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TEXT-S&P raises HealthSouth rating to 'BB-'
May 30, 2012 / 7:53 PM / 5 years ago

TEXT-S&P raises HealthSouth rating to 'BB-'

Overview	
     -- U.S.-based inpatient rehabilitation hospital operator HealthSouth Inc.
 reduced leverage over the past year, exceeding our base-case scenario.	
     -- We are raising our corporate credit rating on HealthSouth to 'BB-' 	
from 'B+'. We are raising the rating on HealthSouth's convertible preferred 	
stock to 'B-' from 'CCC+', based on our notching criteria.	
     -- We are raising our issue-level rating on HealthSouth's senior secured 	
term loan and revolving credit facility to 'BB+' from 'BB' and our issue-level 	
debt rating on the company's unsecured bonds due 2020 and senior unsecured 	
notes due 2018 and 2022 to 'BB-' from 'B+'.  	
     -- The stable outlook on HealthSouth reflects our view that operating 	
trends will continue and its financial risk profile will not appreciably 	
change over the next year. 	
 	
Rating Action	
On May 30, 2012, Standard & Poor's Ratings Services raised its 'B+' corporate 	
credit rating on Birmingham, Ala.-based HealthSouth Inc. to 'BB-'. The outlook 	
is stable. 	
	
We are raising the rating on HealthSouth's convertible preferred stock to 'B-' 	
from 'CCC+', based on our notching criteria. We raised our issue-level rating 	
on HealthSouth's senior secured term loan and revolving credit facility to 	
'BB+' from 'BB'. The '1' recovery rating on these notes is unchanged, in 	
accordance with our notching criteria, indicating our expectation for very 	
high (90% to 100%) recovery in the event of a payment default.	
	
We are raising our issue-level debt rating on the unsecured bonds due 2020 and 	
senior unsecured notes due 2018 and 2022 to 'BB-' from 'B+'. We revised the 	
recovery rating on this debt to '3' from '4', per our notching criteria, 	
indicating our expectation for meaningful (50% to 70%) recovery in the event 	
of a payment default. This action is based on better recovery prospects for 	
the unsecured debt because of the reduced  unsecured debt outstanding.	
 	
Rationale	
The upgrade on HealthSouth Inc. reflects its reduced leverage, which is 3.4x 	
as of March 31, 2012, better than our forecast of 3.9x. We believe it will 	
remain at or below that level in 2012 on stable reimbursement prospects, and 	
are confident HealthSouth is committed to that level. The ratings reflect our 	
assessment of the company's business risk profile as "weak." It also reflects 	
our revision of the financial risk profile to "significant" from "aggressive." 	
We expect HealthSouth to remain subject to significant reimbursement risk, 	
particularly from the government, because Medicare generates over 70% of total 	
revenues. We expect HealthSouth's total revenue to increase by about 5% in 	
2012, a larger increase than the 1.4% growth in 2011 (this includes our 	
expectation that discharges will increase by about 4% for the year). 	
	
HealthSouth's significant financial risk profile reflects our calculation of 	
debt to EBITDA of about 3.4x, and funds from operations to lease-adjusted debt 	
of 23% in early 2012. We expect leverage to decline to 3.3x, and funds from 	
operations (FFO) to debt to increase to about 24% by the end of 2012. We 	
expect revenue growth and the flat EBITDA margin to spur a small increase in 	
EBITDA of about 2.5%. We expect HealthSouth to generate about $160 million of 	
discretionary cash flow after distributions to noncontrolling interests and 	
dividend payments in 2012. HealthSouth may increase its acquisition activity 	
as a use of free cash flow, because debt repayment likely will have a lower 	
priority.	
	
We view HealthSouth's business risk profile as weak because of its operation 	
in a single line of business that relies on one source for a large percentage 	
of its revenues. With a very high 70% of its total revenues subject to 	
Medicare reimbursement and regulatory changes for inpatient rehabilitation 	
services, we view HealthSouth as vulnerable in the long term to adverse 	
reimbursement and regulatory risks in its inpatient rehabilitation business. 	
We believe the company's recently favorable patient discharge trend supports 	
the company's view that it has been gaining market share and provides us with 	
confidence that discharges will increase at an annual rate of 3% to 4%.	
	
We currently do not view Medicare reimbursement as a near-term risk for 	
providers of inpatient rehabilitation services. This is because this subsector 	
already incurred a revision aimed at controlling costs. Relatively recently, 	
Medicare dramatically altered its rules and regulations regarding both 	
eligible cases and reimbursement levels, which its 60% rule reflects. These 	
changes actually reduced total industry discharges and slowed Medicare's 	
spending for inpatient rehabilitation services. However, in the long term, we 	
view reimbursement as a key risk, particularly because of HealthSouth's large 	
reliance on Medicare and higher risk of additional payment cuts and regulatory 	
developments.	
 	
Liquidity	
HealthSouth's liquidity is "strong." Sources of cash are likely to exceed uses 	
of cash over the next 12 months. Relevant aspects of HealthSouth's liquidity 	
are: 	
     -- We believe sources will cover uses by more than 4.0x over the next 12 	
to 24 months, but this metric could deteriorate if unexpected reimbursement or 	
regulatory developments cause EBITDA to sharply contract, weakening funds from 	
operations. 	
     -- Sources include about $400 million of cash flow from operations, $44 	
million of cash, and $331 million of availability on its revolving credit 	
facility as of March 31, 2012.	
     -- Significant uses of cash include capital expenditures of about $100 	
million, and payments to noncontrolling interests and dividends on preferred 	
stock.	
     -- We expect net sources to be positive, even with a 30% drop in EBITDA.	
     -- We believe the company has generally very prudent financial risk 	
management.	
     -- There are no significant debt maturities until 2016.	
 	
Recovery analysis	
For the complete recovery analysis, please see the recovery report on 	
HealthSouth, to be published as soon as possible following this release on 	
RatingsDirect.	
 	
Outlook	
Our outlook on HealthSouth is stable. We expect HealthSouth to continue 	
focusing its efforts on further improving operations to meet ongoing 	
reimbursement and regulatory challenges for the inpatient rehabilitation 	
industry. Although we expect the company to meet these challenges and continue 	
pursuing modest growth initiatives, we do not expect an improvement in its 	
business risk profile. 	
	
We believe a positive rating action is possible if we have confidence that 	
HealthSouth will sustainably reduce lease-adjusted debt to EBITDA to below 3x, 	
and increase funds from operations to lease-adjusted debt to above 30%. 	
Presently, we do not see this as a realistic possibility in 2012. For this to 	
occur in 2013, we believe it would take an estimated 400-basis-point increase 	
in the EBITDA margin and a revenue growth rate of about 4% to achieve both 	
these metrics. 	
	
We would consider a negative rating action if leverage increases above 4x, aor 	
if funds from operations to lease-adjusted debt falls below 20%. We believe 	
this could occur as a result of adverse changes in reimbursement or regulatory 	
requirements, or more aggressive financial or business policies.	
 	
Related Criteria And Research	
     -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011	
     -- Criteria Guidelines For Recovery Ratings On Global Industrials 	
Issuers' Speculative-Grade Debt, Aug. 10, 2009 	
     -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009	
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008	
     -- 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 	
	
Ratings List	
	
Upgraded; Outlook Action	
                                        To                 From	
HealthSouth Corp.	
 Corporate Credit Rating                BB-/Stable/--      B+/Positive/--	
 Senior Secured                         BB+                BB	
   Recovery Rating                      1                  1	
 Senior Unsecured                       BB-                B+	
   Recovery Rating                      3                  4	
 Preferred Stock                        B-                 CCC+

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