NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the Issuer Default Rating (IDR) of UGI Utilities, Inc. (UGIU) at 'A-' and senior unsecured debt rating at 'A'. The Rating Outlook is Stable. The rating action affects approximately $600 million of long-term debt.
UGIU serves approximately 660,000 natural gas and electric customers in Pennsylvania through its UGI Gas Division (UGIGas) and UGI Electric Division as well as through two subsidiaries, UGI Penn Natural Gas, Inc. (PNG) purchased in 2006 and UGI Central Penn Gas, Inc. (CNG) purchased in 2008. The service area covers a broad swath of eastern and central Pennsylvania and stretches into northern Maryland where UGI serves approximately several hundred natural gas customers.
Key Rating Drivers
-- Strong financial profile;
-- Earnings and cash flow generation sufficient to support increased capex;
-- Traditional tariff structure;
-- Parent and subsidiary linkage.
Strong Financial Profile
UGIU exhibits a strong financial profile rooted in a conservative capital structure and low leverage. Key leverage measures including adjusted debt to EBITDAR and funds from operations (FFO)-Adjusted Leverage of, respectively, 2.4x and 2.7x at fiscal year-end Sept. 30, 2014 are projected by Fitch to weaken slightly to average under 3x and 3.4x over the next three-year forecast period. Leverage measures compare favorably to Fitch 'A' category Sector Credit Factor median guideline ratios of 3.25x and 3.50x.
The capital structure has been maintained as upstream dividends to UGI Corp. have been below historical levels for the last two years at under a 60% payout ratio. In Fitch's models, future restraint on dividends will be needed to support the capital structure, since capex is expected to remain elevated over the forecast period.
UGIU exhibits a low-risk business profile consisting of its regulated natural gas and electric distribution businesses. Over 95% of operating income is derived from the natural gas segment. Non-regulated activities consist of services related to its core business including heating equipment and appliance service repairs and service, heating equipment conversions, and off-system bulk natural gas sales.
Robust Earnings and Cash Flows
Earnings and cash flows have been traditionally strong at UGIU with cyclical and, more important, secular factors driving fiscal 2014 results. The record cold 2013/2014 heating season winter saw system throughput of natural gas increase by 8.7% to 208.8 bcf (billion cubic feet) in fiscal 2014 over fiscal 2013 as heating degree days increased 10%.
Continuing a long-term trend that Fitch expects to continue over the next three to five years, UGIU experienced strong new customer growth. Customer growth is driven by the favorable cost and environmental profile of natural gas as compared with other fossil fuels. UGIU added approximately 18,000 residential, commercial, and industrial customers in fiscal 2014 including residential and commercial customers that have existing gas service but are converting their heating systems to natural gas, These customer conversions generate higher margins as it is relatively inexpensive to connect new customers to existing infrastructure.
Most new customers, however, do not have existing gas service, and while located within close proximity to existing mains, require a greater level of capital investment to connect. Fitch expects these new customer additions to continue based on the favorable natural gas profile as well as strong economic activity from drilling operations in the Marcellus Shale region, which is under significant portions of UGIU's service territory, to continue to stimulate economic activity and housing starts.
Capital spending continues to rise , driven by new customer additions, an infrastructure replacement program for aging pipe, and a recently approved program to expand the natural gas distribution system to under-served and un-served markets. This latter program, Growth Extension Tariff or 'GET Gas', commits UGIU to a five-year $75 million investment budget. In total, capex expenditures which grew from $114 million in fiscal 2012 to $164 million in 2014, are expected to top $200 million in fiscal 2015 and Fitch models for continued growth in 2016 and 2017. UGIU receives recovery under the GET Gas program, but for a substantial part of its remaining capital investment, under existing tariff mechanisms UGIU does not receive recovery of such investments.
Traditional Tariff Structure
The UGI Gas Division operates under a tariff structure originally approved by the Pennsylvania Public Utility Commission (PUC) in 1996. Although the UGI Gas Division does not have riders for aging infrastructure replacement or growth capex investments, earnings, cash flows, and the capital structure have been maintained through higher margins driven by strong customer growth and volume-driven higher margins. A new General Rate Case filing by UGI Gas is inevitable although continued customer growth can delay the timing of such a filing.
In general, Fitch considers Pennsylvania regulation to be supportive of UGIU's conservative business model. The company's exposure to commodity price volatility is mitigated by its ability to pass along the related costs to its customers. Fluctuations in natural gas costs are passed through to customers through a Purchased Gas Cost (PGC) tariff. Similarly, variations in electric generation and congestion costs are extenuated by a Default Service (DS) mechanism. The two smaller natural gas utilities, PNG and CNG, are eligible for pipe replacement recovery under Pennsylvania's Distribution System Infrastructure Charge (DSIC). All three utilities also receive timely recovery of investments under the GET Gas program.
Parent and Subsidiary Linkage
UGIU is a wholly-owned subsidiary of UGI Corp. a holding company with interests in a diversified portfolio of energy, power, and utility assets including , AmeriGas Partners, L.P. (APU) which is rated 'BB' (Issuer Default Rating) with a Stable Outlook by Fitch. UGI Corp. operates each one of its businesses separately and does not carry any parent-level debt. There are shared management, treasury, and investor relation functions shared between various entities. However, there are no significant business or operational ties between UGIU and UGI Corp and its other affiliates. Accordingly, Fitch rates UGIU independently of the UGI Corp's other business including APU.
Rating Sensitivities
Factors that individually or collectively could lead to a positive rating action:
-- Given the sizable multi-year capital investment program, positive rating actions are not likely at this time.
Factors that individually or collectively could lead to a negative rating action:
-- A review by the PUC of the company's rate structure that leads to weaker cash flows;
-- Increased leverage due to higher capex and/or higher dividend payments to parent UGI Corp than Fitch models reflect;
-- Debt-to-EBITDAR sustained above 3.75 to 4.0x.
Fitch has affirmed the following ratings with a Stable Outlook:
UGIU
-- IDR at 'A-'
-- Senior Unsecured Debt at 'A'
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);
--'Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)' (March 11, 2014).
Applicable Criteria and Related Research:
Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=735155
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=945315
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