Fitch Affirms McLeod Healths (SC) Bonds at AA-; Outlook Revised to Positive

Fitch Ratings has affirmed the ‘AA-‘ rating on the following Florence County, South Carolina bonds issued on behalf of McLeod Regional Medical Center of the Pee Dee, Inc. (dba McLeod Health):

–$69.9 million series 2014;

–$112.8 million in series 2010A.

The Rating Outlook is revised to Positive from Stable.

SECURITY

The bonds will be secured by a pledge of gross revenues of the obligated group (OG).

KEY RATING DRIVERS

STRONG FINANCIAL PROFILE: The Outlook revision to Positive reflects the improving trend in profitability in 2014 and 2015, further elevating McLeod Health’s (McLeod) already healthy financial profile. McLeod generated a 16.1% operating EBITDA margin and 6.5x coverage of its maximum annual debt service (MADS) in 2015. Solidly consistent profitability has bolstered cash reserves, reflected in strong cash to debt of 276.9%.

SUCCESSFULLY INTEGRATING RECENT ACQUISITIONS: McLeod has been broadening its regional presence with the 2012 acquisition of Loris Health System (now McLeod Loris Seacoast Hospital; MLSH), the June 2015 acquisition of Chesterfield General Hospital (now McLeod Health Cheraw) and the recently announced affiliation with Clarendon Health System. McLeod successfully integrated MLSH into the system and Fitch expects that it will be similarly able to turn around operations at the Cheraw and Clarendon hospitals in fiscal 2016 and 2017, respectively, so that they will be accretive to McLeod.

GROWING MARKET PRESENCE: McLeod’s leading market position improved to 53.5% in 2015, up from 48.5% inpatient share in 2013 within its six-county primary service area (PSA). The growing market presence has translated into notable increases in both medical and surgical utilization. Moreover, the recent hospital acquisitions should continue to provide additional opportunities for market growth.

MANAGEABLE CAPITAL PLANS WITH NO ADDITIONAL DEBT: McLeod’s plan in 2016 and 2017 includes approximately $230 million in capital spending. The largest project is a $117.8 million 50-bed new inpatient tower and emergency department expansion at McLeod Seacoast Hospital. With an average annual operating EBITDA of $137.4 million in fiscal 2014 and 2015, McLeod is able to fund its capital plans without eroding its liquidity or needing to borrow additional debt at this time, thereby preserving balance sheet strength.

RATING SENSITIVITIES

CONTINUED ENTERPRISE GROWTH: Fitch expects McLeod to benefit from its recent community hospital acquisitions and further leverage its growing market reach. Upward rating movement could occur if McLeod maintains the current high level of profitability and further strengthens liquidity metrics to offset the system’s somewhat limited revenue size and regional concentration.

CREDIT PROFILE

McLeod is a $922 million in revenue health system serving the midlands to coastal regions of South Carolina. McLeod owns and operates 453-bed McLeod Regional Medical Center (MRMC) in Florence, 49-bed McLeod Medical Center in Darlington (a division of MRMC), 79-bed McLeod Medical Center in Dillon, 105-bed McLeod Loris Hospital in Loris, 50-bed McLeod Seacoast Hospital in Little River, 59-bed McLeod Health Cheraw and various other entities. The system recently announced its affiliation with Clarendon Health System, which it began managing in May 2016. The final 99-year lease agreement is expected to be executed in July, at which time the hospital in Clarendon will join the OG and be rebranded as McLeod Health Clarendon.

Fitch based its analysis on the consolidated entity. The members of the OG include McLeod Health, MRMC, McLeod Medical Center Dillon, McLeod Health Cheraw and McLeod Physician Associates, which are the only obligors under the Master Indenture. For fiscal 2015 the OG comprised 93% of total assets and 88% of total revenues of the consolidated entity.

