TEXT-S&P revises American Water Works and units' outlook
Overview -- Voorhees, N.J.-based water utility company American Water Works Co. Inc. has continued to strengthen its financial measures and has demonstrated effective management of regulatory risk. -- We are affirming our ratings on the company and its subsidiaries American Water Capital Corp., New Jersey-American Water Co., and Pennsylvania-American Water Co., including the 'BBB+' corporate credit ratings and 'A-2' commercial paper ratings. We also are revising the ratings outlook to positive from stable. -- The positive outlook reflects the potential for a one-notch upgrade over the next 12 to 18 months based on continued improvement in the company's financial condition. Rating Action On July 18, 2012, Standard & Poor's Ratings Services affirmed its ratings on regulated water utility company American Water Works Co Inc. (AWW) and subsidiaries American Water Capital Corp. (AWCC), New Jersey-American Water Co., and Pennsylvania-American Water Co., including the 'BBB+' corporate credit ratings and 'A-2' commercial paper ratings. We revised the ratings outlook to positive from stable. About $5.3 billion of total long-term debt was outstanding as of March 31, 2012. Rationale The outlook revision reflects our expectation that there is at least a one-in-three probability that the company will continue to achieve modest improvements in its financial measures that would support a one-notch upgrade over the intermediate term. Higher ratings are possible if the company continues to strengthen its overall financial condition and if the company continues to effectively manage its regulatory relationships to continually achieve constructive regulatory outcomes in its many jurisdictions. Standard & Poor's ratings on AWW and its subsidiaries reflect its "excellent" business risk profile and "significant" financial risk profile. A favorable competitive position, a diverse and supportive regulatory environment, and stable service territories support AWW's excellent business risk profile. AWW's regulatory framework includes reasonably allowed returns on equity and various cost-recovery mechanisms, including incentives for infrastructure improvements. The company's geographic reach provides it with market, cash flow, and regulatory diversification. We view AWW's operating risks associated with its unregulated operations as fairly low. AWW's elevated capital-spending requirements for infrastructure replacement, increased costs of compliance with water quality standards, and the company's reliance on acquisitions to provide growth partly offset these strengths. AWW provides regulated water and wastewater services to about 3.3 million customers in 15 states. The company's regulated utility subsidiaries represent about 89% of total revenues, but have provided more than 95% of adjusted EBITDA for the past three years. The company's unregulated subsidiaries engage in water and wastewater facility management and maintenance, as well as design and construction consulting services related to water and wastewater plants. We view these unregulated segments as having modest incremental risk for AWW, due to their lack of cash flow contribution and modest expected capital requirements. A state commission regulates each of AWW's regulated subsidiaries, which supports revenue and cash flow stability. In a number of jurisdictions, which represent about 50% of consolidated revenues, the utility recovers replacement capital spending between rate cases up to a stated percentage. The importance of infrastructure surcharge mechanisms has increased, given AWW's large capital program. Certain states also allow for surcharges related to the cost of power, chemicals, and purchased water. For the next few years, we expect AWW to file additional rate cases and request additional recovery mechanisms to cover rising operating costs, capital spending, and pension and other postretirement obligations. AWW estimates that it will need to spend about $800 million to $1 billion annually in each of the next three years to replace infrastructure, build new facilities to comply with water quality standards, and initiate projects to enhance reliability, quality of service, and efficiency. AWW's reliability of supply is high, as the company owns a substantial number of treatment facilities for surface and groundwater treatment, and the majority of supply comes from surface and groundwater. In 2011, surface water provided 65% of supply, groundwater 28%, and purchased water about 7%. AWW's consolidated financial risk profile is significant under our criteria and reflects our baseline forecast that consolidated funds from operations (FFO) to debt and debt to EBITDA will approximate 14% and 4.9x,respectively, over the medium term. The company's cash flow measures continue to improve in 2012 compared with 2011, partially reflecting higher deferred tax benefits and general rate increases. For the 12 months ended March 31, 2012, AWW's adjusted FFO totaled $897 million. FFO to debt was 14.5%, compared with 13.4% as of year-end 2011. Debt to EBITDA improved to 5.1x compared with 5.4x as of year-end 2011. Total debt to capital remained around 60% during the same period. Higher capital expenses are significant risks that may prevent adequate improvements to the company's financial profile. Liquidity The short-term rating on AWW and AWCC is 'A-2' and largely reflects the long-term corporate credit ratings and our view of the company's "adequate" liquidity under Standard & Poor's corporate liquidity methodology, which categorizes liquidity in five standard descriptors. We base our liquidity assessment on the following factors and assumptions: -- AWW's liquidity sources during the next 12 months, including cash, FFO, and credit facility availability, should exceed uses by more than 1.2x. Uses include necessary capital expenditures, debt maturities, and anticipated shareholder distributions. -- Debt maturities are manageable during the next 12 months. -- Liquidity sources would exceed uses even if EBITDA declines by 15%. -- AWW's ability to absorb high-impact, low-probability events with limited need for refinancing, its flexibility to lower capital spending or sell assets, its sound bank relationships, its solid standing in credit markets, and its generally prudent risk management. In our analysis of liquidity during the next 12 months, we assume about $1.2 billion of liquidity sources, consisting primarily of FFO and credit facility availability. We estimate use of $1 billion of liquidity for capital spending, maturing debt, and shareholder distributions. The company maintains a bank credit facility totaling $840 million that expires in September 2013. As of March 31, 2012, the company had $594 million available under the facility. The bank facilities require the parent and the utilities to maintain a minimum total funded debt to capitalization ratio of 70%, with which they comfortably comply. Outlook The positive rating outlook on AWW and its subsidiaries reflects our view that we could raise the ratings one notch within the next 12 to 18 months if we see sustained financial performance above our base-case forecast level of adjusted FFO to total debt of 14% and adjusted debt to total capital of about 59%. Fundamental to our forecast is our expectation that the company continues to effectively manage its regulatory relationships to continually achieve constructive regulatory outcomes in its many jurisdictions. We could lower the rating if financial performance stalls or deteriorates, which could result from substantial debt-financing of capital expenditures or acquisitions, such that FFO to debt falls below 9% and debt to capital rises above 65%. Related Criteria And Research -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- Analytical Methodology, April 15, 2008 -- Ratios And Adjustments, April 15, 2008 -- Assessing U.S. Utility Regulatory Environments, Nov. 7, 2007 Ratings List Ratings Affirmed Outlook Revised To From American Water Works Co. Inc. Corp. credit rating BBB+/Positive/A-2 BBB+/Stable/A-2 American Water Capital Corp. Corp. credit rating BBB+/Positive/A-2 BBB+/Stable/A-2 Senior unsecured debt BBB+ Commercial paper A-2 New Jersey-American Water Co. Corp. credit rating BBB+/Positive/-- BBB+/Stable/-- Senior secured A Recovery rating 1+ Pennsylvania-American Water Co. Corp. credit rating BBB+/Positive/-- BBB+/Stable/-- Senior secured A Recovery rating 1+
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