Heightened Credit Risk in the Post-Acute Healthcare Industry
In 2016, there were more than 50 million people 65-or-older living in the United States. Although the post-acute healthcare industry is still growing along with its prime customer base, this fiercely competitive service industry remains a highly fragmented market. Recent industry trends have operators promoting a mixed use of facilities, such as child day care, in order to diversify revenue streams against regulatory headwinds. Select names have performed adequately in this environment, but others, like Genesis Healthcare Inc. (NYSE: GEN), have become increasingly distressed.
Thousands of CreditRiskMonitor subscribers use the FRISK® score to help identify public company default and bankruptcy risk before it occurs. We suggest that risk managers review financial counterparties when they fall into the high-risk "red zone," which is defined as a score of “5” or below on the “1” (worst) to “10” (best) scale. Genesis Healthcare, which is deep in the red zone is a prime example of a skilled nursing name that shows increasing strains in the post-acute healthcare industry.
Skilled nursing facilities are expected to be the slowest growth category in the post-acute healthcare space for the foreseeable future. According to the National Center for Assisted Living (NCAL), skilled nursing costs are nearly twice as expensive as all other categories in this space. The median cost of skilled nursing is approximately $87,000 per year for a single room, well above what most can afford. In other words, there's an incentive to limit the use of the service.
That remains true even though paying for a nursing home stay is largely covered by government funded Medicare and Medicaid. Over the last three years, regulatory changes have unfavorably affected key revenue drivers such as occupancy rates, length of stay and payment mix. At the same time, higher operating costs have also compressed margins, mostly due to increased labor costs and lease rates as well as stricter requirements in the quality of care.
Genesis Healthcare currently maintains a FRISK® score of "1," the lowest possible rating on our scale. This classification suggests that there is a 10-50% probability of bankruptcy in the upcoming 12-month period for Genesis. The key considerations in their bottom rung FRISK® score include: deteriorating market sentiment, weak financial ratios and a negative signal from CreditRiskMonitor's proprietary subscriber crowdsourcing.
The FRISK® score's incremental decline from "4" mid-year to "1" today has given risk managers a timely indication of increasing financial risk attached to Genesis. We think it makes sense to dig further if you are doing business with this company.
For this industry specifically, the non-GAAP measurement known as EBITDAR is used for maintaining compliance with debt and lease covenants. This metric effectively backs out interest costs, taxes, depreciation, amortization and rental expenses from the bottom line. For the nine months ended 2017, Genesis' EBITDAR declined approximately 9.4% on a year-over-year basis. The company also recorded impairment charges totaling $523.4 million in the third quarter related to facility divestitures and the write down of goodwill.
Moving onto the balance sheet, Genesis has taken on a substantial amount of leverage. Here we are paying attention to the total-debt-to-total-asset ratio, as this considers the company's debt financing and capital lease obligations. Notice the trend for the third quarter on a year-over-year basis, which now stands at approximately 102%:
With the company realizing revenue declines and incurring higher operating costs, EBITDAR margins have been under constant pressure.
Management actually stated in its third quarter MD&A that the existing capital structure may prove to be unsustainable: “As currently structured, it is unlikely that we will be able to generate sufficient cash flow to cover required financial obligations, including our rent obligations, our debt service obligations and other obligations due to third parties.” With this in mind, management may have to work tactically with creditors and lessors in order to avoid triggering a financial default or a bankruptcy filing.
Defaults and bankruptcies are perceived to be uncommon among large publicly traded companies, but it occurs far more often than many credit and procurement managers think. Unfortunately, events like these usually impact financial counterparties in a material way. With respect to trade creditors, public companies account for more than 53% of dollar exposure on average.
Genesis Healthcare is one of the largest skilled nursing facility operators in the United States. There could be a slew of suppliers, service providers and healthcare real estate investment trusts impacted by its deteriorating business prospects. The FRISK® score provided, and continues to provide, an excellent warning signal given how dire the situation has become for this name over the course of the last 12 months.
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