Issue 12

With the highly anticipated second quarter 2020 earnings season over, S&P Global Ratings has been reflecting on the results, and exploring what it could mean for our ratings on companies in the various health care subsectors and their financial performance as they recover from the fallout of the COVID-19 pandemic.

Overall, health care issuer credit ratings have held up well amid the pandemic thus far, given the largely nondiscretionary nature of health care products and services compared with other industries. This is evident by the rapid recovery of patient volumes as markets reopened. Though the weak second quarter results reflected the trough of the pandemic, it also highlighted its briefness because the recovery in volumes was well underway by June. Volumes dramatically improved into the third quarter before plateauing in July and August, coinciding with the summer surge in COVID-19 cases.

At the trough, patient volume dropped precipitously, depending on the service. Hospital admissions, for example, bottomed at roughly 56% below average pre-COVID-19 levels, while other services like outpatient surgery, which is more of an elective, tumbled up to 90% or more, depending on location. To underscore the magnitude of recovery, admissions are now only a few percentage points to about 10% below pre-COVID-19 levels, while outpatient surgery is now close to pre-COVID-19 numbers. As a result, we've updated our recovery timelines (estimating when operational results will recover to near-2020 expectations) on six of the 25 health care subsectors, each by half a year (see chart) compared to our initial recovery estimates (see "Health Care Credit Beat: Industry Recovering From COVID-19, But Timelines Vary and Ailments Abound," published June 25, 2020). Of note is that for three of the subsectors (i.e., laboratories, dialysis, and life sciences and diagnostics), we updated our recovery timelines, essentially indicating a full recovery by year-end, with the pandemic having minimal to moderate impact on health care ratings. Previously, we only saw the pharmaceutical and pharmaceutical-related subsectors as having that much resilience, allowing for revenue to be less negatively affected. Furthermore, while we adjusted timelines positively for only six subsectors, we did not adjust any further out.

Additional Negative Ratings Actions Are Unlikely Given Recovery

Second Quarter Earnings Observations

Trough levels reached, rebound underway

Procedure volumes rebounded sharply, and many medical device companies reported volumes within 10%-20% of normal levels by late second quarter, depending on the procedure. This is well above the lows experienced in the March-April timeframe, when volumes dropped upward of 90% for some highly elective services such as outpatient surgery. Emergency medical services remain relatively weak, at less than 15%-20% pre-COVID levels. We expect recovery to trend more gradually, with operating performance returning to near pre-pandemic levels by late 2021.

Recovery timeline updated, end-2021 envisioned

Based on second quarter results, S&P Global Ratings expects accelerated recovery timelines for six subsectors and we believe the industry will largely recover by end of next year.

Surge in COVID-19 cases in some regions concerning, but limited

There is some concern regarding the spike in COVID-19 cases in some regions that may lead to backsliding in procedure volumes. However, we believe it will have a much more muted impact compared to earlier in the pandemic because providers are likely more prepared to deal with the repercussions.

Life science, diagnostic, and laboratory testing are bright spots

Most health care subsectors suffered setbacks from the pandemic, including the largely insulated pharmaceutical industry (e.g., product launch and promotion delays, as well as fewer new prescription-generating doctor visits). However, select industries, such as life sciences, benefitted on a net basis because pandemic-related tailwinds more than offset headwinds. We expect this to continue for the balance of 2020.

We're still waiting for a vaccine

A full recovery won't likely occur until there's a COVID-19 vaccine, which we aren't expecting to be widely available until the second half of 2021. Still, given the relatively rapid recovery of patient volumes and procedures and an ongoing gradual recovery--assuming no significant backsliding due to regional outbreaks--we don't expect any additional downgrades at this time even without a vaccine.

