Fitch Affirms Southwest Gas Corp. at 'A-'; Outlook Stable
NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the existing ratings of Southwest Gas Corporation (SWX) as follows:
--Long-term Issuer Default Rating (IDR) at 'A-';
--Senior unsecured rating including industrial development revenue bonds at 'A';
-Short-term IDR at 'F2';
-Commercial Paper at 'F2'.
The Rating Outlook is Stable. Approximately $1.4 billion of debt is affected by this rating action.
The ratings reflect strong operational performance at the utility and constructive rate design across SWX's service territory including revenue decoupling and purchase gas agreements (PGAs) in all jurisdictions. The ratings also consider SWX's solid liquidity position, low leverage, minimal long-term debt maturities and improving service territory economics, particularly in Arizona. Fitch notes that revenue decoupling has reduced SWX's earnings and cash flow volatility and business risk.
Stable Rating Outlook: The Stable Outlook reflects the relatively predictable earnings and cash flow from SWX's core natural gas distribution utility and, to a lesser extent, its non-regulated pipeline construction subsidiary, NPL Construction Co. (NPL). The Stable Outlook also considers SWX's manageable consolidated leverage and strong credit metrics.
KEY RATING DRIVERS
--Constructive rate design;
--Solid credit metrics;
--PGA mechanisms in all service territories;
--Revenue decoupling adopted in all jurisdictions;
--AZ general rate case (GRC) moratorium until April 30, 2016;
--Large capex program.
Solid Credit Metrics: For the latest 12 months (LTM) ending March 31, 2014, SWX's EBITDAR decreased slightly to 6.8x as compared to 7.1x for 2013 and primarily reflects a delay in the final outcome of the California GRC and to a lesser extent, increased operating expenses including nonrecurring legal accrual. Funds from operations (FFO) adjusted leverage was modest at 2.7x.
Going forward, Fitch expects EBITDAR-to-interest coverage ratios to remain above 6x, and FFO adjusted leverage to remain below 4.0x, through 2016. Fitch's estimated SWX credit metrics reflect a combination of constructive rate design, improved customer growth, a balanced capital structure, and low natural gas prices.
Large Capex Program: SWX's capex program is focused on projects to enhance safety and maintain reliability of its local distribution company (LDC) system and includes significant aging pipe replacement investment. Fitch expects SWX to spend $1.1 billion through 2016, averaging $375 million per annum. Construction expenditures at NPL are expected to average $50 million per annum and is expected to be self-funded.
In light of the large capex program, Fitch estimates that SWX will be modestly FCF negative, funding the vast majority of estimated capex internally. While Fitch conservatively expects SWX's credit metrics to weaken modestly, FFO adjusted leverage is expected to remain below 4.0x through 2016. Fitch anticipates external funding requirements to be financed via a balanced mix of equity and debt.
California GRC : In June 2014, the California Public Utilities Commission (CPUC) concluded SWX's 2012 GRC, increasing base rates $7.1 million, approximately 60% of SWX's requested rate increase. The rate hike is predicated on a 55% equity ratio and a 10.1% return on equity (ROE) for rates effective January 1 . The rate increase comprised $1.9 million in Southern California, $2.5 million in Northern California, and $2.7 million for the South Lake Tahoe area. Additionally, SWX was authorized to continue a Post-Test Year Ratemaking Mechanism, which allows for annual attrition rate increases of 2.75% through 2018. The CPUC also authorized a limited Company-Owned Yard Line inspection program for schools and an associated infrastructure replacement mechanism (IRM) to recover those costs. For the LTM ending March 31, 2014, California accounted for 10% of total operating margin contributions.
Nevada Regulation: In the fourth quarter of 2012, SWX's Nevada base rates were increased $7 million effective Nov. 1, 2012. Following the decision, SWX filed a petition for reconsideration with the Public Utilities Commission of Nevada (PUCN). In March of 2013, the PUCN authorized a revised base rate increase of $7.5 million, representing 28% of of SWX's request. The rate increase comprises a $6.8 million base rate increase in southern Nevada based on a 10% ROE and a $0.7 million base rate increase in northern Nevada based on a 9.3% ROE. For the LTM ending March 31, 2014, Nevada accounted for 34% of total operating margin contributions.
As part of its last GRC filing, SWX requested the implementation of an IRM to defer and recover costs associated with up to $40 million annually of proposed accelerated replacement of early vintage plastic and steel pipe. In January 2013, the PUCN authorized a separate rulemaking docket regarding the proposed IRM, and in January 2014, the PUCN concluded the rulemaking process by providing for the establishment of regulatory assets that will recover infrastructure replacement investments between rate cases.
