NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the 'BBB+' Issuer Default Rating (IDR) of Duke Energy Corp. (DUK) following its announcement of an agreement to sell its Latin American generation businesses. Fitch has also removed the ratings from Rating Watch Negative and assigned a Negative Rating Outlook.
The Negative Rating Outlook reflects the high consolidated and parent leverage and the uncertainty in DUK's ability to lower leverage to levels acceptable for the current rating and reduced business risk. Fitch will monitor the following actions: application of sale proceeds to debt reduction; the level of future parent level debt issuances; the timely recovery of significant capital investments and operating costs related to coal ash and other investments and expense control.
Cash proceeds from the asset sale are expected to be roughly $1.7 billion to $1.9 billion. Management has indicated that proceeds will be used to retire a portion of the debt incurred to fund the $4.9 billion (excluding fees) acquisition of Piedmont Natural Gas Co., which closed on Oct. 6, 2016 and the remainder to fund parent debt maturities or in lieu of other debt requirements. DUK initially announced plans to sell the Latin American business and to use proceeds for debt reduction in February 2016.
Key Rating Drivers
Asset Sale: Fitch views the sale of the Latin American Generation business and the associated reduction in earnings and cash flow volatility to be credit supportive. However, sale proceeds alone are not sufficient to achieve the debt reduction needed to bring leverage in line with the current ratings and business risk without further adjustments to the company's aggressive growth plan and timely capital recovery.
High Consolidated and Parent Leverage: Despite the anticipated debt reduction consolidated and parent leverage remains high. In the first full year of the Piedmont earnings contribution (2017), Fitch estimates Debt/EBITDAR will approximate 5.0x. Fitch will consider maintaining the rating if the company can demonstrate the ability to reduce leverage below 4.8x by 2019. Prior to the Piedmont acquisition Fitch expected consolidated leverage to be in the 4.5x range. The percentage of holding company debt (including intermediate holdco Progress Energy, Inc.) is also high. With the acquisition and proposed asset sale Fitch expects holdco debt to peak at about 35% in 2017 and not fall below 31% - 32% any time soon.
High Quality Core Businesses: The acquisition of Piedmont Natural Gas Co. and the announced sale of its Latin American business will complete DUK's transition to a primarily regulated business model. However, the transition was accompanied by a meaningful rise in leverage. The businesses provide regulatory and geographic diversity and relatively predictable earnings and cash flow. Each of the utilities have solid credit profiles and are well positioned within their respective rating levels.
Investments in relatively low-risk contracted renewables and FERC-regulated electric and gas transmission projects round out the portfolio. The last vestiges of DUK's U.S. merchant generation portfolio were disposed of in April 2015.
Constructive Regulation: Each of the seven state regulatory jurisdictions in which the DUK subsidiaries operate is considered constructive by Fitch.
Aggressive Growth Plan: Consolidated capex is forecast to average approximately $8.4 billion (excluding Piedmont) annually over the next five years, well in excess of the $6.3 billion average spending over the prior two years. Regulated investments account for approximately 85% of the capex plan. The plan also includes investments in the Atlantic Coast Pipeline, renewable generation and discretionary growth. About 35% of growth capex is recoverable through rider mechanisms or power purchase agreements.
Pending Rate Case: DUK subsidiary Duke Energy Progress, LLC (DEP) filed with the South Carolina Public Service Commission for a $79 million rate request in July 2016 based on a 10.75% return on equity (ROE). The rate request increase was based on a 2015 test year adjusted for known and measureable changes through Sept. 30, 2016. This is DEP's first rate filing in South Carolina since 1988. The majority of the rate request is driven by investments in major generation plant additions. A final decision is expected by January 2017. Given the level of investment by DEP and Duke Energy Carolinas, LLC, Fitch expects additional rate filings in North Carolina as early as 2017. In addition, rider mechanisms in effect in Florida and Indiana are expected to provide additional revenue increases.
Fitch's key assumptions within the rating cases are as follows:
--Sale of Latin American Generation business closes in 2017 and a minimum $1.5 billion is used for debt reduction;
--$42 billion five-year capex plan;
--Ash pond remediation costs are recoverable from ratepayers;
--Current rider mechanisms remain in effect;
--Rate filings as necessary to recover capital investments and operating costs not recovered through rider mechanisms.
Positive Rating Action: A positive rating action is not likely given the high level of parent debt and expected rise in consolidated leverage, but ratings could be maintained if leverage falls to 4.8x or below by 2019.
Negative Rating Action: Ratings could be downgraded if parent leverage rises above current expectations or adjusted debt/EBITDAR exceeds 4.8x on a sustained basis.
To meet short-term cash needs DUK has substantial and relatively stable cash flows from its seven regulated utilities. Nonetheless, like most of the utility sector, consolidated capex exceeds internal cash flow after dividends. Accordingly, to provide for its working capital needs DUK maintains a $7.5 billion committed revolving credit facility (RCF) to support its $4 billion commercial paper (CP) program, letters of credit (LOCs) and variable-rate tax-exempt bonds. The facility includes borrowing sub-limits for DUK and its subsidiaries, each of which are party to the credit facility. DUK has the unilateral ability to at any time increase or decrease the borrowing sub-limits for each borrower, within specified limits. The master credit facility matures in January 2020.
DUK and its subsidiaries also participate in a corporate money pool that supports short-term borrowing needs. DUK may lend funds to the pool, but may not borrow from the pool. DUK's CP program and excess utility cash are the primary source of funds for the money pool.
Fitch has affirmed the following ratings with a Negative Outlook:
Duke Energy Corp.
--Long-Term IDR at 'BBB+';
--Senior unsecured debt at 'BBB+';
--Junior subordinated notes at'BBB-';
--Short-Term IDR at 'F2';
--Commercial Paper at 'F2'.
Disclosure: There was no financial statement adjustments made that were material to the rating rationale outlined above.
Additional information is available on www.fitchratings.com.
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
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