Fitch Rates Southern Power's Senior Notes 'BBB+'

NEW YORK--()--Fitch Ratings has assigned a 'BBB+' rating to Southern Power Co.'s $600 million series 2016D 1.950% senior notes due Dec. 15, 2019, $300 million series 2016E 2.500% senior notes due Dec. 15, 2021 and $400 million series 2016F 4.950% senior notes due Dec. 15, 2046. The notes are unsecured and unsubordinated obligations of Southern Power.

The net proceeds from the series 2016D and series 2016E will be used to fund Southern Power's investments in renewable energy generation, namely solar and wind power generation projects in the U.S. The company will use the proceeds from series 2016F to repay a portion of outstanding indebtedness.

Fitch affirmed the 'BBB+' Issuer Default Rating (IDR) and security ratings for Southern Power on May 12, 2016. Southern Power's ratings and Stable Outlook reflect Fitch's view that the company will continue to operate its portfolio of nonregulated generation assets with a conservative strategy that seeks to minimize commodity risk and maintain a balanced capital structure that generates strong credit metrics. Fitch also expects the company to finance its fast-growing portfolio in a balanced manner.

KEY RATING DRIVERS

Conservative Contracting Strategy: Southern Power's ratings are underpinned by its conservative contracting strategy. The company sells power primarily under long-term power sales agreements with investment-grade counterparties. As of Sept. 30, 2016, the company had an average investment coverage ratio of 92% for the next five years and 91% for the next 10 years with an average contract duration of 17 years. Southern Power is generally able to pass through fuel costs to its customers under power sales contracts for its natural gas generation assets, although it retains margin exposure to the operating efficiency of its plants. For renewable generation projects, Southern Power retains volumetric risks associated with resource variability.

Significant Expansion in Renewable Generation: Fitch views the company's foray into solar and wind as largely neutral to its credit profile at this time. These projects benefit from long-term power purchase agreements (PPAs) with creditworthy offtakers. The long PPA contractual term on renewable projects is offsetting the decline in contract coverage on the natural gas portfolio. Fitch views the technological, completion and operational risks of the solar and wind projects as manageable.

Jump in Capex: The extension of bonus depreciation and federal subsidies for wind and solar projects and a strong interest from both utility and non-traditional offtakers are expected to result in a significant growth of renewable power generation in the U.S. Southern Power has made several project acquisitions in recent months and is on target to invest approximately $4.5 billion in 2016. Over the next five years, Southern Power expects to spend approximately $1.5 billion in growth capex annually, of which $1 billion will be directed towards wind investments reflecting an addition of approximately 650 MW per year to its total generation portfolio. The balance $500 million per year of capex is expected to be directed towards additional wind, solar or natural gas fired plants. Fitch expects Southern Power to finance new projects and/or acquisitions so as to maintain a 55%-60% debt to total capital ratio.

Cleaner Fuel Mix: Southern Power is well positioned relative to other power generators in the face of more stringent environmental regulations that affect coal- and oil-fired generation. Its fleet of modern gas-fired power plants and a growing portfolio of renewable generation projects comprise bulk of its generation portfolio. Fitch expects Southern Power to benefit from the potential retirement of old and inefficient coal capacity in its markets.

Elevated Near-Term Leverage Ratios: Fitch expects Southern Power's leverage based credit metrics to be elevated in the near-term primarily influenced by the timing of completion of the renewable projects and receipt of the investment tax credits (ITC). Due to bonus depreciation, the tax appetite of Southern Company has been limited and the deferred tax assets have been increasing. Fitch expects funds flow from operations (FFO)-adjusted leverage and FFO to fixed charge ratio to approximate 3.0x and 7.0x, respectively, by 2018.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case are as follows:

--Growth projects as announced;

--Funding of growth capex at approximately 55%-60% debt;

--2016-2018 FFO ratios include ITCs for the solar projects during construction.

RATING SENSITIVITIES

Positive Rating Action: Positive action is not anticipated at this time, since Fitch typically caps the IDR of a non-regulated power generation company at 'BBB+'.

Negative Rating Action: Future developments that may, individually or collectively, lead to a downgrade include:

--Significant deterioration in power demand, which could negatively affect re-contracting of natural gas-fired power generation output once existing contracts mature;

--Aggressive investment strategies, such as buying or building merchant generation assets or taking on major construction or completion risks on unconventional technologies;

--Debt-funded acquisitions or new development activities.

LIQUIDITY

Southern Power has good liquidity for its seasonal needs and capital spending under a $600 million revolving credit facility expiring in 2020, which is generally used to back up short-term commercial paper (CP) borrowings. The facility has a 65% debt/capitalization ratio covenant. Southern Power can access the CP market on its own. The company does not conduct short-term borrowings via the Southern Company Funding Corp., an affiliate that issues CP for the regulated utilities subsidiaries of Southern Company. As of Sept. 30, 2016, Southern Power had approximately $1.1 billion of cash and cash equivalents and $532 million in unused revolver capacity.

Date of Relevant Rating Committee: May 12, 2016.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage - Effective from 17 August 2015 to 27 September 2016 (pub. 17 Aug 2015)

https://www.fitchratings.com/site/re/869362

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014812

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https://www.fitchratings.com/regulatory

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Contacts

Fitch Ratings
Primary Analyst
Shalini Mahajan, CFA, +1-212-908-0351
Managing Director
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Julie Jiang, +1-212-908-0708
Director
or
Committee Chairperson
Michael Weaver, +1-312-368-3156
Managing Director
or
Media Relations
Alyssa Castelli, New York, +1-212-908-0540
alyssa.castelli@fitchratings.com