NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned its 'A' rating to the Southern Company's issuance of $500 million series 2013A 2.45% senior notes due Sept. 1, 2018. These notes are senior, unsecured obligations of Southern Company. The Rating Outlook is Stable.
The net proceeds from the offering will be used to repay a portion of Southern Company's outstanding short-term indebtedness, which totaled approximately $739 million as of Aug. 20, 2013, and for other general corporate purposes.
KEY RATING DRIVERS:
Southern Company's ratings recognize the relatively stable and predictable cash generation of its operating subsidiaries and the financial support it gets from them in the form of dividends for the payment of corporate expenses, debt service, dividends to common stockholders, and for other business matters. Southern Company's regulated utility subsidiaries enjoy a relatively favorable regulatory framework in their service territories and exhibit limited commodity price risks due to the ability to recover fuel and purchased power through separate cost trackers.
Its non-regulated generation subsidiary, Southern Power Company, follows a conservative business model by signing long-term sale contracts with creditworthy counterparties and has minimal commodity exposure via recovery of fuel costs through its power supply contracts. Southern Company provides equity funding to its subsidiaries for their long-term growth and to optimize their capital mix within a target range. The Stable Outlook for Southern Company reflects adequate liquidity, financial flexibility, and easy access to capital markets during a period of high capital investment.
Regulatory risk has increased for Southern Company's utility subsidiaries given the ongoing rate proceedings at Georgia Power Company (Georgia Power) and Gulf Power Company (Gulf Power), and higher regulatory scrutiny of Mississippi Power Company's (Mississippi Power) cost overruns associated with the 580 MW Integrated Gasification and Combined Cycle (IGCC) plant at Kemper. Favorable outcome for Georgia Power's regulatory proceedings will be key to sustaining Southern Company's current ratings given that it accounts for approximately 50% of consolidated operating income.
Fitch acknowledges that the downside risk to return on equity (ROE) is high for Georgia Power given the national trend of declining ROEs. At the same time, Fitch recognizes the constructive regulatory regime in Georgia and low commodity prices that provide a favorable backdrop for rate negotiation. The last rate case outcome for Georgia Power in 2010 was quite constructive, which enabled the utility to embark on a heavy capex spend with strong credit metrics. Fitch believes Georgia Public Service Commission (PSC) will continue to be supportive of the financial health of the utility. Furthermore, the expected increase under the Nuclear Construction Cost Recovery (NCCR) tariff of approximately 1% per year through 2017 lowers the overall rate pressure on Georgia Power's customers.
Southern Company's second largest subsidiary, Alabama Power Company (Alabama Power), recently received a vote from the Alabama PSC regarding review of its rate stabilization and equalization (RSE) mechanism. The PSC voted to replace the current ROE range of 13.0%-14.5% and allowed equity ratio of 45% with a weighted cost of equity (WCE) provision. The WCE range was established by the PSC at 5.75%-6.21% with an adjusting point of 5.98%, which is modestly lower than the implied WCE range under current rates of 5.85%-6.53% with an adjusting point of 6.19%. In addition, Alabama Power will be eligible for a performance-based adder of 0.07% if it is rated 'A' by at least one of the major credit rating agencies or is in the top one-third in customer satisfaction survey. The resolution of the RSE review is in line with Fitch's expectation and removes a key source of regulatory uncertainty for Alabama Power.
Fitch's rating concerns for Southern Company include significant construction and regulatory risks associated with the two large baseload projects under construction, namely the 2,200 MW Plant Vogtle nuclear units 3 and 4 being built by Georgia Power and the 580 MW Kemper IGCC plant being built by Mississippi Power. The Vogtle nuclear units have been recovering the financing costs on construction work in progress (CWIP) through a tracker since 2011. Fitch expects that any adjustments to the overall project costs will be deemed recoverable by the Georgia PSC. Significant project cost overruns that cannot be recovered in rates or unexpected long deferral periods for project cost recovery would be adverse credit factors.
