Fitch Affirms Bupa at 'A-'; Outlook Stable
The ratings reflect BF's ability to operate successfully in the highly competitive market for private medical insurance and related services and to develop its business model outside its core established markets. Following a period of significant acquisitive growth, BF's business risk profile has improved as a result of greater geographical and vertical integration with a strong brand at the core of its operations. BF's operations also benefit from favourable demographics in the form of an ageing population, wider access to healthcare and an increasing acceptance in developed markets that healthcare will need to be subsidised by private payments in times of pressure on public finances.
Fitch's views the financial/rating headroom of the group as constrained as the company integrates recent acquisitions and invests to boost its competitive position on international markets. The Stable Outlook, however, reflects our expectation that strong cash generation will continue to facilitate deleveraging over the next four years, keeping the financial risk profile consistent with the ratings.
KEY RATING DRIVERS
Business Model Strengthened by Acquisitions
Fitch views the recent acquisitions as beneficial for BF's business profile, offering greater diversification, access to growth markets, and mitigating some of the risk associated with a monoline insurer.
The ratings are supported by BF's strong market positions in the core private medical insurance (PMI) markets of the UK, Australia and Spain. Furthermore, the company benefits from geographical diversification in terms of economic wealth, customer and fiscal incentives for PMI. The ratings also benefit from BF's strong market positions in the fragmented UK and Spanish care home markets, where it is the second-largest market player.
Fitch expects BF's deleveraging to continue following seven acquisitions over 2013 and 2014, which resulted in a net cash outflow of GBP1.3bn. Adjusted net debt/EBITDAR peaked in 2014 at 2.1x (2013: 1.9x), temporarily breaching Fitch's negative leverage guidance of a maximum 2.0x compatible with the company's 'A-' IDR. EBITDAR fixed charge cover also weakened during the year to 4.1x (2013: 5.1x) due to higher financial charges associated with more expensive drawings to fund the acquisitions. The Stable Outlook, however, reflects Fitch's assumptions of annual funds from operations (FFO) of more than GBP1.0bn over the period between 2015 and 2018 and the expectation that leverage will reduce by 0.5x over the next 18 months to levels more aligned with current ratings as BF invests in its products and healthcare offers in newly entered markets, which will contribute more profits. This is in spite of slightly elevated capex over 2015 and 2016 (estimated at 3-5% of sales).
Solvency Regulation Changes Affect Strategy
Fitch recognises BF's advanced state of preparations for the introduction of new regulatory capital requirements (Solvency II, currently planned to come into force in January 2016). We believe that as a result of potentially more stringent regulatory capital requirements prescribed by Solvency II the company might over the coming months review its business mix and balance sheet structure. Still, in affirming the insurance businesses' ratings, Fitch has taken comfort that BIL is likely to maintain its currently conservative approach to capital and leverage.
Fitch analyses BF both on a stand-alone basis excluding its subsidiary operating in the insurance business, Bupa Insurance Ltd. (BIL), as well on a consolidated basis (see rating action commentary ''Fitch Affirms Bupa Insurance Ltd IFS at 'A+'; Outlook Stable dated 11 September 2015). The strength of BIL's financial profile means that currently its ratings are based primarily on the insurer's standalone characteristics and Fitch views its ownership by BF as neutral to BIL's ratings.
Adjustments to Reported Financial Items
In assessing BF's IDR, the consolidated cash flow figures for the group are adjusted for restricted cash flow and restricted cash at Bupa PMI level (GBP1,831 in FY14) - as a result of regulatory requirements for these businesses. Regulation requires that BF holds a certain amount of cash in its PMI business subsidiaries in proportion to their scale of operations. As a general rule, if the profitable insurance businesses grow in a year, the amount of cash that each individual company needs to keep will also increase. Consequently some of the cash flow has to be left in these entities each year and is not available for debt reduction at BF. The increase in restricted cash flow is hence deducted from EBITDA. Fitch also includes the cash interest received by BF as part of group operating income, as it belongs to the business of an insurance company for investment. Accordingly, Fitch calculates an adjusted EBITDAR for FY14 of GBP1,006m after a net GBP3m adjustment (Fitch added back financial income before return-seeking assets and deducted GBP64m in restricted cash).
Fitch views BF's liquidity as adequate based on the availability of a GBP800m revolving credit facility due in 2020 which was undrawn at end-2014. BF has completed the refinancing of recent acquisitions in 2014, lengthening its maturity profile and lowering the cost of debt. Its 2016 GBP350m bond maturity is covered by sufficient available liquidity.
Fitch's expectations are based on the agency's internally produced, conservative rating case forecasts. They do not represent the forecasts of rated issuers individually or in aggregate. Key Fitch forecast assumptions include:
-Group revenue growth supported by recent acquisitions and broader insurance and healthcare product offerings
- Stable EBIT margins of 6.5% over the four-year rating horizon
-Revenue exposed to FX volatility resulting in continued FX translation risks.
-Capex remains elevated over 2015 and 2016 (estimated at on average around 5% of sales p.a.) as BF continues to invest in product offering and associated services post acquisitions. We then assume investments will taper off to a more sustainable 3.5%-4% of sales.
-Bolt-on acquisition spending assumed at below GBP50m, moderate working capital requirements.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
A change in adjusted net debt/EBITDAR to above 2.0x (or funds from operations (FFO) adjusted net leverage of 2.5x) and EBITDAR net fixed-charge cover of below 5.0x (or FFO adjusted fixed charge cover of 4.5x (2014: 4.1x) on a sustained basis, for example, as a result of inability to deliver on projected growth and/or in case of large capex
-Higher-than-expected investments affecting free cash flow
-Delay in, or negative cash flow impact associated with, integrating recent acquisitions and implementation of Solvency II capital requirements
Positive: Fitch sees a positive rating action currently unlikely given constrained financial headroom post-acquisitions and ahead of regulatory changes associated with Solvency II rules.