The U.S. recession and unemployment fosters uncertainty

According to a recent estimate by the nonprofit, nonpartisan consumer health advocacy organization Families USA, 5.4 million Americans lost health insurance due to furloughs and layoffs between February and May this past year, pushing the number of uninsured in the U.S. to an estimated 33.5 million, an increase of more than 19%. The adverse change in payors mix and likely increase in charity care will mean greater uncertainty for health care providers. And while health care is largely insulated from economic downturns, the pandemic has highlighted the still significant discretionary aspects of health care. How the recession and unemployment colors the health care discussion in Washington remains to be seen.

As a result, health care remained in the middle of all industries in terms of negative ratings actions and outlook revisions (see "COVID-19 Weekly Digest: September 9, 2020"), with no COVID-19-related downgrades since mid-May (see complete list at end of report). However, despite the emerging stabilization of earnings and stable rating outlooks, we believe there's still a lot of uncertainty, as reflected in the few positive rating actions and outlook revisions (i.e., returning ratings to a stable outlook after revising them to negative during the early part of the pandemic). There have been only four thus far: We removed the ratings on one company (Athletico) from CreditWatch with negative implications and assigned a negative outlook. In another action (NN Inc.), we revised the CreditWatch implications to developing from negative due to an announced divestiture to reduced debt.

And while we shortened the timelines of six subsectors, the recovery timelines for all the subsectors remain in flux, given the still considerable uncertainty.

The recovery in hospital-based patient and procedure volumes was better than we expected. But an undetermined portion of the recovery was likely due to previously delayed procedures returning. After this backlog is worked through, recovery, estimated at 80%-90% of pre-COVID-19 levels in late June, may decline again, though we don't believe it will deteriorate anywhere near early pandemic levels. Still, even if we assume the recovery plateaus at current levels, 10%-20% below normal levels is still significant, especially given the uncertain timeframe for a complete recovery. The recent outbreaks in some states and regions such as Texas, California, Florida, and parts of the U.S. Sun Belt, along with the onset of the colder back-to-school months, and speculation about a second wave also add to the uncertainty.

With record unemployment comes record loss of health care coverage. While the U.S. has steadily improved from sky-high unemployment at the pandemic's onset, the pace of gains is slowing (see "U.S. Biweekly Economic Roundup: Job Gains Slow Amid Signs of a Long Recovery to Come," published Sept. 4, 2020). A recent Families USA report estimated that 5.4 million Americans lost health insurance coverage due to job loss between February and May, which puts the year on pace to be the biggest increase in uninsured in a single year. The recession and its impact on the more discretionary aspects of health care spending, such as physical therapy, dental, and ophthalmic, also bear watching.

Nevertheless, given the largely nondiscretionary nature of health care and with the assumption that health care providers are better prepared (e.g., stockpiling of personal protective gear and increased use of telemedicine) for a potential uptick in COVID-19 cases, the worst may be over. And while the industry may have to operate with ongoing significant demand shortfall for an extended period resulting in more strain on financials, possibly leading to more negative rating actions, it's still a better scenario than other more sensitive industries are experiencing.

Subsectors With Updated Recovery Timelines

Hospitals

Rapid recovery in patient volumes and procedures, CARES Act helped, but what next? 

Updated recovery timeline: the end of 2021 

Health care providers, such as hospitals, saw patient and procedure volumes collapse in late March and April during the early part of the pandemic, but they've been recovering quickly. June and July volumes are generally within 10%-20% of pre-COVID-19 levels, though emergency medical services continues to lag. We believe recovery has plateaued, but will pick up again gradually as the surge eases, and providers continue to improve health care delivery processes and procedures amid the COVID climate, and as patients get more comfortable accessing health care.

Looking into the second half 2020  There's significant uncertainty regarding the ongoing pace of recovery in patient volumes and procedures, whether it will plateau, or even backslide should there be another spike in COVID-19 cases. The CARES Act has been positive for the industry, helping bolster bottom lines and liquidity positions. The question remains though--is it enough? With the U.S. recession and unemployment levels, hospital companies' thin margins will have to likely absorb more charity care. We've shortened our recovery timeline given the better-than-expected recovery, but believe overall volume in 2021 will be still be weaker than pre-COVID-19 levels, possibly not returning to normal levels until late 2021. Furthermore, we believe the risks of possible lingering pandemic-related effects coupled with permanent changes in patient behavior could define a new normal with patient volume below our earlier expectations.

