NEW YORK--(BUSINESS WIRE)--Fitch Ratings assigns an 'A-' rating to Atmos Energy Corporation's (Atmos) $500 million 4.125% senior unsecured notes due 2044. The Rating Outlook is Positive. Issuance proceeds will be used to replace a like amount of 4.95% bonds maturing on Oct. 15, 2014.
KEY RATING DRIVERS
--Capital structure repositioning and earnings growth lead to predictable and sustained improvement in credit metrics;
--Constructive regulatory environment that includes annual rate-setting mechanisms and weather normalization covering most LDC jurisdictions;
--Strong earnings contribution from regulated Texas intrastate pipeline network with an authorized Return on Equity (ROE) of 11.8%;
--Exposure to high growth markets and elevated capital expenditures (capex) program;
--Moderate volume and pricing exposure through non-regulated operations as well as exposure to market-based revenues at the pipeline.
CAPITAL STRUCTURE AND SUSTAINED IMPROVEMENT IN CREDIT METRICS
In February 2014, Atmos raised $390 million of new equity, substantially meeting the equity component of its large five-year capital investment program. The equity raise improves Atmos' capitalization which Fitch expects to be maintained over the next few years close to a 50%/50% debt/equity mix similar to the average of the regulatory approved capital structures in the various Atmos divisions.
Debt costs remain elevated as Atmos typically issues long-term fixed rate unsecured debt. Fitch expects interest expenses to decline as higher coupon long term debt matures and is replaced with lower cost debt. Atmos has used forward rate contracts to lock in a substantial portion of its maturing debt. Fitch had modeled the $500 million 4.95% coupon debt maturity in October 2014 to be refinanced at an interest cost of 4%. The actual 4.125% coupon represents a negligible different in Fitch's models and still results in lower interest expense and modestly improved coverage measures.
Future maturities will likely be refinanced with even greater reductions in interest expenses. In the outer years, $250 million of 6.35% notes mature in 2017 and $450 million of 8.5% notes mature in 2019. Fitch expects financing costs to replace the maturing debt to decline between 175bps and 300bps.
CONSTRUCTIVE REGULATORY ENVIRONMENT
Several regulatory mechanisms including annual rate-making, weather normalization, and purchased gas cost adjustments are present in most of Atmos' LDC utility jurisdictions which reduce regulatory lag and add stability to earnings and cash flows.
Approximately 75% of the distribution segments operating margin is subject to annual rate-making, which allows for the recovery of both capex and operating and maintenance (O&M) expenses without filing a formal rate case. Roughly 97% of the LDC utility divisions operating margin is covered under weather normalization mechanisms eliminating weather-related volumetric risks on margins Atmos has purchased gas cost adjustments pass through increases or decreases in purchased gas costs in all distribution service territories.
HIGH GROWTH MARKETS
Atmos has a large presence in Texas, which remains a high growth market benefitting from population and employment growth, new household formations and high energy-related investments related to shale development. Atmos has exposure to this growth through its LDCs including the large Dallas Fort Worth area and operation of an approximately 5,600 mile intrastate pipeline system and five working storage sites. Atmos derives between 65% and 70% of operating income from Texas, a percentage that will likely increase as capex is predominately centered across its Texas LDCs and pipeline operations.
The Atmos pipeline system connects with the three major Texas hubs located in Waha, Katy, and Carthage. The pipeline has a current authorized return on equity (ROE) of 11.8%. The authorized ROE will be reviewed in 2016 adding predictability to earnings over the next two years. Fitch believes the natural gas supply/demand dynamics are favorable in Texas and Atmos will continue to make growth investments in its pipeline system.
Capital expenditures totaled approximately $845 million in fiscal year ended Sept. 30, 2013, approximately 15% above the prior fiscal year. Fitch expects capex to remain elevated and average between $900 million and $950 million over the forecast period. The largest portion is dedicated to distribution integrity or the replacement of pipe or other upgrades. Approximately 20% of the capex budget is related to customer growth at its distribution segments and pipeline expansion projects. Regulatory mechanisms at the distribution segment allow for timely recovery and pipeline expansion projects have relatively short completion time periods of one-year or less.
NON-REGULATED AND MARKET SENSITIVE OPERATIONS
Atmos has a modest exposure to non-regulated activities and market sensitive commodity exposure. At Atmos Energy Holdings (AEH), Atmos conducts a variety of non-regulated operations including natural gas management and transportation services. Profitability has been pressured in recent years reflecting relatively low natural gas prices and compressed basis differentials, although the record cold 2013/2014 winter has provided some uplift to this business. Similarly, in the regulated transmission and storage segment, margins from market based ancillary services have been under pressure in recent years although recent natural gas pricing remains well above fiscal 2013 level.
STRONG EARNINGS AND IMPROVING CREDIT METRICS
Fitch expects organic growth in regulated businesses to continue to drive earnings. Rate base investments drive EBITDA growth in the high single digits over the next few years with some variability from non-regulated AEH and the portion of market based revenues and earnings at the pipeline. Higher natural gas prices and stronger natural gas demand improves the prospects for these businesses.
Fitch expects key leverage measures, currently robust due to the $390 million equity raise in February 2014, to deteriorate slightly, Adjusted debt to EBITDAR, 3.02x at June 30, 2014, is expected to average approximately 3.5x over the next three fiscal years. Similarly, Fitch projects FFO to Adjusted leverage, 2.85x at June 30, 2014, to average 3.44x over the next three fiscal years. Coverage measures improve in Fitch's models over the forecast period. FFO Fixed Charge Coverage averages 5.50x to 6.10x over the next three fiscal years.
Future developments, individually or collectively, that could lead to a positive rating action include:
--Achieving and maintaining a Total Adjusted Debt to EBITDAR leverage measure of 3.25x or below;
--Maintaining consolidated leverage consistent with regulatory approved capital structures.
Future developments, individually or collectively, that could lead to a negative rating action include:
--Failure to maintain the present capital structure while pursuing an elevated capex program.
--Expansion of non-regulated business activities;
--An unexpected adverse regulatory decision.
Atmos is a divisionally structured utility operating in three segments: regulated gas distribution through local distribution companies (LDC), regulated pipelines with its Texas intrastate pipeline system, and through subsidiary Atmos Energy Holdings, Inc. (AEH), non-regulated gas marketing and storage businesses.
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;
--'Recovery Ratings and Notching Criteria For Utilities', Nov. 19, 2013.
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)
Recovery Ratings and Notching Criteria for Utilities