NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned Alabama Gas Corp. (AGC) a first-time Long-Term Issuer Default Rating (IDR) of 'A-' and a senior unsecured rating of 'A' with a Stable Rating Outlook. Additionally, Fitch has affirmed the IDR's of both The Laclede Group, Inc. (LG) and those of its regulated gas distribution subsidiary, The Laclede Gas Company (LGC) at 'BBB+' with Stable Rating Outlooks. Finally, Fitch has affirmed LGC's short-term IDR at 'F2'.
Stable Rating Outlook: LG's ratings reflect the improved business risk profile as a result of the AGC acquisition, modestly lower debt used in acquisition financing than Fitch Ratings' prior assumptions, and expectation for future deleveraging at the parent that will improve consolidated credit metrics toward the end of the forecast period.
Regulated Operations Drive Earnings: LG's stable earnings and cash flows are driven by its regulated gas local distribution companies (LDCs), LGC, Missouri Gas Energy (MGE) and AGC, which collectively composed 97% of consolidated earnings for 2015. LG is primarily engaged in unregulated operations through Laclede Energy Resources (LER), its natural gas retail energy marketing subsidiary. LER has become a smaller part of consolidated operations in recent years due to the low commodity price environment.
KEY RATING DRIVERS
--Improved business risk profile as a result of the AGC acquisition;
--Expectation for future deleveraging at the parent;
--Stable earnings and cash flows from regulated utilities;
--Large Utility capex program focused on distribution investments.
Shift To Organic Growth Strategy: Notably, management in now pursuing a growth strategy centered around distribution investments at the regulated utilities in contrast to a prior focus on utility acquisitions. LG acquired AGC for $1.6 billion in fourth-quarter 2014 and the acquisition comes on the heels of the MGE acquisition in 2013 which solidified LGC's position as the largest LDC in Missouri. Two back-to-back acquisitions highlighted the aggressive growth strategy pursued by management. Fitch notes that the AGC acquisition financing was composed of a relatively balanced 60%/40% mix of debt and equity, including $144 million of equity units. Going forward, Fitch does not expect management to pursue any large acquisitions but may consider small bolt-on acquisitions of municipal utilities within its service territory.
Improved Business Risk Profile: The acquisition of AGC improves the overall business risk profile of LG. AGC has a strong stand-alone credit profile as the largest natural gas distribution company in Alabama. The AGC acquisition increases LG's customer base by roughly 37% to approximately 1.6 million, and AGC currently composes 34% of consolidated EBITDAR.
Solid Metrics; Deleveraging Expected: LG's EBITDAR coverage ratio was relatively flat at 5.2x for 2015, and leverage, as measured by debt to EBITDAR, was high at 5.4x for the same period due to the AGC acquisition. Fitch expects LG's consolidated EBITDAR-to-interest coverage to approximate 5.5x -6.0x through 2019, and expects deleveraging at the parent will result in consolidated EBITDAR leverage strengthening to roughly 4.0x through the same period.
Solid Customer Growth: LG has experienced solid customer growth of 1% across all three utilities for 2015.
Large Utility Capex Program: Fitch expects average annual EBITDAR growth of roughly 6% through 2019, driven by $1.3 billion of distribution investments over the same period. Fitch projects LG to be modestly FCF negative through the forecast period primarily due to the large capex spend. LG expects to spend $315 million this year on capex, approximately 9% more than last year. Approximately 2/3 of the total capex spend will be recoverable under infrastructure riders, either through the Infrastructure System Replacement Surcharge (ISRS) rider in Missouri or through the Rate Stabilization and Equalization (RSE) mechanism in Alabama, and is split roughly two-thirds at LGC and one-third at AGC.
Cash Tax Benefit: The tax basis step-up accounting treatment, which allows LG to treat the AGC acquisition as an asset purchase for income tax purposes, results in a tax benefit with a projected net present value of $260 million.
Stable Earnings: LGC's stable earnings and cash flows reflect the regulated nature of its gas LDC operations, including those of MGE, its western Missouri operating division. LGC and MGE are currently allowed an authorized return on equity and a pre-tax weighted average cost of capital (WACC) of 9.70% and 9.75%, respectively, under their ISRS filings, in line with recent industry averages.
Solid Coverage Ratios: LGC's EBITDAR coverage increased to 6.9x for 2015 as compared with 6.5x in 2014. The increase primarily reflects higher ISRS and base rate revenues and modest customer growth. Fitch expects EBITDAR coverage to approximate more than 6.0x through 2019.
Leverage Expected to Strengthen: LGC's leverage, as measured by debt to EBITDAR, strengthened to 3.8x for 2015 as compared to 4.3x for 2014 due to improved earnings and cashflows. Fitch Ratings expects the large capex program to continue to drive earnings growth and expects debt-to-EBITDAR leverage to strengthen to approximately 3.5x through 2019.
GRC Moratorium Through October: Per the terms of the MGE merger approval, LGC agreed to a general rate case (GRC) moratorium through Oct. 1, 2015. The approved stipulation further requires that the first GRC filed after Oct. 1, 2015, will include both LGC and MGE. Fitch expects LGC and MGE to file their next GRC in April 2017 for new rates effective in mid fiscal 2018 and has assumed an authorized ROE of 10% throughout the forecast period.