Related research 

• Tenet Healthcare Corp. Operating Results Are in Line with Expectations, Aug. 5, 2020
• Select Medical Corp. Posts Better-Than-Expected Second-Quarter Results as Patient Volume Recovers, Aug. 3, 2020
• HCA Healthcare Inc.'s Q2 Operating Results Indicate Resilience to The Pandemic Impact, July 22, 2020

Physician Groups

Benefitting in wake of hospitals recovery. 

Updated recovery timeline: End of 2021 

The shortened recovery timeline for physician groups mirrors that of hospitals and health systems because demand for their services recovers along with patient volumes and elective procedures.

Looking into the second half 2020  Physician groups face the same uncertainties as hospitals and health care systems--a stalled recovery or potential backsliding in patient and procedure numbers. Also, we believe physician groups' performance, similar to other subsectors that service the hospitals such as medical staffing companies (recovery in mid-2022, unchanged), is highly dependent on the mix of specialties offered and regions served. Furthermore, there is a potential delayed effect, because hospitals will likely look to their internal staff before looking outside.

Related research 

• U.S. Health Care Staffing Companies See A Rough Road to Recovery, Filled with Detours, Risks, And Behavioral Changes, June 18, 2020

Lifesciences and diagnostics

Tailwinds offset headwinds in industry, looks to continue.  

Updated recovery timeline: End of 2020 

Lifesciences and diagnostics is one of the health care subsectors that may benefit from the pandemic. While the industry has faced headwinds from reduced activity at government and academic research labs and also from the drop in pre-procedure testing due to lower patient volumes and elective procedures, there has been a significant increase in demand for COVID-19-related diagnostic testing and vaccine research activity. Products required to produce the billions of doses of vaccine, once it is approved, will also be a tailwind. In the meantime, research lab activity is steadily returning, especially in Western Europe and China.

Looking into the second half 2020  While we remain cautious about returning rating outlooks to stable on COVID-19-affected companies currently with negative outlooks due to ongoing uncertainties, we did return the outlook on PerkinElmer Inc. to stable from negative, because we believe demand for the lifesciences and diagnostics subsectors can be more accurately estimated. We don't see the increased demand for pandemic-related testing and vaccine manufacturing products subsiding in the second half of this year into early next year. We also believe research lab activity and elective procedure volumes should hopefully stabilize, if not near normalization. Still, even though this subsector's demand is easier to predict, companies are hesitant to provide full-year guidance.

Related research 

• PerkinElmer Inc. Outlook Revised to Stable from Negative on Strong Second Quarter; 'BBB' Rating Affirmed, July 31, 2020
• Danaher Corp.'s Second-Quarter Earnings Release Highlights Its Solid Revenue Growth And Strong Cash Flow Generation, July 23, 2020
• Thermo Fisher Scientific Inc.'s Second-Quarter Sales Grow On COVID-19-Related Demand, July 22, 2020

Laboratories

Increased demand for testing  

Updated recovery timeline: End of 2020 

Similar to the dynamic seen in the life science and diagnostic subsector, laboratory testing companies have seen a net benefit from the COVID-19-related tailwind. Increased testing volumes related to the pandemic will likely persist for at least the next several quarters and the ongoing recovery in patient volumes and procedures, while still below normal levels, will further aid performance.

Looking into the second half 2020  We project the current COVID-19 tailwind for testing to continue into the second half of 2020 and potentially into 2021, especially as people return to work and school and doctors' offices re-open and testing becomes more widely available. Reimbursement rates on tests and testing capacity are wildcards. However, demand should remain strong and the Center for Medicare and Medicaid Services (CMS) has been supporting expanded testing, recently requiring COVID-19 testing of staff at long-term care facilities.

