NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings for Calpine Corp. (Calpine), including the 'B+' Issuer Default Ratings (IDRs) of Calpine and its subsidiary, Calpine Construction Finance Company (CCFC). A full list of rating actions follows at the end of this release. The Rating Outlook for both companies is Stable.
Calpine's 'B+' IDR reflects the company's high consolidated gross leverage and a generation portfolio that is largely uncontracted in 2015 and beyond. The ratings also incorporate various positive attributes of Calpine's asset portfolio such as a relatively young, clean and efficient generation fleet, geographic diversity and track record of generating relatively stable EBITDA in different natural gas price scenarios. Calpine has a strong liquidity position aided by growing free cash flow profile and has consistently demonstrated opportunistic capital market access that has lowered cost of debt and spread out its debt maturities.
KEY RATING DRIVERS
Improving EBITDA Profile: Calpine's ratings and stable outlook reflects Fitch's view that the fundamental positioning of the company in the merchant generation space continues to improve, leading to strengthening of credit metrics over the forecast horizon. Some of the key trends in the U.S. power generation sector, namely tightening environmental regulations, retirement of uneconomic coal plants and favourable demand supply dynamics in certain markets such as in the Electricity Reliability Council of Texas (ERCOT) are favorable for Calpine, in Fitch's opinion. Calpine is also a beneficiary of stronger than expected results from the latest PJM capacity auction. Contribution from the contracted generation projects that achieved commercial operation last year as well as from the projects under construction in Texas and PJM, is expected to drive EBITDA growth in the near term. Longer term, Calpine remains positively leveraged to a recovery in natural gas prices with its highly efficient fleet and natural gas being on the margin for power prices in most of the markets it operates in.
Large Uncontracted Position: Calpine's generation position has increasingly become more unhedged over the last few quarters. As of March 31, 2014, approximately 28% of 2015 and 20% of 2016 expected output was unhedged. This disclosure is adjusted to reflect the recently announced sale of six south eastern power plans. Consequently, Calpine's open position for the forward years is the highest it has been since the company emerged from bankruptcy in 2008. This hedging strategy underscores management's fundamental view of improving power prices and leaves Calpine's EBITDA exposed to changes in forward natural gas prices and heat rates.
As of March 31, 2014, every $1/MMBtu move in natural gas price changes Calpine's commodity margin by +/-$330 million in 2015 and approximately +/-$400 million in 2016, all else being constant. Similarly, every 500 btu/kwh change in heat rates changes the commodity margin by +/-$170-190 million in 2015 and +/-$180-200 million in 2016. Fitch does note, however, that low natural gas prices typically boost Calpine's generation output, thus, offsetting the compression in generation margins to a large extent. Calpine's EBITDA has proved to be relatively resilient in different natural gas price scenarios as compared to other merchant power generation companies.
Strong Free Cash Flow Generation: Fitch expects Calpine to generate more than $600 million of free cash flow in 2014; annual free cash flow is expected to climb to approximately $1 billion 2016 onwards. These free cash flow estimates incorporate both maintenance and growth capex based on announced new projects. Calpine is actively pursuing new generation projects as part of its growth strategy. The company brought 739 MW of contracted capacity on line in 2013 (Calpine's share was 584 MW), and has under construction 390 MW of merchant capacity in the tight Texas market (COD in 2014) and 309 MW of merchant capacity (COD in 2015) that has cleared the PJM capacity auction. The company is looking at potentially developing additional merchant capacity of up to 1,500 MW and contracted capacity of 345 MW in 2016-17 time frame. Reinvestment of capital in new generation projects under long-term contracts would be viewed positively by Fitch. Investment in new merchant generation projects at deeply discounted capital costs in tight power markets such as Texas would be the next preferred deployment of excess cash.
Capital Allocation Biased Towards Share Repurchases: With the balance sheet restructuring behind it, management has been increasingly focused on share repurchases and growth capex as its primary uses of excess cash. Since August 2011, Calpine has announced $2.1 billion of share repurchases, of which approximately $755 million is yet to be executed (as of March 31, 2014). The pace of share repurchases has been tracking above Fitch's expectation and has been bolstered by proceeds from opportunistic asset sales.
Calpine's recently announced sale of six power plants at attractive valuation ($450/kw or 15.7x EV/EBITDA) along with the use of net operating losses will net approximately $1.53 billion in cash proceeds. Management's public comments indicate a balanced allocation of these proceeds across debt pay down, reinvestment opportunities and share repurchases. Fitch expects the debt pay down to be commensurate with the loss of EBITDA from the plants being sold, management's stated leverage targets and higher business risk at the margin with relatively less contracted portfolio after the sale. There are no debt maturities until 2019.
