NEW YORK--()--Fitch Ratings has assigned a 'BBB' rating to the proposed PPL Capital Funding, Inc.'s (PPL Capital Funding) new $400 million issue of 4.20% senior notes due June 15, 2022. The Rating Outlook is Stable.
PPL Capital Funding's ratings are based on an unconditional guarantee by its parent PPL Corporation (PPL).
Key Rating Drivers:
Transformative Utility Acquisitions
PPL's ratings reflect its rapid transformation from a company heavily reliant on commodity sensitive businesses to one that is highly regulated with substantially less business risk. Driven by the acquisitions of Central Networks in April 2011 and LG&E and KU Energy, LLC in November 2010, regulated operations are expected to provide over 70% of consolidated EBITDA. By comparison, regulated operations accounted for approximately 30% of EBITDA prior to the acquisitions.
Reasonably Balanced Financing Approach
Both acquisitions were funded with a mix of common stock, hybrid securities, and debt in a manner that maintained PPL's consolidated capital structure. Approximately 50% of the permanent acquisition financing was funded by common stock and convertible equity units, which result in a ratio of debt to capitalization of 54.1% as of March 31, 2012, in line with PPL's 'BBB'-rated peers.
Large Capital Spending Program
PPL is investing heavily in its regulated businesses and expects to grow the regulated rate base by approximately 8% annually over the next five years. The investments will require ongoing rate increases in both Kentucky and Pennsylvania, and equity support from PPL. Expenditures in Kentucky are primarily to install environmental upgrades to comply with new Environmental Protection Agency (EPA) standards. In Pennsylvania, the new investments are largely to replace aging infrastructure and for transmission upgrades.
Constructive Regulatory Mechanisms
The two Kentucky utilities operate with an environmental cost recovery (ECR) mechanism that permits approved environmental costs to be recovered in rates two months after incurred. The ECR mechanism is particularly important given the two utilities' reliance on coal-fired electric generation and the substantial investment that will be required to meet the EPA's newest regulations. The ECR provides for recovery of and a return on environment investments, and substantially mitigates construction risk. For Pennsylvania, Fitch views positively the new alternative rate making legislation enacted in February 2012. The new bill allows utilities to utilize a fully projected future test year and extends the distribution system improvement charge to electric and natural gas distribution companies, reducing regulatory lag.
Credit Metrics Expected to Improve
The ratings reflect Fitch's expectation that the initial rise in leverage from funding the acquisitions will decline over the next few years. The expected improvement recognizes a full year of earnings from the two acquisitions, including synergy savings at the newly acquired UK electricity distribution businesses. As of Dec. 31, 2011 and March 31, 2012, PPL produced ratios of debt/EBITDA of 4.0x and 3.75x, respectively. Fitch expects this leverage measure to remain below 4.0x.
A challenging operating environment for PPL's U.S. wholesale power business is a primary concern. Driven primarily by lower energy and capacity prices and higher fuel costs, the earnings and cash flow contribution of PPL's wholesale power business is expected to remain under pressure for several years. Additionally, PPL's ability to achieve on-going rate support is also a concern given its sizeable capital spending program in the next several years.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 12, 2011);
--'Parent and Subsidiary Rating Linkage' (Aug. 12, 2011);
--'Recovery Ratings and Notching Criteria for Utilities' (May 3, 2012);
--'Rating North American Utilities, Power, Gas and Water Companies' (May 12, 2011).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Parent and Subsidiary Rating Linkage
Recovery Ratings and Notching Criteria for Utilities
Rating North American Utilities, Power, Gas, and Water Companies