AZ Decoupling Adopted: In SWX's last Arizona GRC (2010), SWX's base rates were increased by $53 million based on a 9.5% ROE, representing 72% of SWX's requested rate increase. Per the terms of the settlement, SWX agreed to a GRC moratorium until April 30, 2016. Notably, the Arizona Corporation Commission (ACC) authorized a full revenue decoupling mechanism which includes a monthly weather normalization provision. Fitch notes that decoupling surcharges are capped at 5% of annual revenue, with amounts above the threshold deferred for future recovery. For the LTM ending March 31, 2014, Arizona accounted for 56% of total operating margin contributions.
Solid Liquidity: As of March 31, 2014, SWX had total available liquidity of $385 million including $85 million of cash and cash equivalents and its five-year $300 million unsecured credit facility which matures in March 2019. Fitch notes that the credit facility contains a maximum debt-to-capitalization covenant of 70%. Fitch also notes that SWX has no significant long-term debt maturities until 2017 when $25 million of unsecured notes mature.
The moderation in SWX's Arizona and southern Nevada service areas growth has eased the burden of large capital expenditures to meet infrastructure growth and the associated negative effects of rate lag. SWX has strengthened its balance sheet in recent years, strengthening common equity as a proportion of total capital to 51.7% as of March 31, 2014 from 36.2% in 2005. The improvement reflects equity issuance through the utility's Dividend Reinvestment Program, earnings retention and a conservative dividend payout.
Effective Rate Structures: SWX has been able to minimize its exposure to natural gas price volatility through PGAs in Nevada (quarterly adjustments), California (monthly price adjustments), and Arizona (monthly price adjustments within pre-established limits).
Fixed Contract Purchases Mitigate Risk: As part of SWX's gas procurement program, SWX utilizes fixed-price contracts and swaps to effectively fix the price on a portion of its natural gas supply portfolios, currently ranging from 25% to 35% depending on the jurisdiction. Gas costs that are incurred in excess of amounts embedded in customer rates are generally deferred and recovered under PGAs.
Strong NPL Growth: Growth at SWX's unregulated construction subsidiary, NPL, has been strong the last few years as NPL has benefited from the current low interest rate environment, a regulatory environment focused on federal and state pipeline safety-related programs, and bonus depreciation incentives that have spurred utilities to invest in large multi-year distribution replacement projects. For the LTM ended March 31, 2014, NPL's EBITDA decreased slightly to $73 million compared to $77 million in 2013 and primarily reflects a delay in construction caused by severe winter weather, especially in the Midwest and Northeast.
NPL contributes a relatively small proportion to consolidated SWX operating results. For the LTM ending March 31, 2014, NPL's contribution was approximately 14.5% of SWX's consolidated EBITDA. NPL has been a steady performer in recent years. Nonetheless, NPL exhibits a higher degree of business risk compared to SWX's regulated gas distribution operations, which has been factored into SWX's ratings and Stable Outlook.
Proposed LNG Facility: In January, SWX filed an application with the ACC seeking preapproval to construct a 233,000 dekatherm liquid natural gas (LNG) facility in southern Arizona to enhance service reliability and flexibility in natural gas deliveries. The proposed LNG facility would connect directly to SWX's distribution system and the actual cost of the project is not to exceed $55 million. A decision by the ACC is expected to occur during 2014. If approved, construction is expected to be complete within approximately 24 to 30 months following ACC approval.
Paiute Pipeline Expansion: In February, Paiute Pipeline Company, a wholly owned subsidiary of SWX, filed a general rate case with the FERC to expand its existing transmission system to provide additional firm transportation-service capacity in the Elko County, Nevada area. The additional capacity is needed to meet growing natural gas demand caused by increased residential and business loads and energy-intensive mining operations in the area. The project is expected to cost approximately $35 million and has a targeted in-service date of November 2015 for new rates effective in September, subject to refund. If a settlement with the FERC has not been approved by September, hearings would then be conducted in late 2014 or early 2015.
What Could Cause Positive Rating Action:
Supportive regulatory outcomes, continued moderate growth, and FFO leverage better than 3.3x-3.5x on a sustained basis could lead to positive credit rating actions from an investor point-of-view.
What Could Cause Negative Rating Action:
An unexpected deterioration in SWX's Arizona or Nevada regulatory jurisdictions, an acceleration in rate lag and/or a sustained deterioration in FFO leverage above 4.0x could lead to future adverse credit rating actions.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Rating U.S. Utilities, Power and Gas Companies, March 7, 2014;
--'Corporate Rating Methodology', May 28, 2014;
--'Parent and Subsidiary Rating Linkage', Aug. 5, 2013.
Applicable Criteria and Related Research:
Parent and Subsidiary Rating Linkage
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)