NEW YORK–(BUSINESS WIRE)–Fitch Ratings has assigned a rating of ‘BBB-‘ to Black Hills Corporation’s (BKH, IDR ‘BBB+’) issuance of $260 million of junior subordinated notes that are a component of BKH’s equity units. Fitch has also placed BKH’s junior subordinated notes on Rating Watch Negative. Each equity unit consists of a remarketable junior subordinated note due 2028 and a forward equity purchase contract obligating the holder to purchase common stock on Nov. 1, 2018. Under Fitch’s criteria, the junior subordinated notes will receive no equity credit; however, the $260 million of additional equity is captured in Fitch’s forecast period.
Proceeds will be used to support BKH’s acquisition financing of SourceGas Holdings LLC (SGH, not rated by Fitch) from investment funds managed by Alinda Capital Partners and GE Energy Financial Services for approximately $1.89 billion. BKH’s Issuer Default Rating (IDR) remains on Rating Watch Negative. Fitch will resolve the Negative Watch concurrent with or close to the completion of the acquisition. Fitch expects the acquisition to close in the first half of 2016.
KEY RATING DRIVERS
Rating Watch Negative: The Negative Watch for BKH reflects a material increase in consolidated leverage at BKH partially offset by increased scale of utility operations and higher regulated mix in overall earnings and cash flows. The purchase price of $1.89 billion includes assumption of approximately $700 million of debt at closing. While BKH has obtained a $1.17 billion bridge facility, permanent financing will consist of $500-575 million of equity and equity linked securities and $450-550 million of debt. The equity component of acquisition financing is modestly less than the $575-675 million that was originally expected. However, BKH is currently evaluating the sale of up to a 49.9% interest in a 200-MW natural gas-fired power plant from its IPP portfolio, the proceeds from which would be used to reduce debt financing.
However, BKH’s leverage will increase materially with this acquisition. Fitch will update its financial forecasts once there is greater clarity on the post-acquisition debt structure, but considers it unlikely that BKH’s pro forma funds from operations (FFO) adjusted leverage could stay below 4.0x over the medium term, which was Fitch’s prior expectation.
Improved Business Risk Profile: Qualitatively, the SGH acquisition is positive for BKH’s business profile because it increases the utility business mix to approximately 82% of EBITDA in 2016, from approximately 78% previously. BKH already operates in three of the four SGH states, all of which have generally supportive regulatory constructs.
Key Factors to Resolve Watch: The post-acquisition capital structure along with management intent to pay down the acquisition debt, the terms of the regulatory approvals in each of the four states, and the trend in pro forma credit metrics will be the key decision factors for Fitch.
Cost of Service Gas Program: BKH’s proposed cost of service gas program would be beneficial to credit quality and could offset some of the increased risk associated with the leverage from the SGH acquisition. If approved by state regulators, the cost of service gas program would materially lower the risk of BKH’s natural gas exploration and production business by supplying its utilities with 50% of their annual gas consumption through long-term contracts. BKH recently submitted cost of service gas regulatory filings in IA, KS, NE, SD, WY and CO. The acquisition of SGH approximately doubles the amount of natural gas that can be contracted under the cost of service gas provision. A successful outcome in the cost of service gas proceedings could mitigate the potential one-notch downward pressure arising from the SGH acquisition.
Shift in Oil and Gas Strategy: The company’s oil and gas strategy is now centered around its utility cost of service gas program, a notable shift from a 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. BKH has decreased planned capital spending in the oil and gas business segment by 89% to $27 million through 2017, from $242 million previously.
Capex Needs: BKH plans to spend $1.3 billion on capex through 2017 with $357 million spent as of Sept. 30, roughly 15% higher than the preceding three-year period. Approximately $308 million or 24% of that amount is eligible for timely recovery under recovery mechanisms. Capex 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 focused on new natural gas-fired power plants and on small-scale wind and solar renewable projects. Capex at the gas utilities is primarily centered on pipeline replacement programs, typically subject to automatic recovery mechanisms. Now that the 132-MW gas-fired Cheyenne Prairie Generating Station power plant entered service last year major generation projects include the $109 million 60-MW Peak View wind project and the smaller $65 million 40-MW simple-cycle natural gas-fired plant at Colorado Electric, both with scheduled in service dates in 2016. Fitch forecasts BKH to remain FCF negative through the forecast period and has assumed a balanced mix of debt and equity financing.
Fitch’s key assumptions within the rating case for BKH include:
–Constructive regulatory environment across all jurisdictions;
–Capital expenditures of $1.3 billion through 2017;
–Minimal maturities through forecast period including $300 million term loan in 2017.
Positive: Future developments that may, individually or collectively, lead to a stabilization of ratings at the current level include:
–Total adjusted debt/EBITDAR and FFO adjusted leverage at 4.0x or below;
–Constructive outcome in the proposed ‘cost of service gas’ proceedings;
–Regulatory approval for SGH acquisition at reasonable terms.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
–Pro forma FFO fixed-charge coverage sustained below 4.75x;
–Pro forma total adjusted debt/EBITDAR and FFO adjusted leverage sustained above 4.0x;
–Material claw back of potential synergies arising from the SGH acquisition;
–A weaker business and financial risk profile from larger investments in oil and gas drilling and/or unfavourable outcome in the proposed ‘cost of service gas’ proceedings.
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. Maturities through the forecast period are minimal and consist of a $300 million dollar term loan due April 12, 2017 which Fitch expects to be refinanced upon expiry.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology – Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
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