Fitch Ratings has affirmed the Long-term Issuer Default Rating (IDR) for
Black Hills Corporation (BKH) at 'BBB+' following the completion today
of the company's acquisition of SourceGas Holdings LLC (SGH, not rated
by Fitch). BKH's ratings have been removed from Rating Watch Negative
and assigned a Negative Rating Outlook. Fitch previously placed the
company on Negative Watch on July 13, 2015.
Simultaneously, Fitch has upgraded the Long-term IDR for SourceGas, LLC
(SGL), SGH's operating subsidiary, to 'BBB' from 'BB+'. SGL's ratings
have been removed from Rating Watch Positive and assigned a Positive
Rating Outlook. Finally, Fitch has affirmed the Long-term IDR for Black
Hills Power, Inc. (BHP) at 'BBB+'. The Rating Outlook is Stable. A
complete list of rating actions follows at the end of this release.
The affirmation of BKH's IDR reflects the company's improved business
risk profile as a result of the SGH acquisition, expectations for an
improving trend in pro forma credit metrics, and better than expected
merger regulatory approvals set by the state regulatory commissions.
The Negative Rating Outlook primarily reflects the increased leverage
associated with the SGH acquisition; however, BKH's Outlook could be
revised to Stable following a successful outcome in the pending cost of
service gas proceedings. Implementation of a cost of service gas program
would provide a beneficial uplift to BKH's business risk profile and
mitigate the downward rating pressure caused by the company's weaker
pro-forma credit metrics. Fitch expects state regulatory rulings in the
third quarter of this year.
SGL's Positive Rating Outlook reflects Fitch's expectation that the
company's debt would be refinanced at the BKH level before maturity.
SGL's Long-term IDR would then be equalized with BKH's.
The $1.89 billion purchase price includes the assumption of
approximately $760 million of debt at closing. Permanent financing
consists of $255 million of common equity, $299 million of equity linked
securities, and $550 million of unsecured debt. The $554 million equity
component of acquisition financing is modestly less than the $575 - $675
million that Fitch originally expected. Additionally, BKH announced that
it has entered into a definitive agreement to sell a 49.9 percent member
equity interest in a 200-MW natural gas-fired power plant from its IPP
portfolio for $215 million, the proceeds from which would be used to
reduce leverage. The sale is expected to close around April 1.
KEY RATING DRIVERS
Increased Leverage: BKH's leverage increased materially in the near
term, as a result of the SGL acquisition. Pro forma FFO adjusted
leverage is approximately 6.6x, pressuring credit metrics at the current
rating level. Although BKH's financial metrics will remain weak as a
result of increased leverage associated with the acquisition, Fitch
expects consolidated FFO adjusted leverage to strengthen to 4.5x by
2018. Leverage is expected to benefit from a combination of EBITDA
growth due to the timely recovery of utility investments under rate
rider mechanisms, anticipated synergies, and debt reduction.
Improved Business Risk Profile: The SGH acquisition is positive for
BKH's business risk profile, increasing the regulated utility business
mix to approximately 87% of consolidated EBITDA, from 80% previously.
The acquisition also increases BKH's utility customer base by 55%, to
more than 1.2 million, strengthening the company's existing footprint in
Colorado, Nebraska, and Wyoming, while expanding its service territory
into Arkansas. BKH's regulated electric and natural gas utility
operations now span eight states, all of which allow for pass-through of
commodity and/or purchased power costs, with several of the states
allowing other riders or recovery mechanisms that enhance timely
recovery of expenses and invested capital.
GRC Moratoriums: As a condition of receiving regulatory approvals for
the SGH acquisition, management has agreed to general rate case (GRC)
stay-out provisions in AR, CO, NE, and WY ranging from zero to three
years, depending on the regulatory jurisdiction. The GRC moratorium
allows for the realization of potential synergies over the next two
years and does not preclude increases in the various rate recovery
riders.
Cost of Service Gas Program: BKH's proposed cost of service gas program
would be beneficial to credit quality and would largely offset the risk
associated with the increased leverage from the SGH acquisition. If
approved by state regulators, the cost of the service gas program would
materially lower the risk of BKH's natural gas exploration and
production business while also adding stability to the utilities' fuel
costs. BKH's utilities would procure 50% of their annual gas consumption
through long-term contracts tied to the company's natural gas production
costs. BKH recently submitted cost of service gas regulatory filings in
CO, IA, KS, NE, SD, and WY, and the SGH acquisition roughly doubles the
amount of natural gas that could be contracted under this program.
A successful outcome in the cost of service gas proceedings would
mitigate the one-notch downward pressure arising from the SGH
acquisition. Fitch expects regulatory hearings to commence in the first
half of this year. If approved, BKH expects to spend roughly $50 million
on the program during the second half of this year and $100 million on
the program in each of the next two years.
