Fitch Revises Fresenius' Outlook to Stable; Affirms at 'BB+'
Although Fresenius' business risk profile has improved, with its scale, profitability and cash generation pointing towards a higher rating category, this is offset by a financial profile that is still not consistent with an investment grade rating.
Fresenius has seen an increase in scale and service line diversification, achieved by a combination of organic growth and targeted acquisitions to develop presence in selective treatment areas. However, the financial risk profile of the consolidated group, albeit in line with management guidance and Fresenius' communicated financial policies, remains commensurate with only a 'BB' rating category following the ongoing integration of the recent acquisitions. Given the limited scope for an upgrade in the near-term, Fitch has revised the Outlook to Stable from Positive. In maintaining its 'BB+' rating, Fitch projects a continuation of Fresenius' successful acquisition strategy, albeit less strategic and more-bolt-on in nature in the medium term.
The Stable Outlook also reflects Fitch's expectation of a stable government reimbursement environment, improving financial flexibility, and strong liquidity.
KEY RATING DRIVERS
Improved Diversification and Market Positions
FSE's business risk profile continues to improve through organic growth and acquisitions in non-dialysis service lines (Kabi, Helios, and Vamed). Fitch believes that all these businesses have now achieved critical operating mass and are contributing to the group's improved cash flow generation. As a result, Fresenius is now less reliant on one single treatment area and has improved geographic diversification, albeit still with a strong focus on developed markets.
Defensive Revenue
Fitch believes the underlying revenue streams of the group's four service lines are defensive and underpinned by positive fundamentals such as an ageing population, increase in chronic diseases and improving access to healthcare. This is, however, counterbalanced by growing pressures on healthcare budgets in times of austerity, a key risk for the group as their operations are predominantly exposed to developed markets (US and Europe), where issues around healthcare costs and productivity are most pressing.
Resilient Operating Performance
Fitch expects the group's resilient operating performance to continue with a projected EBIT margin of 13%-14%, an EBITDAR margin of more than 20%, and a free cash flow (FCF) margin of 2.5%-3.5%. Such profitability points towards a higher rating level compared with peers in the healthcare sector that is characterised by low revenue volatility and predictable cash flows. The group's financial leverage and key debt protection ratios (defined as funds from operations (FFO) adjusted net leverage), however, remain firmly in the 'BB' rating category following its recent Rhoen acquisition, with FFO adjusted net leverage at 5.1x and FFO fixed charge cover at just over 3.0x for 2014, which are worse than assumed under the previously assigned Positive Outlook.
While Fitch acknowledges Fresenius' satisfactory free cash flows, based on improving profitability and cash conversion, and hence the group's capacity to deleverage, we also recognise the stated desire to continue its acquisition-driven growth strategy, which has consistently kept financial metrics within a 'BB' rating category.
Communicated Financial Targets
Fitch considers large, strategic debt-funded acquisitions currently unlikely, adding to our expectation of improving credit metrics and supporting the rating. Fitch's rating case allows for USD400m p.a. bolt-on acquisitions (see also key rating assumptions below) whereas larger and more strategic acquisitions are treated as event risk. Although the group has communicated a medium-term net debt-to-EBITDA target within the 2.5x-3.0x bracket (potentially breached for about 18 months if a debt-funded acquisition opportunity occurs), recent acquisitions meant that Fresenius has not sustainably operated within this corridor for a period of time, which is key for a rating upgrade.
Readily Available Cash
In its leverage calculations, Fitch considers cash held at FMC as restricted for debt service at FSE as this would be upstreamed by way of dividends. As cash management for healthcare operators does not have pronounced seasonal cycles, Fitch does not make further adjustments to the group's readily available cash.
Vertical Integration Benefits
Vertical integration provides the group with cost advantages and bargaining power relative to smaller or less integrated operators. It could theoretically build a hospital and equip it with machinery (Vamed) and medicines (Kabi), supply it with dialysis machines and run a dialysis centre (FMC).
Reliance on Government Reimbursement
As a majority of FMC's dialysis services sales in the US are generated by Medicare/Medicaid patients, the group is exposed to increasing pricing pressure over the medium term. Other elements of the US healthcare reform are likely to have a detrimental yet manageable impact on FMC's performance such as the medical device tax and the effect of sequestration.
RATING SENSITIVITIES
Future developments that could lead to positive rating actions include (based on the consolidated profile of the group):
-Improvements in the operating and regulatory environment resulting in industry-leading profitability and cash flows with an EBITDAR margin of more than 19% and FCF margin consistently at 3%-5%
-Financial leverage moving sustainably within target range of FFO adjusted net leverage of less than 4.0x and FFO fixed charge cover trending towards 4.0x
Future developments that could lead to negative rating actions include (based on the consolidated profile of the group):
-Pressures in the operating and regulatory environment leading towards sustained impairment of profitability and cash flows
-Sustained high financial leverage with FFO adjusted net leverage of more than 5.0x and FFO fixed charge cover trending towards 2.0x
KEY ASSUMPTIONS
-Underlying growth in patient volumes at FMC offsets on-going reimbursement rate pressure
-Various efficiency measures mitigate margin erosion due to rising cost of care
-Bolt-on acquisition of up to USD400m per year; no strategic acquisition assumed, which Fitch considers as event risk
-Flat group EBITDA margin of around 18%
-Capex of 5%-6% of sales per annum
-Cash at FMC is not readily available for debt service at FSE (other than via dividends)
-Consolidated approach under Fitch Parent Subsidiary Rating Linkage criteria
LIQUIDITY AND DEBT STRUCTURE
Adequate Liquidity
The group has unutilised committed credit facilities available of EUR2.6bn (of which USD1.4bn is available at FMC level) in addition to EUR653m of cash which Fitch considers as readily available for debt repayment at FSE level. The group's consolidated annual FCF have been between EUR600m-EUR1bn over the past four years and we expect positive FCF generation to continue for another four years.
Capital Structure Considerations
Fitch views the linkage between FMC and FSE as strong given the consolidation of FMC, management control, shared finance function (albeit no cash pooling) and - most relevant - cross default provisions between the entities' debt. Fitch's IDR therefore is applied to the consolidated group, reflecting both entities' similar financial profiles and guidelines.
FULL LIST OF RATING ACTIONS
FSE
Long-term IDR: affirmed at 'BB+'; Outlook revised to Stable from Positive
Senior unsecured debt: affirmed at 'BB+'
Senior secured debt: affirmed at 'BBB-'
Short-term IDR/commercial paper: affirmed at 'B'
Fresenius Finance B.V.:
Guaranteed senior notes: affirmed at 'BB+'
Fresenius US Finance II Inc.:
Guaranteed senior notes: affirmed at 'BB+'
FMC:
Long-term IDR: affirmed at 'BB+'; Outlook revised to Stable from Positive
Senior unsecured debt: affirmed at 'BB+'
Senior secured debt: affirmed at 'BBB-'
Short-term IDR: affirmed at 'B'
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