Fitch Affirms WGL Holdings, Inc. IDR at 'A'; WG at 'A '; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed the Issuer Default Rating (IDR) of WGL Holdings, Inc. (WGL) at 'A' and those of its primary utility holding subsidiary, Washington Gas Light Co. (WG), at 'A+'. Both Rating Outlooks are Stable. Approximately $1.2 billion of consolidated debt is affected by today's rating action.
KEY RATING DRIVERS
WGL ratings reflect the predictable cash flows and strong credit metrics of WG, a regulated gas distribution utility subsidiary, and the increased business risk of its retail marketing and midstream businesses. For the latest 12 months (LTM) ending June 30, 2015, WG comprised 82% of consolidated EBITDAR.
The Stable Outlooks reflect the expectation that the company will continue to effectively manage the risks associated with its growing non-regulated businesses and large utility capex plan.
Leverage Under Pressure: Due to the large capex program, leverage at both WGL and WG is expected by Fitch to increase over the next few years. Fitch expects WGL's EBITDAR leverage will increase to approximately 3.7x in 2017 and then trend down to approximately 3.3x by 2019 as projects under construction are completed and begin contributing to earnings and cash flow. By comparison, for the LTM period, WGL's EBITDAR leverage was 3.3x. At WG Fitch expects EBITDAR leverage to increase to 3.0x in 2019 as compared to 2.1x currently. Ultimately, Fitch expects credit ratios for both entities to be consistent with our target ratios for their current rating levels.
Solid Operating Performance: Fitch expects funds from operations (FFO) coverage ratios at WGL and WG to remain above 5.0x through the forecast period, consistent with current rating levels. For the LTM period, FFO coverage ratios at WGL and WG approximated 7.4x and 9.0x, respectively.
Growth in Diversified Businesses: Fitch expects strong growth in WGL's non-utility businesses through the forecast period, driven by significant investments in the midstream and commercial energy systems business segments. For WGL these operating segments made up 5% and 2% of adjusted EBIT for 2014, respectively, and Fitch expects the segments may contribute up to 15% and 20% of adjusted EBIT by 2019. WGL's midstream investments are focused on gas storage and pipeline investments that primarily move gas from the expanding Marcellus basin to consuming markets. WGL's commercial energy systems business segment invests in distributed generation assets including PV solar, combined heat and power plants, and natural gas fuel cells typically structured through purchase power agreement (PPAs) with a term of 20 years. Fitch views both businesses as relatively low risk.
Large Capex Program: WGL expects to spend $3 billion on capital expenditures through 2019, averaging $606 million per annum, levels significantly higher than previous years. The capex program is primarily focused on accelerated pipe replacements at WG and growing unregulated midstream pipeline and alternative energy investments, which will pressure credit metrics. Fitch expects WGL's capex levels to peak in 2016 and 2017 at $607 million and $825 million, respectively, due to increased midstream investments and then taper off and average $545 million through the balance of the forecast period. Fitch expects that both the midstream and utility business segments will be moderately free cash flow (FCF) negative though the forecast period and will need equity support from the parent in 2016 and 2017 to help maintain balanced capital structures. Fitch expects WGL to fund the deficit by a roughly 50% mix of debt and equity. Notably, accelerated pipe replacement investments at the utility average under 30% of total capex through 2019, subject to recovery under Infrastructure Recovery Mechanisms (IRMs) in MD, VA, and Washington DC, which will provide for a timely return on invested capital.
Volatile Retail Energy Business: WGL has grown its unregulated investments primarily through Washington Gas Energy Services (WGES), its retail energy marketing subsidiary which primarily services commercial customers. For the nine months ending June 30, WGES contributed $54.6 million of adjusted EBIT (approximately 17% of consolidated), as compared to a loss of $1.5 million for the same period last year. The earnings volatility highlights the increased risk of this business. Fitch notes that during the same period last year WGES earnings were negatively impacted by extreme weather due to the polar vortex. Revenues at WGES have been growing modestly for the last six years at a 2% CAGR and Fitch expects prospective large commercial and government customers to drive modest growth at WGES.
