[June 24, 2015]

Fitch Affirms Universal Health Services' IDR at 'BB+'; Outlook Stable

Fitch Ratings has affirmed Universal Health Services Inc.'s (UHS) ratings, including the Issuer Default Rating (IDR) at 'BB+'. A complete list of ratings follows at the end of the release. The ratings apply to approximately $3.1 billion of debt at March 31, 2015. The Rating Outlook is Stable.

KEY RATING DRIVERS

--UHS has the strongest balance sheet in the for-profit hospital sector, with total debt-to-EBITDA of 1.9x at March 31, 2015. Fitch expects UHS to operate with leverage between 2x and 3x over the ratings horizon.

--Unlike many of its peers, UHS has not engaged in large-scale acquisitions since its $3.1 billion purchase of Psychiatric Solutions, Inc. (PSI) in 2010. Fitch expects UHS to pursue more deals in 2015-2016, likely moderate-sized, targeted acquisitions. UHS has a good degree of flexibility in credit metrics at 'BB+' rating to incur additional debt to fund M&A.

--Cash flows are strengthening on a stabilizing acute care hospital business - aided by coverage expansion provisions of the Affordable Care Act (ACA) - and growing behavioral health operations. Free cash flow (FCF) totaled $682 million for the LTM period ended March 31, 2015. Fitch anticipates that UHS will generate solid FCF of around $800 million in 2015-2016.

--UHS behavioral health (BH) business accounts for more than half of the company's revenues, this diversification business model enhances financial stability and profitability. Good organic growth in the mid-single digits, driven by mental health parity rules and UHS' capacity growth initiatives, and moderately improving profit margins are expected over the ratings horizon for the BH business.

--UHS' same-hospital (SH) acute care admissions growth for the first quarter 2015 and fourth quarter 2014 were 4.3% and 3.5%, respectively. SH acute care admissions were flat in 2014 and 2013, but better than the 2% and 2.2% declines in 2012 and 2011, respectively. While some of UHS' largest acute care hospital markets were hard hit during the recession (Texas, Las Vegas), these markets have benefited the most from the good economic recovery, aiding in UHS' positive growth.

--Fitch views the ACA as a net positive for UHS and its hospital operator peers. Fitch expects net revenue growth from declining uncompensated care, on a fairly constant cost base, to drive an increase in absolute profits during 2015. Fitch thinks it is likely, however, that profit gains will begin to erode in later years due to a constrained healthcare reimbursement for the foreseeable future.

Potential for More, Larger Deals

Most large acute care hospital operators have been active acquirers and aggressive in recruiting physicians and expanding outpatient service line offerings over the last few years. UHS has instead directed most of its FCF toward debt repayment. Debt-to-EBITDA has declined to 1.9x at March 31, 2015 from nearly 5x (reported) at year-end 2010.

Each of UHS' acquisitions over the past four years has been of behavioral health targets, including the $500 million acquisition of Ascend Health Corporation in Oct. 2012 and the $431 million acquisition of Cygnet Health Care in September 2014. Going forward, most targets are likely to be in this range, with purchase prices of $300 million to $500 million, as well as small not-for-profit (NFP) hospitals or behavioral health operations of local NFPs below $100 million. Fitch does not expect UHS to engage another transformational deal - like the 2010 PSI acquisition - over the ratings horizon, partly because a lack of targets of that size in the fragmented behavioral health segment.

Despite the lack of capital directed toward M&A, UHS has been investing in its acute care business through capital expenditures. A new hospital opened in UHS' southern California market in second-half 2013. Furthermore, UHS reports that the majority of its discretionary capex is used for acute care facilities. It is possible that UHS could pursue acquisitions of acute care hospitals, as management has commented that purchase multiples seem to be moderating for possible targets.

SCOTUS Review of Health Insurance Subsidies

There remains a significant amount of uncertainty regarding the ACA's ultimate impact on the hospital sector. Most immediately, the upcoming SCOTUS decision on the legality of tax subsidies for health plan exchange plan enrollees, and future state Medicaid expansion decisions are major questions marks. However, any changes to the ACA are unlikely to be impactful enough to business profiles and financial flexibiliy to move the ratings of hospital companies in the medium term.