Related research 

• Quest Diagnostics' Test Volume Declined Substantially in March but Should Improve in The Third Quarter, Rating Unchanged, April 29, 2020

Dialysis

Margins remain steady, despite disruption. 

Updated recovery timeline: End of 2020 

Patients didn't skip dialysis-related visits, given the nondiscretionary nature of the service. Dialysis operators experienced some weaker volume growth due to mortality but this didn't impair their credit quality. At the onset of the pandemic, we were closely watching the detrimental effects on margins and efficiencies due to the extra costs needed to ensure safety and disruption. However, the industry's major players, DaVita Inc. and Fresenius Medical Care AG & Co. KGaA, have since reported results that reflect the pandemic's impact, but remain largely in line with our expectations. DaVita actually raised its full-year margin guidance despite COVID-related costs, given successful cost control and labor productivity measures, which offset the fallout. Fresenius generated strong cash flows from its Fresenius Medical Care North American dialysis business, due partially to advanced payments under the CARES Act.

Looking into the second half 2020  The sustainability of cost-saving measures remains uncertain, especially if the pandemic continues or worsens as we enter the flu season. The bigger risk is the potential increase in unemployment and related loss of insurance for Americans, which could also lead to adverse mix changes.

• DaVita Inc.'s Higher Guidance for Margin and Cash Flow A Positive Surprise; Payor Mix And Financial Policy Risk Remain, July 30, 2020
• Fresenius SE & Co. KGaA -- full analysis, July 15, 2020

Contract Research Organizations (CROs)

Moderate impact to 2020 results, recovery in 2021. 

Updated recovery timeline: Mid-2021 

Disruption to ongoing clinical trials--delayed clinical trial starts, patient recruitment issues, and clinical sites closure--hurt contract research organization's (CRO) results in the second quarter and will likely do so into the second half of the year. Some companies have also benefitted from COVID-19-related clinical trial work, though we see it as more short term and unlikely to fully offset headwinds.

Looking into the second half 2020  There will be ongoing pressure on operating results, depending on the severity of the pandemic and each company's ability to control costs and adopt remote clinical trial monitoring. However, pharmaceutical companies are continuing to authorize new clinical trials and we expect a quick rebound in 2021. We didn't take any negative rating actions in the subsector during the pandemic's peak, and we believe there won't likely be any for the second half 2020 and beyond, given that we can readily anticipate industry demand.

Related research 

• Parexel International Corp. Outlook Revised to Positive from Stable on Solid Cash Flow, Improving Business Trend, Aug. 26, 2020

Subsectors With Unchanged Timelines

Pharmaceuticals – Branded and Generic

Negatively affected, but remains largely insulated.  

Recovery timeline: End of 2020, unchanged. 

We viewed the pharmaceutical and pharmaceutical-related subsectors, including drug distributors, pharmaceutical benefit managers, and contract research organizations, as among the most insulated of the health care industries from the pandemic's repercussions, as far as earnings and ratings go. And that has largely been the case, with only one pandemic-related negative rating action (Arbor Pharmaceuticals Inc.).

There were some reverberations in the pharmaceutical industry stemming from the pandemic, such as hampered new drug launches and promotion efforts, disrupted and delayed clinical trials, and less prescription-generating doctor visits. The vulnerability of pharmaceutical supply lines, notably for the high volume generic drugs that make up 90% of U.S. prescriptions, were also caught in the crossfire. This is especially concerning given the context of economic nationalism.

Still, the negative impact to the pharmaceutical industry was more limited (generally mid-single-digit revenue declines) relative to other subsectors, given that pharmacies remained opened, prescriptions were readily delivered by mail, and the increased use of telemedicine offset a significant portion of the plunging doctor office visits.

Looking into the second half of 2020  We still expect the pharmaceutical industry to largely recover to pre-pandemic levels by the end of the year, with few, if any more rating changes. Though we think it's unlikely until mid-2021, the successful launch of a COVID-19 vaccine would not only result in significant sales for select players, but also improve the badly bruised public image of the pharmaceutical industry and perhaps slow the momentum behind potential drug pricing legislation.

