NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned an 'AA-' rating to Southern California Gas Company's (SoCalGas; Issuer Default Rating [IDR] 'A'/Outlook Stable) $500 million first mortgage bonds, series TT, due 2026. The proceeds will be used to repay commercial paper and for general corporate purpose. The Rating Outlook is Stable.
KEY RATING DRIVERS
--Gas leak incident uncertainties remain;
--Significant capital investments;
--Strong credit metrics;
--Parent subsidiary linkage.
Gas Leak Incident Uncertainties Remain
The termination of the relocation program for the Porter Ranch area residents is credit positive for SoCalGas, as the program comprised the largest portion of the total cost associated with the Aliso Canyon gas storage leak. On May 4, 2016, SoCalGas indicated that the cost related to the leak could total $665 million, 70% of which is related to cost estimates of the relocation program through June 7, 2016 and 15% is related to attempts to stop the leak and to investigate the root cause. $660 million of the total is recorded as insurance receivable. These costs will pressure SoCalGas' credit metrics. For the latest 12 months (LTM) March 31, 2016, funds from operations (FFO)-adjusted leverage increased to 3.5x from 2.5x in 2014. SoCalGas' rating and Outlook assume that majority of the costs can be recovered through insurance proceeds.
Fitch is concerned with the potentially higher operating costs and/or capital expenditures if the storage facility is out of service for an extended period of time or closes permanently. Fitch is also concern with the political backlash if summer blackout occurs as a result of the shortage of gas supply for power generation, as well as the possible refund of collected revenues from the Aliso Canyon gas storage field.
Supportive Regulatory Environment
SoCalGas's ratings and Outlook benefit from California's supportive regulatory framework, such as revenue decoupling, bifurcation of general rate case (GRC) and cost-of-capital proceedings, forward-looking test years, and the use of balancing accounts. Fitch believes that California commission administrative law judge's proposed decision on SoCalGas' 2016 general rate case is constructive and any rate change will be retroactive to Jan. 1, 2016. A final decision is expected in the next several months. SoCalGas currently operates under a 10.1% return on equity (ROE) with 52% equity ratio authorized by the California commission. The next cost of capital filing deadline has been extended to April 2017.
Significant Capital Investments
SoCalGas' capex began ramping up in 2013 and will total $6 billion from 2015 to 2019, nearly doubling the capex spending from 2009 to 2013. The uncertainties associated with the execution and recovery of the capex program including the pipeline safety investments are reasonably mitigated by the balanced regulatory structures at both the state and federal levels, including pre-approval of construction projects.
Strong Credit Metrics
SoCalGas' credit metrics are expected to weaken noticeably in the next five years given the sizeable capex. To offset such decline, the company plans to decrease upstream dividend. Despite FFO adjusted leverage increasing to an average of 3.3x from 2x and FFO fixed-charge coverage declining to an average of 8x from over 10x, SoCalGas's credit profile remains well-positioned for its rating category.
Parent Subsidiary Linkage
The relatively wide notching between SoCalGas and its corporate parent, Sempra Energy (Sempra; IDR 'BBB+'/Stable Outlook)is supported by regulatory restrictions in California that limit SoCalGas distributions to Sempra and the view that maintaining a sound capital structure at its California utilities continues to be in the best interest of the parent from an economic perspective. Conversely, SoCalGas' ratings are upwardly constrained by its parent due to Sempra's investments in the unregulated U.S. Gas and Power segment and in the international operations, as well as by the degree of leverage that exists at the parent to support these investments.
--Total capital expenditure $6 billion from 2015 to 2019;
--Annual dividend ranges from $50 million to $100 million;
--Incorporates the settlement rate increase and escalation of 2.75% from 2017-2018.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--In light of SoCalGas' large capex program and absent an upgrade at Sempra, it is unlikely that its ratings will be upgraded in the foreseeable future.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--Capex program is not prudently financed, experiences significant cost overruns or regulatory delay in cost recovery, thus causing the FFO adjusted leverage to be above 4.5x during construction; Post-construction, the FFO adjusted leverage is above 4x on a sustained basis;
--A material portion of the cost related to the gas leak is not recoverable;
--Aliso Canyon storage facility is out of service or closed permanently, resulting in material increase in operating costs or capex that cannot be recovered in rates;
--SoCalGas is found to be liable for the leak, resulting in substantial penalties that are not recoverable;
--Sempra is downgraded;
--A downgrade at its utility affiliate San Diego Gas & Electric could result in a downgrade at SoCalGas.
Date of Relevant Rating Committee: April 20, 2016
Additional information is available on www.fitchratings.com
Corporate Rating Methodology - Including Short-Term Ratings and Parent
and Subsidiary Linkage (pub. 17 Aug 2015)
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT
Credit Analysis (pub. 29 Feb 2016)