May 30, 2012 / 5:53 PM / 5 years ago

TEXT-S&P affirms Capstone Infrastructure ratings

Overview	
     -- We are affirming our ratings, including our 'BB+' long-term corporate 	
credit rating, on Capstone Infrastructure Corp..	
     -- In addition, we are removing the ratings from CreditWatch with 	
developing implications. 	
     -- The affirmation and CreditWatch removal reflect our view of the 	
progress that the company has made in regard to the various initiatives to 	
address its liquidity.	
     -- The stable outlook reflects our view that Capstone benefits from 	
contracted revenue and insulation from electricity demand and price risks 	
provided by power purchase agreements with investment-grade off-takers.	
	
Rating Action	
On May 30, 2012, Standard & Poor's Ratings Services affirmed its ratings, 	
including its 'BB+' long-term corporate credit rating, on Toronto-based 	
Capstone Infrastructure Corp. The outlook is stable. Standard & Poor's also 	
removed the ratings on CreditWatch with developing implications, where they 	
were placed April 5, 2012.	
	
The affirmation and CreditWatch removal reflect our view of the progress that 	
the company has made in regard to the various initiatives to address its 	
liquidity.	
	
Rationale	
The ratings on Capstone reflect Standard & Poor's view that the company's 	
revenues and cash flow from long-term power purchase agreements (PPAs) with 	
provincial government agencies and investment-grade off-takers is stable. In 	
addition, the company has made two substantial investments within the past 	
year in district heating and Bristol Water plc, a regulated U.K. water utility 	
that provides more consistent revenue streams. These investments have helped 	
increase Capstone's asset and geographic diversity. We forecast that Bristol 	
will account for approximately 30% of Capstone's annual consolidated EBITDA 	
during the next three years. In addition, we believe there is a track record 	
of sustained high availability and operating performance of the company's 	
generation assets. 	
	
We believe that offsetting these strengths to a certain degree is the 	
recontracting risk of two power purchase agreements at the Cardinal and 	
Whitecourt facilities in 2.5 years. While Capstone has entered negotiations 	
with respect to the Cardinal facility, it is not clear as to whether the 	
company will be able to negotiate contracts on as favorable terms. In 	
addition, Capstone has been pursuing a number of refinancing initiatives to 	
address its pending bank facility maturities. While these measures have been 	
largely successful, we believe that the increase in leverage from these 	
initiatives in conjunction with the expected revision of its dividend policy 	
significantly reduces financial flexibility. 	
	
Capstone owns and operates seven electricity generation assets with a total 	
installed capacity of 316 megawatts (MW), in addition to one 20 MW solar 	
facility which began operation in June 2011 and interests as preferred share 	
holder and lender to a 28 MW biomass facility at Chapais, Que.; a 30% 	
ownership interest in a Swedish district heating business; and a 50% interest 	
in a regulated U.K. water utility. In 2011, Capstone's facilities generated 	
1.88 tetawatt-hour (TWh) of electricity with an average availability of 97% 	
for gas, wind and biomass; 51% for hydro and 20% for solar. The generation 	
assets are mainly in Ontario and British Columbia and all (but 4 MW) of their 	
capacity are contracted under PPAs, largely with government agencies. The 	
company owns a solar park at Amherstburg (ASP), Ont., with projected capacity 	
of 20 MW and that commenced operations in June 2011. ASP sells its electricity 	
output through a 20-year PPA with the Ontario Power Authority. In March 2011, 	
Capstone also acquired 33% equity interest in Varmevarden, a company that 	
operates 11 district heating facilities in Sweden; and in October it acquired 	
a 70% interest (since reduced to 50%) in a U.K. regulated water utility.	
	
Standard & Poor's uses a hybrid approach that assigns a business risk profile 	
and a financial risk profile while applying its "Rating Criteria For Project 	
Developers" (published Sept. 30, 2004, on RatingsDirect on the Global Credit 	
Portal) in evaluating Capstone's credit quality. We consider the rating 	
approach appropriate because the company's portfolio consists of investments 	
in operating companies such as the Swedish heating business and Bristol and a 	
portfolio of projects which employ specific nonrecourse project debt. In 	
accordance with these methodologies, we have assigned a satisfactory business 	
risk profile and significant financial risk profile. In addition, we assess 	
the quality of Capstone's investment portfolio cash flow as having moderate 	
stability and predictability to reflect the increased diversity which the new 	
assets provide while remaining cognizant of the recontracting risks of two key 	
assets.	
	
