Fitch Rates AquaSure's Proposed US Private Placement Notes 'A-(EXP)'

(The following statement was released by the rating agency) Fitch Ratings-Sydney/London-September 19: Fitch Ratings has assigned AquaSure Finance Pty Ltd's proposed US private placement notes an expected rating of 'A-(EXP)'. The Outlook is Stable. AquaSure Finance is the financing vehicle for Australia-based AquaSure Pty Limited.The rating is in line with AquaSure Finance's existing bonds and bank debt. The final rating is contingent upon the receipt of final documents conforming to information already received. The issuer intends to raise the equivalent of USD250 million, with the final amount to be determined following investor feedback. AquaSure Finance intends to use the proceeds to repay part of its AUD362 million bank debt that matures in October 2020. The notes are expected to have a term of 15 years and include the following: US dollar Series 2018A fixed-rate notes; and Australian dollar Series 2018B floating-rate notes. Fitch removed AquaSure Finance's notes from Rating Watch Negative in November 2017 and assigned a Stable Outlook following the completion of repairs to its electrical equipment and the subsequent strong operating performance of AquaSure's water desalination plant in the state of Victoria, which suffered an outage caused by equipment failure. Fitch reviewed reports on the outage that were prepared by AquaSure and its consultants and believes the event is unlikely to recur. Following ramp-up for 2017 water production, the plant consistently operated above nameplate capacity and 14% above the production rate required to meet the maximum annual water order of 150 gigalitres (GL). KEY RATING DRIVERS AquaSure's concession, ending in 2039, provides stable cash flow from Victoria, its financially strong counterparty. AquaSure's contracts allow it to pass through operating and lifecycle costs and revenue abatement to contractors. The rated debt is senior and benefits from adequate covenants and reserving mechanisms. Fitch's rating case forecasts an average debt service coverage ratio (DSCR) of 1.33x and a minimum projected DSCR of 1.28x. Revenue from Strong Counterparty: Revenue Risk - Stronger The water desalination project does not face price or volume demand risk. AquaSure receives monthly payments from Victoria in return for operating and maintaining the project, regardless of whether or not the state calls upon the plant to produce water. Contractual provisions establish strong incentives for performance by AquaSure, with robust cure periods for non-performance. The risk of revenue abatement due to a failure to meet water production or other requirements is effectively passed through to a third-party operator, subject to a cap. Cost Risk - Mid-Range Overall cost risk takes into account scope risk, cost predictability and volatility as well as structural protection. These are detailed below: Moderately Complex Maintenance: Scope Risk - Mid-Range Operation and maintenance (O&M) and lifecycle cost risk is passed through to AquaSure rather than retained by the public sector, although Victoria will, from October 2019, absorb the risk of non-performance by electricity provider, AGL Energy - one of Australia's largest energy utilities. Most other risks are passed through to the O&M joint venture (see Cost Pass-Through Available below). Lifecycle costs are generally spread out over the concession term, with some periods of concentration during major maintenance. Proven Technology and Experienced Operator: Cost Predictability - Stronger The plant's design is based on proven technology, with 7.5% excess nameplate capacity above the highest potential water requirement. In addition to passing performance tests at the time of commissioning, the plant performed strongly over the period of several months that it was operating during 2017, consistently producing water at a rate above nameplate capacity. Energy efficiency was also significantly better than target levels during the production period. Cost Pass-Through Available: Cost Volatility and Structural Protection - Stronger AquaSure has contracted with a joint venture of Suez and Ventia Utility Services (O&M JV), to perform O&M, including asset replacement, under a set-price contract for the life of the concession. The O&M JV partners absorb the risk of cost overruns, with their obligations backed by security bonding and joint and several parent-company guarantees from Suez Environment S.A. and CIMIC Group. AGL Energy guarantees the fixed-price electricity contract. AquaSure holds a maintenance and repair account to meet budgeted asset replacement costs for the next 12 months. Refinancing Risk Well-Mitigated: Debt Structure - Mid-Range Refinancing risk of the AUD3.6 billion senior debt is mitigated through a broad spread of debt maturities and equal sharing with Victoria of any losses due to higher refinancing margins. Base rate risk is passed through entirely to the state, with base-rates fully hedged until 2020 at the state's request. AquaSure Finance has consistently demonstrated strong access to debt markets, most recently refinancing AUD766 million of debt