NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'A-' long-term IDR for Nextera Energy, Inc. (Nextera) following yesterday's announcement of a definitive agreement to acquire Hawaiian Electric Industries, Inc. (HEI) The transaction excludes HEI's banking subsidiary. The Rating Outlook for Nextera is Stable.
Fitch views HEI acquisition as moderately positive for Nextera driven by modest increase in earnings from regulated businesses, predominant use of equity to finance the acquisition, and attractive regulated investment opportunities at HEI's utility. That said, Fitch's view is somewhat tempered by structural issues with the Hawaii service territory with its excessive reliance on oil for power generation, high retail prices, increasing penetration of residential roof top solar and need for significant capital investment to transition to cleaner fuel sources. This could put pressure on retail prices in the short to medium term.
Concurrently, Fitch has placed the 'BBB' IDR for HEI on Rating Watch Positive. Fitch will likely resolve the Rating Watch on the conclusion of the transaction and could upgrade HEI by one notch given its ownership by a higher rated company. In such a scenario, the ratings of HEI will be equalized with that of its wholly-owned subsidiary, Hawaiian Electric Company (HECO), given the transaction contemplates the spin-off of the bank. Post-closing, HEI will become a second tier holding company of Nextera and will remain as the direct parent of HECO.
Fitch has also affirmed the 'A-' IDR for Nextera Energy Capital Holdings (Capital Holdings) and 'A' IDR for Florida Power and Light Company (FPL). The Rating Outlook is Stable for both these entities. The IDR of Capital Holdings is equalized with that of Nextera due to the full, irrevocable and unconditional guarantee by Nextera. The one-notch differential between the IDRs of FPL and Nextera is in line with Fitch's approach to closely align IDRs of parent and subsidiaries where a high degree of rating linkages exists.
Fitch has also affirmed the 'BBB+' IDR of HECO with a Stable Rating Outlook. HECO will benefit significantly from Nextera's ownership, in Fitch's view, given access to Nextera's expertise in developing renewable projects, superior operational performance and portfolio transformation to cleaner fuels in addition to access to capital. However, the structural weakness in its service territory due to rising penetration of roof top solar compounded by the uncertainty around the fleet modernization plan limits any positive rating actions at this time.
The transaction is valued at $4.3 billion and includes $1.7 billion in HEI consolidated debt. HEI shareholders will receive 0.2413 Nextera shares and a one-time special cash dividend payment of $0.50 per share. HEI is planning to spin off ASB Hawaii, the parent company of American Savings Bank, to its shareholders; the spin-off is expected to be tax free to HEI shareholders and will be completed immediately prior to the Nextera HEI combination. Nextera will assume approximately $1.60 per HEI share of tax liability for the spin-off. Management expects the transaction to be completed in approximately 12 months, which is subject to HEI shareholder and various regulatory approvals.
KEY RATING DRIVERS
Modest Improvement in Business Risk
Fitch views the acquisition of HEI as modestly improving Nextera's business risk profile and supporting management's oft repeated strategy of diverting the business mix toward more regulated and/ or contracted sources. HECO is the largest utility in Hawaii, serves 450,000 customers and owns three operating utilities with a total regulated rate base of approximately $2.6 billion.
HECO has several constructive rate mechanisms in place that mitigate cash flow volatility. These include revenue decoupling for approximately 90% of revenues that offset impact from a high energy efficiency mandate, fuel and purchased power pass-through recovery, rates based on forward test years, and recovery of increases in certain operating expenses and capital investments between rate cases through riders. HECO's current regulatory approved tariff reflects 56% authorized equity ratio and 9.9% authorized Return on Equity (ROE).
Structural Challenges in Hawaii
HECO faces several structural issues in its service territories that emanate from a high reliance on oil (close to 70%) to fuel its power generation. With fuel and power purchased costs comprising 65% of the total retail bill, the resulting high retail price (~3x the national average) has led to a contentious relationship between HECO and other constituents including political, regulatory and consumer groups. HECO's utilities earn below their authorized ROEs despite favorable rate mechanisms.
Additionally, abundance of good solar resources, a high renewable standard in the state (40% by 2030) and net energy metering at retail rates has sparked a jump in residential roof top solar. Approximately 11% of HECO's customers have rooftop PV systems that substantially reduce their own consumption of utility supplied power. Through net metering, this allows customers to sell excess generation back to the utility. At the current scale, integration of solar into the grid as well as cost shifting to non-net metering customers, typically lower income, is raising material concerns for both the utility and the regulator.
Fitch believes with its strong leadership position in renewable energy, both wind and utility scale solar, project development skills, strong operational performance and high customer reliability, Nextera is uniquely positioned to address the structural issues outlined above. FPL has successfully modernized its generation fleet and reduced customer rates at the same time. While FPL's track record in Florida offers us comfort, Fitch does acknowledge that HECO is a much smaller utility and the potential investments needed to transform the generation portfolio could be multiples of the current rate base. The high level of capex coupled with rising roof top solar penetration could put pressure on retail prices in the interim and it remains uncertain what kind of regulatory support Nextera could garner to implement its plan.
