-- 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.
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 modest recovery 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.
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
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%. For the current rating,
we consider debt to EBITDA of less than 3.5x and FFO to debt of about 20% to
be appropriate. John B. Zachry owns or controls 100% of the company's equity
and has the ability to control all matters requiring shareholder approval,
including the election of the board of directors and significant transactions.
In our view, during the past few years, the company's financial policies have
not been very aggressive given industry risks.
We believe Zachry has 'adequate' liquidity. Our assessment of Zachry's
liquidity profile incorporates the following expectations and assumptions:
-- We expect sources of liquidity, including available cash and FFO, to
exceed uses by 1.2x or more over the next 12 months.
-- We believe net sources would remain positive even if EBITDA declines
The revolver contains minimum net worth, leverage, and interest coverage
covenants, while the proposed notes would not contain maintenance covenants.
We expect Zachry to maintain more than 15% cushion against covenants.
We expect liquidity sources to include availability under the proposed upsized
$350 million revolver due 2018 (net of outstanding letters of credit) and cash
balances, which we believe will adequately covers its uses, mostly in the form
of capital expenditures, working capital investments, and any dividends over
the next 12 months. Financial and performance letters of credit could increase
to about $250 million in 2013.
Our assessment assumes the completion of the proposed upsize and extension of
Zachry's revolver maturity.
For the complete recovery analysis, see the recovery report on Zachry to be
published on RatingsDirect after this report. Zachry Holdings Inc.'s proposed
$250 million senior unsecured notes due 2020 have a preliminary 'B+' issue
rating and '5' recovery rating (indicating our expectation of modest
recovery in the event of payment default).
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.
(Privately held Zachry does not disclose financial results.)
Related Criteria And Research
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
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
(New York Ratings Team)
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