a year in advance of maturity through the issuance of 15-year fully amortising facilities. Structural protection includes a six-month debt service reserve account and lockup of distributions if the DSCR falls below 1.20x. Financial Profile Fitch's rating case produces an average DSCR of 1.33x over the remaining expected amortisation period for the senior debt, with a minimum of 1.28x. The concession life coverage ratio (CLCR) is 1.41x and takes into account cash flow in the 18-month "tail" between final amortisation and maturity of the concession. PEER GROUP AquaSure Finance carries refinancing risk, while two other Fitch-rated availability projects - Meridian Hospital Company PLC (senior secured debt rating: BBB+/Stable) and Derby Healthcare Plc (senior secured debt rating: BBB-/Stable) - have fully amortising debt. Victoria protects AquaSure by assuming all base-rate risk and sharing 50% of any refinancing losses due to higher-than-expected margins. AquaSure also benefits from stronger cost protection from the full O&M and lifecycle cost risk pass-through as well as a higher all-cost breakeven ratio. The Carlsbad desalination plant (California Pollution Control Financing Authority's Series 2012 plant and pipeline bonds, BBB-/Stable) also has fully amortising debt, but has encountered operating problems since its start-up in late 2015, causing it to fail to meet minimum production requirements in some months. The latest reviewed DSCRs for all three AquaSure peers are below 1.20x, while AquaSure's DSCR for the financial year ending 30 June 2017 (FY17) was 1.27x despite the electrical equipment damage, and the DSCR for FY18 was 1.46x, above Fitch's rating case expectation of 1.35x. RATING SENSITIVITIES Future Developments that May, Individually or Collectively, Lead to Negative Rating Action: - Inability to successfully deliver water orders to the state due to operational or other issues - Projected average DSCR over the life of the debt consistently below 1.30x Future Developments that May, Individually or Collectively, Lead to Positive Rating Action: - Debt amortisation occurring faster than Fitch expected, raising the projected average DSCR over the life of the debt above 1.40x. CREDIT UPDATE Performance Update Following the delivery of the state's water order of 15GL for FY18, which was completed in August 2017, AquaSure commissioned an external consultant to review the equipment failure that resulted in a major outage earlier in 2017. The consultant determined that the electrical equipment failure is unlikely to recur and expects the equipment to have a high level of reliability. A further study on plant performance during 2017 production determined that the plant exceeded design capacity, there were no reported water or environmental abatements, power efficiency was good and the operations team was well-trained and knowledgeable and operated the plant with robust systems and processes. AquaSure received a water order from the state of 15GL for FY19, the same quantity as for the previous year. The facility commenced delivery of the order on 3 September 2018. The facility was operating at capacity as of 11 September 2018, with all three streams operational. The plant has been running smoothly, with no operational difficulties. AquaSure expects to complete delivery of the water order by mid-October, after which the plant will be transitioned back into preservation mode. Fitch Cases Fitch's base case assumes that the plant produces at full output and that minor revenue abatement is incurred at the P50 level, as advised by the technical consultant, but the abatement is fully passed through to the operator. AquaSure's assumptions are used for operating and capital expenditure. The base case assumes a refinancing margin of 150bp-180bp. The base case results in an average DSCR of 1.38x during the debt life, with a minimum DSCR of 1.32x. The CLCR is 1.47x. Fitch's rating case imposes more conservative assumptions, with no pass-through of abatement or higher costs. All operating and lifecycle costs are increased by 7.5% above the base-case assumptions for the life of the project, except that costs for power and renewable energy certificates are only increased until 2019, after which the state takes the risk of non-performance of the counterparty. The rating case assumes a refinancing margin of 250bp-280bp. The resulting DSCR is 1.33x on average with a minimum of 1.28x. The CLCR is 1.41x. Asset Description AquaSure designed, built and operates and maintains a 150GL per year desalination plant located in Victoria under a 30-year concession with the state. Contact: Primary Analyst David Cook Director +61 2 8256 0363 Fitch Australia Pty Ltd Level 15, 77 King Street Sydney NSW 2000 Secondary Analyst James Hodges Associate Director +44 20 3530 1278 Committee Chairperson Stephane Buemi, CFA Senior Director +44 20 3530 1236 Date of Relevant Rating Committee: 28 November 2017 Media Relations: Athos Larkou, London, Tel: +44 20 3530 1549, Email: athos.larkou@fitchratings.com; Leslie Tan, Singapore, Tel: +65 6796 7234, Email: leslie.tan@fitchratings.com. 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