News Column

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

June 26, 2014

AUSTIN, Texas--(BUSINESS WIRE)-- Fitch Ratings affirms the following ratings for Alisal Water Corporation (Alco):

--$6.8 million of outstanding 2007A senior secured taxable bonds at 'BB+';

--Issuer Default Rating 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, including very low liquidity levels. A rate base increase in 2011 improved Alco's financial profile from prior levels, although ongoing margins are expected to be relatively modest.

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

LIMITED SERVICE AREA AND MANAGEMENT: The customer base is limited and includes a narrow economic profile and very high unemployment. Reflective of the size of operations, organizational leadership is concentrated, although the executive team is well qualified.

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

LONG-TERM SUPPLY ADEQUACY: The utility provides an essential service and water supplies are sufficient to meet long-term demands. Drought conditions affecting the state have limited impact to Alco's operations.

RATING SENSITIVITIES

USAGE DECLINES: Declines in sales volume would erode financial results and make it difficult to achieve Alco's approved return on equity (ROE) absent additional rate adjustments. Alternatively, rate base offsets to counter lower sales volumes would push already high user charges even higher.

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

REGULATORY FRAMEWORK: Unfavorable changes in California's regulatory environment that make it more difficult to achieve sufficient rate base adjustments to preserve financial margins would be viewed negatively.

CREDIT PROFILE

ADEQUATE BUT WEAK FINANCIAL RESULTS

Operating revenues improved 4% in calendar 2013 on higher sales volumes. However, improvement to Alco's income statement performance for the year was offset by a similar percentage increase in operating expenses - driven by higher production costs, repairs on a well, and an increase in income tax expenses - as well as higher debt service costs. For 2013, EBITDA covered interest by 2.3x (up from 1.7x in 2012) but EBITDA only covered total debt service by 1.5x (down from 1.8x).

Along with the relatively neutral operating results, cash flows were similarly unchanged in 2013 from the year prior. Cash flows from operations were down a total of $66,000 although free cash flow was up a modest $43,000. Alco's return on equity (ROE) - per Fitch's calculation which includes interest costs - fell slightly to just under 6% in 2013 from 7% in 2012.

No new financial projections are available, but forecast estimates prepared last year and that extend through 2017 reportedly remain valid. These figures point to relatively similarly EBITDA coverage of interest of 1.9x-2.2x assuming certain inflationary and rate base offsets in future years, flat sales, and limited growth in operating expenses.

DEBT PROFILE REMAINS ELEVATED

For 2013 Alco's debt relative to equity improved marginally to 74% from 75% in 2012 as a result of amortization of existing debt and lack of new borrowings. Debt-to-EBITDA saw similar movement to 5.3x from 5.7x in 2012 given the neutral financial performance during the year. Ongoing incremental improvement in the system's debt profile is expected over the near term as a result of limited planned borrowing and continued amortization of existing obligations. Nevertheless, the system's elevated debt profile continues to be a major credit factor.

MANAGEABLE CAPITAL BUT PAY-GO TO LIMIT LIQUIDITY IMPROVEMENT

Alco's current capital improvement program (CIP) for 2014-2017 totals $7.6 million. Capital projects and costs are unchanged from the last year's figures and are essentially unchanged from expectations over the last couple of years. Funding for the CIP is anticipated largely from surplus revenues (around 61%). While the extent of equity capital funding will help to improve Alco's capital structure to some extent, it will likely limit any improvement in Alco's weak liquidity position; for 2013 days equaled just 11 days. However, the completion of projects should allow Alco to seek rate base offsets, which will enhance future annual cash flows.

STABLE REGULATORY ENVIRONMENT

Alco is regulated by the CPUC but regulations are fairly well defined and Alco has received timely rate relief. However, as a result of Alco's 2011 rate case, 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 ROE 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.

LIMITED SERVICE TERRITORY AND MANAGEMENT

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. Supplies are estimated to be sufficient to meet customer demands for the foreseeable future and are essentially unaffected by the severe drought conditions currently plaguing the state.

Given the scope of operations, the number of company personnel is limited, including the executive team. Largely offsetting the concern related to limited personnel is the sound experience and qualifications associated with Alco's executive management team.

In addition to the sources of information identified in the Corporate Rating Methodology and Revenue-Supported Rating Criteria, this action was additionally informed by information from Creditscope.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 28, 2014);

--'Revenue-Supported Rating Criteria' (June 16, 2014);

--'U.S. Water and Sewer Revenue Bond Rating Criteria' (July 31, 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Water and Sewer Revenue Bond Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715275

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=836776

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. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst

Doug Scott, +1-512-215-3725

Managing Director

Fitch Ratings, Inc.

111 Congress, Suite 2010

Austin, TX 78701

or

Secondary Analyst

Scott Monroe, +1-415-732-5618

Director

or

Committee Chairperson

Karen Ribble, +1-415-732-5611

Senior Director

or

Media Relations

Elizabeth Fogerty, New York, Tel: +1-212-908-0526

elizabeth.fogerty@fitchratings.com

Source: Fitch Ratings


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