Shift in Oil and Gas Strategy: BKH's oil and gas strategy would be
centered around its utility cost of service gas program, a notable shift
from the prior focus on unregulated exploration and production
activities. BKH has meaningfully reduced its planned capex in the Mancos
and Piceance shale basins over the next two years, as the current
commodity price environment does not support drilling fundamentals. The
company's planned oil and gas capital spending for 2016 and 2017 has
decreased by 89%, to $24 million total, from $242 million previously.
Increased Capex Needs: BKH plans to spend roughly $2 billion on capex
through 2019 with approximately 80% of that amount at the regulated
utilities. The projected capex spend currently excludes the proposed
cost of service gas program and will be primarily focused on new
generation, transmission, and distribution investments at the electric
and gas utilities. Due to looming regulations under the EPA's Clean
Power Plan, future electric generation needs are likely to be in the
form of new natural gas-fired power plants and on small-scale wind and
solar renewable projects. Capex at the gas utilities is primarily
focused on pipeline replacement programs, typically subject to automatic
recovery mechanisms. Fitch expects BKH to remain FCF negative through
the forecast period and has assumed a balanced mix of debt and equity
financing.
SGL:
Acquisition by BKH: Fitch considers the acquisition by BKH to be
positive for SGL's credit quality, given BKH's stronger financial
profile, larger scale and scope of operations, and better financial
flexibility as a publicly-traded entity. Fitch expects BKH to
consolidate SGL's debt under BKH and its operations under its utility
holdings subsidiary, Black Hills Utility Holdings, Inc., as BKH did when
it acquired the Aquila natural gas utilities in 2008. The constraints on
credit quality that SGL previous faced as a subsidiary of a leveraged
holding company with private equity ownership would be alleviated by the
acquisition by BKH. SGL is expected to benefit from operational
efficiencies and financial synergies as well as improved consolidated
leverage metrics and enhanced access to capital.
Low-Risk Utility Business: SGL conducts its regulated natural gas
distribution businesses in four states: Arkansas, Colorado, Nebraska,
and Wyoming. Regulated activities account for more than 90% of gross
margin and are supported by several regulatory mechanisms that reduce
earnings and cash flow volatility. Commodity costs are a straight
pass-through to customers via recovery mechanisms, riders allow for
recovery of capital investment for system upgrades for meter and pipe
replacement, and Arkansas, SGL's largest state of operations, employs
weather normalization.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for BKH include:
--Constructive regulatory environment across all jurisdictions;
--Successful integration of businesses;
--Excludes the cost of service gas program;
--Capex of $2.1 billion through 2019.
RATING SENSITIVITIES
BKH:
Positive: Future developments that may, individually or collectively,
lead to a stabilization of ratings at the current level include:
--Constructive outcome in the pending cost of service gas program
regulatory proceedings;
--Total adjusted debt/EBITDAR and FFO adjusted leverage at 4.0x or below.
Negative: Future developments that may, individually or collectively,
lead to a negative rating action include:
--An unfavorable outcome in the pending cost of service gas program
regulatory proceedings;
--Expectations for FFO adjusted leverage to remain above 4.5x through
the forecast period;
--A weaker business risk profile from larger investments in the oil and
gas business, outside of a cost of service gas program.
BHP:
Positive: A positive rating action is not expected at this time.
Negative: Unexpected adverse regulatory decisions; FFO fixed-charge
coverage sustained below 4.75x and total debt/EBITDAR sustained above
3.75x.
SGL:
Positive: The refinancing at the BKH level of SGL's remaining long-term
debt before maturity would result in an equalization of the IDRs at SGL
and BKH.
Negative: A negative rating action at SGL is unlikely barring an
unexpected change in the post-acquisition capital structure.
LIQUIDITY
BKH had $391 million of liquidity available under its $500 million
unsecured revolving credit facility, including $39 million of
unrestricted cash and cash equivalents as of Sept. 30, 2015. The credit
facility can be upsized to $750 million with the consent of the lenders
and matures in June 2020. The credit facility is subject to a maximum
debt-to-capitalization ratio covenant of 65% as of Sept. 30, 2015, and
BKH was in compliance with a debt-to-capitalization ratio of 57%. BKH's
$500 million bank credit facility contains covenants that trigger
cross-default if BKH or its subsidiaries fail to make timely payments of
debt obligations. BKH's long-term debt maturities are expected to be
manageable through the forecast period.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Black Hills Corporation (BKH):
--Long-term IDR at 'BBB+';
--Senior unsecured debt at 'BBB+';
--Junior subordinated debt at 'BBB-';
--Short-term IDR at 'F2'.
The Rating Outlook is Negative.
Fitch has affirmed the following ratings:
Black Hills Power, Inc. (BHP):
--Long-term IDR at 'BBB+';
--First mortgage bonds at 'A';
--Short-term IDR at 'F2'.
The Rating Outlook is Stable.
Fitch has upgraded the following:
SourceGas, LLC (SGL):
--Long-term IDR to 'BBB' from 'BB+';
--Senior unsecured notes to 'BBB+' from 'BBB-'.
The Rating Outlook is Positive.
Additional information is available on www.fitchratings.com
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and Parent
and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362
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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=999475
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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