Medical Devices and Products

Results encouraging, but caution still. 

Recovery timeline: Mid-2021 to early 2022, depending on subsector, unchanged.  

By the end of the second quarter, health care procedure volumes strongly rebounded and results indicated a somewhat faster-than-expected recovery. We have some evidence that many procedures are being performed at rates as high as 90% of pre-COVID levels, indicating significant improvement from March and April, when procedure volumes declined as much as 50%-70%. However, we remain cautious about the second half, because we attribute some fast recovery to pent-up demand from rescheduled procedures. We believe that in many therapeutic areas, new patients are still reluctant to undergo medical procedures, especially in an inpatient setting, and the numbers may plateau below pre-COVID-19 levels.

Though federal aid from the CARES Act has helped, hospital budgets are going to be pressured over the next year, especially as the government funds dissipate. This will also mean less demand for diagnostic hardware, because hospitals will likely likely put off upgrades. In addition, we anticipate that companies are likely going to resume mergers and acquisitions and pursue strategic goals, which may put additional pressure on leverage and ratings. For a more in depth discussion on the medical devices and related industries, please see "Medical Devices, Life Sciences: Improving Vitals, Ratings Remain in Guarded Condition", published Sept. 10, 2020.

Looking into the second half of 2020  Given our base case, and the potential headwinds we envision for the companies we rate, we aren't revising our negative outlooks just yet. However, we expect to do so after at least one or two quarters as companies progress down their recovery paths. We'd like to see the number of procedures stabilize, if not improve. We'd also like to see financial policies regarding the resumption of share repurchases and acquisitions before revising outlooks to stable.

Related research 

• Becton Dickinson & Co. Operating Results Are Consistent With Expectations; Growth In Some Businesses Offset Losses, Aug. 7, 2020
• Zimmer Biomet Holdings Inc. Procedure Volumes Are Improving, Though Uncertainties Remain, Aug. 4, 2020
• Stryker Corp.'s Second-Quarter Results Are Consistent With Our Expectations, July 31, 2020
• Baxter International Inc.'s Second-Quarter Operating Results Indicate It Is Well Positioned To Withstand the Pandemic, July 30, 2020
• U.S.-Based Boston Scientific Corp.'s Second-Quarter Operating Results Are Consistent With Our Expectations, July 29, 2020
• Koninklijke Philips N.V.'s Diverse Business Model Helps Moderate COVID-19's Effects, July 21, 2020
• Abbott Laboratories' Second Quarter Results Consistent With Our Expectations; Long-Term Leverage Targets Intact, July 16, 2020

Ophthalmic

Visibility in the vision care business remains low. 

Recovery timeline: End of 2021, unchanged.  Our view of the ophthalmic and vision care recovery timeline remains the same even though second quarter results were decidedly mixed in contrast to other subsectors with encouraging second quarter results and unchanged recovery timelines. A portion of the business, such as cataract surgery, is nondiscretionary and delayed procedures are occurring. However, a significant part of the business, such as contact lens and lens solutions and laser eye surgeries, are discretionary and lost sales (reduced lens wear from people working more from home) are irreplaceable.

Looking into the second half of 2020  Predictability for a large part of the subsector remains low relative to other health care subsectors and results may less than expected in the second half. Major players, such as Bausch Health Companies Inc. and Alcon Inc will have to continue relying heavily on their non-ophthalmic businesses and strong liquidity to protect ratings. We believe both companies have significant cushion, even if hit with another severe pandemic-related downturn, though unlikely.

Related research 

• Bausch Health Companies Inc. Planned Spinoff Overshadows Underwhelming 2Q Results; 'B+' Rating Unchanged, Aug. 26, 2020
• Alcon’s Solid Liquidity Should Help It Weather Near-Term Challenges, April 8, 2020