Fitch Rates Southwest Gas Corporation's $300MM Notes 'A'
Net proceeds will be used toward the repayment of short-term debt and for general corporate purposes.
Fitch currently rates Southwest Gas' Long-Term Issuer Default Rating 'A-'/Stable Outlook..
KEY RATING DRIVERS
Constructive Regulatory Environment
The ratings of Southwest Gas benefit from a relatively constructive regulatory environment. The utility's natural gas distribution business has revenue decoupling and purchased gas adjustments (PGAs) throughout its service territory. These rate mechanisms increase the stability and predictability of earnings and cash flows and provide for more timely cost recovery.
General Rate Case Filing in Arizona
In May 2016, Southwest Gas filed a general rate case (GRC) in Arizona, following the end of its GRC moratorium on April 30, 2016. The company requested a $74 million increase in annual operating income, based on a 10.25% authorized return on equity (ROE) and a 52% equity capital structure. Settlement discussions are scheduled for December 2016, and new rates are expected to become effective in May 2017.
Southwest Gas' most recent GRC in Arizona resulted in a settlement agreement, with rates effective January 2012. Fitch considers that settlement agreement to have been constructive, supporting credit quality. Base rates were increased $52.6 million, representing 72% of the utility's requested amount, based on a 9.5% authorized ROE and a 52.3% equity ratio. In addition, the Arizona Corporation Commission approved full revenue decoupling with a monthly weather adjuster.
Modest Regulatory Diversification
Southwest Gas' natural gas distribution business has a modest level of regulatory diversification, which helps limit exposure to any one jurisdiction. In 2015, Arizona and Nevada accounted for 55% and 34%, respectively, of the utility's operating income, while California accounted for 11%.
Strong Financial Metrics
The constructive regulatory environment has enabled Southwest Gas' financial metrics to remain strong. Through 2018, Fitch expects FFO fixed-charge coverage to average 7.0x-7.5x, FFO adjusted leverage to average 3.1x-3.4x, and adjusted debt/EBITDAR to average 2.9x-3.2x, continuing to provide headroom at the existing ratings.
Moderate Risk in Construction Services Business
Southwest Gas' solid credit profile is slightly weakened by the greater business risk at Centuri Construction Group (Centuri). Centuri is a full-service contractor that works with local distribution companies (LDCs) to install, repair, and maintain pipeline distribution systems in the U. S. and Canada. Centuri contributed slightly more than 20% of consolidated EBITDA for the last 12 months ended June 30, 2016, and Fitch expects Centuri's EBITDA contribution to remain around that level going forward.
Centuri primarily operates under unit-price contracts that establish prices for each of the various services performed and often have annual pricing reviews, minimizing the risk of cost overruns for multiyear projects. However, 13% of Centuri's revenue in 2015 was earned under fixed-price contracts, and some of its unit-price contracts have revenue caps. Fixed-price contracts and unit-price contracts with revenue caps expose Centuri to the possibility of losses, particularly for longer-term projects, due to the necessity of estimating costs far in advance.
Elevated Capex Program
Southwest Gas is undergoing a period of increased capex, primarily focused on safety and reliability. Fitch expects Southwest Gas' natural gas distribution business to spend a total of $1.4 billion-$1.6 billion over 2016-2018, with the annual amount gradually increasing each year. Concerns regarding the relatively large capex program are mitigated by the utility's various infrastructure replacement cost-recovery mechanisms. Capex at Centuri is self-funded.
Fitch's key assumptions within the rating case for Southwest Gas include:
--Net customer growth averaging 1.5% per year through 2018;
--Capex of $1.6 billion during the three-year period 2016-2018;
--Utility operations accounting for 80% of consolidated EBITDA on average through 2018;
--Holding company reorganization taking effect before year-end 2016;
--No asset divestitures or acquisitions.
Positive Rating Action: A rating upgrade is unlikely at this time due to Southwest Gas' increased business risk associated with Centuri's construction services business.
Negative Rating Action: A negative rating action could result from a significant deterioration of the regulatory environment in Arizona or Nevada or if Fitch were to expect FFO adjusted leverage to exceed 4.0x and adjusted debt/EBITDAR to exceed 3.7x on a sustained basis. If the planned holding company reorganization does not occur, a material expansion of Centuri's business activities to greater than 20%-25% of consolidated EBITDA could also result in a negative rating action.
Fitch considers Southwest Gas' liquidity to be adequate. The company primarily meets its short-term liquidity needs through the issuance of commercial paper (CP) under an uncommitted $50 million CP program, which is backstopped by a $300 million five-year revolving credit facility (RCF) that matures March 25, 2021. As of June 30, 2016, Southwest Gas had full availability under its CP program and only $2.5 million of borrowings on its credit facility, leaving $297.5 million of availability.
In July 2016, Southwest Gas used its credit facility to fund the early redemption of its $100 million 2005 4.85% series A fixed-rate industrial development revenue bonds (IDRBs). The company also used its credit facility to fund the early redemption on Sept. 2, 2016 of its $24.855 million, 4.75% series 2006A Clark County, Nevada IDRBs.
Southwest Gas' operations require modest cash on hand to fund its daily business needs. At June 30, 2016, the company had $12 million of unrestricted cash and cash equivalents.
Long-term debt maturities over the next five years are manageable, with $25 million of unsecured 7.59% medium-term notes maturing in January 2017 and $125 million of unsecured 4.45% debentures maturing in December 2020.
Centuri is self-funding and maintains access to liquidity through its $300 million secured revolving credit and term loan facility, which expires in October 2019. At June 30, 2016, Centuri had $60 million of availability under the RCF. Centuri assets securing the facility as of June 30, 2016 totaled $479 million.