Regulatory Approvals Required
The transaction requires approvals from Hawaiian Public Utilities Commission, Federal Energy Regulatory Commission, Federal banking regulators, SEC registration process and the expiration or termination of the waiting period under the Hart-Scott-Rodino Act and is contingent upon the spin-off of ASB Hawaii. The transaction also requires approval from holders of at least 75% of HEI's shares, which presents a higher than average hurdle.
Credit Metrics Trajectory Unchanged
Given the size of the acquisition and predominantly equity driven acquisition financing, Fitch sees little change in its forecasted metrics for Nextera. On a consolidated basis, Fitch expects FFO Fixed Charge Cover to approximate 5.25x in 2017. Fitch expects adjusted Debt to EBITDA and FFO adjusted leverage to approximate 3.5x by 2017.
Fitch also looks at an alternative rating scenario for Nextera, which incorporates off-credit treatment to a large portion of limited recourse debt and proportionately consolidates Nextera Energy Partners (NEP). Fitch accordingly excludes the debt, interest expense, EBITDA contribution and tax attributes from the limited recourse projects and includes only the distributable cash flow. Nextera's credit metrics look stronger in the alternative rating case. FFO fixed charge cover remains above 7.5x over the forecast period and FFO adjusted leverage is forecasted to improve to 3.2x by 2017 under this scenario.
RATING SENSITIVITIES
Nextera and Capital Holdings:
Positive rating actions for Nextera and Capital Holdings appear unlikely at this time. Downward rating pressure could result from the following scenarios:
--Inability to Reach Targeted Credit Metrics: A failure to achieve adjusted FFO leverage of 3.5x - 3.75x by 2017 on a consolidated basis could lead to negative rating action for Nextera;
--Deterioration in Florida Regulation: Any change in current regulatory policies at Florida Public Service Commission would adversely affect Nextera's and FPL's ratings. Any weakness in the current business climate in Florida will also be a cause for concern;
--Increase In Business Risk Profile: A change in strategy to invest in more speculative assets, non-contracted renewable assets or a lower proportion of cash flow under long-term contracts would increase business risk. This in turn could result in lower ratings for Nextera. The high level of capital expenditures at both FPL and Capital Holdings creates completion risks, as well as funding risk;
--Aggressive Financial Strategy: Any deterioration in credit measures that result from higher use of leverage or outsized return of capital to shareholders could lead to negative rating actions. Fitch will continue to monitor management's strategy with respect to NEP and an aggressive acquisition or financial strategy, rising conflict of interest between Nextera and NEP, or predominantly shareholder focused use of sell down proceeds will have negative implications for Nextera's credit;
--Change In Tax Laws or Regulations: Changes in tax rules that reduce Nextera's ability to monetize its accumulated production tax credits, investment tax credits, and accumulated tax losses carried forward would be adverse to Nextera's cash flow credit measures.
FPL:
Positive or negative rating actions for FPL look unlikely at this time. However, downward rating pressure could result from the following scenarios:
--Change In Florida Regulation: Unfavorable changes in current Florida regulatory policies for timely recovery of utility capital investments, fuel and purchased power costs, and storm-related costs would adversely affect FPL's ratings;
--Increasing Parent Risk Profile: If Nextera increases its debt leverage or changes its corporate strategy such that its risk profile materially worsens, it could adversely affect FPL's ratings in line with Fitch's Parent and Subsidiary Rating Linkage Criteria.
HEI and HECO:
Positive: Future developments that may, individually or collectively, lead to positive rating action include the following:
-- A successful execution of the fleet modernization program under Nextera's ownership and with no material pressure on retail rates;
-- FFO adjusted leverage at HECO less than 4.0x on a sustainable basis; and
-- Successful closing of the acquisition by Nextera will likely result in one-notch upgrade of HEI.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
-- An inability to earn an adequate and timely recovery on invested capital;
-- Accelerating competitive inroads by distributed generation and energy efficiency; and
-- Failure to consummate acquisition by Nextera and material deterioration in regulatory environment.
Fitch has affirmed the following ratings with a Stable Outlook:
NextEra Energy, Inc.
--Long-term IDR at 'A-'.
NextEra Energy Capital Holdings, Inc.
-- Long-term IDR at 'A-';
--Senior unsecured debentures at 'A-';
--Equity units at 'A-';
--Junior subordinate hybrids at 'BBB';
--Short-term IDR and commercial paper at 'F1'.
FPL Group Capital Trust I
--Trust preferred stock at 'BBB'.
Florida Power & Light Company
--Long-term IDR at 'A';
--First mortgage bonds at 'AA-';
--Unsecured pollution control revenue bonds at 'A+';
--Short-term IDR and commercial paper at 'F1'.
HECO
--Long-term IDR 'BBB+';
--Senior unsecured debt 'A-';
--Subordinated debt 'BBB';
--Short-term IDR 'F2';
--Commercial paper 'F2'.
Fitch has placed the following ratings on Rating Watch Positive:
HEI
--Long-term IDR 'BBB';
--Senior unsecured debt 'BBB';
--Short-term IDR 'F3';
--Commercial paper 'F3'.
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);
--'Recovery Ratings and Notching Criteria for Utilities' (Nov. 18, 2014);
--'Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis'
(Nov. 25, 2014);
--'Rating U.S. Utilities, Power and Gas Companies, (March 9, 2014).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Recovery Ratings and Notching Criteria for Equity REITs
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=813628
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=821568
Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=735155
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=942495
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.