Continued Customer Growth: WG operates in an attractive service territory in the metropolitan Washington DC, area, one of the stronger residential markets in the country, and forecasts modest annual customer growth of 1% through 2016 increasing to 2% in 2017 through 2019. Customer growth for the nine months ending in June was approximately 1.1%. WG continues to capture over 90% of new single-family homes in its service territory and is targeting the multifamily home segment for new growth opportunities.
Revenue Decoupling: In MD, a full revenue decoupling mechanism mitigates the sales volume volatility which is due to weather variability and customer conservation. In VA, a decoupling mechanism allows WG to recover costs related to conservation and energy-efficiency programs. In addition, WG also operates under a weather normalization mechanism in VA. Therms delivered by jurisdiction were approximately 47%, 36%, and 17% in MD, VA, and Washington DC, respectively, for the year ended Sept. 30, 2014.
MD 2013 GRC Settled: In November 2013, the Public Service Commission of Maryland (PSC) approved an $8.9 million rate increase for WG based on a 9.5% return on equity, which represented 31.4% of the revised requested amount for rates effective going forward.
MD STRIDE: In July, the PSC of MD approved WG's request to expand its existing $200 million, five-year accelerated pipe replacement program by an additional $31 million over the remaining four years through 2018. The approval specified that only transmission-related accelerated pipe replacements in MD would be eligible for recovery under the IRM. WG subsequently filed an appeal addressing accelerated pipe replacements outside of MD which is currently pending. In December 2014 the PSC of MD approved WG's 2015 Strategic Infrastructure Development and Enhancement (STRIDE) program, totaling approximately $37 million in capex and an associated IRM to collect an estimated $3.8 million of revenue in 2015.
DC GRC Filing Expected: As part of WG's settlement agreement with the PSC of DC, the utility agreed to file its next rate case in 2016. Previously, in May 2013, the Public Service Commission of DC (PSC of DC) approved an $8.4 million rate increase for WG, predicated on a 9.25% ROE, which represented 29% of the requested amount, for rates effective June 4, 2013. WG plans to spend roughly $22 million per annum over the next five years through 2019 related to its accelerated pipe replacement program and the PSC of DC) granted final approval of WG's new IRM in January. The IRM will allow for the timely recovery of costs and is a credit positive.
VA GRC Settled: On July 2, 2012, the Virginia State Corporate Commission (SCC of VA) approved a $20 million rate increase for WG, which represented 70.2% of the requested amount, based on a 9.75% ROE. In June the SCC of VA authorized WG to expand its existing $191 million five-year pipe replacement program by an additional $66 million over the remaining three years. Costs associated with this accelerated infrastructure replacement program are recovered through an IRM that is subject to commission approvals and annual true-ups.
VA Gas Reserves in Rate Base: WG entered into a 20-year agreement with Energy Corporation of America (ECA) in May to acquire non-operating working interests in 25 producing wells located in PA's Appalachian Basin for $126 million and subsequently filed with the SSC of VA to include the gas reserves in the rate base. The purchase agreement is conditional upon commission approval and a final decision is expected by November 8. The approval of gas reserves in the rate base would be a constructive development and provide for a timely return on invested capital.
New Midstream Investments
Constitution Pipeline: In May 2013, WGL Midstream entered into $79 million equity investment in the Constitution Pipeline Company, LLC for a 10% share in a proposed 121-mile long pipeline. The pipeline project is designed to transport at least 650,000 dekatherms of natural gas per day from the Marcellus region in northern Pennsylvania to major northeastern markets and is expected to enter service in the second half of 2016. WGL Midstream joins Williams Partners L.P.'s ('BBB'/Negative Rating Watch; 41% share), Cabot Oil and Gas Corporation (25% share) and Piedmont Natural Gas (24% share) in the project. As of June 30, WGL invested approximately $26 million in the constitution pipeline.
