Credit rating giant Moody's Investors Service ("Moody's") recently downgraded the Corporate Family Rating (CFR) of Community Health Systems, Inc. (CYH - Free Report) from Caa2 to Caa3 and the Probability of Default Rating from Caa2-PD to Caa3-PD. The agency has further downgraded the first lien senior secured debt to Caa1 from B3, the junior lien debt to Ca from Caa3, the unsecured debt to C from Ca and the Speculative Grade Liquidity Rating to SGL-4 from SGL-3. The outlook of these ratings is stable.
The agency’s announcement of the ratings followed Community Health’s notification of paying $262 million to settle the investigations made by the US Department of Justice (“DOJ”). This probe dates back to the buyout of Health Management Associates, Inc. in the year 2014. Moody’s states that the resolution of the issue will not only further dent the company’s limited liquidity but also increase the possibility of a default event over the next 12-24 months. The rating outlook remains stable.
These ratings show that the agency considers Community Health’s liquidity to be weak over the upcoming 12 to 18 months, elevating the likelihood of a default event. Moreover, the same reflects the company’s significantly high financial leverage with debt/EBITDA over 8.0x and the current interest costs and capital requirements of the business. The agency projects that unsecured and junior lien lenders would incur significant losses in a default case.
As of Jun 30, 2018, Community Health had $208 million of cash in hand and the agency expects negative free cash flow over the next 12 months. It believes that the company will have to rely on its $1-billion asset-based lending facility and a $425-million revolving credit facility to fund the DOJ settlement. Community Health also has maturities of unsecured notes of nearly $300 million over the upcoming 12-18 months.
Under the revolving facilities, combined availability totaled nearly $800 million as of Jun 30, 2018 after drawings and letters of credit. Using the same to finance the settlement will tighten the financial covenant that governs the revolving credit facility. A violation of this covenant, if not let off by lenders, could induce the facility’s unavailability, which would further weigh on liquidity.
The Caa1 rating granted to the first lien secured debt is upgraded by a notch over the rating result estimated by Moody's Loss Given Default model. This highlights Moody's view that recovery on the first lien secured debt is better than the model’s implication, which is pegged at nearly 90% or more.
Meanwhile, the C rating on the unsecured debt is downgraded by a notch, comparing unfavorably with the rating result projected by Moody's Loss Given Default model. This represents Moody's opinion that recovery on the unsecured debt is inferior to what is predicted by the model.
Factors That Can Drive Future Ratings
The rating agency can downgrade the ratings if the likelihood of the default rises or the credit recovery prospects weaken.
Meanwhile, Moody’s can upgrade the same if operational initiatives lead to the company’s improved volume growth as well as margin expansion. It can also upgrade the ratings if leverage declines or free cash flow improve in such a way that it can refinance future debt maturities and sustain the current capital structure becomes more assured. An upgraded rating would also require better liquidity consisting of greater covenant cushion.
Shares of this Zacks Rank #3 (Hold) company have gained 5.4% quarter to date, underperforming the industry’s rally of 22.9%.
Stocks to Consider
Better-ranked stocks from the medical sector include WellCare Health Plans, Inc. (WCG - Free Report) , Anthem, Inc. (ANTM - Free Report) and Molina Healthcare, Inc (MOH - Free Report) .
WellCare provides managed care services for government-sponsored health care programs. The company sports a Zacks Rank #1 (Strong Buy) and managed to pull off an average four-quarter positive surprise of 53.89%. You can see the complete list of today’s Zacks #1 Rank stocks here.
Anthem and units operate as a U.S.-based health benefits company. Holding a Zacks Rank #2 (Buy), the company came up with an average trailing four-quarter earnings surprise of 6.65%.
Molina offers Medicaid-related solutions to meet health care needs of low-income families and individuals. The stock has a Zacks Rank of 1. In the past four quarters, the company delivered a whopping average beat of 164.17%.
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