Liquidity	
We assess consolidated liquidity to be "less than adequate". In our opinion, 	
there is a decreased flexibility on the operating companies' part to generate 	
cash flow to meet their respective debt servicing requirements and remit 	
sufficient to Capstone for it to in turn make its own dividend payment as well 	
as any other financial obligations. Nevertheless, the company has stated that 	
it is reviewing its dividend policy and expects to make an announcement during 	
second-quarter 2012. If it were to decrease the dividend by an amount equal to 	
50% or greater, we believe that liquidity sources could exceed uses 1.2x or 	
more in the next 12 months.	
	
Factors that support our liquidity assessment are the following:	
     -- We believe that the increased leverage in the operating companies 	
reduces the companies' financial flexibility.	
     -- We believe the current trading price of Capstone's common shares 	
precludes further equity issuance at this time, further limiting financial 	
flexibility.	
	
Our assessment of liquidity under the scenario outlined above includes the 	
following:	
     -- We forecast that consolidated funds from operation for 2012 will be 	
approximately C$68 million. 	
     -- The company has approximately C$11 million in principal repayments and 	
a maturity at Bristol Water in October 2012 of approximately C$24 million (of 	
which 50% would be attributable to Capstone).	
     -- Absent a change in policy, we forecast dividends to be approximately 	
C$42 million in 2012.	
	
Outlook	
The stable outlook reflects our view that Capstone benefits from contracted 	
revenue and insulation from electricity demand and price risks provided by 	
PPAs with investment-grade off-takers in the medium term. In addition, the 	
cash flows from its nonpower related acquisitions increase cash flow diversity 	
and reduce reliance on the current PPAs, in particular Cardinal. 	
	
We could raise the ratings if the company takes steps to improve its liquidity 	
(for example, through a reduction in its common share dividend) such that it 	
is consistent with our criteria description of "adequate" and demonstrates 	
concrete steps in recontracting the expiring PPAs while maintaining or 	
improving its significant financial risk profile. We expect the company to 	
continue to focus its growth strategy on assets with cash-flow predictability 	
supported by either favorable contracts or regulation.	
	
We could consider lowering the ratings should Capstone's overall cash flow 	
quality weaken materially from its moderate level of stability. This could 	
come from major operational disruptions in its generation facilities or 	
acquisition of assets with materially higher cash flow variability. In 	
addition, we could consider a negative rating action if we expect the 	
company's cash-flow coverage measures to weaken materially, with partially 	
consolidated cash flow to interest falling below 2.7x or partially 	
consolidated cash flow to total recourse debt falling below 20% on a sustained 	
basis, in accordance with our criteria for project developers. This could 	
happen if it increases its reliance on debt financing to support its growth 	
initiatives or its distribution. In addition, failure to renew expiring PPAs 	
or replace them with acquisitions of other contracted assets could also lead 	
to a downgrade in the medium term.	
	
Related Criteria And Research	
     -- Methodology And Assumptions: Liquidity Descriptors For Global 	
Corporate Issuers, Sept. 28, 2011	
     -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, 	
May 27, 2009	
     -- Key Credit Factors: Business And Financial Risks In The Investor-Owned 	
Utilities Industry, Nov. 26, 2008	
     -- Hybrid Capital Handbook: September 2008 Edition, Sept. 15, 2008	
     -- Rating Criteria For Project Developers, Sept. 30, 2004	
	
Ratings List	
Ratings Affirmed And Removed From CreditWatch Developing	
	
Capstone Infrastructure Corp.	
                               To                   From	
 Corporate credit rating       BB+/Stable/--        BB+/Watch Dev/--	
 Preferred stock	
  Global scale                 B+                   B+/Watch Dev	
  Canada scale                 P-4(High)            P-4 (High)/Watch Dev

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