Improving Underlying Volumes; Pricing Dynamics from Expansion Coverage

Fitch believes that strength in organic volume performance in the acute care hospital segment is likely to persist in the first half of 2015, continuing from the positive volume performance in 4Q14 and 1Q15. In addition, the effects of the ACA health insurance exchange enrollments were muted in 1Q14, and there should be some ramp up given the strong uptake in public exchange plans during the second open enrollment period.

UHS is among the best-positioned for-profit hospital operators to benefit from lower bad debts due to the health insurance coverage expansion elements of the ACA due to its presence in states expanding their Medicaid programs, including Nevada and California. Fitch thinks EBITDA margins at UHS' acute care business could expand by 150-200 bps or more from 2013 to 2015. Such margin gain is expected to slowly erode in the years that follow, however, due to an overall constrained reimbursement environment and the expectation for inpatient volumes to remain relatively flat or slightly down for the foreseeable future.

KEY ASSUMPTIONS

Fitch expects low single digit organic topline growth in the acute care segment through the forecast period. This incorporates the assumption that both patient volumes and pricing will show some pull back from the strong results of the past couple quarters. Secular headwinds to growth in the hospital sector remain intact, comparisons will become more difficult in the second half of 2015, and the tailwind from the ACA health insurance expansion is likely to taper. The behavioral health segment will continue to contribute stability to UHS' operating profile.

Fitch forecasts EBITDA of $1.7 billion and free cash flow (FCF; CFO less capital expenditures and dividends) of about $800 million for UHS in 2015, including the contribution of recent acquisitions.

Fitch expects UHS' operating EBITDA margin to remain relatively flat in 2015 versus 2014. This is driven by the expectation for continued improvement in some of UHS' largest markets (South Texas, Las Vegas), tempered by some negative operating leverage as the recently very strong overall volume growth recedes.

Capital expenditures are forecasted at $400 million in 2015. The company deploys cash for both acquisitions and share repurchases; total debt is maintained at a level commensurate with the 'BB+' rating.

RATING SENSITIVITIES

Maintenance of a 'BB+' IDR will require a continued demonstrated commitment to operating with debt leverage below 3x, with FCF-to-adjusted debt of 8% or higher. Fitch notes that UHS' has good flexibility at the current 'BB+' ratings to consummate debt-funded M&A, especially as it supports longer-term growth in light of prevailing trends in healthcare (i.e. integrated care delivery, physician employment, outpatient service lines, etc.).

A downgrade of UHS' IDR to 'BB' could result from pressured margins and cash flows - or a large, leveraging transaction - that results in debt leverage expected to be sustained above 3x and/or FCF-to-gross adjusted debt below 8%. Margin and cash flow pressures of this magnitude are not likely occur abruptly, but could materialize due to severe pricing pressures or unfavorable large-scale reform of Medicare and/or Medicaid programs.

An upgrade of UHS' IDR to 'BBB-' is unlikely in the near-term, since UHS' current ratings and credit metrics provide the firm with flexibility to participate in the consolidation of the healthcare provider space, which Fitch expects to continue through the intermediate-term.

DEBT MATURITIES EXTENDED, LIQUIDITY SOLID

Available liquidity is sufficient. Though UHS does not usually carry large amounts of cash ($35 million at March 31, 2015), it maintains an $800 million revolver, of which $739 million was available at March 31, 2015. UHS also maintains a $360 million A/R facility, of which $35 million was available at March 31, 2015.

Debt maturities are manageable for the firm. The 2014 recapitalization transaction extended UHS' debt maturity wall out past 2016. The $400 million senior secured notes remain due in 2016, but the term loans and new secured notes do not start to mature until 2019.

FULL LIST OF RATING ACTIONS

Fitch affirms UHS' ratings and assigns Recovery Ratings (RRs) as indicated:

--IDR at 'BB+';

--Senior secured bank facility at 'BBB-/RR1';

--Senior secured bonds at 'BBB-/RR1';

The Rating Outlook is Stable.

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=986932

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=986932

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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