Fitch Rates Arizona Public Service Co's $250MM Sr. Unsecured Notes 'A'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has assigned an 'A' rating to Arizona Public Service Company's (APS) issuance of $250 million of senior unsecured notes, due Nov. 15, 2045. The senior unsecured notes rank pari passu with existing senior unsecured debt.
Proceeds will be used to defease approximately $70 million of tax exempt pollution control bonds and for general corporate purposes including the funding of capex. The Rating Outlook for APS is Stable.
KEY RATING DRIVERS
--Strong credit metrics;
--Improving customer growth;
--Net metering rate design evolving;
--Balanced regulatory environment;
--Large capex program.
Stable Rating Outlook: The Stable Outlook reflects the regulated nature of APS' utility operations and a constructive regulatory environment in Arizona. Fitch also assumes the Arizona Corporation Commission (ACC) will continue to address rate design regarding energy efficiency (EE) and distributed generation (DG) in a constructive manner. Fitch expects APS to file its next GRC in mid-2016 for rates effective mid-2017 and has modeled in a 10% ROE for APS. The ratings also reflect expectations for continued customer growth, an improving service territory economy and strong projected credit metrics.
Strong Credit Metrics; Increase in Leverage Expected: Fitch expects APS' credit metrics to remain strong throughout the four-year forecast period. Fitch estimates EBITDAR coverage to approximate 6.0x through 2018. EBITDAR-to-interest coverage increased to 6.2x for the LTM ending Sept. 30, 2015, compared with 6.0x for 2014, primarily reflecting new revenues under the Four Corners rate rider, improved customer growth and hot summer weather. Due to the large capex spend EBITDAR leverage, which is currently low at 2.9x, is expected to rise modestly but remain strong at less than 3.5x through 2018.
Higher Customer Growth: Fitch expects customer growth to average about 1%-2% per year through the forecast period, reflecting improving economic conditions in Arizona, including lower unemployment, rising housing starts and new household formations. APS' customer growth for the nine months ending Sept. 30, 2015 increased 1.2% over the year-earlier period, which continues a trend of positive annual customer growth of 1.3% during the three years ending 2014, a marked improvement over the prior three-year period, when customer growth averaged 0.6%.
AZ Regulatory Compact: GRC orders have been more balanced for APS in the past several years, and more timely adjudication of rate filings is a constructive development that has enabled the utility to improve its earned returns. Regulators have adopted several regulatory mechanisms to facilitate cost recovery outside of GRCs. Such cost-recovery mechanisms include the power supply adjustor, renewable energy surcharge, transmission cost adjustor, demand-side management adjustor charge, the environmental improvement surcharge and the lost fixed-cost recovery (LFCR) mechanism. Fitch views the ACC's recognition of an extended post-test year period for new plant additions and the allowance of a premium rate of return on fair value of rate base as further constructive developments. Fitch expects APS to file its next GRC in mid-2016.
Positive Sales Trend: Fitch expects total weather-normalized retail electricity sales will be about 0.5% on average per year through 2017 as a result of customer growth, net of EE and DG. Retail electricity sales, adjusted to exclude the effects of weather variations, increased 0.7% for the nine months ended Sept. 30, 2015, when compared with the prior-year period. This reflects the effects of customer conservation, EE and DG, offset by improving economic conditions and customer growth. The delta between customer growth and sales growth is roughly negative 1.5% due to the effects of EE, demand response and DG.
Net Metering Rate Design Evolving: Rate design regarding DG and net metering continues to evolve in Arizona and the ACC recently voted to proceed with a generic docket to consider rate design and cost of service hearings on distributed generation and net metering with the findings used to inform prospective GRC filings. Concurrently, the ACC also dismissed APS' request to increase its grid access charge. APS previously filed with the ACC to forgo its request for a rate increase to its grid access charge if the ACC moves forward with cost-of-service hearings for its residential solar and non-solar customers, predicated on a decision by March 2016 so it can be incorporated APS' next GRC filing expected in June 2016.
