OREANDA-NEWS. Fitch Ratings expects to assign a 'BBB+' rating to Southern Company Gas Capital Corporation's (GAS Capital) proposed senior unsecured notes issuance. The Rating Outlook is Stable. GAS Capital's rating is based on an unconditional guarantee by Southern Company Gas (GAS; Issuer Default Rating [IDR] 'BBB+'). GAS plans to use the issuance proceeds to refinance upcoming maturities and for general corporate purposes.

KEY RATING DRIVERS

No Rating Impact from Gas Pipeline JV: GAS' rating and Stable Outlook takes into consideration the recent acquisition of a 50% equity interest in Southern Natural Gas Company (SNG; 'BBB+'/Outlook Stable) from Kinder Morgan, Inc. (KMI; 'BBB-'/Outlook Stable) for approximately $1.4 billion. Fitch views GAS' investment in SNG as part of a continued strategic effort to expand its existing natural gas pipeline investments. The SNG system fits strategically with GAS' distribution service territories and the locations of its parent's, Southern Company ('A-'/Outlook Stable), gas-fired generating plants. SNG's revenue and cash flow profile is supported by long-term capacity reservation contracts with primarily investment grade counterparties, which provide most of the pipeline system's revenue independent of volumes shipped through the system or commodity prices. SNG's contracts are largely demand pull contracts with utility counterparties, with Southern Company's subsidiaries being the largest holder of capacity on the system. SNG serves the southeastern U. S. where Fitch expects gas demand to grow moderately in the near-to-intermediate term. SNG is the principal natural gas transporter to southeastern markets in Alabama, Georgia and South Carolina. These states are part of the fastest growing natural gas demand regions in the U. S.

The equity interest in SNG is held in an unconsolidated subsidiary of GAS. However, Fitch proportionately consolidates the investment in SNG when calculating GAS' credit metrics. Although GAS' adjusted credit metrics will modestly weaken due to the SNG transaction, Fitch believes its business risk profile is strengthened by SNG's low risk, highly contracted, FERC-regulated natural gas pipeline system. Additionally, Fitch expects that GAS will fund future growth investments at SNG in a credit supportive manner.

Utility and Pipeline Earnings Drive Performance: GAS' rating reflects its relatively stable gas distribution earnings and cash flows and generally constructive regulations across its seven-state service territory. Stable earnings from gas distribution utilities are supported by supportive regulatory tariffs, including weather normalization or revenue decoupling, commodity cost pass-through mechanisms, and infrastructure program pre-approval and rider recovery. These mechanisms mitigate regulatory lag and provide a reasonable opportunity for GAS' utilities to earn their authorized returns, in Fitch's view. In addition, GAS' three pipeline projects under development are over 90% contracted with mostly investment-grade regulated utility off-takers. These pipelines are expected to come online during 2018-2019.

Including SNG, Fitch believes that more than 83% of GAS' EBIT will come from its regulated utilities and contracted pipeline businesses by 2019, which Fitch views positively. The remainder of consolidated EBIT would be contributed by the company's retail and wholesale segments. While results from the non-utility businesses can be volatile, the exposure is somewhat contained, given their relatively small contribution to the combined entity.

Large Capex Program Weaken Credit Metrics: The elevated capex and the investment in SNG is likely to pressure GAS' credit metrics temporarily. GAS expects to spend on average nearly $1.2 billion in capital expenditures annually over the next several years, compared to an average of $770 million annually from 2012-2014. Approximately 60% of GAS' capex is subject to recovery through riders or have a minimal regulatory lag.

After proportionally consolidating SNG and excluding any future expansion opportunities under SNG, Fitch estimates GAS' adjusted debt to EBITDAR to increase above 4.5x in 2016 before declining to approximately 4.0x by 2020 driven by the three new pipeline projects becoming operational. Fitch expects funds from operations (FFO) fixed charge coverage to range between 5.5x-6.0x over the next five years.

KEY ASSUMPTIONS

Key assumptions within the rating case for GAS include:

--Capex spending at the distribution utilities will average $990 million from 2016-2020 and peak in 2016-2017;

--Non-utility capex averages approximately $190 million per year from 2016-2020 and peaks in 2017-2018;

--The Dalton lateral pipeline is expected to be operational in 2018 and PennEast and Atlantic Coast pipeline projects are expected to be operational in 2019;

--Dividend payments of $270 million on average per year; --Includes investment in SNG but excludes any future expansion opportunities.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

--A positive rating action is not anticipated in the near to intermediate term. If adjusted debt-to-operating EBITDAR improves to 3.5x or below on a sustained basis, Fitch may consider a positive rating action.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

--Material debt funded expansion or shift towards risky uncontracted non-utility businesses;

--Negative developments in the regulatory supportiveness in which AGL's utilities operate; and

--Adjusted debt-to-operating EBITDAR above 5.0x and/or FFO fixed charge cover below 4.0x on a sustained basis.

LIQUIDITY

GAS and its subsidiaries have good liquidity in the next 12 to 18 months. Operating cash flow is supplemented by the committed domestic bank credit facilities aggregating $2 billion, which includes $1.3 billion at GAS Capital and $700 million at Northern Illinois Gas Company (Nicor Gas, a wholly owned subsidiary of GAS), expiring in November 2018 and December 2018, respectively. As of June 30, 2016, $114 million ($20 million at GAS Capital and $94 million at Nicor Gas) of commercial paper was outstanding, leaving approximately $1.89 billion capacity available. The credit facilities include a financial covenant that requires GAS Capital and Nicor Gas to maintain a ratio of total debt to total capitalization of no more than 70% at the end of any fiscal month. As of June 30, 2016, GAS Capital and Nicor Gas were in compliance with the covenant, with total debt to total cap ratio of 52% and 45%, respectively. Debt maturities are manageable in the next two years with $120 million due for the remaining of 2016 and $22 million in 2017, which are expected to be refinanced.