TEXT-S&P revises American Water Works and units' outlook

Wed Jul 18, 2012 3:29pm EDT

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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