Fitch Downgrades Sikeston, MO's Electric Revs to 'BBB'; Outlook Remains Negative

NEW YORK--()--Fitch Ratings has downgraded the rating on the following city of Sikeston, MO revenue bonds to 'BBB' from 'BBB+':

--$85,515,000 electric system revenue refunding bonds, 2012 series.

The Rating Outlook is Negative.

SECURITY

The bonds are secured by a first lien on net revenues of the Sikeston Board of Municipal Utilities (BMU) including wholesale revenues from power sales contracts (PSCs) with four municipal offtakers.

KEY RATING DRIVERS

FINANCIAL PERFORMANCE DETERIORATES FURTHER: The rating downgrade reflects further deterioration in cash flow and liquidity metrics driven by lower than anticipated wholesale margins and lagging rate relief. Based on audited results through fiscal 2015 and preliminary unaudited financial results for fiscal 2016 Fitch calculated debt service coverage remained well below 1.0x in both years.

OUTLOOK REMAINS NEGATIVE: The Negative Rating Outlook is based on financial projections provided by BMU that show debt service coverage remaining below 1.0x through the current fiscal year (fiscal 2017) while available liquidity falls further to less than 90 days of cash on hand in 2018. Outer years of BMU's latest financial forecast indicate cash flow and liquidity metrics will stabilize at levels likely to be consistent with the current rating, although realization of the projected results will be contingent on more favorable wholesale margins and passage of additional rate increases.

SIZEABLE OFF-SYSTEM SALES: BMU sells a considerable 88% of the capacity from its single, 235MW coal-fired generating facility into the wholesale market. Half of total capacity is sold pursuant to long-term, take-or-pay power sales contracts (PSCs) with four solid municipal offtakers and a sizeable one-third of the total is sold on a spot basis, which is unusual for a municipal utility. Wholesale spot market sales, which provided all of BMU's net margins historically, have eroded in recent years amid low natural gas prices and reduced demand.

AMPLE RATE FLEXIBILITY EXISTS: Sizeable rate increases in fiscals 2015 and 2016 support performance, but have failed to offset lower wholesale margins. More moderate rate increases will be necessary to support the current rating and are expected based on the current financial forecast ending in fiscal 2022. BMU's existing retail rates still rank among the lowest in the state, providing considerable headroom to generate additional revenues.

CASH RESERVES PROVIDE SUPPORT: Despite higher than anticipated depletion of cash on hand in recent years, balances are forecast at no less than 85 days of cash on hand through the current forecast period, providing continued support for BMU's uneven cash flows.

SOLID CREDIT QUALITY OF OFFTAKERS: BMU's four municipal offtakers' sound economic profiles and solid financial metrics, including low debt levels and healthy cash flow metrics, support its rating.

RATING SENSITIVITIES

DEPLETION OF CASH RESERVES: Sikeston, MO's inability to meet its debt service coverage requirement and sustain cash balances approximating 85 days whether as a result of insufficient retail rate increases, lower than anticipated wholesale margins or declining energy sales would likely lead to downward rating action and potentially a speculative grade rating.

CREDIT PROFILE

COMPRESSED MARGINS PERSIST

Fitch revised its Rating Outlook for BMU to Negative from Stable in June 2014 reflecting softening wholesale market conditions and limited retail rate action which impaired BMU's ability to fully recover costs and comply with its rate covenant. Traditionally, BMU's sales of excess capacity in the spot market had allowed its retail system to produce negative net margins and but still operate with the lowest rates in the state.

Wholesale sales have since continued declining, largely offsetting the implementation of a 14.3% retail rate increase in fiscal 2015, and passage of an additional 15% retail rate increase in fiscal 2016. Fitch calculated debt service coverage weakened as a result, declining to .78x in each of the prior two fiscal years.

Fitch notes that non-compliance with the rate covenant to provide 1.10x annual debt service coverage from net revenues does not trigger an immediate event of default under the bond ordinance. As in fiscal 2010 and 2014, BMU continued transferring moneys from its unrestricted cash reserves into the revenue fund in fiscals 2015 and 2016 in order to sufficiently remedy the shortfall as permitted by the ordinance. The ongoing use of cash reserves to comply with the bond covenant has steadily eroded BMU's previously robust liquidity. Fiscal 2016, based on unaudited financial results, ended with approximately 120 days of cash on hand, equal to less than half the number on hand at fiscal year-end 2013.

Financial projections extending through fiscal 2022 indicate debt service coverage will remain below 1.0x for the current fiscal year (2017) before rebounding and remaining adequately above 1.0x in each of the subsequent years of the forecast. Liquidity, according to the forecast, also declines in the initial years of the current forecast, falling to a low point of 85 days of cash on hand before gradually improving in the outer years of the current planning period.

Forecast results rely in large part on city council's passage of additional 5% semiannual rate increases in fiscals 2018-2020. The forecast further assumes aggregate energy sales will grow by about 5.0% in fiscal 2017, remain flat in 2018, and then increase by nearly 7% in fiscal 2019 as BMU potentially begins serving an additional wholesale customer pursuant to a yet to be approved five-year contract. Energy sales are forecast to remain flat in the three remaining years of the forecast.

Fitch considers the forecast assumptions feasible, but notes that weaker than projected financial performance over the initial years of the current forecast would likely prompt additional negative rating action. Conversely, BMU's ability to generate cash flow and liquidity metrics in line with its targeted ratios of 1.1x and no less than 90 days cash on hand, respectively, would likely stabilize the rating at the current level.

ASSET OPERATIONS

BMU's 235MW, coal-fired generating unit provides it with competitively priced power. The unit average heat rate was 10,720 Btu/kWh in 2015, consistent with industry standards for coal-fired plants. However, continued low natural gas prices coupled with a nine-week maintenance outage prompted declines in the unit's availability and capacity factors to 80% and 70%, respectively in fiscal 2015.

UTILITY OVERVIEW

BMU provides electric, water, and sanitary sewer services to the city of Sikeston, MO. The electric utility, which has been in operation since 1931, directly serves nearly 9,300 retail customers principally from a single, owned coal-fired resource. In addition, the utility makes sizable wholesale contract sales representing almost one-half the capacity of its generating asset to four municipal offtakers -- the cities of Carthage, Columbia, Fulton, and West Plains -- pursuant to long-term, take-or-pay PSCs that extend to the later of June 1, 2022 (the year the city's electric revenue debt fully matures), or the useful life of the plant, with certain exceptions. The obligations of the municipal purchasers are several, not joint. Approximately one-fifth of total capacity serves the city's retail base. The excess is sold on a wholesale basis.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria

Revenue-Supported Rating Criteria (pub. 16 Jun 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

U.S. Public Power Rating Criteria (pub. 18 May 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=864007

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1006250

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1006250

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Christopher Hessenthaler, +1-212-908-0773
Senior Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Lina Santoro, +1-212-908-0522
Senior Director
or
Committee Chairperson
Dennis Pidherny, +1-212-908-0738
Managing Director
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Christopher Hessenthaler, +1-212-908-0773
Senior Director
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Lina Santoro, +1-212-908-0522
Senior Director
or
Committee Chairperson
Dennis Pidherny, +1-212-908-0738
Managing Director
or
Media Relations
Elizabeth Fogerty, New York, +1-212-908-0526
elizabeth.fogerty@fitchratings.com