Central Penn Line Pipeline: In February 2014, WGL Midstream formed Meade LLC with COG Holdings LLC, Vega Midstream MPC LLC, and River Road Interests LLC to partner with Transcontinental Gas Pipeline Company, LLC (Transco; 'BBB+'/Negative Rating Watch) to invest in the Central Penn Pipeline. The 177-mile Central Penn Pipeline, as part of Transco's Atlantic Sunrise project, is designed to transport up to approximately 1.7 million dekatherms per day of natural gas from Susquehanna County, PA to a delivery point into Transco's mainline in southeast PA. The Central Penn Line currently has a projected in-service date in 4Q17. WGL Midstream plans to invest an estimated $412 million for a 55% interest in Meade and Meade will invest an estimated $746 million for an approximate 39% interest in the Central Penn Line. As of June 30, WGL invested $22 million in the Central Penn Line pipeline.
WGL Midstream becomes supplier to Cove Point: WGL Midstream entered into a 20 year gas sale and purchase and capacity agreement with GAIL Global LNG LLC, a subsidiary of GAIL Limited (GAIL), to be their sole provider of natural gas to the Cove Point LNG facility for export to the growing Indian market. Under the agreement, WGL has agreed to sell up to 430,000 Dth/day of natural gas at Henry Hub linked prices commencing on the in-service date of the Cove Point LNG export facility in June of 2017. The majority of natural gas would be purchased at Henry Hub linked prices through an existing arrangement with Antero Resources Corporation (Antero), helping to mitigate pricing risk. Additionally, WGL Midstream has the option invest $100 million to $150 million to acquire a 30% ownership interest in a 70-mile extension of an existing gathering pipeline system to support deliveries serving the Mid-Atlantic market. The gathering system is expected to enter service in late 2015 or early 2016.
Mountain Valley Pipeline: In March 2015, WGL Midstream acquired a 7% equity interest in the proposed Mountain Valley Pipeline Project for a projected investment between $230 million and $245 million dollars. The pipeline is expected to cost up to $3.5 billion and as of June 30, WGL invested $6 million dollars. The proposed pipeline will transport approximately 2.0 million dekatherms of natural gas per day from the Marcellus basin to the Mid-Atlantic market. Mountain Valley has a projected in service date in December 2018.
Fitch's key assumptions within our rating case for the issuer include:
--GRC Filing at PSC of DC in 2016.
--Utility rate base CAGR of 11% through 2019.
--Capex totalling $3 billion through 2019.
--Maturities of $20 million in 2015, $25 million in 2016, none in 2017 and 2018, and $50 million in 2019.
What Could Lead to a Credit Rating Upgrade?
--No positive rating actions are anticipated in the near term.
What Could Lead to a Credit Rating Downgrade?
--WGL: A marked increase in the risk profile of its retail marketing operations could lead to negative rating actions. Sustained debt to EBITDAR leverage metrics above 3.65x and/or FFO fixed charge coverage below 5.0x over the forecast period could cause negative rating actions.
--WG: A greater than expected increase in leverage to fund the large capex program coupled with adverse regulatory outcomes which limits WG's ability to earn an adequate return on invested capital. Sustained EBITDAR leverage above 3.25x and/or FFO fixed charge coverage below 5.0x could trigger a downgrade.
--A downgrade at WGL could trigger other negative rating actions.
Sufficient Liquidity: As of June 30, 2015, WGL had total consolidated available liquidity of $710 million under their credit agreements including $66 million of cash and cash equivalents. WGL and WG can upsize their $450 million and $350 million senior unsecured credit facilities, which mature in December 2019, to $550 million and $450 million, respectively, with consent of the lenders. The credit facilities backstop the companies' commercial paper programs and contain a maximum debt-to-capital covenant of 65%. As of June 30, there were no direct borrowings under the facilities and WGL had $156 million of commercial paper outstanding.
Manageable Debt Maturities: Long-term debt maturities over the next five years are modest and as follows: $20 million in 2015, $25 million in 2016, none in 2017 and 2018, and $50 million in 2019.
FULL LIST OF RATING ACTIONS
WGL Holdings, Inc.
--Long-term IDR affirmed at 'A';
--Senior unsecured debt affirmed at 'A';
--Short-term IDR affirmed at 'F1';
--Commercial paper affirmed at 'F1'.
Washington Gas Light
--Long-term IDR affirmed at 'A+';
--Senior unsecured notes affirmed at 'AA-';
--Preferred stock affirmed at 'A';
--Short-term IDR affirmed at 'F1';
--Commercial paper affirmed at 'F1'.