TEXT-S&P affirms Serco DES 'A-' rratings
(The following statement was released by the rating agency)A) Overview -- We are affirming our 'A-' long-term issuer credit and senior secured debt ratings on Serco DES Inc. -- The ratings on Serco reflect our view of its strong business risk profile, satisfactory financial risk profile, and healthy liquidity. -- The stable outlook reflects our view that Serco's financial and operational performance remains in line with expectations and that provincial policies will remain stable during the next year. Rating Action On Oct. 29, 2012, Standard & Poor's Ratings Services affirmed its 'A-' long-term issuer credit and senior secured debt ratings on Ontario-based Serco DES Inc. (Serco or DriveTest). The outlook is stable. Rationale The ratings on Serco reflect Standard & Poor's opinion of a strong business risk profile, a satisfactory financial risk profile that includes a supportive covenant package, and adequate liquidity. In our view, modest volume risk and a lack of rate-setting autonomy somewhat offset these strengths. We believe that the foundation of Serco's strong business risk profile is its monopoly position and relatively strong and fairly predictable underlying demand profile for driver testing services in the Province of Ontario (AA-/Negative/A-1+). The company's service area is Ontario, Canada's most populous province. Under the terms of the delegation agreement (DA) between Serco and the Ontario Ministry of Transport, the company has almost exclusive rights with respect to driver examination services. Recent Census results indicate that 15-to-19-year-olds (one of the primary demand bases for examination services), represented about 7% of total population for Ontario in 2011. We expect that this level should remain relatively stable as a proportion of the province's total population until 2013 (when the DA expires). In addition, Ontario projects that net migration to the province (a second demand base for examination services) will remain strongly positive for the decade. We believe that the company's financial risk profile is satisfactory. As of year-end 2011, the rolling four-quarter debt service coverage ratio (DSCR) was 1.05x; for the six months ended June 2012, it was 1.17x. Standard & Poor's expects the annual DSCR will remain at 1.15x-1.20x during the next two years. In addition, an amortizing debt profile, which results in no retirement risk, bolsters the company's financial risk profile. Furthermore, Serco's bond covenant package provides creditor support and is at least consistent with similarly rated peers'. The package includes a six-month debt service reserve fund (DSRF; subject to the adjustment) and a restricted permitted distributions test of 1.15x annual senior DSCR cash trap. In our opinion, DriveTest's liquidity is healthy. As of Dec. 31, 2011, the company had a cash balance of C$9.8 million. Further bolstering its liquidity are two letters of credit for C$4.5 million and C$2.0 million. At year-end 2011, the lines remained undrawn. The company's liquidity includes its DSRF, which had a balance of C$14.0 million at year-end, which is more than the sum of the next two principal and interest payments. An employee severance reserve account allows Serco to pay its employees all of the projected employee severance and termination costs for which it would be liable at the end of the initial term (August 2013), assuming that the company would cease operations then and terminate all of its employees. DriveTest's lack of rate-setting autonomy constrains our assessment of the ratings. Serco's inability to raise fees, and the lack of any automatic annual fee adjustments based on inflation, mean it relies completely on the underlying demand volume and cost management to meet revenue targets. However, we believe that the DA's provisions, which requires the Ontario Ministry of Transportation (MTO) to fully compensate Serco for any negative unilateral changes to its business position, partially mitigates this weakness. Notwithstanding fairly predictable demand for driver examination services in Ontario, we believe moderate volume risk still exists. Negative changes in demographic profile of, immigration to, or interprovincial migration patterns into Ontario would result in a decrease in the number of road tests, which subsequently would result in a lower revenue stream, thinner DSCRs, and a weaker financial risk profile. Outlook The stable outlook reflects our view that Serco's financial and operational performance remains in line with expectations and that provincial policies will remain stable during the next year. Downside pressure on the rating could occur if the company's operational performance was to deteriorate significantly, and its financial metrics were to weaken markedly. We see limited rating upside without a pronounced improvement in the financial risk profile. Related Criteria And Research Updated Project Finance Summary Debt Rating Criteria, Sept. 18, 2007 Ratings List Ratings Affirmed Serco DES Inc. Issuer credit rating A-/Stable/-- Senior secured debt A- Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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