Fitch Affirms Central Hudson's IDR at 'BBB+'; Outlook Stable
KEY RATING DRIVERS
Low-Risk Business Model: CHG&E operates a low-risk transmission and distribution (T&D) regulated utility business, which bears no commodity price risk. The New York regulatory framework features balanced tariff mechanisms, including forward-looking test years, trackers for significant operating expenses, and a revenue decoupling mechanism that isolates net margins from variations in sales, weather, and energy efficiency and conservation. Furthermore, the inclusion of a storm reserve in rate design allows CHG&E to recover incremental storm-related costs on a timely basis.
Multi-Year Rate Plan: CHG&E's electric and gas businesses operate under a three-year rate plan that provides earnings visibility and regulatory predictability through mid-2018. Under the plan, the utility will receive aggregate base rate increases for combined electric and gas service of approximately $56 million over the period July 1, 2015 through June 30, 2018. However, the benefit of tariff increases is partly offset by the New York State Public Service Commission's (NYSPSC) use of existing regulatory liabilities as one-time bill credits to moderate the immediate impact of the rate increase. The rate credits have no impact on earnings but do reduce cash flows. Fitch notes that the 9% return on equity (ROE) authorized by the NYSPSC in CHG&E and other New York utility peers' recent rate cases is significantly below what was granted, on average, to T&D utilities nationwide in 2015.
Rising Capex: Fitch projects CHG&E's capital investments to approximate $900 million over 2016-2020. By contrast, total capex amounted to roughly $550 million over the previous five years. The high capex will require significant external funding that is likely to pressure operating cash flows in the near - to intermediate-term. However, any credit concern is largely alleviated by the regulatory predictability provided by the multi-year rate plan and the use of forward-looking test years in rate-setting. Capex is primarily allocated toward the upgrade of T&D infrastructure, advanced grid initiatives and heating oil to natural gas conversions. Capex also reflects accelerated investments in leak-prone pipe replacement projects. Fitch expects capex to be funded with a mix of internally generated cash flow and long-term debt issuance, in a manner consistent with the authorized regulatory capital structure that reflects a 48% common equity ratio.
Moderate Decline in Credit Metrics: Adjusted debt/EBITDAR is projected to average 4x over 2016-2020, and EBITDAR/interest, 4.6x, over the same time frame. Adjusted debt/FFO is forecasted to average 4x. For the second quarter (2Q16) TTM, the ratios of adjusted debt/EBITDAR and EBITDAR/interest were 3.7x and 5.6x, respectively. Projected credit metrics remain sound for the current rating category and reflect continued rate relief post-2018 to support CHG&E's elevated capex. Timely recovery of capex and cost control, including control around manufactured gas plant (MGP) site remediation expenses, will continue to be key factors of credit quality. The deferral of projected MGP clean-up costs results in a significant build-up of regulatory assets, which generates a lag in cash recovery.
Ownership by Fortis: CHG&E's credit profile reflects its stand-alone operations under Fortis Inc. (Fortis) ownership. The utility maintains a separate board, has its own bank credit facility, and can issue long-term debt on its own. Fitch believes Fortis' ownership provides the utility with some level of financial flexibility as far as parent equity infusions or upstream dividends. Fitch expects upstream dividend distributions to be manageable within CHG&E's existing financial profile over the next five years.
REV-based Regulation: The implementation of the 'Reforming the Energy Vision' (REV) initiative, spearheaded by the NYSPSC, has been relatively slow to develop and remains credit neutral at this time. Under a REV framework, rate plans that span multiple years and provide long-term rate visibility could be favorable to New York utilities. Furthermore, a successful penetration of distributed energy resources, one of REV's key objectives, could lead to reduced peak energy demand and allow T&D utilities to scale back capital spending on costly infrastructure-related projects. This is particularly relevant in the case of CHG&E given its large capex cycle and funding requirements.
In the context of REV, CHG&E has four demonstration projects, approved by the NYSPSC, that focus on investments in community solar, micro-grid, demand-side management, and smart meters. Fitch expects REV-related projects to represent a modest portion of total utility capital investments over the forecast period.
Fitch's key assumptions within the rating case are as follows:
--Tariff increases per the 2015 rate order and incremental rate relief at the expiration of current rate plan;
--Capex totalling approximately $900 million over 2016-2020;
--Core O&M kept relatively flat.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
Adjusted debt/EBITDAR below 3x on a sustained basis.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--Adverse regulatory developments, including the absence of timely recovery of commodity costs or the termination of the revenue decoupling mechanism;
--Adjusted debt/EBITDAR greater than 4x and FFO-adjusted leverage greater than 4.7x on a sustained basis.
Fitch considers liquidity to be adequate. CHG&E has access to a total capacity of $200 million under a bank credit facility that expires in October 2020. At June 30, 2016, there were no borrowings outstanding under the bank facility and $32 million of cash and cash equivalents. Long-term debt maturities are considered manageable with $33 million due in 2017, $30 million due in 2018, and $27 million due in 2019.
FULL LIST OF RATING ACTIONS
Fitch affirms the following:
--Long-term IDR at 'BBB+';
--Senior unsecured debt at 'A-';
--Short-term debt at 'F2'.