CHICAGO--(BUSINESS WIRE)-- Fitch Ratings' 2010 outlook for the U.S. healthcare sector remains negative. Persistently high unemployment with its impact on health insurance coverage along with consumer's lessened ability to manage out-of-pocket costs of co-payments and co-insurance will continue to hamper prospects for the industry, in general, in 2010. Growing event risk surrounding U.S. healthcare reform and that impact on health insurance coverage, reimbursement and the corresponding change in the competitive landscape all create uncertainty regarding long-term financial results for the sector.

While there have been some signs of improvement in the economy, high unemployment is expected to continue well into 2010. This is particularly troublesome due to its ongoing impact on insurance coverage and people's ability to manage out-of-pocket expenses for healthcare. Therefore, people will continue to focus on reducing healthcare expenses and delaying non-essential care. While this focus will pressure top-line growth, EBITDA is expected to remain stable due to on-going cost containment and continued operational restructuring of companies. Additionally, flexibility in capital expenditure along with stable EBITDA should result in sustained levels of free cash flow in 2010. Fitch expects many industry participants to continue to be aggressive in returning capital to equity shareholders through dividends and share buybacks.

Congress continues to work on crafting healthcare reform legislation. While a bill has been approved in the House of Representatives, the Senate has not voted on its own version. Consequently, it is unclear what the ultimate impact will be for the industry from this initiative. However, key issues surrounding the reform relate to coverage, reimbursement and changes in the industry competitive environment. In relation to insurance coverage, if the reform achieves its goal of increased insurance coverage, this will be a positive for the industry. Fitch believes that in part, to pay for the insurance coverage expansion, industry participants will see declining profitability margins as a result of reimbursement declines.

Reimbursement pressure could come from Medicare reductions, another public payer or other restrictions associated with the reform. Key to overall profitability will be whether the coverage expansion offsets margin erosion in a timely manner to maintain profit levels. Finally, the most difficult part of reform to evaluate will be its effect on the competitive environment of the industry. New restrictions could permanently change prospects for certain areas of the industry and result in changes in business strategies. These strategy changes could lead to increases in merger and acquisition activity in an attempt to improve prospects through broadening product or service portfolios and increasing efficiency with scale. With the potential for increased acquisition and merger activity comes the expectation for increased debt issuance that could lead to higher leverage at least in the near term.

The U.S. healthcare industry continues to maintain strong liquidity. U.S. healthcare companies with Fitch credit ratings generated last 12 months (LTM) free cash flow, as of third-quarter 2009, of approximately $46 billion and maintained balance sheet cash of approximately $86 billion. However, it is important to note that Fitch estimates that approximately two-thirds of this cash balance is outside of the U.S. and would be subject to repatriation. Nevertheless, this internal liquidity compares to a Fitch estimated 2010 maturity schedule of approximately $6 billion. Revolving credit capacity for the industry also remains strong with an average availability of approximately 93% or $52 billion.

Pharmaceutical Manufacturers:

Fitch sees a negative outlook for the U.S. pharmaceutical industry in 2010 as drug developers contend with healthcare reform, the lingering effects of the current macroeconomic environment, the start of an unprecedented series of significant drug patent lapses, and the challenging regulatory climate.

Managed-care focus on favoring generic pharmaceuticals to control drug spending will be accelerated in 2010, when the industry begins facing a period of record patent challenges. Key drug patent losses for U.S. drug developers during the year are Pfizer's anti-depressant Effexor-XR, Merck's anti-hypertensives Cozaar and Hyzaar, and Eli Lilly's oncologic Gemzar. Following a year of major consolidation to fill research and development (R&D) and product portfolio gaps, Fitch expects business development activities to be directed to bolstering R&D programs in 2010.

Fitch expects sales growth in the low single digits, and manageable margin pressure for brand name pharmaceutical manufacturers. Continued operating costs reductions serves as margin support as the industry confronts prospects of lower top-line growth from potential government reimbursement changes and near-term patent challenges. Incremental margin support is attained from merger and acquisition synergies.

In general, cash flows generated by drug developers are expected to cover capital commitments in 2010. Fitch estimates some cash flow to be directed to debt reduction for those drug manufacturers involved with recent industry consolidation. The pharmaceutical industry will continue to use significant operating cash flow for shareholder-friendly purposes, specifically sustaining or raising dividends and actively purchasing common shares.

Medical Devices:

Fitch's 2010 outlook for the medical device sector is stable. Moderate revenue growth and relatively stable margins should generate sufficient cash to fund operations, share repurchases and targeted acquisitions. Selected debt refinancing is expected to be met with ample liquidity and adequate access to the credit markets. Despite the relative stability within the sector, Fitch recognizes that 2010 potentially poses meaningful operational, legislative, regulatory and business cycle risks.

