Rating action

Scope Ratings has today assigned a first-time issuer rating of BB to JSC Evex Hospitals (Evex). The agency also assigned a first-time rating of BB to senior unsecured debt issued by JSC Evex Hospitals. The Outlook is Stable.

Rating rationale

Scope has rated Evex’s business risk profile at BB. The company’s underlying industry of healthcare services has relatively favourable credit characteristics including a low macro-economic cyclical exposure, medium market entry barriers, and medium substitution risk. These factors translate into an overall industry risk rating of A. Regarding competitive position, Evex’s market shares and comparatively high operating margins provide the strongest support for the ratings. With about GEL 300m of revenues expected for 2019, the company holds a market share of more than 20% in Georgia. Sales and capacity utilisation of beds are expected to already grow significantly in 2019 after the recent modernisation and expansion programme. This makes it likely that market shares will continue to rise, helping Evex to maintain its strong national lead.

With a 2018 EBITDA margin of about 28% (28% in the first quarter of 2019), Evex’s operating profitability compares well not only to domestic peers but also to much larger international ones such as Mediclinic or Helios. The strong profitability reflects both its scale and the looser regulation in Georgian healthcare services than in Western markets.

Evex’s diversification is weaker than that of larger multinational peers, given its focus on one country and one industry (health care). This might improve in the future following plans to increase the sales share of ‘medical tourism’, by attracting wealthy patients from neighbouring countries such as Armenia and Azerbaijan. This business will take some years to grow in relevance, currently it is at less than 5% of company sales. Scope believes that the company’s diversification within hospitals is good, with a treatment area exposure that is much stronger compared to its domestic peers’. Evex is presently most exposed to the Georgian state in terms of the payor structure. The national healthcare insurance, UHC, accounts for about two-thirds of Evex’s annual revenues. This is credit-positive due to regulatory transparency and the state’s ability to pay, assuming the country’s positive economic development is maintained. However, management is seeking to expand its private sector exposure as this would accelerate cash inflows and decrease UHC dependence.

Evex’s financial risk profile (rated BB) is the same quality than its business risk profile. The company’s solid operating profitability, with an EBITDA margin of about 28%, is likely to enable significant free cash flow generation in 2019. This was not the case in the previous three years due to Evex’s modernisation and expansion programme that ended in 2018. Capex of about GEL 50m in 2018 (compared to an annual maintenance capex of about GEL 10m) still resulted in negative free operating cash flow of GEL-12m last year. Consistently negative working capital via high receivables are the result of the delayed payment policy by state insurance (five months) – the negative aspect of UHC dependence. In 2018, credit metrics were thus depressed but still reflected a low BB credit quality on average. Due to a 20% increase in EBITDA during 2017, leverage as expressed by Scope-adjusted debt/EBITDA was 3.3x. To offset the effect of high capex in 2018, Evex’s sole owner, GHG, increased equity by GEL 20m, which contributed to a GEL 14m deleveraging (on a net-debt basis). Scope views this as a strong commitment by GHG to keep credit metrics under control during the expansion programme. Management’s conservative financial policy is also reflected in no dividends having been paid during 2018.

Evex’s liquidity has just barely covered short-term debt in recent years. There are no committed credit lines, which appears in line with other Georgian companies rated recently by Scope. However, as 2018 was Evex’s first year as a stand-alone company and liquidity was addressed by its parent beforehand, there are good chances for substantial free cash flow generation going forward, and liquidity is likely to reach adequate levels. Evex’s short-term debt maturities stand at about GEL 20m. This is likely to reduce in the future given a successful bond placement, which is likely to replace several amortising bank loans.

For 2019, Scope expects strong revenue growth, already confirmed by the 16% growth in the first quarter. This is also likely to lead to a parallel increase in operating profits, resulting in a stable underlying EBITDA margin of about 28% for full-year 2019. Together with the normalisation of capex (GEL 12m assumed for 2019), this should translate into free cash flow of about GEL 40m in our base case. Significant deleveraging is thus possible, making improvements in 2019 credit metrics likely.

Scope’s projections on financial metrics for the next two years are conservative, reflecting the evolving dynamics of both the country of Georgia and the healthcare services sector.

Among the supplementary ratings drivers, Scope does not expect financial policy to be an issue. Evex is fully owned by GHG, which is focused on deleveraging and reaching a leverage of 2x by the end of 2020. There are no dividend expectations by the parent and Scope has therefore assumed zero for 2019 and 2020. Transparency is satisfactory, in Scope’s view, given Evex’s recent carve-out from GHG.

Scope calculates recovery values to bond holders in a hypothetical case of default. A recovery rate of about 60% was calculated for GEL 90m senior unsecured bond (existing bank loans rank ahead), based on a distressed EBITDA of about GEL 38m and an exit multiple of four in Scope’s hypothetical default case. While this would technically result in a one-notch uplift for the bond compared to the issuer rating, Scope decided not to apply it. This is because of the risk of an appreciation in foreign-currency-denominated debt, and the risks surrounding bankruptcy resolution in Georgia, an emerging market.

Rating-change drivers

• Positive: improved diversification; and FFO/Scope-adjusted debt (SaD) of above 35%, SaD/EBITDA of below 3x
   
• Negative: FFO/SaD of below 15%, SaD/ EBITDA of above 4x

Stress testing & cash flow analysis
No stress testing was performed. Scope performed its standard cash flow forecasting for the company.

Methodology
The methodology used for this rating and rating outlook Corporate Ratings is available on www.scoperatings.com.
Historical default rates of the entities rated by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/#governance-and-policies/regulatory-ESMA. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default as well as definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com.
The rating outlook indicates the most likely direction of the rating if the rating were to change within the next 12 to 18 months.

Solicitation, key sources and quality of information
The rated entity participated in the rating process.
The following substantially material sources of information were used to prepare the credit rating: public domain, the rated entity and Scope internal sources.
Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.
Prior to the issuance of the rating or outlook action, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds on which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Regulatory disclosures
This credit rating and/or rating outlook is issued by Scope Ratings GmbH.
Lead analyst Olaf Tölke, Managing Director
Person responsible for approval of the rating: Thomas Faeh, Executive Director
The ratings/outlooks were first released by Scope on 11 July, 2019.

Potential conflicts
Please see www.scoperatings.com for a list of potential conflicts of interest related to the issuance of credit ratings. Scope provided the following ancillary services to the rated entity and/or its agents within two years preceding this credit rating action: Credit Estimate

Conditions of use / exclusion of liability
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