net revenues from lower bad debts on a fairly constant cost base. Fitch does not expect UHS to direct cash flows toward material accelerated debt repayment going forward, as the firm has achieved its de-leveraging target following the 2010 PSI acquisition. Furthermore, management has commented recently that UHS' current leverage is at the low end of its preferred range.

UHS could become more aggressive in pursuing acquisition targets, particularly in the acute care space, as Fitch expects the pipeline of mid-sized single hospitals and smaller urban hospital networks coming up for sale will remain robust for at least the next few years. Furthermore, management has commented recently that purchase multiples seem to be moderating for possible targets. A resumption of share repurchases, which UHS has nearly eliminated from its capital deployment strategy over the last four years, is also possible.

ACA TO DRIVE BETTER PROFITABILITY

UHS is among the best-positioned for-profit hospital operators to benefit from lower bad debts in 2014 due to its presence in states expanding their Medicaid programs, including Nevada and California. Fitch thinks the coverage expansion provisions of the ACA could drive EBITDA margin expansion in UHS' acute care business by 150 bps or more from 2013 to 2015. Importantly, margin gains achieved in 2014-2015 are expected to slowly erode in the years that follow, due to an overall constrained reimbursement environment and the expectation for inpatient volumes to be flat or slightly down for the foreseeable future.

PERSISTENT ACUTE CARE VOLUME PRESSURES TO CONTINUE

Fitch thinks secular shifts in the setting of care delivery - toward lower-cost, often outpatient settings - and evolving components of especially government reimbursement (i.e. readmissions penalties and patient criteria) are increasingly to blame for weak same store admissions figures among acute care hospitals nationwide. Persistently weak economic growth and high unemployment in many markets are also pressuring both volumes and profitability, albeit now in a less pronounced manner.

Fitch continues to believe that mid-2013 was an inflection point at which admissions in UHS' core markets began to show signs of stabilization, though admission figures were fairly weak in 4Q'13 and 1Q'14. The ACA is not expected to meaningfully add to inpatient volumes in the near term, and overarching trends related to healthcare reform are likely to continue gradually shifting volumes to outpatient settings. As a result, moderately negative to possibly flat inpatient volumes are expected to be indicative of stable markets for UHS and its peers for the foreseeable future.

Commercial pricing remains strong and has largely offset the effects of Medicare sequestration and weak volumes. UHS has reported annual commercial rate increases of 6%-7%. It is possible that commercial insurers may apply more reimbursement pressure to acute care operators given the reduction in bad debts expected to result from the implementation of the ACA in 2014-2015. Government reimbursement will continue to be constrained as public payers continue to seek to moderate healthcare spending.

Fitch expects good behavioral volume growth over the ratings horizon in light of mental health parity rules, a possible bottoming of length of stay pressures, and UHS' capacity expansion initiatives. Notably, expanded Medicaid programs are not likely to bolster behavioral health volumes due to the Medicaid Institutes for Mental Diseases (IMD) exclusion. The elimination of this exclusion could drive greater growth opportunities vis-a-vis the ACA for UHS' behavioral health business over the intermediate term.

MOST DEBT MATURES IN 2016, LIQUIDITY IS AMPLE

Available liquidity is sufficient. Though UHS does not usually carry large amounts of cash ($16 million at March 31, 2014), it maintains an $800 million revolver, of which $743 million was available at March 31, 2014. UHS also maintains a $275 million A/R facility, of which $115 million was available at March 31, 2014.

Debt maturities are manageable for the firm, though the bulk of the outstanding term loans are due in August 2016 (2016 maturities represent 86% of total debt.) Fitch expects UHS will have adequate access to capital as it seeks to refinance its credit facilities in advance of this date. Debt maturities are estimated as follows: remainder of 2014: $56 million; 2015: $123 million; 2016: $2.77 billion; 2018: $250 million.

NOTCHING SCHEME

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, supporting the one notch differential.

The unsecured notes are rated one notch below the IDR to reflect the substantial amount of secured debt to which they are subordinated. More than 90% of UHS' outstanding debt at March 31, 2014 was secured, reducing the potential recoveries for unsecured creditors.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Hospitals Credit Diagnosis' (April 10, 2014);

--'High-Yield Healthcare Checkup' (April 4, 2014);

--'2014 Outlook: U.S. Healthcare' (Nov. 25, 2013).

--'For Profit Hospital Insights: Fitch's Annual Review of Bad Debt Accounting Policies and Practices' (Oct. 24, 2013);

--'Margin Preservation Strategies: Different Angles (U.S. Hospitals and Health Insurers)' (Oct. 1, 2013);

--'The Affordable Care Act and Healthcare Providers: Assessing the Potential Impact' (May 1, 2013);

--'Corporate Rating Methodology' (May 28, 2014).

Applicable Criteria and Related Research:

Hospitals Credit Diagnosis (Consolidation Supports Growth in a Weak Organic Operating Environment)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=745816

High-Yield Healthcare Checkup: Comprehensive Analysis of High-Yield U.S. Healthcare Companies

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=736356

2014 Outlook: U.S. Healthcare Secular Challenges Require a Compelling Value Proposition

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724141

For-Profit Hospital Insights (Fitch's Annual Review of Bad Debt Accounting Policies and Practices)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=721280

Margin Preservation Strategies: Different Angles (Credit Implications for U.S. Hospitals and Health Insurers)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=718975

The Affordable Care Act and Healthcare Providers (Assessing the Potential Impact)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=706654

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=836299

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst

Jacob Bostwick, CPA

Director

+1-312-368-3169

Fitch Ratings, Inc.

70 W Madison Street

Chicago, IL 60602

or

Secondary Analyst

Megan Neuburger

Senior Director

+1-212-908-0501

or

Committee Chairperson

Michael Weaver

Managing Director

+1-312-368-3156

or

Media Relations

Brian Bertsch, New York, +1-212-908-0549

brian.bertsch@fitchratings.com

Source: Fitch Ratings


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