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Rating Action:

Moody's assigns Baa1.mx to Comisión de Agua y Alcantarillado (State of Quintana Roo, Mexico)

 The document has been translated in other languages

24 Dec 2007
Moody's assigns Baa1.mx to Comisión de Agua y Alcantarillado (State of Quintana Roo, Mexico)

New York, December 24, 2007 -- Moody's Investors Service has assigned issuer ratings of Baa1.mx (Mexico National Scale) and Ba3 (Global scale, local currency) to the Comision de Agua Potable y Alcantarillado (CAPA) of the State of Quintana Roo, the State Water Commission. The ratings incorporate an assessment of CAPA's growing customer base, primarily in the Riviera Maya region; a debt profile which changed recently with a new financing; and financial operations which appear to be stabilizing but have been challenged.

CAPA is a decentralized entity of the State of Quintana Roo charged with the provision of water and sewer services to the state's seven municipalities. CAPA is governed by a Board of Directors and managed by the general administration, with day to day operations administered by operating entities in each of the seven municipalities. Each operator prepares its own financial statements, and the financial statements of the CAPA represent the consolidated statements of the operators. Water and sewer service in the municipalities of Cancun and Isla Mujeres is under a concession with Desarrollos Hidraulicos de Cancun (DHC), for which DHC pays an annual concession fee to the state of Quintana Roo.

Reflecting the application of Moody's Joint Default Analysis rating methodology, the ratings incorporate a baseline credit assessment (BCA) of 14 on a scale of 1 to 21 (in which 1 represents the lowest credit risk) and a medium likelihood that the State of Quintana Roo (rated Ba1/A1.mx) would act to prevent a default by the CAPA. The medium likelihood of support is based on the absence of an explicit state guarantee, the essentiality of the service provided by CAPA, and oversight exercised by the state over the water company.

The State of Quintana Roo has an estimated population of 1.2 million. A majority of the population is concentrated in the northern to middle portions of the state that comprises Cancun and Solidaridad, where tourism has developed rapidly in the last 15 -- 20 years. As of September 2007, CAPA's customer base comprised approximately 145,000 users, with a large majority represented by domestic households. Growth in the user base has slowed in recent years, but is expected to continue at a moderate pace. This growth is expected to impel CAPA and the state to add infrastructure to meet the growing demand.

Coverage for the provision of potable water is high throughout the state (98%). Approximately 63% of users are on metered service, with deficiencies present in rural municipalities, as both Cozumel and Solidaridad are almost fully metered. Sewage collection and treatment coverage varies in the state, with the south and rural municipalities presenting a challenge in this area.

Spending on capital infrastructure has been limited. Although CAPA reports capital spending of Ps. $1.6 billion over the last 6 years (2001-2006), this amount includes contributions from developers and the state, as well as an incorporation carried out in 2006 of already existing assets. Investment has not been adequate, as CAPA estimates a deficit in infrastructure and deferred maintenance of approximately Ps. $2 billion.

As of the end of 2006, CAPA had a small loan of Ps.7 million from Banobras, which represented 3.3% of operating revenues. However, CAPA recently borrowed Ps $315 million from the Instituto de Financiamiento para el Estado de Quintana Roo (IDEFIN). The loan is payable over a 15 year period and is being paid through an administrative and paying trust.

CAPA's ratio of debt to operating revenues at the end of 2007 will approximate 75%, which is higher than other water and sewer entities rated by Moody's in Mexico, but not high by international standards given the capital intensive nature of these systems.

CAPA net revenues are not expected to be sufficient to cover debt service on the loan, hence the use of a structure which includes several other sources of funds, including funds derived from the DHC concession fee to the state, own source revenues and 5% of the state's federal participaciones. Additionally, the state is the ultimate obligor on the loan. Loan proceeds will be used primarily for capital investment in the areas covered by the concessionaire, with matching funds of Ps. $300 million to be invested in other municipalities. Long term planning for infrastructure is one of the challenges facing the water company.

Financial results in the last six full fiscal years have been mixed, with financing deficits in three of those years, but recent years show improvement with financing surpluses of 3.2% and 5.9% of revenues in 2005 and 2006, respectively. The system's operating margins (EBITDA) also improved to 18% of operating revenues in these years, compared to 7.8% in 2004. The improvement is in part driven by increases in operating revenues, which grew 30% in 2005 and 22% in 2006. The growth in revenues is due to an increase in customer accounts, fee increases matching inflation and, to some extent, improvements in metered service and collections.

On the expenditure side, the cost of goods sold has increased in line with operating revenues, with the exception of 2006 when an effort to expand and update services throughout the state notably raised CAPA's operating costs.

The CAPA Board of Directors sets fees annually based on the results of rate studies prepared by each of the operators. These take into account the cost of service and the socioeconomic conditions of the area served. Starting in 2008, the state congress will provide final approval on fees. On average, the current fees charged for water service are below the cost of service provision. CAPA's capacity to increase rates to more adequate levels is limited in the domestic sector by users' ability to pay, and in the commercial/hotel sector by the threat of competition if large users should drill their own wells or install desalinization plants.

Financial results through September 2007 indicate an operating deficit. In August 2007 the state transferred, as a loan, one half of this year's concession funds (Ps $17.5 million) to CAPA, which may help close the gap.

Cash flow analysis indicates that the CAPA does not consistently generate positive cash flow from operations. CAPA's liquidity is adequate, though cash on hand dropped in 2006 to Ps. $17.6 million, an amount less than half its current liabilities.

New York
Yves Lemay
Managing Director
International Public Finance
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Laura Barrientos
VP - Senior Credit Officer
International Public Finance
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

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