Overview -- San Antonio, Texas-based privately held Zachry Holdings Inc. plans to issue $250 million senior unsecured notes to refinance an existing term loan, which it used to partly finance an acquisition in 2012. -- We are assigning our preliminary 'BB-' corporate credit rating to the company and our preliminary 'B+' issue rating to the company's proposed $250 million senior unsecured notes. -- The stable outlook reflects our expectation for positive free operating cash flow generation in 2013 based upon slow ongoing recovery in the company's end markets. Rating Action On Jan. 11, 2013, Standard & Poor's Ratings Services assigned its preliminary 'BB-' corporate credit rating to Zachry Holdings Inc. At the same time, we also assigned our preliminary 'B+' issue rating and '5' recovery rating (indicating our expectation of modestrecovery in the event of payment default) to Zachry Holdings Inc.'s proposed $250 million senior unsecured notes due 2020. All ratings are subject to a review of final documentation. Rationale The ratings on Zachry reflect our view of the company's "weak" business risk profile and "significant" financial risk profile. The stable outlook indicates our expectation for sustained mid-single-digit EBITDA margins on recovering demand in its end markets from the downturn in 2009 and 2010. Our financial risk assessment reflects leverage expectations of leverage below 3x and positive free cash flow generation prospects in 2013. The proposed refinancing extends the maturity on its existing debt. The business risk profile assessment reflects the company's exposure to cyclical end-markets amid competitive bidding. The company provides engineering, procurement, and construction (EPC), and maintenance and turnaround services in the U.S. to the domestic energy and industrial infrastructure end markets, including refining, petrochemicals, power generation, and other related energy sectors. Through the September 2012 acquisition of JV Industrial Companies Ltd. (JVIC), Zachry has added to its maintenance and turnaround business. After being deferred during the economic downturn, EPC projects, as well as maintenance and plant turnaround activity, are slowly picking up across the company's end markets. Still, the company remains exposed to some pricing pressure given the presence of a number of regional, national and international competitors. The ratings incorporate the inherent cyclicality of the engineering and construction services sector in which Zachry participates. We believe other risks include the competitive nature of the industry and the potential for cost overruns in the execution of fixed-price contracts. As of Sept. 30, 2012, a little more than half of the company's revenues were from cost reimbursable contracts with the remainder from contracts that are primarily fixed-price. We believe the company's long-term operating performance could benefit from fundamentals supporting increased activity in some of Zachry's end markets. Additionally, with more than 15,000 employees, Zachry is one of the largest direct-hire EPC and industrial service companies in the U.S. The company estimates that they self-perform more than 90% of the labor scope of construction projects, including all of the major crafts (civil, structural, mechanical, piping, insulation, electrical, instrumentation, and controls), giving the company the ability to directly control the majority of the on-site craft labor work force and thereby reduce interface inefficiency costs and duplication of overhead costs, which may occur in a subcontract construction approach. Therefore, we view this as a competitive advantage for Zachry. The company's backlog was $2.7 billion as of Sept. 30, 2012 (pro forma for the JVIC acquisition), up significantly from $1.8 billion at year-end 2011. Its adjusted EBITDA margins remain in the mid-single-digit area as of Sept. 30, 2012. The cyclical nature of the company's end markets and thin margins can significantly erode operating results during a downturn. In our base case, we estimate leverage (including our adjustments, mainly for operating leases and postretirement obligations) at less than 3x in 2013, with funds from operations (FFO) to debt of more than 20%.recovery in the event of payment default). Outlook The stable outlook reflects our expectation for positive free cash flow in 2013 based upon slow ongoing recovery in the company's end markets. We could lower the ratings if a shortfall in operating performance (arising from unexpected weakness in end-market demand) dampens profit margins, leading to significantly lower-than-expected free cash flow generation. A downgrade is also likely to occur if credit protection measures deteriorate--for instance, if we expect adjusted leverage persistently above 3.5x. We could consider raising the rating if we expect the company to maintain leverage of less than 2.5x with consistent free cash flow over the business cycle, and if we expect the company to pursue financial policies consistent with a higher rating. Related Criteria And Research -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List New Ratings; Outlook Stable Zachry Holdings Inc. Corporate Credit Rating BB-(prelim)/Stable/-- Senior Unsecured B+(prelim) Recovery Rating 5(prelim) 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.