S&P Boosts Outlook on American Water Works (AWK) to Positive

Standard & Poor's Ratings Services said it has revised its rating outlook on Voorhees, N.J.-based American Water Works Co. Inc. (NYSE: AWK) and subsidiaries American Water Capital Corp. (AWCC), New Jersey-American Water Co., and Pennsylvania-American Water Co. to positive from stable. At the same time, we affirmed all of our ratings, including the 'A-' corporate credit ratings, on AWK and its subsidiaries.

"The positive outlook reflects our expectation of the continued strengthening of AWK's financial profile resulting from the company's increasingly effective handling of regulatory risk and leading to more favorable rate outcomes," said Standard & Poor's credit analyst Matthew O'Neill.

We view AWK's business risk as "excellent," based on its monopolistic and lower-risk rate-regulated water distribution business that provides an essential service in regulatory jurisdictions that we generally view as supportive of credit quality. In addition, the company's geographic diversity, reliability, and efficient operations also support its business risk profile. AWK's elevated capital-spending requirements for infrastructure replacement, increased compliance costs for water quality standards, and reliance on acquisitions to provide growth, partly offset these strengths. The company serves approximately 3.2 million water and wastewater customers across 16 states. We currently view the company as consisting of 95% regulated businesses and 5% unregulated businesses on an EBITDA basis. While we view the unregulated businesses as having higher business risk compared with the regulated operations, we also recognize that AWK's unregulated businesses marginally affect the company's business risk profile because of its modest expected capital requirements, affiliation with its regulated service jurisdictions, and its lower-risk service contracts.

AWK is regulated by the public utility commissions of the states in which they operate primarily New Jersey, Pennsylvania, Illinois, Missouri, Indiana, California, and West Virginia, which represent approximately 88% of revenues and 85% of customers. We assess all of the aforementioned regulatory jurisdictions as "strong/adequate." We also view AWK's regulatory advantage assessment as "strong" resulting from the above-average overall effective management of regulatory risk partially through the use of multiple riders including a distribution system improvement charge in a number of its jurisdictions, including New Jersey and Pennsylvania, as well as a decoupling mechanism in New York. These mechanisms allow for rate increases outside of a general rate case, which we view as credit-supportive because it reduces regulatory lag.

We assess AWK's financial risk profile as "intermediate" based on our low volatility benchmark ratios, reflecting the company's lower-risk regulated water business model and our assessment of the regulatory advantage score as "strong."

AWK has "adequate" liquidity and can more than cover its needs for the next 12 months, even if EBITDA declines by 10%.

The positive rating outlook on AWK reflects improvement in the financial measures, which we expect to continue throughout the forecast period. The improvement in financial measures stems from the company effectively managing its regulatory risk resulting in more favorable rate outcomes. Under our baseline forecast, we expect FFO to debt of more than 16% and debt to EBITDA of about 4.5x. We expect that AWK will continue to manage its regulatory risk while maintaining financial measures that remain consistent within its "intermediate" financial risk profile category.

We could revise the outlook to stable if regulatory risk increased or financial performance stalled or deteriorated, which could result from substantial debt financing of capital spending or acquisitions, such that FFO to debt fell to less than 16% and debt to EBITDA rose to more than 4.5x on a sustained basis.

We could raise the ratings if FFO to total debt consistently remained more than 17% and debt to EBITDA were less than 4.5x. This could most probably occur if the company were able to manage its regulatory risk and achieve higher-than-expected rate case outcomes along with continuing to manage its expenses in a conservative manner.

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