S&P: Ratings On SGSP (Australia) Assets Pty Ltd. And Jemena Ltd. Raised To 'A-' On Group Support; Outlook Stable
"The rating upgrade follows our reassessment of the benefit of group support to SGSPAA from its majority shareholder, SGID. The track record of the shareholders over the past two years and their forward strategy for SGSPAA suggest an alignment of interest between the companies and their willingness to support SGSPAA in times of stress as it pursues growth opportunities," said S&P Global Ratings credit analyst Meet Vora.
As a result, we assess SGSPAA as a moderately strategic subsidiary of SGID, leading to one-notch uplift to 'A-' from SGSPAA's stand-alone credit profile, which remains at 'bbb+'.
SGSPAA is the owner of a portfolio of regulated monopoly network businesses, which strongly support its business risk profile. The modest geographic and segment diversity (electricity and gas) of network assets provides cash flow stability, with the balance coming from SGSPAA's contracted gas pipelines and unregulated asset-management business.
Underpinning the rating is the high visibility of the company's cash flows on the back of recent regulatory determinations for most of the regulated assets until 2020. Jemena Gas Networks (JGN) has established parameters from July 2015 to June 2020, and Jemena Electricity Networks (JEN) from January 2016 to December 2020. Although the reset parameters have been somewhat tighter compared with SGSPAA's expectations, we expect the company to operate within the permitted allowances.
Still, we expect a drop in EBITDA in 2017 and marginally lower EBITDA margins over the next four-to - five years, which is likely to be offset by lower interest costs. Cash flows from the contracted assets remain stable, supported by medium-to-long term contracts. Our analysis does not incorporate possible upside from regulatory appeals due to the uncertainty on the timing and magnitude of the outcomes.
Over the next two-to-three years, our focus will be on how SGSPAA manages the construction risk of the Northern Gas Pipeline (NGP; including the gas processing facility) and its contracting strategy as the project nears completion by end 2018. The company estimates the construction cost to be around A$800 million with capital spending likely to peak in 2017.
We expect that the company would debt fund the majority of this project, substantially increasing its leverage during the construction period, without any corresponding earnings contribution. While the balance sheet can currently support the capital spend, the management and shareholders have represented that they will support to preserve the credit profile should there be any unforeseen delays or cost increases. We believe the first lever that SGSPAA would exercise in such a case would be potential reduction in dividends. SGSPAA's other operations are simple and it has a good operating track record.
We expect SGSPAA's revenues to decline in the high single-digit percentage for the year-ending Dec. 31, 2016, before settling at that level as the regulatory resets flow through. EBITDA margins are likely to drop to about 50% in 2016 and settle around 46%-47% over the next two-to-three years, subject to how the company manages its operating costs. Realignment of interest rate hedges and progressive refinancing of debt at the currently low prevailing rates would lower its interest expenses, which would mitigate the lower earnings to some extent. As a result, its funds from operations (FFO)-to-total debt could drop to about 11.5% for year-end 2016, compared with 14.4% in fiscal 2015.
We expect SGSPAA's FFO to total debt to drop to around the company's policy levels of 9.5% over 2017-2019 with potential debt-funding of the NGP project. This means that SGSPAA would have limited headroom at the current rating level for further indebtedness, particularly if it were to pursue other market opportunities. We expect its shareholders would provide support, mainly in the form of dividend discretion, to enable SGSPAA to continue operating at or above its financial policies. This includes maintaining its FFO-to-debt of more than 9.5%, FFO interest coverage of at least 2.5x, and total leverage of less than 65%.
Mr. Vora added: "The stable outlook on SGSPAA reflects the predictable and visible cash flows from the company's regulated businesses and stable contracted assets. The outlook also incorporates our expectations that SGSPAA would maintain FFO to debt of above 9.5%, in line with its publicly articulated financial policies to support its current ratings."
In addition, we expect SGSPAA would manage the construction risk of NGP appropriately and would minimize any associated market risk by entering into firm contracts for the available capacity before it completes the construction.
The rating could come under pressure if SGSPAA's financial performance weakens such that its FFO to debt were to fall below 9.0%, with no expectations of recovery back to above 9.0%. This could most likely happen if SGSPAA does not manage its capital spending and shareholder returns in a credit-supportive manner.
Upward movement of the rating is unlikely over the next 12 months, given that we don't expect substantial improvement in SGSPAA's stand-alone credit profile. Nevertheless, an upgrade could occur if SGSPAA can maintain an FFO to debt above 11.0% and management is committed to maintaining that credit profile.