NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'BBB-' Issuer Default Rating (IDR) and security ratings of Empire District Electric Company (EDE). The Rating Outlook is Stable. A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
Low-Risk Business Model: EDE's predictable earnings and cash flows are derived from its regulated electric and gas businesses that operate in the regulatory jurisdictions of Missouri, Kansas, Arkansas, and Oklahoma. EDE generates the majority of its earnings from Missouri, which represented approximately 86% of operating revenue in 2013. All jurisdictions feature fuel adjustment mechanisms that allow for timely recovery of fuel costs and purchased power expense and stabilize cash flows.
Missouri Regulatory Framework: EDE has done well in recent rate proceedings. In EDE's last rate decision, the utility was granted a $27.5 million electric base rate increase effective April 2013, representing near 90% of its original request. In addition, Missouri rate design features trackers for some operating expenses and a fuel adjustment clause, which was implemented in 2009. Nonetheless, regulatory lag, driven by a reliance on historical test years to determine base rates and an extended review period, continues to remain a credit concern. Proposals to mitigate the impact of regulatory lag, which would take effect no earlier than 2015, have been brought forward by the Missouri Legislature, and Fitch will monitor future legislative actions that, if implemented, would be credit positive, in Fitch's view.
Elevated Capex: Management plans on spending approximately $500 million over the next three years compared with $407 million over the previous three years. Elevated capex is driven by ongoing investments in transmission and distribution infrastructure, environmental retrofit at the Asbury coal-fired plant, and the conversion of the Riverton 12 natural gas plant to combined cycle. EDE is installing a scrubber and baghouse at the 189MW coal-fired Asbury plant with an expected completion date in early 2015. EDE estimates project cost to range from $112 million to $130 million. As of March 31, 2014, EDE had spent $89.4 million. EDE is also converting its Riverton Unit 12 plant from a simple cycle combustion turbine to a combined cycle unit. Management expects the project to be completed in mid-2016 at a cost estimated to range from $165 million to $175 million. As of March 31, 2014, EDE had spent $29.8 million on the project. Concurrently with the conversion of Riverton Unit 12, EDE will retire older Riverton Units.
Importantly, EDE expects to be in full compliance with existing environmental mandates after completion of the Asbury and Riverton projects. Given the absence of an environmental recovery mechanism in Missouri, EDE is expected to file a rate case in 2014 to recover its capital investments on the Asbury project. Fitch has assumed an additional rate filing in 2016 to recover capital spending on the Riverton project. Efficient cost control during the construction cycle and balanced regulatory outcomes will be critical towards maintaining the current rating profile. Fitch expects EDE to use a balanced mix of internally generated cash flows, debt and equity to finance capex.
Pressured Credit Metrics: Fitch expects EDE's leverage metrics to weaken from existing levels over the next two years, driven by elevated capex and the expiration of bonus depreciation and other supportive tax policies. Fitch forecasts FFO lease-adjusted leverage to approximate 5x in 2014 and 4.8x in 2015. Adj.debt/EBITDAR is forecasted to approximate 4.2x in both 2014 and 2015. Fitch projects FFO leverage metrics to improve below 4x by 2017, as EDE completes the Riverton project.
For the LTM period ended March 31, 2014, FFO lease adjusted leverage was 3.6x, and Adj. debt/EBITDAR, 3.4x. The ratios of FFO fixed charge coverage and EBITDAR/(gross interest + rents) were 4.9x and 5.2x, respectively. A constructive outcome in the 2013 rate case, modest customer growth from the sustained post-tornado Joplin economic recovery, and cash flow benefits stemming from bonus depreciation and other tax benefits, were the primary drivers of the utility's robust financial performance.
Adequate Liquidity: EDE has access to a total capacity of $150 million under an unsecured bank credit facility that matures Jan. 17, 2017. At March 31, 2014, there was $149.6 million of available liquidity, including $145.5 million of unused facilities and $4.1 million of cash and cash equivalents. Long-term debt maturities are considered manageable with $25 million due in 2016 and $90 million due in 2018. Fitch expects EDE to continue to have adequate access to the capital markets to refinance long-term debt maturities and finance capex.
Factors that could lead to a positive rating action:
No positive rating actions are anticipated at this time given the near-term elevated capex and uncertainty of rate case outcomes. However, Fitch would consider a positive rating action in the event of a constructive rate outcome in the next rate case, along with achieving FFO lease-adjusted leverage of approximately 4.25x on a sustained basis.
Factors that could lead to a negative rating action:
Unfavorable regulatory developments in Missouri, resulting in significant cost recovery disallowances associated with EDE's projects, would likely lead to negative rating actions.
FFO lease-adjusted leverage above 5x on a sustained basis would trigger negative rating actions.
Fitch has affirmed EDE's ratings as follows:
--IDR at 'BBB-';
--Senior secured debt at 'BBB+';
--Senior unsecured debt at 'BBB';
--Short-term IDR at 'F3';
--Commercial paper at 'F3'.
The Rating Outlook is Stable.
Additional information is available at 'www.fitchratings.com'.
Applicable Research Criteria and Related Research:
--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014);
--'Rating U.S. Utilities, Power and Gas Companies' (March 11, 2014).
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)