NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the Issuer Default Ratings (IDRs) of NRG Energy, Inc. (NRG) at 'B+' and GenOn Energy, Inc. (GenOn) at 'B-'. Fitch has also affirmed the IDRs of GenOn Americas Generation, LLC (GAG) and GenOn Mid-Atlantic, LLC's (GMA) at 'B'. GAG and GMA are intermediate holding company subsidiaries of GenOn. The Rating Outlook is Stable for NRG and the GenOn entities.
Fitch is simultaneously withdrawing all the ratings for NRG, GenOn and GenOn's subsidiaries. The level of information available through public disclosures is insufficient for Fitch to support a rating for these entities. NRG's debt structure has become complex over the last year driven by a series of corporate transactions and increased use of non-recourse debt to finance renewable and other conventional fuel projects. The acquisition of GenOn in 2012 and the recently announced proposed acquisition of Edison Mission Energy (EME) are structured such that the target becomes an excluded project subsidiary of NRG. NRG management provides forward-looking public disclosure on a consolidated basis, which is inadequate to perform a rating analysis for GenOn and its subsidiaries. At the same time, consolidated credit metrics cannot be used to rate NRG's debt, in Fitch's view, since non-recourse debt comprises approximately 50% of the total consolidated debt.
KEY RATING DRIVERS
The IDRs of NRG and GenOn are based on the respective standalone credit profiles based on Fitch's assumption that there is a weak linkage between the entities. As an excluded project subsidiary of NRG, GenOn exhibits no specific, tangible legal ties with the parent. GenOn and its subsidiaries do not guarantee NRG's debt, nor do any downstream guarantees flow from NRG to GenOn or its subsidiaries. There are no cross-default provisions between NRG's debt and the debt at GenOn entities and GenOn's debt is excluded from covenant calculation of NRG's debt. Operational ties are limited by a shared services agreement between NRG and GenOn. The absence of common treasury and an arm's length bilateral credit agreement between NRG and GenOn further limits the level of operational integration between the two entities. Fitch does deem GenOn to hold strategic importance for NRG. Any demonstrated tangible support by NRG towards GenOn, such as equity infusion or intercompany loans could be deemed a sign of a tighter rating linkage.
NRG's major corporate transaction this year has been the formation and initial public offering of NRG Yield Inc. (NRG Yield). NRG retains a 65.5% economic and voting interest in NRG Yield. The assets that have been dropped down into NRG Yield are renewable and natural gas fueled projects, whose economics are well supported by long-term power purchase agreements. NRG Yield holds the right of first refusal for six additional contracted assets currently owned by NRG. To sustain its credit profile at the current rating level, Fitch would expect NRG management to offset the loss of a stable, well-contracted stream of cash flows with commensurate reduction in parental leverage.
Fitch does note that an emphasis on high distributions as well as a growing stream of distributions at NRG Yield could create challenges for both the company and its parent over the long term by having to ensure that assets are available to drop down into NRG Yield. This could, in turn, cause NRG and/or NRG Yield to pursue an aggressive acquisition-led strategy if organic growth proves to be a challenge. In this vein, Fitch notes that the proposed acquisition of EME could put pressure on NRG's credit metrics given the acquisition price and the upfront partial debt funding unless the proceeds from the drop down of contracted assets into NRG Yield are used for parent debt reduction.
NRG's ratings are supported by a stronger post-merger business profile, successful execution of an integrated wholesale/retail model in Texas, a strong liquidity position, and the company's historically conservative hedging strategy, which has enabled it to generate strong free cash flow despite a persistently weak commodity environment. GenOn's generation portfolio lends geographic diversity, size and scale benefits to NRG's fleet. GenOn's northeast and western generation assets provide physical backup to NRG's retail aspirations in these markets, thereby lowering costs to compete. The IDRs of GenOn, GAG and GMA primarily reflect a tepid power price environment, compressed dark spreads, expiring above market hedges, and deactivations and planned retirements of a portion of its coal fleet.
