Fitch Affirms NorthWestern Corp.'s IDR at 'BBB+'; Outlook Stable
OREANDA-NEWS. Fitch Ratings has affirmed the 'BBB+' long-term Issuer Default Rating (IDR) of NorthWestern Corporation (NWE) and all debt instrument ratings as shown at the end of this release. The Rating Outlook is Stable.
The ratings affirmation reflects NWE's low-risk fully regulated utility business model, manageable capex, a gradual improvement in credit metrics over the rating horizon, healthy local economy, and robust cash flows and liquidity provided by the availability of net operating loss (NOL) carryforwards that shield net income through 2017. The additions in rate base of hydro and wind assets further support NWE's stable financial profile over the next five years.
KEY RATING DRIVERS
Low-Risk Business Model: NWE is a divisionally structured utility, and all debt and debt service requirements are directly supported by utility cash flows. NWE derives 100% of its earnings and cash flows from regulated electric and gas divisions in Montana, South Dakota and Nebraska. Montana has the substantial majority of earnings and cash flows and accounted for 84% of gross margin in 2014, with South Dakota accounting for almost all of remaining earnings.
Relatively Balanced Regulation: NWE benefits from trackers for fuel and purchased power, and cost of gas, in all regulatory jurisdictions. Montana rate design also includes a property tax tracker. However, regulatory lag due to the use of historical test years remains a credit concern in a period of rising operating costs and peaking capex over 2015-2017. The Montana Public Service Commission's (MPSC) decision to eliminate NWE's lost revenue adjustment mechanism (LRAM) bears no material impact on the utility's financial profile, in Fitch's view. Under the LRAM, which was established in 2005, NWE was collecting an annual $7.1 million from customers to compensate the company for lost sales due to the effects of demand-side management (DSM) activities and energy efficiency and conservation. The impact of DSM programs and energy efficiency on retail sales will be addressed in a future rate case.
In the most recent regulatory action in Montana, the MPSC authorized the $870 million rate base of 633 MW of hydro assets acquired from PPL Montana in 2014, reflecting an return on equity (ROE) of 9.8% and a 48% common equity ratio. The natural gas reserves are rate-based similar to other infrastructure assets with 9.8% ROE and 48% common equity ratio. The Battle Creek natural gas production asset, purchased in 2010, is currently reflected in rates while Bear Paw North and Bear Paw South natural gas assets, which were acquired in 2012 and 2013, respectively, are recovered through the gas tracker until a future rate filing in Montana, where NWE would seek their inclusion in rate base.
NWE reached a balanced rate order in its South Dakota electric rate case, in line with Fitch's expectations. The utility received an electric base rate increase of $20.2 million compared with its initial request of $26.5 million. The order was silent on authorized ROE and capital structure. The rate request was primarily driven by the recovery of investments made to meet federal environmental mandates, including environmental costs associated with the Big Stone and Neal power plants, and for infrastructure upgrades. As part of the rate order, the South Dakota Public Utilities Commission authorized the inclusion of the Beethoven wind farm in rate base.
NWE closed the acquisition of the 80MW Beethoven wind farm from BayWa r.e. Wind LLC for $143 million (about $1,800/Kw) in September 2015. The asset is immediately accretive to earnings, providing $9 million of annual incremental revenue over the forecast period. The benefit of production tax credits (PTCs) that are associated with the asset results in a lower revenue requirement and hence helps moderate pressure on utility bills, which are some of the lowest in the nation. Absent PTCs, the Beethoven revenue requirement is about $20.5 million.
Prior to the acquisition, the energy and capacity was contracted by NWE via a 20-year purchased power agreement (PPA) which terminated upon transaction closing. NWE successfully funded the acquisition using a combination of $70 million of long-term debt, $57 million of common equity, and the remainder with cash and short-term debt. The 25-year $70 million first mortgage bond was issued at an attractive 4.26% coupon rate.
