NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned its 'A' rating to the Southern Company's issuance of $400 million series 2014A 1.30% senior notes due Aug. 15, 2017 and $350 million series 2014B 2.15% senior notes due Sept. 1, 2019. These notes are senior, unsecured obligations of Southern Company. The Rating Outlook is Stable.
The net proceeds from both the offerings will be used to repay a portion of Southern Company's outstanding short-term indebtedness, which totaled approximately $777 million as of Aug. 18, 2014, 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 sales 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 reflects adequate liquidity, financial flexibility, and easy access to capital markets during a period of high capital investment.
At present, regulatory risk is subdued for Southern Company's utility subsidiaries, except Mississippi Power Company, given the recent rate resolutions at Georgia Power Company, Alabama Power Company and Gulf Power Company). Georgia Power's rate case outcome in December 2013, while modestly below Fitch's expectations, provides for a three-year rate certainty and reflects an authorized return on equity (ROE) of 10.95% that is above industry average. Alabama Power received a favorable outcome from the Alabama Public Service Commission (PSC) regarding review of its Rate Stabilization and Equalization (RSE) mechanism in August 2013. The PSC voted to replace the current ROE range of 13%-14.5% and allowed an equity ratio of 45% with a weighted cost of equity (WCE) provision. The resolution of the RSE review was in line with Fitch's expectation and removes a key source of regulatory uncertainty for Alabama Power. Gulf Power received a constructive outcome in its 2013 rate case that authorized a continuation of its retail ROE midpoint of 10.25% with a range of +/- 100 basis points (bps). The authorized ROE midpoint and range can be increased by 25 bps in the event the 30-year treasury yield rate increases by an average of at least 75 bps above 3.7947% for a consecutive six-month period.
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 Vogtle nuclear units 3 and 4 in which Georgia Power owns a 45.7% stake 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. Earlier this week, the Georgia PSC voted unanimously to approve $389 million of capital spent on Vogtle nuclear units in 2013. To date, the PSC has approved $2.6 billion in costs incurred on Vogtle units 3 and 4; these units are projected to be in-service by 4Q'17 and 4Q'18, respectively. 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 $5.5 billion, of which $1.1 billion is subject to exemptions and exceptions from the regulatory cost cap. Of the remaining $4.4 billion, Mississippi Power does not intend to seek rate recovery for $1.56 billion of costs incurred above the $2.88 billion cost cap and has taken an equivalent charge to income through its 2Q'14 financial results. Southern Company has committed to inject equity in Mississippi Power to restore its capital structure.
Southern Company is planning to finance its equity infusion into Mississippi Power through equity issuance. The funding of Kemper cost overruns primarily by equity is a key factor that underpins Southern Company's Issuer Default Rating of 'A' 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 equity in the capital structure remains within the targeted range of 44%.
Mississippi Power continues to face significant project execution risks, which reflect the ongoing construction and operational risks associated with Kemper, and still-elevated regulatory risk. Significant risks that remain are associated with the gasifier start-up and integration with the combined cycle turbines. The primary regulatory risk for Mississippi Power pertains to ongoing discussions with the Mississippi PSC staff and intervenors to arrive at a global settlement that could address both the changes in the seven-year rate plan and prudency of Kemper project costs incurred through March 2013.
Southern Company's consolidated environmental compliance expenditures remain significant over Fitch's forecast period. The company is planning to spend approximately $3.2 billion over 2014-2016 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, 2014, the funds flow from operations (FFO) adjusted leverage stood at 3.5x, which includes the benefit of bonus depreciation. Fitch expects Southern Company's FFO adjusted leverage to be approximately 4.0x by 2016. Fitch forecasts Southern Company's FFO coverage ratios to remain strong, over 5x, which reflects the declining benefit of bonus depreciation subsidies. 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.
Negative Rating Actions:
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 increased 1.1% year-to-date as compared to the same period last year. Residential and commercial sales have continued to exhibit anemic growth while industrial sales are showing strength. 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.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage', May 28, 2014;
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', Dec. 23, 2013;
--'Recovery Ratings and Notching Criteria for Utilities', Nov. 19, 2013;
--'Rating U.S. Utilities, Power and Gas Companies', March 11, 2014.
Applicable Criteria and Related Research:
Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)
Recovery Ratings and Notching Criteria for Utilities
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis - Effective Dec. 13, 2012 to Dec. 23, 2013
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage