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Fitch Affirms Universal Health Services, Inc.'s IDR at 'BBB+'; Outlook Revised to Negative

Posted on: Friday, 22 December 2006, 12:00 CST

Fitch has affirmed Universal Health Services, Inc.'s (NYSE:UHS) ratings as follows:

--Issuer Default Rating (IDR) affirmed at 'BBB+';

--Senior Unsecured Notes affirmed at 'BBB+';

--Unsecured Bank Facility affirmed at 'BBB+'.

Fitch also revises the Rating Outlook to Negative from Stable. Total rated debt at Sept. 30, 2006, was approximately $468 million.

UHS's ratings are supported by the company's diversification through its behavioral business, strong organic growth, and improved credit statistics. At the same time, UHS faces a worsening industry environment which Fitch expects to pressure operating income over the next several years. In addition, Fitch expects leverage to increase from its current level (1.0 times[x] total debt/EBITDA and 1.86x total debt/EBITDAR at LTM Sept. 30, 2006) to fund acquisitions, capital expenditures and share repurchases.

UHS continues to be one of the strongest performers in the for-profit hospital industry. Both acute care and behavioral health same facility admissions have consistently grown over the past couple years. The strength in the acute care business is driven in large part by the booming Las Vegas market, which is one of the fastest growing regions of the country and where UHS commands a leading market position. Fitch believes the company is well positioned to capture more market share in this area, as it adds more capacity to the region. In addition, UHS should benefit from recent contract disputes between its competitor, HCA, Inc., and the region's largest private insurer, Sierra Health Services.

UHS also benefits from the diversification of its behavioral health business, which has grown in importance to the company over the past few years. In 2005, the Behavioral Health Services segment comprised 21% of company revenues, and Fitch estimates the segment will comprise approximately 45% of Operating Income in 2006. Fitch views the increase in the behavioral health business as a positive, since the market has several favorable characteristics that differentiate it from the acute care market. First, the segment is experiencing strong volume growth as evidenced by high occupancy rates as well as same store admissions increases well above the acute care industry average. Second, the behavioral health business is less impacted by bad debt expense and uncompensated care than the acute care market. Fitch believes this is a large contributor to UHS's lower acceleration in bad debt expense and uncompensated care than its peers.

Although UHS benefits from its exposure to the behavioral health market, UHS has still encountered the same issues that challenge the entire acute care industry. The rising numbers of uninsured and underinsured have led to an increase in bad debt expense as well as uncompensated care (in the form of charity care and uninsured discounts) that have dampened profitability for both UHS and the sector as a whole. Fitch believes the key drivers of this trend, rising uninsured and increased cost-shifting to consumers, will continue to grow barring any structural change in the industry (i.e., regulatory action). As a result, Fitch projects UHS will continue to feel pressure on margins.

UHS will need to counter the impact of increased bad debt expense in the midst of an increasingly competitive marketplace. Fitch projects the competitive threats from specialty hospitals, ambulatory surgical centers (ASCs), and entrepreneurial physicians will continue to impact volumes across the sector. Providers will face continued challenges from specialty hospitals that focus on lucrative procedures and patients (e.g., cardiology and orthopedics). In addition, providers will face challenges from physicians who seek to move more and more procedures from an inpatient setting to the doctor's office. An example of the impact new entrants can have in the market is UHS's McAllen, TX, operations which have decreased from approximately 19% of consolidated earnings in 2003 to 4% in 2005, in large part because of the loss of lucrative patients and procedures to a physician-owned full service hospital in the area.

Fitch believes UHS will be able to partially mitigate the impact of rising bad debt and dampened volumes through continued strong pricing. Medicare rates are set for 2007, with an average expected increase of 3.5% for inpatient services and 3.0% for outpatient services for urban acute care providers. The Prospective Payment System (PPS) for inpatient psychiatric services is also favorable, with an increase of 4.5% for the 12 months from July 1, 2006, to June 30, 2007. In addition, despite some recent highly publicized contract disputes in the industry, Fitch expects UHS to continue to achieve strong pricing increases from managed care insurers. This is enabled by UHS's strategy to operate in markets where it can command a #1 or #2 position, giving it leverage in negotiations.

UHS will face additional operational challenges beyond bad debt and volumes. Recent union actions in Las Vegas (including the union's desire to implement nurse staffing ratios like those in California) along with increasing demand for nurses as the market grows may lead to pressure on labor expenses. In addition, the Keystone facilities (acquired from Keys Group Holdings, LLC in October 2005) are not performing up to expectations and have reduced operating margins in 2006. Fitch believes that UHS will need to focus on successfully integrating the Keys facilities as well as incremental acquisitions in the coming years.

Fitch projects UHS will continue a high rate of expenditures in order to fund internal investment. Fitch expects UHS to continue making significant capital expenditures as well as incremental acquisitions in the coming years. UHS may also use cash to fund additional share repurchases (the company had 2.6 million shares authorized for repurchase at Oct. 31, 2006). As a result, Fitch believes that an increase in leverage to fund these actions is likely in the next few years.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, 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.

Source: Business Wire

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