Manageable Capex: Management's projected capex budget is manageable and presents only modest external financing needs, in Fitch's view. NWE plans to spend approximately $1.45 billion of capex over 2015-2019, with peak spending over 2015-2017. The maintenance of NWE's distribution and transmission infrastructure is a key driver of capital spending. With the near completion of Big Stone environmental upgrades, Fitch expects environmental exposure to be limited going forward excluding potential investments needed to meet Clean Power Plan mandates. Fitch expects NWE to fund capex using a balanced mix of internally generated cash flows and long-term debt. Favorably, Fitch estimates NWE's internal cash flows will fund, on average, 85% of capex requirements over 2015-2019.
Low-Cost Energy Supply: The acquisitions of the hydro and wind assets significantly advance the reintegration of generation into NWE's rate-based assets. Owned hydro and wind (including Beethoven) represent approximately 35% of NWE's total generation portfolio, and NWE's total owned generation is expected to supply more than 70% of its average electric load, effectively reducing its reliance on purchased power and spot market purchases.
In addition, NWE owns approximately 85 bcf of proven natural gas reserves, which are estimated to provide about 29% of annual retail gas load in Montana. The company targets to expand its production assets to supply 50% of its total annual gas requirements, including gas usage at its gas-fired generation fleet. The ownership of natural gas reserves enhances liquidity and has allowed the utility to reduce storage and hedging expenses while limiting exposure to natural gas price spikes that customers from other utilities experienced with the Polar Vortex of 2013/2014. Fitch expects NWE will be able to receive regulatory approval for future gas reserve acquisitions.
Economically Healthy Service Area: Unemployment rates in all three service areas are meaningfully below the national rate, and customer growth has been robust, with electric and natural gas customers growing by roughly 6% and 5%, respectively, since 2008. Retail rates are materially below the national average, and management projects weather-normalized annual retail sales growth of about 1% for the next five years, which is moderately above industry average.
Adequate Credit Metrics: Forecasted credit metrics show steady improvement in each year of the five-year forecast. Adjusted debt/EBITDAR improves to 4.5x by 2018 from 6.5x in 2014 and 5.1x in 2015. Similarly, funds from operations (FFO) leverage improves to 4.8x by 2018 compared with 5.3x in 2015 and 6.4x in 2014. Coverage ratios are strong with EBITDAR coverage expected to average near 5.2x and FFO coverage, 5x, over 2015-2019. Although leverage ratios are on the lower echelon of the 'BBB+' utility rating profile, they remain relatively in line with Fitch's prior expectations and continue to support a stable credit profile. Fitch views balanced rate relief in future Montana rate filings and cost control to be critical towards maintaining a stable financial profile.
Fitch's key assumptions within the rating case include:
--Capex totals $1.45 billion over 2015-2019;
--Montana rate increases;
--South Dakota rate increase per rate order;
--Retail sales growth of 1%.
Future developments that may, individually or collectively, lead to a positive rating action:
FFO-adjusted leverage between 3.5x-4x on a sustained basis could trigger a positive rating action.
Future developments that may, individually or collectively, lead to a negative rating action:
--Regulatory outcomes that restrict NWE from earning an adequate and timely return on invested capital;
--FFO-adjusted leverage at or greater than 5.25x on a sustained basis.
NWE has access to a total capacity of $350 million under an unsecured bank credit facility that expires Nov. 5, 2018. It had approximately $142 million of unused funds, including $10 million of cash and cash equivalents, at Sept. 30, 2015. The credit facility includes a financial covenant that the debt/capitalization ratio should be no greater than 65% and NWE is in compliance. Long-term debt maturities are considered manageable with $55 million due in 2018 and $250 million due in 2019.
Liquidity is bolstered by the availability of approximately $615 million of net operating loss (NOL) carryforwards (federal and state combined), which reduce cash tax payments and shelter net income into 2017. Consequently, the expiration of bonus depreciation will not have a material impact on cash flows, in Fitch's view. The favorable cash flow position has led management to focus on growing dividends over the last five years, and NWE increased its dividend by 20% in early 2015. Management targets a dividend payout ratio of 60%-70% over the forecast period, which is relatively in line with industry average, and should be manageable within the existing credit profile.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings with a Stable Outlook:
-Long-term IDR at 'BBB+';
-Short-term IDR at 'F2';
-Commercial paper at 'F2';
-First mortgage bonds at 'A';
-Pollution control bonds at 'A';
-Senior unsecured/bank credit facility at 'A-'.