TEXT-S&P affirms Dycom Industries 'BB' corporate credit rating
Overview -- Palm Beach Gardens, Fla.-based Dycom Industries Inc. (Dycom) is acquiring certain subsidiaries of Quanta Services Inc., which provide specialty contracting services to the telecommunications and cable television industries. -- Dycom plans to finance the $275 million acquisition through a $90 million add-on to its 7.125% senior subordinated notes due 2021 and through borrowings under the new $400 million five-year senior secured credit facility due 2017 (comprising a $125 million Term Loan A and a $275 million revolving facility). -- We are affirming our 'BB' corporate credit rating on Dycom and our 'BB-' issue ratings on its senior subordinated notes. -- The stable outlook reflects our expectation that the debt-financed acquisition will cause credit metrics to weaken year over year over the next two quarters, but metrics will remain in line with our expectations for the rating and credit metrics will improve somewhat by fiscal 2014. Rating Action On Nov. 28, 2012, Standard & Poor's Ratings Services affirmed its 'BB' corporate credit rating on Dycom Industries Corp. The outlook is stable. At the same time, we affirmed our 'BB-' issue-level ratings (with a '5' recovery rating) on the company's 7.125% senior subordinated notes due 2021 after a proposed $90 million add-on to the existing $187.5 million 7.125% senior subordinated notes. The '5' recovery rating indicates our expectation of modest (10%-30%) recovery in a payment default scenario. The borrower under the notes is Dycom's wholly owned subsidiary Dycom Investment Inc. All ratings are subject to review of final documentation. Rationale The affirmation follows Dycom's announcement to acquire substantially all of Quanta Services Inc.'s domestic telecommunications infrastructure services subsidiaries. In our view, the acquired entity is likely to bolster the company's exposure to rural customers, including broadband stimulus recipients; provide increased scale; and enhance profitability and cash flows. The ratings reflect our assessment of Dycom's "fair" business risk profile, as a provider of engineering and construction services, and its "significant" financial risk profile, highlighted by share repurchases and some midsize acquisitions that the company completed in the past few years. Following the debt-financed acquisition, we estimate total debt to EBITDA (including our adjustments) to be about 2.8x at close of transaction. We expect contributions from this acquisition and our assumption for debt reduction to result in some improvement in credit metrics during 2013 and into 2014. Over the next 12-18 months we estimate that leverage would remain at 2.5x or less, with funds from operations (FFO) to debt approaching 30%. For the ratings, we expect Dycom to maintain FFO to total debt well above 20% with modest free cash flow generation (free operating cash flow to total debt of about 10% or more). Our business risk assessment incorporates our view that Dycom will continue to compete in large, highly fragmented, cyclical markets. Competition in this industry is based on price, service breadth, and geographic reach. In our view, telecommunications companies' spending on wireless and wireline networks and stimulus-driven broadband network development have benefitted the company. We expect increased demand in these markets to offset the continued weakness in residential construction. In the long term, larger industry participants, including Dycom, are likely to benefit from the gradual outsourcing and vendor consolidation. After the proposed acquisition, roughly 90% of Dycom's expected annual sales will likely continue to come from specialty contracting services, including installation and maintenance, which the company provides primarily to cable and telecommunications companies. The company is likely to continue to also provide utility-line locating services to those industries and certain electric utilities, but at lower-than-historical levels following a planned termination of technician-intensive customer contracts last year. Dycom also provides electric and other construction and maintenance services to electric utilities. Dycom's credit quality is marked by high customer concentration, exposure to highly cyclical end markets, and somewhat limited revenue visibility. The company's geographic reach (which is broader than that of most of its peers in North America), fair risk management (which includes over 80% of revenue from multiyear master service agreements and other long-term contracts), limited maintenance capital expenditure requirements, and long-term relationships with stable customers partially mitigate company weaknesses. Key company profitability measures such as EBITDA margins and returns on permanent capital have typically been comparable with those of peers such as MasTec Inc. (BB/Stable/--). EBITDA margins and returns on permanent capital were roughly 11.6% and 10.8%, respectively, as of Oct. 27, 2012. Our base-case scenario assumptions for Dycom include: -- Flat to minimal organic revenue growth over the next 12 months; -- EBITDA margins remaining above 10% over the next two years; -- Credit measures trending toward preacquisition levels by 2014 fiscal year-end; and -- $40 million to $50 million annual free cash flow generation over the next two years to be directed toward debt repayment. Dycom's financial risk profile is significant, and it had about $100 million in share repurchases over the past three years and recent midsized acquisitions. Although credit measures can significantly weaken during downturns, as the company's declining profitability during the telecom bust in the early 2000s indicates, we expect Dycom's FFO to total debt to continue to significantly exceed 20%. We also expect Dycom to scale back on share repurchases in light of the recent debt-financed acquisition and that it would direct any excess cash flow toward debt repayment. Liquidity We believe Dycom has "adequate" sources of liquidity to cover its needs in the next one to two years, even if its EBITDA declines unexpectedly. The company has minimal upcoming debt maturities. Our assessment of the company's liquidity profile incorporates the following expectations and assumptions: -- We expect the company's sources of liquidity, including cash and facility availability, to exceed its uses by 1.2x or more over the next 12 to 18 months. -- We expect net sources to remain positive, even if EBITDA declines by 15%. -- We assume Dycom would have more than 15% EBITDA under its new credit facility's financial covenants, which allow for maximum leverage of 3.5x (gradually stepping down to 3.0x by mid-2015) and minimum interest coverage of 3.0x. -- We believe Dycom could absorb low-probability, high-impact shocks. As of Oct. 27, 2012, the company had cash balances of about $55 million and will likely have about $134 million availability (after incorporating $44 million letters of credit) under its new $275 million revolving credit facility due 2017 after the acquisition transaction. The facility includes a $150 million sublimit for letters of credit and a $100 million accordion feature. There are no near-term scheduled debt maturities. Working-capital requirements should also be manageable, along with capital expenditures, which should average about 5.5% of sales, partially funded by recurring proceeds from the sale of its existing equipment. Recovery analysis We rate the company's senior subordinated notes 'BB-' (with a '5' recovery rating. The '5' recovery rating indicates our expectation of modest (10%-30%) recovery. The borrower under the notes is Dycom's wholly owned subsidiary Dycom Investment Inc. Outlook The stable outlook reflects our expectation that the debt-financed acquisition will cause credit metrics to weaken year over year over the next two quarters but that these metrics will remain in line with our expectations for the rating. A sluggish overall recovery in construction activity is likely to continue to weigh on specialty contractors' operations. However, we expect Dycom to manage discretionary spending and debt repayment from excess cash flow, and contributions from the proposed acquisition should improve credit measures more toward fiscal 2014. We could lower the ratings if the acquisition integration risk and growth initiatives result in sustained negative free cash flow. A higher rating is unlikely over the next 12 months. Over the long term, however, we could raise our ratings if Dycom's operating prospects remain positive and it successfully integrates recent acquisitions to strengthen and diversify its business profile further, resulting in sustained positive free cash flow. At the same time, we would expect Dycom to demonstrate financial policies in line with a higher rating, notably by continuing to pursue a disciplined acquisition and share repurchase strategy. Related Criteria And Research -- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Methodology And Assumptions: Liquidity Descriptors for Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Affirmed Dycom Industries Inc. Corporate Credit Rating BB/Stable/-- Dycom Investments Inc. Subordinated $277.5 mil 7.125% sr sub nts due 2021 (add-on) BB- Recovery Rating 5 $150 mil 8.125% sr sub nts due 2015 BB- Recovery Rating 5 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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