Fitch Upgrades Black Hills Corp's IDRs to 'BBB+'; Outlook Stable
NEW YORK--(BUSINESS WIRE)--Fitch Ratings has upgraded the Issuer Default Ratings (IDR) of Black Hills Corporation (BKH) and its subsidiary, Black Hills Power, Inc. (BHP) to 'BBB+' from 'BBB'. Fitch has also upgraded the short-term IDRs of both BKH and BHP to 'F2' from 'F3'. The Rating Outlook for both entities is Stable. See the complete ratings list at the end of this release. Approximately $1 billion of long-term debt is affected by the rating actions.
Fitch rates BKH on a consolidated basis and equalizes the ratings of BHP with those of BKH given the strong linkage and interdependence of BKH and its regulated and non-regulated subsidiaries.
Key Rating Drivers
--Successful refinancing of the capital structure;
--Substantially improved coverage measures from lower interest expense burden;
--Low-risk regulated electric and natural gas utility businesses;
--High degree of financial and operational integration amongst BKH's numerous regulated and non-regulated businesses;
--Evolving upstream oil and gas strategy.
Lower Interest Expense and Improved Credit Metrics
The upgrade of BKH's ratings reflects the successful refinancing of the scheduled debt maturity of a 9% coupon debt due in 2014 and closing out underwater out-of-the money interest rate swaps which were both legacies of financing assets acquired in the Aquila transaction. The capital markets were under considerable stress during the 2008 to 2009 time-period when the purchase closed.
This process concludes the capital structure repositioning which included the early redemption of $225 million of relatively high, 6.5% coupon debt from the proceeds of the sale of some oil and gas interests in the Bakken.
On an annualized basis, Fitch models assume an annualized consolidated interest expense of approximately $75 million, approximately 35% lower than interest expense in 2013. Reflecting the lower interest expense, Fitch sees substantial improvement in coverage metrics in 2014. Fitch projects that funds from operations (FFO) fixed charge coverage and EBITDAR-to-Interest will improve to 5.08x and 5.11x, respectively, from 3.73x and 3.34x in 2013.
BKH profiles strongly with Fitch's 'BBB' utility credit factor medians. Debt-to-EBITDAR, however, reflects a moderately higher degree of leverage. Fitch expects debt-to-EBITDAR to gradually decline over the forecast period and average approximately 3.6x between 2014 and 2018, about average for 'BBB' category utility parent companies.
Low-Risk Business Profile
Substantially all cash flows and earnings are derived from regulated activities or investments that are under long-term contract to BKH's utilities. Following the sale of Enserco, BKH's energy marketing business in March 2012, non-regulated investments consist of a legacy upstream energy exploration and development business. Fitch considers BKH's coal and competitive generation businesses which are largely contracted to BKH's utilities as possessing relatively low risk.
BKH operates regulated electric and natural gas utilities in seven states, all of which allow for pass-through of commodity and/or purchased power costs and many feature other riders or recovery mechanisms that enhance timely recovery of expenses and invested capital. Transmission investments are regulated by the Federal Energy Regulatory Commission (FERC). The diversity by regulated jurisdiction further enhances the predictability of cash flows and minimizes the effects of exogenous factors.
Capex will peak in 2014 along with the completion of the Cheyenne Prairie Generating Station, a $222 million, 132 MW natural gas-fired power plant owned jointly by sister utilities BHP and Cheyenne Light Fuel and Power (not rated by Fitch). The plant is expected to achieve commercial operation by the fourth quarter of 2014.
Environmental expenditures are modest as BKH has a fairly modern coal-fired fleet. Environmental capex is estimated by management at between $5 million to $6 million per year between 2014 and 2016.
Financial and Operational Integration
BKH's utilities are individually relatively small and share centralized treasury functions with working capital financed through a money pool. While BHP as well as its sister utility Cheyenne Light Fuel and Power issue long-term debt in their own names, the utilities purchased in 2008 including the four natural gas local distribution companies (LDCs) and Colorado Electric are held in a second-tier holding company, Black Hills Utility Holdings, Inc., which is largely financed by intercompany advances from BKH.
Fitch considers BKH's liquidity adequate. BKH's $500 million bank credit facility contains cross-default covenants if BKH or its subsidiaries failed to make timely payments of debt obligations.
Along with jointly owned power plants and contracted purchase agreements by the utilities for coal from BKH's coal subsidiary and power purchase agreements from the competitive generation subsidiary, Fitch considers BKH's various subsidiaries to be highly integrated amongst themselves.
Evolving Oil and Gas Strategy
BKH has interests in the Mancos Shale Play and is committing relatively large capital investments in order to further assess and prove its potential reserves in the area. BKH has forecast annual investments to its drilling program at between $110 million and $125 million per year. Fitch models assume a capex budget approximately 10% higher than management forecasts, although Fitch would not be surprised if even higher capital levels were committed to this business if drilling results are successful.
Fitch considers the upstream oil and gas business to be neutral to BKH's credit profile. Larger capital commitments to drilling would only occur if drilling results are positive and Fitch does not expect the business mix or risk profile to change from an increased investment in the oil and gas business. BKH has traditionally managed this business in a conservative manner and uses swaps and other instruments up to two years in duration to hedge pricing risk.
Black Hills Power
BHP has displayed a consistently strong and stable financial profile and on a standalone basis, one that is slightly stronger than its parent. BHP has a conservative capital structure with equity representing 56% of capitalization at Dec. 31, 2013. Fitch models show FFO adjusted leverage to average 3.5x and FFO fixed charge coverage to average 4.5x, respectively, over the three-year period between 2014 and 2016. Given the strong degree of financial and operational integration between BHP and other BKH operations, ratings are aligned with those of BKH.
Given the recent upgrade of BKH, no further positive rating actions are anticipated over the near- to intermediate term.
Factors that may individually or collectively lead to a downgrade of BKH and BHP:
--Regulatory decisions that restrict the ability to earn an adequate and timely return on invested capital;
--Higher financial leverage (FFO fixed charge coverage sustained below 4.75x and total debt/EBITDAR sustained above 3.75x);
--A higher business risk profile from larger investments in oil and gas drilling.
Fitch has upgraded the following ratings with a Stable Outlook:
Black Hills Corp.
--Long-term IDR to 'BBB+' from 'BBB';
--Senior unsecured debt to 'BBB+' from 'BBB';
--Short-term IDR to 'F2' from 'F3'.
Black Hills Power, Inc.
--Long-term IDR to 'BBB+' from 'BBB';
--First Mortgage Bonds to 'A' from 'A-';
--Short-term IDR to 'F2' from 'F3.
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
--'2014 Outlook: Utilities, Power, and Gas' Dec. 12, 2012
Applicable Criteria and Related Research:
2014 Outlook: Utilities, Power, and Gas (Electricity Sales Unplugged)
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)