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Fitch Affirms Alisal Water Corp. (CA) Senior Secured Debt at 'BB+'; IDR at 'BB-'.

AUSTIN, Texas -- Fitch Ratings takes the following actions on Alisal Water Corporation (Alco):

--$7.6 million of outstanding 2007A senior secured taxable bonds affirmed at 'BB+';

--Issuer Default Rating (IDR) affirmed at 'BB-'.

The Rating Outlook is Stable.

SECURITY

The bonds are secured by a security interest in pledged collateral, which consists of all tangible and intangible assets owned by Alco.

KEY RATING DRIVERS

FINANCIALS REMAIN NARROW BUT ADEQUATE: Alco's ratings reflect the utility's adequate but relatively weak financial metrics, particularly with regards to liquidity. A recent general rate increase has improved Alco's financial profile from prior levels, although ongoing margins are expected to be somewhat modest.

CONSTRUCTIVE REGULATORY ENVIRONMENT: The California regulatory environment is relatively predictable, and the utility has achieved rate relief as needed, although customer charges are high.

SMALL SERVICE AREA: The customer base is limited and includes a narrow economic profile and very high unemployment.

CAPITAL STRUCTURE TO CONTINUE: Capital needs are manageable, which should help to further improved Alco's elevated debt to equity mix.

LONG-TERM SUPPLY ADEQUACY: The utility provides an essential service and water supplies are sufficient to meet long-term demands.

WHAT COULD CHANGE THE RATING

SUSTAINED FINANCIAL IMPROVEMENT: Sustained performance of key financial metrics and improvement in liquidity would be viewed favorably.

CAPITAL STRUCTURE: Improvement in Alco's capital structure would alleviate leverage concerns.

REGULATORY FRAMEWORK: Unfavorable changes in California's regulatory environment would be viewed negatively.

CREDIT PROFILE

With a marginal decrease in sales and a 15% increase in operating expenses, income statement results were moderately lower overall in calendar 2011 relative to 2010 (Alco's fiscal year also ends Dec. 31). For 2011, EBITDA covered interest by 2.5 times (x) (down from 3.2x in 2010) and EBITDA covered total debt service by 1.7x (down from 2.2x). Alco's forecast through 2016 anticipates an additional drop in EBITDA coverage of interest to 1.8x in 2012 in light of rising interest costs associated with a note placement. But coverage is expected to gradually improve thereafter once the note is extinguished by the end of 2012 and assuming certain rate base offsets in future years.

Despite the weakened income statement results in 2011, cash flows were more favorable as a result of approval of various surcharges and a general rate base increase by the California Public Utilities Commission (CPUC) in March 2011. For 2011, cash flow from operations more than doubled from the prior year to $3.4 million, allowing Alco to boost capital spending to $1.4 million or a solid 219% of depreciation. The strong cash flow performance in 2011 also allowed Alco to pay down $2 million of debt. The reduction in debt is a positive given Fitch's historical concerns relating to Alco's capital structure.

For 2011 Alco's debt relative to equity dropped to 77% from 85% in 2010. With the amortization of debt and relative maintenance of net income over the last two years, debt-to-EBITDA also has gradually improved, falling to an average 3.9x in 2011. Despite the positive changes in capital structure and expected improvement over the near term, the system's elevated debt profile continues to be a major credit factor.

Alco's current capital improvement program for 2012-2016 totals $8.9 million and is anticipated to be funded largely from surplus revenues (around 70%), with a moderate 30% funded through capital leases. While the extent of equity capital funding will assist in further reducing debt levels to some extent, it should limit any increase in Alco's weak liquidity position; for 2011 days cash equaled just 18 days. However, the completion of projects should allow Alco to seek rate base offsets, which will enhance future annual cash flows.

Alco is regulated by the CPUC, but regulations are fairly well defined, and Alco has received timely rate relief. However, as a result of the recent rate increase passed by the CPUC, Alco's residential charges, which were already relatively high, have risen to a very high 1.4% of median household income based on 1,400 cubic feet per month. While Fitch expects the CPUC will allow future adjustments to cover necessary operating and capital expenditures and to generate a continued return on equity commensurate with other similarly-sized private water utilities in the state (currently in the 10% range), the system's level of charges poses some concern.

Alco is a private retail water company in Monterey County California, serving a portion of the city of Salinas and a population of around 29,000. Part of Alco's certificated service area includes undeveloped land within the city's extra-territorial jurisdiction. Water supplies are derived exclusively from groundwater sources, which are estimated to be sufficient to meet customer demands for the foreseeable future.

Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology', Aug. 12, 2011;

--'Rating North American Utilities, Power, Gas, and Water Companies', May 16, 2011;

--'Revenue-Supported Rating Criteria', June 12, 2012;

--'U.S. Water and Sewer Revenue Bond Rating Criteria', Aug. 10, 2011.

For information on Build America Bonds, visit 'www.fitchratings.com/BABs'.

Applicable Criteria and Related Research:

Corporate Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229

Rating North American Utilities, Power, Gas, and Water Companies

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=625129

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=681015

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647331

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE.
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Date:Jun 28, 2012
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