17% Return, Near-Term Debt Opportunity With Community Health Systems 2020 Bonds

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About: Community Health Systems, Inc. (CYH)
by: Jeremy LaKosh
Summary

Community Health Systems continues to raise cash through asset sales.

The company has a large amount of debt maturing in 2022 and 2023.

Is the company's free cash flow strong enough to justify an investment in its longer-term debt?

Community Health Systems' (CYH) stock returned to near a 52-week low this week as investors continue to struggle with whether the company's turnaround strategy is going to be successful. Investors in the company's near-term bonds have seen their value increase by 10% during the same period. With the company's 2019 bonds set to mature in November, high yield debt investors may want to steer their attention towards the company's July 2020 17% yielding bonds.

Source: FINRA

Before investing in Community Health Systems debt, fixed income investors should understand the difference between its senior secured, junior priority secured, and senior (unsecured) notes. The company's senior secured notes have the highest degree of safety. In the event of a bankruptcy, those creditors would need to be made whole before the other two class of investors would get a dime. Junior priority secured investors are next in line, followed by senior (unsecured) investors. Because of the differing security in each investment, the bonds hold different yields to maturity.

Source: FINRA Data Loaded into Author Spreadsheet (dark green- senior secured, light green- junior priority, orange- senior (unsecured))

While the November maturing bonds also offer a great yield, I'm not crazy about advising investors to park their money in such a short duration bond. The 2020 bonds, however, mature in one year and can provide a reasonable return on investment if the company is able to generate the cash necessary to fund those bonds at maturity.

Community Health's transition into a leaner operation continues to be struggling. While the expectation was for revenue to decline as the company downsized, Community Health has been unable to reduce its expenses commensurate with income, leading to a decline in operating income. Furthermore, the increase in interest expense has led to a larger net loss compared to a year ago.

Source: SEC 10-Q

The balance sheet was quite uneventful in the first quarter. With no real changes in long-term debt balance, the important indicator for near-term debt investors to watch is cash. While Community Health's cash has increased, it is more important to note that the cash balance is greater than the debt amount due in November, leading investors to believe that the company will be able to pay out its next debt maturity with cash.

Source: SEC 10-Q

For Community Health to continue to reduce its debt load, the company will need to be able to generate positive free cash flow (operating cash flow less capital expenditures). In the first quarter of 2019, the company managed to eke out positive free cash flow versus negative free cash flow in the same quarter of 2018. This was mainly due to the reduction in capital expenditures. Additionally, the company sold $161 million in assets to boost its cash position. While asset sales are a good source of cash to meet short-term obligations, the consistent sale of assets to do so is a red flag for any potential long-term debt or equity investor.

Source: SEC 10-Q

Community Health did have a noticeable milestone in the first quarter. The company was able to refinance a term loan maturing in 2021 to a senior secured note due in 2024. While the 8.625% coupon will likely increase the interest expense, the amendment to the maturity profile makes the 2020 maturing debt more likely to be redeemed.

Source: SEC 10-Q

Community Health's debt maturity schedule is quite timid until 2022 when the company will need to refinance $2.6 billion in debt and 2023 when the amount maturing reaches a staggering $5.6 billion! If Community Health restructures, it will likely occur while trying to tackle these two maturities. The term loan refinancing may give longer-term debt holders some piece of mind, but I believe investing in debt from 2021 and beyond is still too speculative.

Source: Author Spreadsheet

Community Health Systems should be able to fund its 2019 and 2020 maturing debt with cash from operations. I do not advise investors to get involved in the company's debt maturing beyond 2020 or in its shares. I believe the lack of stable operating metrics combined with the company's tower of 2022 and 2023 maturing debt will ultimately lead to restructuring.

  • CUSIP: 12543DAQ3
  • Price: 90.94
  • Coupon: 7.125%
  • Yield to Maturity: 17.298%
  • Maturity Date: 7/15/2020
  • Credit Rating (Moody's/S&P): C/CCC-

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I own CYH bonds maturing in November 2019. I have indicated that I am bearish on the stock, but I am bullish on 2019 and 2020 maturing bonds, neutral on bonds maturing in 2021 and 2022, and bearish on bonds maturing after 2022.