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Fitch Rates Voyage Care Bonds 'BB-'/'B-'
May 24, 2017 / 4:42 PM / 7 months ago

Fitch Rates Voyage Care Bonds 'BB-'/'B-'

(The following statement was released by the rating agency) LONDON, May 24 (Fitch) Fitch Ratings has assigned Voyage Care Bondco PLC's GBP215 million senior secured notes an instrument rating of 'BB-' with a Recovery Rating of 'RR1' (100% recovery rate in the event of default) and GBP35 million second lien notes an instrument rating of 'B-' with a Recovery Rating of 'RR4' (33% recovery rate). Fitch has also affirmed the 'B-'Long-Term Issuer Default Rating (IDR) for Voyage Bidco Ltd. (Voyage) with Stable Outlook. The new notes were used to refinance Voyage's existing GBP222 million senior notes maturing in August 2018 and GBP50 million second lien notes maturing in February 2019. These notes were redeemed on 13 May 2017. In addition, the refinancing saw an equity contribution of GBP28 million into the business and provided a GBP45 million revolving credit facility (RCF), resulting in slightly better rating headroom. The transaction has addressed Voyage's short-dated capital structure and improved the company's liquidity profile over the medium term. The modest equity injection as well as the lower senior and second lien debt amounts, have been reflected in our updated Recovery Ratings. We base our recovery analysis on a liquidation approach given Voyage's significant owned real estate portfolio. KEY RATING DRIVERS Significant Asset Base: The instrument ratings and recovery prospects of Voyage are underpinned by its ownership of 90% of its registered properties. Valued at GBP360 million in November 2016 (freehold and long leasehold assets), Voyage's strong portfolio of freehold assets properties gives the company greater operating flexibility due to lower rental costs. This underpins our superior recovery expectations for the secured notes, which are reflected in the instrument rating being three notches above the IDR. Fitch bases its recovery analysis on the company's underlying asset values, by applying a liquidation approach. Average Recovery Prospects for Second Lien Notes: Based on our recovery assumptions, the second lien notes carry moderate recovery prospects in a default scenario given their subordination to the super senior RCF and senior secured notes in the debt waterfall. This is reflected in the instrument rating of 'B-'/'RR4'. Pressure on Credit Metrics: Fitch conservatively expects funds from operations (FFO) adjusted net leverage to peak at above 7.5x in financial year ending March 2018 (FY18), with only gradual and modest deleveraging thereafter. The anticipated increase in leverage and weak free cash flow (FCF) generation, together with FFO fixed charge cover of just above 1.5x, underpin the IDR of 'B-'. However, we expect slightly better financial flexibility by way of lower interest costs leading to improved free cash flow (FCF) generation and FFO fixed charge cover trending towards 2.0x by FY19. Diversified Services Support Credit Profile: Voyage's business risk profile is supported by a diversified service offering covering the full spectrum of social care needs for people with learning disabilities in either a registered care home, a supported living setting or as outreach services. Voyage's service line diversification provides resilience to the tightening in registered care homes eligibility criteria set by local authorities as they move towards less costly options such as supported living and domiciliary care. Meaningful Execution Risk: Voyage's strategy is to expand substantially its community-based care services business, which bears some execution risks in our view. However, Fitch sees Voyage's ability to offer the full service spectrum to local authorities as a key competitive advantage compared with smaller, less diversified players. Dependence on Local-Authority Funding: Voyage's ratings are constrained by a high dependence on local government, which accounts for around 90% of the company's funding. Due to the current reduction in UK local-authority budgets, Fitch expects the average level of fees paid by them to remain under pressure. The implementation of the council tax precept (an option to increase council tax with revenues ring-fenced for social care) by the majority of local authorities has resulted in an increase in average fees, although not sufficient to compensate fully the existing underfunding of care, which has been exacerbated by the introduction of the National Living Wage. As a result, Fitch expects Voyage EBITDA margin to remain under pressure. Volatile Outlook for UK Social Care: The UK social care market will remain difficult, entering a period of short-term volatility, characterised by continued growth in demand, further expected wage inflation and potentially widening labour shortage as a result of the focus on limiting immigration. Fitch is sceptical about the current political will and ability to address the long-term funding issues given the current political priorities relating to Brexit and the uncertainty it presents to the long-term planning of public finances. In Fitch's opinion, this will remove some of the visibility for the sector and increase short-term volatility, which could delay any further consolidation in the short term. The subject has, however, gained greater prominence in the political debate and is emerging as a central topic in the run-up to the general election in June 2017. DERIVATION SUMMARY Fitch has observed significantly pressures on ratings in the UK leveraged care home sector that has been affected by a reduction of local authorities' fee rates in real terms, with pressures on profitability exacerbated by increasing costs as a result of the increase in the National Living Wage from April 2016. This has led to impaired profitability across the sector as cost inflation could not be passed on to payers, increasingly threatening the underlying business model of operators and making leveraged capital structures increasingly unsustainable. However, immediate funding pressures have eased as local authorities are now able to raise the social care council tax precept, which - as it is applied cumulatively over years - has alleviated imminent funding shortages. During late 2016 the sector saw for the first time funding increases, predominantly in areas of most critical needs such as elderly services. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: -Increase in sales by 3% in FY17, 6% in FY18 and around 12% thereafter, mainly driven by a significant growth of community-based care services through tender wins, together with an average 2%-3% increase in local-authority average weekly fee funding the registered care division; - EBITDA margins declining to 14.1% in 2020 from 20.3% in 2016 mainly due to a shift in Voyage's business mix with an expansion of the community base care services division which is expected to represent 45% of Voyage Care revenue in 2020 compared with 25% in 2016. In addition, payroll costs will rise due to the introduction of the National Living Wage in April 2016, which is not adequately compensated by the local authorities' increase in fees, especially for the Community Base Care Services division. - Capex at around 6% of sales up to FY18, 4% of sales thereafter. Capex is essentially maintenance capex, which is compulsory for the reputation and the occupancy rate of the business. - FCF generation flat during FY17 and FY18, followed by around 3% of sales on average. - No dividends paid. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action -Improving medium-term visibility around the sustainability of the UK social care business model, resulting in greater scale (EBITDA above GBP50 million) and/or improving profitability and cash generation along with: -FFO adjusted net leverage of 6.5x or below on a sustained basis; -FFO fixed charge coverage above 2.0x; -Sustained FCF generation translating into FCF margin of at least low -single digits as a percentage of sales. Future Developments That May, Individually or Collectively, Lead to Negative Rating Action -Further pressure on the UK social care business model, including Voyage's inability to reposition the business model towards the growth of the assisted living sector, leading to: -FFO adjusted net leverage trending above 8.5x on a sustained basis; -FFO fixed charge coverage sustainably below 1.5x; -Sustained negative FCF generation leading to weak liquidity buffer. LIQUIDITY Fitch considers Voyage's liquidity is satisfactory with cash on balance sheet of GBP28 million post-refinancing, together with committed undrawn RCF of GBP38 million. Voyage does not have meaningful debt maturities in the near-term as the group's newly issued GBP215 million senior secured notes and GBP35 million second lien mature in 2023. Contact: Principal Analyst Louise Liu Analyst +44 203 560 1660 Supervisory Analyst Frank Orthbandt Director +44 20 3530 1037 Fitch Ratings Ltd. 30 North Colonnade London E14 5GN Committee Chairperson Pablo Mazzini Senior Director +44 203 530 1021 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: Summary of Financial Statement Adjustments - Fitch adjusts financial leverage for annual lease obligations capitalising these with a multiple of 8x. We also consider GBP2 million of cash as restricted, absorbed by the group's working capital needs. 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