The Kemper IGCC project has faced significant overruns relative to its original project costs estimate. The project is now expected to cost $4.7 billion, of which $853 million is subject to exemptions and exceptions from the regulatory cost cap. Of the remaining $3.87 billion, Mississippi Power does not intend to seek rate recovery for $990 million of costs incurred above the $2.88 billion cost cap and has taken an equivalent charge to income in the year-to-date financial results. Southern Company has committed to inject equity in Mississippi Power to restore its capital structure.
Southern Company is planning to finance the approximately $1 billion equity infusion into Mississippi Power largely through equity. Management has committed to issue equity of $700 million in 2013 and $600 million in 2014. Management has further committed to issue additional equity in 2015, if needed, to maintain the consolidated equity ratio at the targeted 44% levels. The funding of Kemper cost overruns primarily by equity is a key factor for Fitch's recent affirmation of Southern Company's Issuer Default Rating and Stable Outlook. It is Fitch's expectation that any future cost overruns at Kemper will be similarly funded largely through equity such that the consolidated capital structure remains within the targeted range. Fitch's financial projections assume that Kemper becomes operational within the currently projected capital costs and schedule and that the Mississippi PSC approves the seven-year plan proposed by Mississippi Power to ensure rate stability for retail customers.
Southern Company's consolidated environmental compliance expenditures remain significant over Fitch's forecast period. The company is planning to spend approximately $3.6 billion over 2013-2015 on environmental capex. All of Southern Company's regulated subsidiaries, with the exception of Georgia Power, have environmental trackers. Georgia Power has typically recovered environmental compliance-related costs through base rate case decisions.
For the last 12 months (LTM) ending June 30, 2013, the funds flow from operations (FFO)-to-total debt ratio stood at 21%, which includes the benefit of bonus depreciation, and the adjusted debt-to-EBITDA ratio stood at 3.9x. Fitch forecasts Southern Company's coverage ratios to remain strong, over 6.0x, which reflects the declining benefit of bonus depreciation subsidies. Fitch expects Southern Company's adjusted debt-to-EBITDA ratio to be approximately 3.5x and FFO-to-adjusted debt to be approximately 21% by 2015. Incorporated in the ratings is Fitch's expectation that Southern Company's financial measures will remain weak through the large capex cycle at Georgia Power, its largest subsidiary.
Positive Rating Actions: Fitch does not anticipate any positive rating actions for Southern Company in the near future.
Project execution risk: Significant time/cost overrun at the Vogtle and/or Kemper projects that are primarily debt financed and negative regulatory actions on the recovery of those costs would be a trigger for downward rating actions.
Significant slowdown in sales: Weather-adjusted retail sales have declined 0.7% year-to-date as compared to the same period last year. Residential and commercial sales have continued to exhibit weakness while industrial sales are beginning to firm up modestly. Lower than expected sales are a key factor in both Gulf Power's and Georgia Power's pending rate increase request. Persistent economic weakness and lower than expected sales across Southern Company's utility subsidiaries could lead to weak consolidated credit metrics putting pressure on ratings.
Unfavorable regulatory actions: Less than constructive outcomes in the pending rate proceeding at Georgia Power can also lead to negative rating actions.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology', Aug. 5, 2013;
--'Parent and Subsidiary Rating Linkage', Aug. 5, 2013;
--'Short-Term Ratings Criteria for Non-Financial Corporates', Aug. 5, 2013;
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', Dec. 13, 2012;
--'Recovery Ratings and Notching Criteria for Utilities', Nov. 13, 2012;
--'Rating North American Utilities, Power, Gas and Water Companies', May 16, 2011.
Applicable Criteria and Related Research:
Rating North American Utilities, Power, Gas, and Water Companies
Recovery Ratings and Notching Criteria for Utilities
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis
Short-Term Ratings Criteria for Non-Financial Corporates
Parent and Subsidiary Rating Linkage Fitch's Approach to Rating Entities within a Corporate Group Structure
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage