NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the long-term Issuer Default Rating (IDR) of Otter Tail Corporation (OTTR) at 'BBB-' and the long-term IDR of its regulated electric utility subsidiary, Otter tail Power Company (OTP) at 'BBB'. The Rating Outlook for both entities is revised to Stable from Negative. A complete rating list appears at the end of this release.
Due to the risks of its diversified business portfolio, Fitch rates OTTR one notch below its regulated subsidiary OTP. OTTR's current IDR of 'BBB-' takes into consideration the company's diversified business portfolio including a relatively small electric utility and a mix of small cyclical industrial businesses that operate in fragmented, competitive markets. Fitch also assumes that the utility's relatively large capex program will be funded with a balanced mix of debt and equity.
The Stable Outlook reflects the earnings recovery at the non-regulated operations reflecting improved overall performance and the divestiture of the money-losing wind tower business in 2012 and waterfront business in 2013.
Key Rating Drivers
--Strong and stable performance at OTP;
--Rationalization and downsizing of the diversified non-regulated business portfolio;
--Large capex program at the utility will require substantial reliance on external financing;
--Earnings recovery at the non-regulated subsidiaries
OTTR
OTTR's ratings reflect its higher risk profile from its downsized, but still prominent, diversified business portfolio. These diversified operations have been a source of large operating and non-recurring losses in recent years. OTTR's non-regulated activities are conducted through Varistar, a second-tier holding company and consist of three segments: manufacturing, plastics, and construction. Manufacturing and plastics have performed strongly in recent periods while construction continues to operate a loss.
Offsetting the higher risks and volatility of the non-regulated businesses, is a relatively low consolidated leverage position, although credit metrics have weakened as OTTR's net income was insufficient to support its common dividend payment to shareholders for the last three years. OTTR has realized approximately $240 million in cash proceeds from its divested businesses providing sufficient liquidity to support the dividend. OTTR presently has $100 million of parent level debt outstanding.
The earnings recovery is evident in the improvement in EBITDA to Interest which improved to 5.1x at the LTM period ended March 31, 2013 from 4.5x and 3.6x at year-end 2012 and 2011 respectively. Fitch expects EBITDA to Interest to remain slightly above 5.0x during the 2013 to 2015 forecast period.
OTTR has traditionally employed a low level of leverage, although Fitch expects leverage to trend higher over the forecast period. Fitch expects consolidated Debt to EBITDA, currently at 3.0x, to trend up to 3.5x over the forecast period reflecting higher debt levels to finance the utility's large capex program. Concomitantly, OTTR will be required to raise equity in future years to maintain its own capital structure as well as to downstream equity to support OTP's capital structure during the capex build-out.
OTP
OTP continues to perform strongly but faces pressures from a $715 million capex program that will almost double rate base over a five-year period. While OTP will require substantial external debt financing as well as equity infusions from OTTR during the capex cycle, operating cash flows are expected to be supported by construction work in progress (CWIP) on the transmission projects as well as recovery riders on the Big Stone environmental upgrade.
Regulatory mechanisms support OTP's earnings and cash flows. OTP enjoys full commodity and purchased power recovery across its three state jurisdictions. OTP's rural service area in Minnesota, North Dakota, and South Dakota has been economically stable and Fitch considers the regulatory oversight as reasonably balanced.
Credit metrics are strong. For the LTM period ended March 31, 2013, EBITDA to Interest was 5.7x, Debt to EBITDA was 3.1x, and FFO to Debt was 29%. Fitch expects some slippage in credit metrics to occur over the forecast period as the capex program ramps up but recover in 2016 as projects are completed. Over the forecast period, Fitch project EBITDA to Interest to average 5.3x, Debt to EBITDA to approximate 4.0x and FFO to Debt to average 21%.
Parent Subsidiary Linkage
Fitch's ratings of OTTR and OTP take into consideration some modest ring-fencing of the utility subsidiary from the parent and other affiliates, a factor that reduces but does not eliminate linkage between the ratings of OTTR and OTP. The utility's IDR of 'BBB' is one-notch higher than OTTR. Fitch typically notches diversified parent holding companies lower than their regulated subsidiaries.
Despite the downsizing of the non-regulated business investments, OTTR management expects to derive 15% to 25% of consolidated earnings from non-regulated businesses. Consequently, Fitch expects to maintain the rating differential between OTTR and OTP.
Liquidity
Liquidity is strong for both OTTR and OTP which both recently renewed their respective bank credit facilities for five years. OTTR has a $150 million credit facility with pricing at LIBOR plus 175bps and OTP has a $170 million facility with pricing at LIBOR plus 125bps. There are no debt maturities until 2016.
Rating Sensitivities
Execution and funding of a large capital investment program limits positive rating action at this time.
A downturn in the economically sensitive non-regulated higher risk businesses could pressure earnings and consolidated leverage.
Any change in the regulatory structure which limits timely and full recovery of invested capital during this large capex cycle would likely result in a negative rating action.
Fitch affirms the following ratings with a Stable Outlook:
Otter Tail Corporation (OTTR)
--Long-term IDR at 'BBB-';
--Short-term IDR at 'F3';
--Senior unsecured at 'BBB-'.
Otter Tail Power Company (OTP)
--Long-term IDR at 'BBB';
--Short-term IDR at 'F3';
--Senior unsecured at 'BBB+'.
Fitch has also withdrawn the following rating:
Otter Tail Corporation (OTTR)
--Preferred stock to WD from 'BB'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology', Aug. 8, 2012;
--'Recovery Ratings and Notching Criteria For Utilities', Nov. 12, 2012;
--'Parent and Subsidiary Rating Linkage', Aug. 8, 2012;
--'Short Term Criteria For Non-Financial Corporates', Aug. 9, 2012.
Applicable Criteria and Related Research:
Corporate Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=684460
Recovery Ratings and Notching Criteria for Utilities
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=693750
Parent and Subsidiary Rating Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685552
Short-Term Ratings Criteria for Non-Financial Corporates
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685553
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=795321
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