Fitch expects the drug-eluting stent (DES) market will remain relatively flat in terms of revenues, with single-digit volume growth offset by price declines. Pricing will likely be negatively affected by moderation in new product introductions and hospitals becoming more aggressive in their negotiating posture. While Fitch expects the industry to closely manage costs, some margin pressure is possible. Within the DES segment, Fitch expects market share volatility will persist to the extent that new products are launched into the marketplace. Fitch expects that Abbott Lab's (ABT) Xience DES platform and Boston Scientific's (BSX) Promus DES platform will continue to gain incremental market share in the U.S., Europe and Japan.

The cardiac rhythm management (CRM) market is expected to generate low- to mid-single-digit revenue growth, with volume increases somewhat offset by price declines. Fitch expects this environment will improve if the Food and Drug Administration (FDA) expands the use of this technology to patients with less severe forms of heart failure, which were studied in the MADIT-CRT clinical trial. Nevertheless, CRM adoption by physicians would likely increase in a steady, incremental fashion, as opposed to a step-change function. While BSX conducted the trial with its devices and would likely be the first to benefit, Fitch believes Medtronic (MDT) and St. Jude Medical (STJ) will also benefit over time.

Fitch expects the majority of acquisitions in the sector will be targeted, relative to individual firms' size and breadth. In addition, share repurchases are likely to be funded primarily through cash flow. As such, Fitch expects any incremental transaction-related debt to be manageable for the industry's credit profile.

For-Profit Hospital Operators:

Fitch has a negative outlook for the for-profit hospital sector in 2010. Fitch expects many of the 2009 favorable trends - including improved margins, decreased leverage, and strengthened free cash flow - to reverse in 2010 as providers face reimbursement pressure and limited opportunities to enact additional cost controls. Fitch believes a return to an inflationary environment for labor, supplies and other key operating expenses is inevitable and will reverse some of the profitability gains enjoyed by the sector in 2009. In addition, bad debt expense is expected to remain high through most of 2010, further pressuring margins. Reimbursement is also likely to be pressured, with declines in Medicaid and a moderation in Medicare growth, although managed care rates should remain robust. Overall, Fitch projects a net deterioration in margins, free cash flow, and leverage across the sector in 2010. However, Fitch believes positive rating actions are still possible, particularly for those companies that use excess cash flow generated in 2009 to reduce debt and maintain stable credit metrics in 2010.

The year 2010 will also be an active one for mergers and acquisitions within the industry, in Fitch's opinion. Fitch believes there is a plenitude of acquisition targets in the market as a result of the recession and that valuation levels have become easier to determine, which, along with the record free cash flow generated in 2009, should lead to an uptick in consolidation within the industry. Fitch believes any of the for-profit hospitals it rates could be active acquirers in 2010, although LifePoint, Universal Health Services, and Community Health Systems should be the most active.

Fitch currently rates the U.S. healthcare sector as follows:

Abbott Laboratories ('A+'; Stable Outlook)
Allergan, Inc. ('A-'; Stable Outlook)
AmerisourceBergen Corp. ('BBB'; Stable Outlook)
Amgen, Inc. ('A', Stable Outlook)
Baxter International Inc. ('A'; Stable Outlook)
Beckman Coulter, Inc. ('BBB'; Stable Outlook)
Boston Scientific Corporation ('BB+' ; Positive Outlook)
Bristol-Myers Squibb Company ('A+' ; Stable Outlook)
Cardinal Health, Inc. ('BBB'; Stable Outlook)
CareFusion Corporation ('BBB'; Stable Outlook)
Community Health Systems, Inc. ('B'; Stable Outlook)
Covidien Ltd. ('A'; Stable Outlook)
DaVita, Inc. ('BB-'; Stable Outlook)
Eli Lilly & Co. ('A+' ; Negative Outlook)
Express Scripts, Inc. ('BBB'; Stable Outlook)
HCA, Inc. ('B', Stable Outlook)
Health Management Associates ('B+' ; Stable Outlook)
Johnson & Johnson ('AAA'; Stable Outlook)
Life Technologies Corporation ('BBB-'; Stable Outlook)
LifePoint Hospitals Inc. ('BB-'; Stable Outlook)
McKesson Corp. ('BBB+' ; Stable Outlook)
Medco Health Solutions Inc. ('BBB'; Stable Outlook)
Merck & Co. ('A+', Stable Outlook)
Owens & Minor Inc. ('BBB-'; Stable Outlook)
Pfizer Inc. ('AA-', Stable Outlook)
Quest Diagnostics Inc. ('BBB+'; Stable Outlook)
Royalty Pharma Finance Trust ('BBB'; Stable Outlook)
St. Jude Medical, Inc. ('A'; Stable Outlook)
Tenet Healthcare Corp. ('B-'; Stable Outlook)
Thermo Fisher Scientific Inc. ('A-'; Stable Outlook)
Universal Health Services ('BBB'; Stable Outlook)
Watson Pharmaceuticals Inc. ('BBB-'; Stable Outlook)

Additional information is available at 'www.fitchratings.com'.

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Fitch Ratings
Cindy Stoller, +1-212-908-0526 (New York)
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Michael Weaver, +1-312-368-3156 (Chicago)
Michael Zbinovec, +1-312-368-3164 (Chicago)
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Source: Fitch Ratings