Cost-shifting issues associated with net metering (NM) remain a concern, and APS had previously filed with the ACC in April 2015 to increase its rooftop solar grid access charge to $3/kW effective Aug. 1, from $0.70/kW currently, resulting in a monthly charge of $21 for a typical residential customer, based on a 7-kW system. The current grid access charge addresses a portion of the cost shift, which APS estimates at $67 per month per rooftop solar customer. Fitch views the potential adoption of an increased grid access charge as positive for APS and notes the previously requested grid access charge had been supported by the ACC, ACC staff and the Residential Utility Consumer Office as reasonable. The grid access charge is revenue neutral and credited to the LFCR mechanism.
The ACC previously opened a new docket in December 2014 focused on studying solar DG business models and their effects on corporations and ratepayers, which is currently pending.
The ACC also had no objection to APS' plan to implement a 10-MW utility-owned residential rooftop solar program focused on low-income customers, with associated costs to be filed for recovery in the next GRC. APS' earned ROE for the LTM ended Sept. 30, 2015 approximated 9%, below its authorized ROE of 10%.
Large CapEx Driving Growth: Fitch expects rate base growth of 6% - 7% through 2018, driven by average annual capex of $1.2 billion through the same time period, levels approximately 30% higher than the preceding four-year period. Capex is focused on generation, distribution and transmission investments and includes emissions control upgrades at APS' coal-fired generating facilities, new transmission capacity, and renewable investments through the AZ Sun program. On average 70% of capex is recoverable through rate recovery mechanisms and depreciation cashflow, which provides for a timely return on invested capital.
FCF Negative through 2018: Due to the large capex program, Fitch expects APS to remain moderately free cash flow (FCF) negative through 2018 and expects the utility to fund the majority of forecasted capex internally. The balance is expected to be funded with a 50/50 mix of debt and equity and Fitch anticipates an equity infusion from PNW to APS in 2017 to help maintain the balanced capital structure and authorized 54% equity ratio.
Ocotillo Plant Modernization Project: APS plans to increase the capacity of its gas fired Ocotillo power plant to 620MW to help maintain service reliability in the growing Phoenix area. APS plans to install five new 102MW combustion turbines and simultaneously retire two older and inefficient 110MW steam generators. The project is expected to cost $500 million and construction has begun with a projected in-service date during the summer of 2019.
Four Corners Rate Rider Approved: In December 2014, the ACC authorized APS to establish a rate rider to collect $57.1 million of costs related to the acquisition of the additional interests in Units 4 and 5 and the related closure of Units 1-3 of the Four Corners coal-fired generating facility effective Jan. 1, 2015. ACC approval of the rider is a constructive development from a credit point-of-view.
Fitch's key assumptions within the rating case for APS include:
--A 10% ROE;
--Positive retail sales growth of 0.5% per annum;
--Customer growth of 1%-2% per annum;
--Capex averaging $1.2 billion per annum through 2018;
--Anticipated equity infusion from PNW to APS in 2017 to preserve a balanced capital structure.
Future developments, individually or collectively, that could lead to a positive rating action include:
--Sustained debt-to-EBITDAR leverage metrics under 3.3x;
--Continued supportive regulatory regime in Arizona;
--Greater clarity regarding tariff design and competitive pressures associated with DG.
Future developments, individually or collectively, that could lead to a negative rating action include:
--Deterioration in the regulatory compact in Arizona;
-- An adverse outcome in APS' next GRC;
--Sustained debt-to-EBITDAR leverage metrics over 3.6x;
--A sharp acceleration in competition from DG and/or other emerging technologies could pressure the rating.
Solid Liquidity: As of Sept. 30, 2015, APS had total consolidated liquidity available of $948 million including $5 million of cash and cash equivalents. APS maintains liquidity through two $500 million unsecured credit facilities which mature in September 2020 and May 2019, respectively. Additionally, APS can upsize their $500 million credit facilities to $700 million with consent of the lenders. The credit facilities backstop the company's commercial paper program and are subject to a maximum debt-to-capitalization covenant of 65% and as of Sept. 30, 2015 APS was in compliance with debt-to-capitalization ratio of 42.4%. APS' long-term debt maturities are manageable with $428 million scheduled to mature through 2017 as follows (includes capital lease obligations): $39 million in 2015, $357 million in 2016, and $32 million in 2017.