Fitch expects the consolidated credit profile for NRG to be modestly weaker through 2015. GenOn's financial profile weakens in 2015 with the loss of above-market hedges and lower capacity payments. On a consolidated basis, Fitch anticipates NRG's funds flow from operations (FFO)-to-debt to be in the 12%-13% range and Debt/adjusted EBITDA to be in approximately 5.75x-6.00x range by 2015, which is weak compared to Fitch's guideline metrics of 15% FFO-to-debt and 5.0x Debt/adjusted EBITDA for a high-risk 'B+' rated issuer. Fitch expects GenOn's FFO-to-debt to be in the 7%-10% range and Debt/adjusted EBITDA to be approximately 7.0x by 2015.
Liquidity at NRG remains strong. As of Sept. 30, 2013, NRG had $3.7 billion of liquidity, which reflects cash and cash equivalents of $2.4 billion and revolver availability of $1.2 billion. Fitch expects NRG to generate upwards of $1 billion in free cash flow in 2014-2015. These estimates do not reflect the cash proceeds received from NRG Yield in return for assets to be dropped down. In this context, management's future capital allocation policies will be a key rating driver for NRG. GenOn had $825 million of unrestricted cash and cash equivalents as of Sept. 30, 2013, with an additional $198 million available under the $500 million intercompany revolver from NRG.
The Stable Outlooks for NRG, GenOn, GAG and GMA reflect strong liquidity to withstand a sustained period of depressed natural gas prices, manageable debt maturities, and greater diversity in generation portfolio.
The individual security issue ratings at NRG, GenOn, GAG and GMA are notched above or below the IDR, as a result of the relative recovery prospects in a hypothetical default scenario.
Fitch values the power generation assets of NRG, GenOn, GAG and GMA using a net present value analysis. Fitch uses the plant valuation provided by its third-party power market consultant, Wood Mackenzie, as an input as well as Fitch's own gas price deck and other assumptions. The generation asset net present values (NPVs) vary significantly based on future gas price assumptions and other variables, such as the discount rate and heat rate forecasts in the deregulated markets, where the power generation assets are based. Fitch calculates the value of NRG's retail business by applying a 5.0x multiple to EBITDA expectations of $500 million.
Tough operating environment: Power prices continue to be depressed and show only a modest recovery in tandem with natural gas prices in Fitch's base case for most regions where NRG and GenOn and its subsidiaries operate. The only exception is Texas, where reserve margins continue to fall and regulators continue to debate structural changes that may lead to stronger price signals to incentivize new generation. Worsening gas basis in PJM and potential for tougher environmental rules in Maryland could render additional coal plants uneconomic in GenOn's fleet. Competition continues to be intense in the retail electricity markets and margins are under pressure. A meaningful worsening of the current operating environment could adversely affect the credit profile of NRG, GenOn, GAG and GMA.
Aggressive growth strategy: Fitch views the creation and partial spin-off of NRG Yield and recently proposed EME acquisition as signs of the aggressive growth strategy being pursued by management. The pricing of future drop downs of contracted assets into NRG Yield and use of the proceeds remains uncertain. Without a commensurate parent debt reduction, the proposed drop down of highly contracted assets into NRG Yield would be detrimental to NRG's credit quality.
Capital allocation strategy: Capital allocation decisions by management will be key rating drivers for NRG. Large shareholder-friendly actions without commensurate debt reduction could lead to negative rating actions. An aggressive growth strategy focused on expansion of merchant generation assets would also be a cause for concern.
Fitch has affirmed and withdrawn the following ratings:
NRG Energy, Inc.
--Long-term IDR at 'B+';
--Senior secured term loan B at 'BB+/RR1';
--Senior secured revolving credit facility at 'BB+/RR1';
--Senior unsecured notes at 'BB/RR2';
--Convertible preferred stock at 'B-/RR6'.
GenOn Energy, Inc.
--Long-term IDR at 'B-';
--Senior unsecured notes at 'B+/RR2';
--Short-term IDR at 'B'.
GenOn Americas Generation, LLC
--Long-term IDR at 'B';
--Senior unsecured notes at 'BB-/RR2'.
GenOn Mid-Atlantic, LLC
--Long-term IDR at 'B';
--Pass-through certificates at 'BB-/RR2'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research
--'Parent and Subsidiary Rating Linkage' (Aug. 5, 2013);
--'Corporate Rating Methodology' (Aug. 5, 2013);
--'Recovery Ratings and Notching Criteria for Non-financial Corporate Issuers' (Nov. 19, 2013).
Applicable Criteria and Related Research:
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage