Fitch Ratings-New York-July 20:
Fitch Ratings has assigned a 'BBB' Long-Term Issuer Default Rating (IDR) and an 'F2' Short-Term IDR to Algonquin Power & Utilities Corp. (APUC) and to its regulated utility subsidiary, Liberty Utilities Co. (LUCo).
Fitch has assigned a 'BBB' Long-Term IDR and an 'F3' Short-Term IDR to APUC's unregulated power generation subsidiary, Algonquin Power Co. (APCo).
The Rating Outlook for each entity is Stable.
In addition, Fitch has assigned a 'BBB+' rating to the senior unsecured debt issued by Liberty Utilities Finance GP1 (LU Finance GP1), LUCo's financing entity. The debt at LU Finance GP1 is guaranteed by LUCo.
A full list of rating actions follows at the end of this release.
KEY RATING DRIVERS
LUCo Diversified Portfolio of Utility Assets: LUCo accounted for two-thirds of APUC's 2017 consolidated EBITDA and consists of a diversified portfolio of 38 regulated utility systems spread across 12 states, all located in the U.S. The assets are further diversified among electric (62% of operating profit), natural gas (25% of operating profit) and water (13% of operating profit). This asset diversification mitigates the company's exposure to any regional or state-specific shocks that could affect cash flows. LUCo was built from several acquisitions, the most significant of which was the acquisition of The Empire District Electric Company (Empire District) on Jan. 1, 2017. Empire District accounted for a little more than 45% of LUCo's 2017 consolidated EBITDA. Fitch expects LUCo to remain acquisitive, primarily looking for smaller utility systems that could benefit from operational efficiencies. LUCo has a strong track record of improving performance at the utilities it acquires. Improving Regulatory Environment: LUCo's overall regulatory environment is considered balanced and has improved in recent years. Significant improvement occurred this year in Missouri, LUCo's largest state of operations. Legislation was signed June 1, 2018 that allows for revenue decoupling at all electric utilities in Missouri, effective Jan. 1, 2019. Following implementation of this law, two-thirds of LUCo's utility revenue would be fully decoupled, providing for more stability and predictability to earnings and cash flows. The Missouri legislation allows electric utilities to opt out of revenue decoupling if they would prefer to defer for future recovery 85% of all new depreciation expense, with the resulting regulatory asset balances subject to carrying charges at the utility's weighted average cost of capital and amortized over a 20-year period once included in rates. LUCo has been able to effectively manage its operations to earn an aggregate realized ROE near its average authorized ROE of 9.6%. The company has been able to maximize its returns by keeping O&M expense low, optimizing capital deployment, and using cost recovery riders to help limit its average regulatory lag to six months. LUCo's efficient utility operations also enable it to have lower customer rates than many of its utility peers. Fitch views LUCo's balanced and improving regulatory environment as supporting a solid business risk profile. Strong Organic Growth Opportunities: LUCo benefits from organic growth in the form of pipe replacement, reliability improvements and the Granite Bridge natural gas lateral project. The largest of the company's projects is its $1.6 billion 'greening the fleet' initiative, which involves retiring some of Empire District's coal-fired generation facilities and replacing the lost generation capacity with 600 MW of wind power facilities in Missouri. A regulatory decision is pending regarding the recovery method of these future costs through rates. Timely recovery of costs associated with the 600 MW wind power investment would be important for LUCo to maintain a supportive financial profile during this large project. Adequate Financial Metrics: LUCo's financial profile is supported by stable and predictable earnings from the company's regulated utility operations. Fitch expects FFO-adjusted leverage to average 4.8x-5.1x and FFO fixed-charge coverage to average 4.5x-5.0x through 2020. These metrics are adequate for LUCo's BBB Long-Term IDR. Rating Linkage: Fitch uses a bottom-up approach in determining the ratings, and the APUC/LUCo linkage follows a weak parent/strong subsidiary approach. There is a moderate linkage between the Long-Term IDRs of LUCo and APUC. The moderate linkage is supported by separate financing through LUCo's financing affiliate company, LU Finance GP1, along with LUCo's strategic importance to APUC by accounting for two-thirds of consolidated EBITDA. Fitch would not allow APUC's Long-Term IDR to be higher than that of LUCo, although LUCo's Long-Term IDR could be up to one notch higher than that of APUC. APCo Conservatively-Managed Power Generation Business: APCo accounted for one-third of APUC's consolidated 2017 EBITDA and consists of 40 power facilities, providing for a meaningful amount of asset diversification. Three-quarters of APCo's EBITDA is derived from U.S.-based assets, with one-quarter of EBITDA from Canadian assets. APCo owns 1.6 GW of net generation capacity, of which 68% is onshore wind, 22% is thermal, 8% is hydro and 2% is solar. Although Fitch views the unregulated power generation business somewhat riskier than regulated utilities, APCo's conservative management of the business mitigates much of this increased risk. Long-term power purchase contracts with investment grade counterparties cover 88% of APCo's generation. The average length of APCo's PPAs is 15 years, providing a long timeline of high profitability margins and relatively stable and robust cash flows. In addition, APCo maintains a relatively low leverage on the business, with Fitch expecting adjusted FFO-leverage to average 4.1x-4.4x through 2020. Strong Organic Growth Opportunities: APCo's power generation business has exhibited strong and steady growth over the past few years, with installed capacity growing at an 8% CAGR over 2013-2017 and operating profit growing at a 10% CAGR over 2013-2017. Fitch expects that growth to continue, supported by APCo's large backlog of projects. APCo also has the ability to use 450 MW worth of wind turbines that fall under the safe harbor provision, enabling the company to receive the full benefit of production tax credits once these turbines are put into service during the next two years. Supportive Financial Metrics: APCo's financial profile is supported by strong cash flows from the company's power generation business. Fitch expects FFO-adjusted leverage to average 4.0x-4.5x and FFO fixed-charge coverage to average 4.5x-5.0x through 2020. These metrics are supportive of APCo's 'BBB' Long-Term IDR. Rating Linkage: Fitch uses a bottom-up approach in determining the ratings, and the APUC/APCo linkage follows a strong parent/weak subsidiary approach. There is a weak linkage between the Long-Term IDRs of APCo and APUC. The weak linkage is supported by weaker strategic ties between APUC and APCo than between APUC and LUCo. Fitch would not allow APCo's Long-Term IDR to be higher than that of APUC, although APCo's Long-Term IDR could be up to two notches lower than that of APUC. APUC Strong Organic Growth Opportunities: APUC has a significant amount of growth opportunities over the next several years, both at LUCo and APCo. Management estimates that organic growth opportunities alone could result in greater than 10% CAGR for consolidated EBITDA. Supportive Consolidated Financial Metrics: APUC's financial profile is supported by stable and predictable earnings from LUCo's regulated utility operations and strong cash flows from APCo's power generation business. Fitch expects FFO-adjusted leverage to average 4.8x-5.2x and FFO fixed-charge coverage to average 3.8x-4.3x through 2020. These metrics are supportive of APUC's 'BBB' Long-Term IDR. Ownership Interest in Atlantica Yield: APUC's ratings also consider the company's ownership interest in renewable energy yield company Atlantica Yield (AY). Abengoa-Algonquin Global Energy Solutions (AAGES), APUC's 50/50 joint venture with Abengoa S.A., owns 25% of the common shares of AY and has exercised its option to purchase the remaining 16.5%. APUC owns 100% of AAGES' economic interest and voting rights in AY through its ownership of AAGES' preferred shares. Fitch considers AY's credit quality to be weaker than that of APUC. Fitch has made conservative projections for AY's distributions to APUC to help account for increased risk with AY's operations, particularly due to AY's exposure to a possible decrease in returns at its Spanish solar facilities. AAGES represents a relatively small amount of APUC's consolidated EBITDA, limiting the impact that any negative event at AY could have on APUC's credit quality. DERIVATION SUMMARY APUC's 'BBB' Long-Term IDR is appropriately positioned relative to peer parent holding companies, NextEra Energy (NYSE:NEE), Inc. (NextEra; A-/Stable), AVANGRID, Inc. (BBB+/Stable) and CenterPoint Energy (NYSE:CNP), Inc. (CenterPoint; BBB/Stable). APUC's proportion of consolidated EBITDA generated from regulated utility operations is about two-thirds, less than NextEra (70%), CenterPoint (70%) and AVANGRID (75%-80%). Fitch projects APUC's consolidated FFO-adjusted leverage to average 4.8x-5.2x through 2020, weaker than that of NextEra (3.6x-4.1x) and AVANGRID (2.8x-3.2x), but slightly stronger than that of CenterPoint (5.5x). APUC's smaller proportion of regulated utility operations in its asset mix, combined with higher leverage metrics than NextEra and AVANGRID and a much smaller scale of operations than all its peer parent holding companies supports APUC's lower relative rating than that of NextEra and AVANGRID. CenterPoint's diversified utility operations and supportive regulatory environment are stronger than those of APUC, although APUC's unregulated generation business provides cash flows that are much more stable and predictable than CenterPoint's unregulated midstream operations and other non-utility businesses. LUCo, APUC's regulated utility business, benefits from significant geographic and regulatory diversification. LUCo consists of 38 natural gas, electric, and water utility systems in 12 states. This portfolio of utility systems compares favorably to larger single-state utilities from a diversification perspective, although its larger peers may benefit more from efficiencies of scale. Nearly half of LUCo's EBITDA is exposed to Missouri, which historically has had a somewhat challenging regulatory environment. However, regulation in Missouri has improved recently, and legislation passed this year will soon allow for full revenue decoupling for both electric and natural gas utilities. Fellow Missouri integrated electric utility Union Electric Co. (BBB+/Stable) has a similar business risk profile to LUCo's Empire District Electric utility operations. However, LUCo's financial metrics are relatively weaker than those of Union Electric. Fitch expects FFO-adjusted leverage to average 4.8x-5.2x through 2020, compared with 3.0x-3.3x for Union Electric. APCo, APUC's unregulated generation business, benefits from having 88% of its generation under long-term power purchase agreements with investment grade counterparties, mitigating some of the risk associated with these operations. The average length of its power purchase contracts is 15 years, which provides APCo with a longer runway of relatively stable and predictable cash flows than many of its peer generation companies. Southern Power Co. (BBB+/Stable) has a similarly strong percentage of generation under contract, with an average investment coverage ratio (ratio of investments under contract to total investments using net book value) of 91% through 2022 and 89% through 2027, with an average remaining contract duration of 15 years. TransAlta Corporation (BBB-/Stable), on the other hand, has its power contracts starting to roll off in 2018 and Fitch expects at least 50% of TransAlta's fleet to be exposed to market prices after 2020. APCo owns and operates 1.6GW of net generation capacity spread across 8 U.S. states and 6 Canadian provinces, providing beneficial geographic diversification. Southern Power also benefits from ownership of 12.3 GW of generating capacity spread across 11 U.S. states. Although TransAlta owns and operates 9.5GW of net generation capacity in Canada, the U.S. and Australia, it has significant exposure to Alberta, which has a more challenging environment for its power market. APCo and Southern Power also benefit from being part of corporate families with stronger credit profiles than TransAlta. APCo's leverage metrics are weaker than those of Southern Power, but stronger than those of TransAlta. Fitch expects APCo's FFO-adjusted leverage to average 4.1x-4.4x through 2020, compared with 3.5x for Southern Power and 4.5x for TransAlta. KEY ASSUMPTIONS Fitch's Key Assumptions Within Our Rating Case for APUC, LUCo, and APCo: --LUCo's capex totaling $3.3 billion over 2018-2021, $1.6 billion of which is for 600 MW of wind power investments in 2020 and 2021; --APCo's capex totaling $1.3 billion over 2018-2021; --Timely recovery of costs associated with LUCo's 600 MW wind power investment in Missouri; --Revenue decoupling is implemented for LUCo's Missouri electric utility operations; --Normal weather and renewable energy production. RATING SENSITIVITIES APUC Developments That May, Individually or Collectively, Lead to Positive Rating Action Consolidated FFO-adjusted leverage expected to be less than 4.5x on a sustained basis. APUC's ratings are capped by the ratings on LUCo; LUCo's Long-Term IDR would need to be upgraded in order for APUC's Long-Term IDR to be upgraded. Developments That May, Individually or Collectively, Lead to Negative Rating Action --Consolidated FFO-adjusted leverage expected to exceed 5.7x on a sustained basis; --A downgrade of LUCo's Long-Term IDR would result in a commensurate downgrade of APUC's Long-Term IDR. LUCo Developments That May, Individually or Collectively, Lead to Positive Rating Action FFO-adjusted leverage expected to be less than 4.5x on a sustained basis. Developments That May, Individually or Collectively, Lead to Negative Rating Action --FFO-adjusted leverage expected to exceed 5.7x on a sustained basis; --Adverse regulatory decisions; --A downgrade of at least two notches of APUC's Long-Term IDR would result in a downgrade of LUCo's Long-Term IDR. APCo Developments That May, Individually or Collectively, Lead to Positive Rating Action --An upgrade of APCo's Long-Term IDR could only occur if APUC's Long-Term IDR were upgraded; --FFO-adjusted leverage expected to be less than 3.5x on a sustained basis. Developments That May, Individually or Collectively, Lead to Negative Rating Action --FFO-adjusted leverage expected to exceed 5.0x on a sustained basis; --A material decrease in the percentage of generation under long-term contracts; --A downgrade of APUC's Long-Term IDR would result in a commensurate downgrade of APCo's Long-Term IDR. LIQUIDITY Fitch considers the liquidity for APUC and its operating subsidiaries APCo and LUCo to be adequate. APUC's liquidity includes a CAD 165 million senior unsecured revolving credit facility that matures Nov. 19, 2018. LUCo's liquidity is primarily supported by a $500 million senior unsecured revolving credit facility and a $150 million commercial paper program. The credit facility and the CP program both mature on Feb. 23, 2023. APCo's liquidity is primarily supported by a $500 million senior unsecured revolving credit facility that matures Oct. 6, 2022. APCo also has a $200 million letter of credit facility that matures Jan. 31, 2021. APUC's operating subsidiaries require modest amounts of cash on hand to fund their operations; APUC had $68 million of unrestricted cash and cash equivalents as of March 31, 2018. Long-term debt maturities over the next five years are manageable. On a consolidated basis, APUC has $280 million due in 2018, $179 million due in 2019, $391 million due in 2020, $153 million due in 2021 and $492 million due in 2022. FULL LIST OF RATING ACTIONS Fitch has assigned the following ratings: Algonquin Power & Utilities Corp. --Long-Term IDR 'BBB'; --Short-Term IDR 'F2'. Algonquin Power Co. --Long-Term IDR 'BBB'; --Short-Term IDR 'F3'. Liberty Utilities Co. --Long-Term IDR 'BBB'; --Short-Term IDR 'F2'. Liberty Utilities Finance GP1 --Senior unsecured debt 'BBB+'. Contact: Primary Analyst Kevin L. Beicke, CFA Director +1-212-908-0618 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Shalini Mahajan, CFA Managing Director +1-212-908-0351 Committee Chairperson Philip W. Smyth, CFA Senior Director +1-212-908-0531 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity are disclosed below: --Operating leases are capitalized using the 8x rent expense method; --Preferred stock is given 50% equity credit. Media Relations: Elizabeth Fogerty, New York, Tel: +1 212 908 0526, Email: elizabeth.fogerty@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Hybrids Treatment and Notching Criteria (pub. 27 Mar 2018) https://www.fitchratings.com/site/re/10024296 Corporate Rating Criteria (pub. 23 Mar 2018) https://www.fitchratings.com/site/re/10023785 Corporates Notching and Recovery Ratings Criteria (pub. 23 Mar 2018) https://www.fitchratings.com/site/re/10024585 Parent and Subsidiary Rating Linkage (pub. 16 Jul 2018) https://www.fitchratings.com/site/re/10036366 Additional Disclosures Dodd-Frank Rating Information Disclosure Form https://www.fitchratings.com/site/dodd-frank-disclosure/10038712 Solicitation Status https://www.fitchratings.com/site/pr/10038712#solicitation Endorsement Policy https://www.fitchratings.com/regulatory ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. 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