Fitch Rates Dominion Resources' Junior Subordinated Notes 'BBB-'
NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a 'BBB-' rating to Dominion Resources, Inc.'s (DRI) proposed $900 million issuance of junior subordinated notes which are a component of DRI's equity units. The equity units initially will be in the form of a 2014 series A corporate unit consisting of the series A remarketable subordinated notes and a three-year forward purchase contract obligating the holder to purchase DRI common stock. The notes are pledged as security for the holders' obligation to purchase the DRI common stock. The securities have not yet been priced.
Prior to the remarketing, DRI will have the right to defer interest on the securities without giving rise to an event of default. Under Fitch's criteria, the junior subordinated notes receive no equity credit; however, the underlying equity issuance is incorporated in Fitch's forward year financial modeling for DRI.
Net proceeds of the offering will be used for general corporate purposes including capital expenditures for the Cove Point liquefaction project.
KEY RATING DRIVERS
-- Evolving corporate structure;
-- Development of the Cove Point LNG export project;
-- Elevated utility capital investment program;
-- Consolidated leverage pressured by large three-year capex program.
Evolving Corporate Structure
In 2013, DRI announced a corporate reorganization for its large diversified base of energy investments. In October 2013, DRI formed Dominion Gas Holdings, LLC (D-Gas) to own most of the regulated gas assets of DRI including Dominion Transmission, Inc., The East Ohio Gas Company, and a 24.7% ownership interest in the Iroquois Gas Transmission System, L.P. The creation of D-Gas will permit it to issue debt in its own name and manage its liquidity independent of DRI. Previously, DRI financed all operations except Virginia Electric & Power Co. (VEPCo; 'BBB+' IDR Stable Outlook).
In a second step, DRI also announced its intention to form a Master Limited Partnership (MLP) in 2014. DRI's remaining directly owned gas and midstream assets, mostly consisting of Cove Point, an import LNG facility and the Blue Racer joint venture, a midstream gatherer and processor in the Utica Shale, are initial candidates for asset drop-downs into this newly formed MLP. Fitch expects any asset drop-downs to be managed over a multi-year period.
The creation of D-Gas and the expected formation of the MLP afford greater liquidity and financial flexibility to DRI as these entities can access capital independently and access a larger and different investor base. MLPs typically have a lower cost of capital than traditional corporate entities. Following completion of the restructuring, although consolidated cash flows will be largely unchanged, parent level cash flows from D-Gas and the MLP in the form of dividends and distributions to DRI become subordinated to other debt obligations of those entities.
DRI expects to begin construction of its Cove Point LNG Export Facility in the second half of 2014 after receipt of final regulatory clearances. DRI estimates that the overnight project development costs to be between $3.4 billion and $3.8 billion with commercial operation in late 2017. Capacity is fully subscribed to two highly rated counterparties under 20 year agreements and DRI takes no commodity or volumetric risks during the contract term.
The development of the Cove Point export facility, with its three year timeframe to achieve commercial operation, weighs on DRI's already leveraged capital structure. A large utility growth capex cycle over the same time-period further pressures leverage. DRI's use of mandatory convertible units provides some relief with the first two tranches totaling approximately $1 billion converting to equity in 2016. However, DRI on a consolidated basis will remain outside of Fitch's leverage guideline metrics until at least 2017.
DRI faces the normal risks associated with any large-scale development project including potential cost-overruns and construction delays that can occur.
Utility Capex Program
VEPCo's capital investment plan over the 2014 to 2018 time-period remains elevated and includes $3.2 billion of electric transmission projects and the 1,329MW Warren County and 1,358MW Brunswick County gas fired combined cycle power plants with total estimated project costs of $1.1 billion and $1.3 billion, respectively. Both projects received a 100 basis points (bps) incentive ROE in Virginia with the Warren County plant expected to come-on-line at year end 2014 and the Brunswick plant expected to be completed in mid-2016.
Fitch views the regulatory environment in Virginia and North Carolina as constructive. Fitch considers the inclusion of riders that provide timely recovery of invested capital and incentive returns on approved projects as supportive of credit quality during an extended period of elevated capital investments.
Financial and Debt Profile
Fitch expects parent company debt which was $11.6 billion at Dec. 31, 2013, to decline as D-Gas assumes a capital structure more consistent with that of its regulatory approved capital structure of its underlying wholly-owned assets. However, consolidated debt levels do not change and Fitch expects leverage to remain high relative to guidelines for the rating category and risk profile. Debt-to-EBITDAR (as calculated by Fitch) at 4.9x at year-end 2013 is not likely to improve materially in the near term as funding of a large capital plan limits near-term deleveraging opportunities. Fitch expects deleveraging to begin in 2016 with the conversion of equity units and maturation of DRI's capital investment program.
An MLP may permit a partial monetization of DRI's non-regulated energy investments with proceeds otherwise reducing DRI's financing needs. The creation of the MLP along with the self-financing of D-Gas will likely lead Fitch to view DRI more as a holding company with a portfolio of subsidiaries that support the parent through dividends and distributions rather than an operating company with direct control of consolidated cash flows.
Execution of a sizable capital investment plan limits positive rating actions at this time. Fitch considers timely execution of new projects as critical to maintaining a stable credit profile.
-- Given the evolving corporate and ownership structure of DRI's gas and midstream assets, ratings of Dominion and rating alignments of its primary subsidiaries may change over time.
-- Subordination of cash flows resulting in the event of corporate spin-offs without a concomitant reduction in parent level debt could lead to a negative rating action;
-- An aggressive multi-year capital investment plan exposes the company to execution risk, including construction delays and cost overruns which could pressure financial metrics if debt financed.
-- A material increase in parent level debt to finance higher-risk investments could lead to a negative rating action.
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.
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent
and Subsidiary Linkage
Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)