STRONG FINANCIAL PROFILE

McLeod’s strong financial profile was further enhanced in fiscal 2015 (ended Sept. 30) when the operating margin reached 8.9%, an increase from 7.1% in 2014 and 6.8% in 2013. Similarly, operating EBITDA increased to 16.1% in 2015 from 15.4% in 2014, above the median value of 11.5% for the ‘AA’ rating category. The system benefited from an increased revenue level of $921.7 million (from $824.3 million in 2014) as a result of strategic growth, increased utilization, and $5 million in higher Medicaid disproportionate share payments (DSH).

Management expects the results in fiscal 2016 to be slightly more modest than 2015, but still in line with Fitch’s ‘AA’ category medians. McLeod reported an operating margin of 6.7% in the six months ended March 31, 2016 as compared to 7.3% in the same period in 2015. The results in fiscal 2016 are expected to be slightly tempered by the investments in physician recruitment to integrate the medical staffs at the new acquisition hospitals in Cheraw and Clarendon to McLeod’s clinical model. McLeod Health Cheraw is still generating a modest loss of about $700,000 but is expected to break even by the end of calendar 2016. Clarendon had an operating loss of approximately $5.5 million in its last year before the acquisition, but it is expected to break even by the end of calendar 2017 with the planned enhancements and consolidation of clinical and non-clinical functions.

The historically strong operating results have allowed the system to build and sustain a robust balance sheet. McLeod reported 397.6 days cash on hand (DCOH), 33.2x cushion ratio and 276.9% cash-to-debt in 2015. McLeod reported similar results for the six-month interim period in 2016 with DCOH at 374.4 days, 33.9x cushion ratio and 288.3% cash-to-debt. Fitch expects these metrics to remain relatively stable over the next couple of years.

SOLID AND GROWING MARKET POSITION

McLeod remains the market leader with 53.5% inpatient market share in 2015 within its PSA, approximately double the market share for its closest competitor Carolinas Hospital System in Florence. MRMC has been enhancing its position as a regional referral center by broadening its reach in fast-growing Horry, Clarendon, Chesterfield and Marlboro counties in recent years. All of McLeod’s community hospitals represent important referral streams to the main hospital in Florence for higher acuity needs.

McLeod Health Cheraw in Chesterfield has absorbed most of the volume from the Marlboro Park hospital in Bennettsville that was closed in 2015. The Clarendon facility similarly provides an opportunity for McLeod to leverage the short-term market disruption caused by the 18-24-month closure of the community hospital in neighboring Williamsburg which was closed due to flood damage.

McLeod reports profitable operations at the Loris and Seacoast hospitals that were added to the system in 2012. Inpatient admissions grew at these facilities, although they have experienced enhanced competition for outpatient surgeries. McLeod is building on its market presence in this area to take advantage of the growth near the coast with the expansion at McLeod Health Seacoast and a new medical office building and outpatient clinic in a new 43-acre plot of land it purchased in Carolina Forest. Both of these projects will be ongoing in fiscal 2016 and 2017.

DEBT PROFILE

McLeod has a conservative debt profile with fixed-rate borrowings accounting for approximately 80% of the total $310.1 million in debt outstanding at fiscal year-end 2015. No new debt issuances are currently planned. Additionally, there is no pension liability as the system maintains a defined-contribution plan.

With robust EBITDA generation, McLeod posted solid MADS coverage of 6.5x in fiscal 2015 based on consolidated MADS of $25.8 million in 2022. McLeod’s annual debt service is approximately $21 million or less each year, except for the MADS year of 2022. MADS for the OG is $15.9 million, yielding a stronger coverage ratio of 9.3x for the OG.

CONTINUING DISCLOSURE

McLeod covenants to provide annual audited disclosure within 180 days after fiscal year-end and quarterly disclosure within 45 days after each quarter-end. Disclosure includes financial statements, utilization, and management discussion and analysis. Fitch notes that disclosure has been thorough and timely, with good access to management.

Applicable Criteria

Additional Disclosures