New ISRS Rates: LGC and MGE recover distribution investments through their ISRS mechanism, which provides a timely return on investment and helps reduce regulatory lag between GRC proceedings. ISRS filings are made roughly every six months and are subject to approval by the Missouri Public Service Commission. The MPSC recently approved incremental ISRS revenues of $4.4 million for LGC and $1.9 million for MGE in November for new annualized rates of $19.6 million for LGC and $6.7 million for MGE effective December 1.
Distribution Investments Drive Growth: Fitch anticipates average annual EBITDAR growth of 5% through 2019, driven by roughly $900 million of distribution investments over the same time period. LGC expects to spend $220 million this year on capex, approximately 11% more than last year. Fitch expects LGC to finance the majority of the capex spend through internal cashflows and to be modestly FCF negative through the forecast period. Approximately 50% of the total capex spend will be recoverable under the ISRS rider and Fitch expects regulatory lag to be minimized as a result of anticipated timely ISRS filings.
Constructive Regulation in Alabama: Since 1983, AGC has been operating under the RSE regulatory framework and is regulated by the Alabama Public Service Commission (APSC). The current RSE framework will continue through Sept. 30, 2018, after which the APSC can vote to modify or end the RSE methodology. Under the RSE, AGC is authorized to earn an ROE between 10.5% - 10.95%, with a midpoint of 10.8% based on an equity-to-total capitalization ratio of 56.5%. Additionally, AGC recently received an incentive increase of 5 basis points to its authorized return on equity for excellent customer service. The authorized ROE and equity component compare favorably to industry averages. Notably, AGC can implement rates once a year, effective December 1, subject to a 4% cap on prior revenues. Reductions in rates can be made quarterly, however, to keep AGC within the targeted ROE. Fitch expects the regulatory environment in Alabama to remain constructive and has assumed an authorized ROE of 10.8% throughout the forecast period.
Strong Credit Metrics: AGC's credit metrics remain strong and are expected to remain commensurate with the rating category through the forecast period. AGC's EBITDAR coverage ratio approximated 8.2x for 2015, and leverage, as measured by debt to EBITDAR, was low at 2.0x for the same period. Fitch expects AGC's EBITDAR coverage to approximate 8.0x - 9.0x through 2019 while EBITDAR leverage is expected to modestly increase to 2.4x through the same period due to the large capex program.
Distribution Investments Drive Growth: Fitch anticipates AGC to spend $368 million of distribution investments though 2019, approximately 28% more than the preceding four year period. Fitch expects AGC to finance the majority of the capex spend through internal cashflows and to be modestly FCF negative through the forecast period which will require external financing that will incrementally pressure leverage metrics. Fitch expects future regulatory lag to be minimized due to timely recovery under the RSE mechanism.
Fitch's key assumptions within the rating case includes:
--10% ROE for LGC and 10.8% ROE for AGC through the forecast period.
--Customer Growth of 1/2%.
--Consolidated capex of $1.3 billion through 2019 focused on distribution investments.
--Long-Term Debt maturities totalling $525 million through 2019 as follows: $250 million in 2017, $100 million in 2018, and $175 million in 2019.
Positive Rating Action: No positive rating actions are expected due to increased leverage from the AGC acquisition and given management's acquisitive strategy to pursue growth.
Negative Rating Action: An unexpected leveraged acquisition funded at the parent or a substantive change in anticipated deleveraging over the forecast period could cause negative rating actions. Sustained debt-to-EBITDAR metrics over 4.5x throughout the forecast period could also cause negative rating actions.
Positive Rating Action: Sustained debt-to-EBITDAR metrics under 3.25x could cause positive rating actions.
Negative Rating Action: An unexpected change in Missouri regulation that prevents LGC from earning an adequate and timely return on investments could cause negative rating actions.
Positive Rating Action: No positive rating actions are expected at this time.
Negative Rating Action: An unexpected change in the RSE framework and or sustained Debt to EBITDAR metrics over 3.5x could cause a negative rating action.
LG had approximately $426 million of available liquidity under its unsecured revolving credit facilities as of Sept. 30, 2015, including $13.8 million of unrestricted cash and cash equivalents. Borrowings are concentrated during the winter heating season, which runs from November through April. LG maintains consolidated liquidity through a $150 million credit facility at the parent, a $450 million credit facility at LGC and a $150 million credit facility at AGC. LGC's credit facility supports its commercial paper program. The credit facilities contain a maximum debt-to-capitalization covenant of 70%, and mature in September 2019. LG, LGC and AGC were in compliance with all financial covenants under the credit facilities as of Sept. 30, 2015, with debt-to-capitalization ratios of 58%, 50% and 24%, respectively.
LG's long-term debt maturities total $525 million through 2019 as follows: $250 million in 2017, $100 million in 2018, and $175 million in 2019. Fitch expects LG to refinance these maturities on a timely basis.
FULL LIST OF RATING ACTIONS
Fitch assigns the following ratings with a Stable Rating Outlook:
--Senior Unsecured 'A'.
Fitch affirms the following ratings with a Stable Rating Outlook:
--IDR at 'BBB+' '
--Senior Unsecured at 'BBB+'.
--IDR at 'BBB+';
--First mortgage bonds at 'A';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
Dodd-Frank Rating Information Disclosure Form