S&P Cuts HCA Debt to Junk

The ratings agency says the hospital operator's aggressive financial policy is no longer consistent with an investment-grade status

On Oct. 13, Standard & Poor's Ratings Services lowered its ratings on Nashville, Tenn.-based hospital operator HCA (HCA ) to 'BB+' -- below investment grade -- from 'BBB-'.

The downgrade primarily reflects the company's intention to repurchase $2.5 billion of its shares through a Dutch auction process, which is to be completed in the fourth quarter of 2004. The magnitude of the transaction is indicative of a financial policy that is no longer consistent with an investment grade rating. This is particularly true considering the company's pre-announcement of weaker-than-expected 2004 third-quarter earnings that highlights operating risks.

HCA is the largest owner and operator of acute-care hospitals, with a portfolio of 190 hospitals and 91 ambulatory surgery centers (including seven hospitals and nine ambulatory surgery centers owned through equity joint ventures) in 23 U.S. states, U.K., and Switzerland. Notwithstanding its aggressive financial policy, the company has a reasonably diversified hospital portfolio, strong positions in several of its markets, and relatively favorable reimbursement.

Growing uninsured patient volume has contributed to a decline in HCA's operating margins, which fell to about 16% by mid-2004 from nearly 20% a year before. The company remains challenged to collect its private-pay billings fully and promptly, and bad debt reserves are now approaching 12% versus 8% in early 2003. Still, the company's operating cash flow remains significant, and Standard & Poor's expects the company to internally generate funds over the next couple of years in excess of capital needs.

Nevertheless, reflecting the debt required to accomplish its share repurchase proposal, credit protection will be more characteristic of a speculative-grade financial profile; funds from operations to lease-adjusted debt will decline to the low- to mid-20% range, and total debt to EBITDA will increase to about 2.7 times.

Liquidity: In addition to robust operating cash flow of about $1.5 billion for the six-month period ended June 30, 2004, HCA had $120 million in cash and short-term investments, and only $350 million outstanding on its $1.75 billion senior unsecured revolving credit facility. The facility matures in December 2006, and HCA is currently in the process of replacing it with a new bank facility.

HCA has now designated a large portion of its cash flow to pay for its dividend program and to service the debt incurred with large share repurchases. Unforeseen weakness in cash flow could make it more difficult to meet these needs.

Bank loans: HCA's $1.75 billion senior unsecured revolving credit facility, maturing in 2006, is rated 'BB+', the same as the corporate credit rating and the company's $750 million bank term loan maturing in April 2006. The bank agreement contains two financial covenants governing debt to capitalization and interest coverage, and HCA is comfortably within the specified levels.

Outlook: The ratings outlook is stable. Standard & Poor's expects HCA's management to respond to weakness in operating performance or cash flow by scaling back discretionary spending to maintain credit measures characteristic of its current rating.