Target Hospitality’s rating downgraded at S&P due to contract instability

Investing.com -- S&P Global Ratings has downgraded Target (NYSE:TGT) Hospitality (NASDAQ:TH) Corp. to ’B’ from ’B+’ due to contract volatility, despite maintaining a stable outlook. The company, a specialty rental and hospitality provider, recently announced the termination of its Pecos Children’s Center (PCC) services agreement by the U.S. government, effective February 2025. The PCC contract was a significant revenue source for Target, contributing $168 million in minimum annual revenue.

In response to the termination, Target secured a new contract with CoreCivic (NYSE:CXW) in March 2025, which is expected to alleviate some of the financial pressures later in the year. Despite this, S&P Global Ratings anticipates a significant weakening of Target’s operating performance, with a projected decline of about 35% in 2025.

Target intends to repay its senior notes, due in June 2025, using existing liquidity sources. This repayment is perceived as a positive move, providing the company with flexibility to navigate through business volatility.

The stable outlook is based on expectations that Target will be able to partially mitigate contract losses with new business wins. This includes a contract with the South Texas Family Residential Center (STFRC), supporting 2,400 beds with expected revenue of $246 million over its five-year term, and a contract with Lithium Americas (NYSE:LAC) for the Thacker Pass Project, which will generate $76 million of committed revenue with the potential to reach up to $140 million through 2027.

Target’s recent contracts, however, do not match the revenue potential of the terminated PCC agreement. The company is actively seeking ways to repurpose the vacant assets at the PCC and STFRC sites, the speed of which will determine profit and cash flow benefits.

Target plans to redeem all outstanding senior secured notes, valued at $181 million, on March 25, 2025. As of September 2024, the company had $178 million in cash and a fully available $175 million revolver. Despite contract instability, Target is expected to continue generating solid free operating cash flow, albeit at lower levels compared to previous years.

S&P Global Ratings suggests that a rating downgrade could occur if Target fails to maintain contracts that result in a leverage nearing 5x. Conversely, a rating upgrade could happen if the company demonstrates strong and consistent operating performance while diversifying its business, or if it maintains leverage comfortably below 5x to accommodate contract volatility.

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