Strengthening Credit Metrics: Fitch expects gross adjusted debt to EBITDAR ratio to be 6.2x in 2014 and improve to 4.7x in 2017. FFO adjusted leverage is expected to be 6.2x in 2014 and improve to 4.9x in 2017. Coverage ratios remain in the 2.75 - 3.00x range, in line with a strong 'B+' profile. Fitch's forecast assumes cash builds up on the balance sheet as the projects under construction achieve COD. To the extent management deploys a portion of the excess cash to new generation projects, there would be upside to our forecasted EBITDA and FFO metrics. It is Fitch's expectation that management continues to prudently invest excess cash flow proceeds in growth oriented projects and manage its balance sheet in a conservative manner. Calpine's liquidity position is strong with approximately $515 million of unrestricted cash and cash equivalents and $761 million of availability under the corporate revolver, as of March 31, 2014.
Rating Linkages: In accordance with its Parent and Subsidiary Rating Linkage Criteria, Fitch is currently linking the IDRs of Calpine and CCFC. Calpine and CCFC are distinct issuers, the subsidiary debt is non-recourse to the parent, and there are no cross-guarantees or cross-default provisions between the two entities. However, there are strong contractual, operational and management ties between Calpine and CCFC. CCFC sells a majority of its power plant output under a long-term tolling arrangement with Calpine's wholly owned marketing subsidiary. CCFC is also a party to a master operation and maintenance agreement and a master maintenance services agreement with another wholly owned Calpine subsidiary. For these reasons, Fitch is assigning the same IDR to CCFC as the parent even though its standalone credit profile is stronger.
The individual security ratings at Calpine 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 that guarantee the parent debt using a net present value (NPV) analysis. A similar NPV analysis is used to value the generation assets that reside in non-guarantor subs and the excess equity value is added to the parent recovery prospects. The generation asset NPVs vary significantly based on future gas price assumptions and other variables, such as the discount rate and heat rate forecasts in California, ERCOT and the Northeast. For the NPV of generation assets used in Fitch's recovery analysis, Fitch uses the plant valuation provided by its third-party power market consultant, Wood Mackenzie as well as Fitch's own gas price deck and other assumptions.
Fitch rates Calpine's corporate revolving facility, first lien credit facility and senior secured notes, which rank pari passu, at 'BB+/RR1'. The 'RR1' rating reflects a three-notch positive differential from the 'B+' IDR and indicates that Fitch estimates outstanding recovery of 91-100%. Fitch rates the first lien senior secured term loan facility at CCFC at 'BB+/RR1'.
Further Positive Rating Actions Unlikely: Positive rating actions for Calpine and CCFC appear unlikely unless there is material and sustainable improvement in Calpine's credit metrics compared with Fitch's current expectations. Management's net leverage target of 4.5x effectively caps Calpine's IDR at the 'B+' category.
Weak Wholesale Power Prices: Calpine's EBITDA is sensitive to the level of power demand and the supply dynamics in each of the markets it operates in. Regulatory construct and market rules can distort pricing signals relative to the underlying power demand and supply fundamentals. These factors could depress Calpine's EBITDA and FFO below Fitch's expectations and, if sustained over a period of time, could lead to negative credit actions.
Aggressive Capital Allocation Strategy: An enhanced pace of share repurchases without hitting or sustaining the stated net leverage targets would be a cause of concern.
Higher Business Risk: An aggressive growth strategy that diverts significant proportion of growth capex towards merchant assets could lead to negative rating actions. Management has been disciplined about M&A and has largely focused on tuck-in acquisitions in its core markets. Large-scale, expensive, and debt laden acquisitions will adversely affect Calpine's credit profile. Inability to renew its expiring long-term contracts could potentially lead to a higher open position and elevate the business risk for Calpine.
Weakening Credit Metrics: Sustained FFO leverage metrics below 6.5x and Total Adjusted Debt/EBITDAR below 6.0x could lead to negative rating actions.
Fitch has affirmed the following ratings with a Stable Outlook:
--IDR at 'B+';
--Corporate revolving facility at 'BB+/RR1';
--Senior secured first lien term loan at 'BB+/RR1';
--Senior secured first lien notes at 'BB+/RR1'.
--IDR at 'B+';
--Senior secured first lien term loan at 'BB+/RR1'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology', May 28, 2014;
--'Rating U.S. Utilities, Power and Gas Companies', March 11, 2014;
--'Recovery Ratings and Notching Criteria for Utilities', Nov. 19, 2013;
--'Parent and Subsidiary Rating Linkage', Aug. 5, 2013.
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)
Recovery Ratings and Notching Criteria for Utilities