Fitch Affirms Mountaineer Gas at 'BB+'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed the Long-Term Issuer Default Rating (IDR) of Mountaineer Gas Company (MGC) at 'BB+'. Fitch has affirmed MGC's senior unsecured debt at 'BBB-' and assigned a Recovery Rating of 'RR1'. A complete list of rating actions follows at the end of this release.

The Rating Outlook is Stable.

KEY RATING DRIVERS

Small Scale of Operations

The ratings of MGC are restricted by the utility's small scale of operations. MGC is one of the smallest investor-owned natural gas distribution utilities rated by Fitch. Due to MGC's modest size, small changes in revenue or expenses can have an outsized impact on financial metrics, causing the utility to be more vulnerable to external shocks.

Private Equity Ownership

MGC's ratings are also restricted by the utility's private equity ownership. MGC's holding company, Mountaineer Gas Holdings Limited Partnership, is owned by private equity funds ultimately owned by iCON Infrastructure LLP, Deutsche Bank AG, and IGS Utilities LLC. Fitch considers private equity ownership to present an increased level of credit risk due to the typically more aggressive dividend payout policy, weaker financial flexibility, and less transparent corporate governance compared with a publicly traded company.

Challenging Regulatory Environment

Fitch regards West Virginia's regulatory environment as challenging. The Public Service Commission of West Virginia (PSCWV) does not allow MGC to use revenue decoupling or weather normalization. In addition, the PSCWV's use of a historical test year for rate case decisions makes it difficult for MGC to earn its authorized return on equity (ROE). However, the PSCWV's recent implementation of an infrastructure replacement and expansion program (IREP) cost recovery rider partially mitigates regulatory lag. MGC's latest rate case resulted in an increase of $7.7 million, or 3%, effective Nov. 1, 2015 and an authorized ROE of 9.75%.

Supportive, But Volatile, Financial Metrics

Fitch expects MGC's financial profile to remain supportive of the ratings, but the company's small size, large seasonal working capital borrowings, and exposure to the effects of weather result in significant swings in financial metrics, both on a seasonal basis and year to year. Assuming normal weather, Fitch expects adjusted debt/EBITDAR to average 4.3x-4.7x, funds flow from operations (FFO) adjusted leverage to average around 4.5x, and FFO fixed-charge coverage to average 3.7x-4.2x through 2019.

Large Capex Program

Capex is expected to be significantly larger over the next several years. Excluding the Eastern Panhandle expansion project, capex is expected to average approximately $25 million per year over 2016-2020. An additional $28 million of capex in 2018 and $15 million in 2019 are planned to be spent on MGC's Eastern Panhandle expansion project, which is designed to provide natural gas distribution service to unserved and underserved areas in northeastern West Virginia. The inclusion of the Eastern Panhandle expansion project capex in MGC's IREP cost recovery rider helps to alleviate concerns related to the large capex program.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for MGC include:

--Gas sales volume growth of 5.5% in 2017 and 0%-0.5% in 2018 and 2019;

--EBITDA margin averaging 15% through 2019;

--Capex averaging approximately $25 million per year over 2016-2020, with the Eastern Panhandle expansion project adding another $28 million in 2018 and $15 million in 2019;

--Normal weather.

RATING SENSITIVITIES

Positive Rating Action: A positive rating action is not likely, given the small scale of operations, the aggressive financial policy of MGC's private equity owners, and the challenging regulatory environment in West Virginia. Implementation of revenue decoupling and/or other regulatory measures sufficient to provide a greater level of stability and predictability to MGC's credit metrics would be needed for a ratings upgrade.

Negative Rating Action: A negative rating action is not likely, but could occur if MGC's private equity owners instituted a more aggressive financial policy that increased leverage, with adjusted debt/EBITDAR around 5.0x and FFO fixed-charge coverage less than 3.5x on a sustained basis.

LIQUIDITY

MGC's natural gas distribution business is very seasonal, with much larger sales during the winter heating season. Short-term debt is used to temporarily fund natural gas inventories and customer receivables, which normally peak in late December and return to more normalized amounts by the end of the first quarter.

Fitch considers MGC's liquidity to be adequate, primarily supported by a $100 million unsecured revolving credit facility. The five-year facility expires Dec. 1, 2019 and includes an accordion feature that could expand the facility's size to $170 million to account for the possibility of unusually high natural gas prices and sales volumes that could occur during an abnormally cold winter heating season. Fitch expects this facility to provide MGC with sufficient availability for its working capital needs. As of Sept. 30, 2016, $9 million of borrowings were outstanding under the facility, leaving $91 million available.

The credit facility includes financial covenants requiring MGC to maintain a minimum EBITDA interest coverage ratio of 2.0x and a maximum debt-to-capital ratio of 65%.

MGC's next long-term debt maturity is in December 2017, when $70 million of 7.58% unsecured senior notes comes due. The company's only other long-term debt outstanding is its $20 million floating rate senior note due in 2022, which has its interest rate hedged at 4.48%.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

Mountaineer Gas Company

--Long-Term IDR at 'BB+', Stable Outlook;

--Senior unsecured debt at 'BBB-'; assigned Recovery Rating of 'RR1'.

Disclosure: There were no financial statement adjustments made that were material to the rating rationale outlined above.

Additional information is available on www.fitchratings.com

Applicable Criteria

Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)

https://www.fitchratings.com/site/re/885629

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1014690

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014690

Endorsement Policy

https://www.fitchratings.com/regulatory

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Contacts

Fitch Ratings
Primary Analyst
Kevin L. Beicke, CFA
Director
+1-212-908-0618
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Philippe Beard
Director
+1-212-908-0242
or
Committee Chairperson
Philip W. Smyth, CFA
Senior Director
+1-212-908-0531
or
Media Relations
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elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Kevin L. Beicke, CFA
Director
+1-212-908-0618
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Philippe Beard
Director
+1-212-908-0242
or
Committee Chairperson
Philip W. Smyth, CFA
Senior Director
+1-212-908-0531
or
Media Relations
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com