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 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.

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%. 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.

Liquidity

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

by 15%.

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.

Recovery analysis

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).

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.

(Privately held Zachry does not disclose financial results.)

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.

(New York Ratings Team)

(e-mail: pam.niimi@thomsonreuters.com; Reuters Messaging: pam.niimi.reuters.com@reuters.net; Tel:1-646-223-6330;)

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