Research: Rating Action: Moody’s confirms Encompass Health Corp.’s Ba3 Corporate Family Rating, stable outlook


New York, June 29, 2022 — Moody’s Investors Service (“Moody’s”) confirmed Encompass Health Corp’s (“Encompass”) Ba3 Corporate Family Rating, Ba3-PD Probability of Default Rating, Baa3 ratings on the first lien senior secured revolving credit facility and senior secured term loan, and B1 rating on the unsecured debt. There is not change to the Speculative Grade Liquidity Rating at SGL-1 (very good). The rating outlook is stable. The ratings on the first lien senior secured term loan will be withdrawn upon close of the transaction. Today’s rating actions concludes the review of Encompass’ ratings initiated on February 4, 2022.

The rating action follows the completion of the spin-off of Encompass’ home health and hospice divisions that was first announced on February 2, 2022. The two businesses collectively represent about 22% of Encompass’ total revenue. The spin-off will become effective on July 1, 2022.

The confirmation of the Ba3 CFR reflects Moody’s expectation that the company’s pro forma, as of March 31, 2022, leverage will increase to 3.5x following the transaction. Governance risk considerations are material to the rating action as Encompass will use $570 million of proceeds from the spin to repay existing debt on its term loan facilities and draws on its revolving credit facility. Moody’s views the debt repayment positively compared to using the proceeds for other shareholder friendly policies. Moody’s forecasts that despite the spin-off resulting in an overall reduction of debt, Encompass will continue to invest in growth with new hospitals and capacity expansion at existing facilities, so leverage will likely remain in the 3.5x range. After the spinoff, Encompass will be less diversified and with reduced scale, but management will be more focused on the inpatient rehabilitation business, which should translate to improved profitability over the longer term.

The stable outlook reflects Moody’s expectation that Encompass will maintain solid credit metrics but will also remain highly reliant on Medicare and vulnerable to potential reimbursement changes. Moody’s anticipates that Encompass will continue to operate with leverage in the 3.5x range as labor pressures continue to compress margins and Encompass continues with its expansion plans.

Moody’s took the following rating actions:

Confirmations:

..Issuer: Encompass Health Corp.

…. Corporate Family Rating, Confirmed at Ba3

…. Probability of Default Rating, Confirmed at Ba3-PD

…. Senior Secured 1st Lien Revolving Credit Facility, Confirmed at Baa3 to (LGD2) from (LGD1)

…. Senior Secured 1st Lien Term Loan, Confirmed at Baa3 to (LGD2) from (LGD1)

…. Senior Unsecured Notes, Confirmed at B1 (LGD4)

Outlook Actions:

..Issuer: Encompass Health Corp.

….Outlook, Changed To Stable From Rating Under Review

RATINGS RATIONALE

Encompass Health’s Ba3 Corporate Family Rating reflects the company’s high exposure to Medicare reimbursement and the potential for adverse changes to Medicare rates for the company’s services. Moody’s believes that reimbursement for post-acute services could evolve in a way that would pressure Encompass’ margins. That said, CMS’proposed rule is contemplating an increase in rates in 2023, which should help partially offset higher costs related to labor pressures. Post spin of the home health and hospice divisions, Encompass will be smaller and less diversified but management will be more focused on the growth and profitability of the inpatient rehabilitation segment. The Ba3 CFR also reflects the company’s considerable scale and good geographic diversification with beds in 35 states including Puerto Rico.

There is no change to the company’s SGL-1 Speculative Grade Liquidity Rating reflecting the company’s very good liquidity, supported by stable, strong free cash flow and significant availability under its revolver. Moody’s does forecast some revolver usage to fund future growth, but Encompass should be able to maintain adequate covenant cushions.

The Baa3 rating on the first lien senior secured credit facilities is three notches above the Ba3 CFR reflects the loss absorption provided by the unsecured debt in Encompass’ pro forma capital structure. The B1 rating on the new senior unsecured notes is one notch below the CFR, reflects their junior position in the capital structure.

ESG risks considerations are material to Encompass Health’s ratings. As a for-profit hospital operator, Encompass faces social risk but less so than operators in the general acute care space. The affordability of hospitals and the practice of balance billing has garnered substantial social and political attention. However, this is less of an issue in the IRF space because the patient stays in these facilities are never a “surprise”. Encompass is reliant on government payors for a substantial portion of its revenue and any changes to reimbursement rates from Medicare or Medicaid directly impacts revenue and profitability. While there is no disclosed litigation or other contingencies, as a healthcare service provider, Encompass remains at risk to government investigations in regards to patient care. Encompass is also exposed to labor pressures and human capital constraints as the company relies on highly specialized labor to provide its services.

From a governance perspective, the company operates with moderately aggressive financial policies that include some debt funded M&A, particularly relative to its rated hospital peers. Moody’s forecasts leverage to remain about 3.5x as Encompass continues to invest in growth of the business.. Encompass is using the $570 million of proceeds from the sale of the home health and hospice divisions to repay debt, rather than to fund a dividend or other shareholder friendly policies.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

The ratings could be downgraded if operating performance weakens or if liquidity declines significantly, or if Moody’s expects adverse developments in Medicare reimbursement for IRFs. Specifically, a downgrade could occur if Encompass is expected to sustain debt/EBITDA above 4 times.

The ratings could be upgraded if the company’s debt/EBITDA approaches 3 times. Greater levels of business diversity or increased visibility into prolonged stability of Medicare reimbursement could also support an upgrade.

Headquartered in Birmingham, Alabama, Encompass Health Corp. is the largest operator of inpatient rehabilitation facilities including 150 hospitals in 35 states and Puerto Rico. Revenues are approximately $5.2 billion as of March 31, 2022 for the combined business, as of December 31, 2021 revenues were approximately $4.0 billion for Encompass inpatient rehabilitation business.

The principal methodology used in these ratings was Business and Consumer Services published in November 2021 and available at https://ratings.moodys.com/api/rmc-documents/356424. Alternatively, please see the Rating Methodologies page on https://ratings.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For further specification of Moody’s key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody’s Rating Symbols and Definitions can be found on https://ratings.moodys.com/rating-definitions.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody’s rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider’s credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the issuer/deal page for the respective issuer on https://ratings.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody’s Policy for Designating and Assigning Unsolicited Credit Ratings available on its website https://ratings.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody’s general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://ratings.moodys.com/documents/PBC_1288235.

At least one ESG consideration was material to the credit rating action(s) announced and described above.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody’s affiliates outside the EU and is endorsed by Moody’s Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody’s office that issued the credit rating is available on https://ratings.moodys.com.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody’s affiliates outside the UK and is endorsed by Moody’s Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK . Further information on the UK endorsement status and on the Moody’s office that issued the credit rating is available on https://ratings.moodys.com.

Please see https://ratings.moodys.com for any updates on changes to the lead rating analyst and to the Moody’s legal entity that has issued the rating.

Please see the issuer/deal page on https://ratings.moodys.com for additional regulatory disclosures for each credit rating.

Jaime Johnson
Vice President – Senior Analyst
Corporate Finance Group
Moody’s Investors Service, Inc.
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New York, NY 10007
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Ola Hannoun-Costa
Associate Managing Director
Corporate Finance Group
JOURNALISTS: 1 212 553 0376
Client Service: 1 212 553 1653

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