Fitch Rates CenterPoint Energy's Series A Preferred Stock 'BB+'.
The perpetual preferred stock is eligible for 50% equity credit under Fitch's hybrid methodology, dated March 27, 2018, titled "Corporates Hybrids Treatment and Notching Criteria" and available at www.fitchratings.com. The key rating characteristics for the preferred stock include ability to cumulatively defer interest and payments, no maturities or call provisions for principal repayment within five years, no voting rights, and ranks only above the common equity. The net proceeds from the offering will be used to fund the proposed merger with Vectren Corporation. If the merger doesn't close, the proceeds will be used for general corporate purpose.
In April 2018, Fitch affirmed CNP's 'BBB' long-term Issuer Default Rating (IDR) and revised the Outlook to Stable from Positive following an announcement that it will acquire 100% of Vectren Corporation's equity interest. CNP plans to fund the merger with $2.5 billion of equity and $3.5 billion in debt. Vectren's low risk regulated gas and electric operations (80% of net income in 2017) in Indiana and Ohio will enhance CNP's diversification and business risk profile. However, the meaningful increase in leverage, relatively complex corporate structure and exposure to Vectren's power generation and non-utility operations, limit any upward migration of CNP's ratings at this time.
Merger closing requires approval from the Federal Communications Commission, the Federal Energy Regulatory Commission (FERC), Vectren's shareholders and approval under the Hart-Scott-Rodino Antitrust Improvements Act. Fitch understands that change of control filings are not required by the Indiana Utility Regulatory Commission (IURC) and Public Utilities Commission of Ohio (PUCO). Vectren's shareholders will vote on Aug. 28, 2018. CNP has made informational filing in both Ohio and Indiana and filed with the FERC. The transaction is expected to close in the first quarter of 2019.
KEY RATING DRIVERS
Improving Risk Profile: The acquisition will modestly increase CNP's exposure to regulated utility operations and improve geographic diversification. Pro forma, CNP's operating income in 2019, including equity earnings from investment in Enable Midstream Partners (Enable, BBB-/Stable), is estimated to be comprised of approximately 70% regulated utilities, compared to 65% without Vectren. Gas utilities will represent 31% of the pro forma operating income, up from 24%. Fitch views this trend favorably as gas utilities enjoy more supportive regulation, robust rate-base growth through politically uncontroversial gas infrastructure modernization programs and have less exposure to environmental control mandates.
Credit Metrics Impaired by Merger Financing: Fitch estimates that CNP's FFO adjusted leverage will average 5.5x in the next two years with 2019 metrics to be particularly weak due to one-time merger and integration related expenses. Fitch proportionately consolidates Enable's debt and cash flow in calculating this ratio. If Enable is not consolidated, and if including Enable's distribution in the operating cash flow, the FFO adjusted leverage will be an average of 5.2x in the next two years. Fitch believes that these metrics position CNP at the 'BBB' rating level.
Supportive Regulation: Indiana is Vectren's primary service territory with approximately 77% of the rate base at the end of 2017, followed by 15% in Ohio and 8% under FERC and shared assets. Fitch views Indiana as one of the most supportive regulatory jurisdictions in the country, allowing utilities to consistently earn near or exceed their allowed ROEs. Vectren's earned ROEs exceeded 12% from 2015 to 2017, compared with allowed ROEs ranging from 10.15% to 10.6%. Indiana utilities have full or partial decoupling or weather normalization, and the Ohio gas utility has a straight fixed variable rate structure for residential customers. All utilities have gas and fuel and cost recovery and adjustment clause, and infrastructure recovery programs. Indiana also allows recovery for environmental or federal mandates. Other mechanisms include trackers for bad debt expenses, demand side management and filing of integrated resource plans.
In the next 10 years, Vectren will invest approximately $3.8 billion in the gas utilities and $2.2 billion in the electric utility, supporting rate base growth of 7% CAGR for gas and 5% for electric. Seventy-five percent of this capex can be recovered through mechanisms and deferrals. Supportive regulation and robust infrastructure programs more than offset the tepid customer growth in Indiana and Ohio. Vectren utilities' long-term customer growth is projected to be between 0.5% to 1%, versus CEHE and CERC's 1% to 2%.
Vectren's Financial Profile: Vectren's financial profile is strong, rooted in a conservative capital structure and low leverage. Vectren and Vectren Utility Holdings Inc. (VUHI)'s FFO adjusted leverage was in the mid-3x and low 3x, respectively, in the last two years. These credit metrics, combined with the supportive regulatory framework in Indiana and Ohio, could position them strongly in the 'A' rating category. However, Fitch expects these credit metrics to weaken primarily due to increasing capex, and impact from the tax reform. The company will increase capex spending by nearly 40% in year 2021 and 2022 at the utilities primarily for the construction of the new natural gas combined cycle plant. Vectren's rating assignment and its subsidiaries will be subject to review of the final capital structure, updated credit metrics and clarity of the regulatory treatment of the tax reform benefit.
Unregulated Operations: Unregulated operations will represent approximately 29% of the combined operating income in 2019, compared with 35% currently at CNP. This includes Enable's equity income contribution, which will decline modestly to 20% in 2018 from 23% in 2017. The decline will likely continue as CNP executes its plan to sell the common units in the open market, a credit positive. Fitch estimates that Vectren's non-utility businesses represent approximately 4% of the total operating income in 2019. They are expected to grow within the new entity but will remain manageable. Similar to CNP's existing non-utility operations, they are complementary to the core utility business. Vectren's non-utility segment includes infrastructure services and energy services. Infrastructure services provide underground pipeline construction and repair services. Energy services provide renewable project development and energy efficiency management.
Exposure to Generation: Vectren's electric utility owns and operates 1.248 GW of power generation including 1 GW coal, 245 MW gas, and 3 MW of landfill gas electric. Though exposure to power generation is credit negative, CNP is expected to continue Vectren's current plan to retire or exit 70 MW of natural gas generation in the next two years and 730 MW of coal generation in 2023 and 2024. Additionally, Vectren plans to construct a 700 MW natural gas combined cycle plant by 2024 and add 50 MW of solar generation. Indiana allows pre-approval and recovery of environmental mandates with a return. In early 2015, IURC approved Vectren's request for capital investment to comply with the mercury and air toxic standards for its coal plants and address certain issues at the A.B. Brown station. In February 2018, Vectren filed a request to begin recovery for the projects. An order is expected in early 2019.
Complex Corporate Structure: Assuming no changes in the existing corporate structure at Vectren, the merger will add more complexity in CNP's existing structure. VUHI currently funds the short-term and long-term financing needs of the regulated utilities, which also have their own debt prior to the formation of VUHI. VUHI's obligations are severally and jointly guaranteed by the utilities. Vectren Corporation guarantees the debt obligations at Vectren Capital Corp., which funds the non-utility business. Additionally, the transaction will increase CNP's parent-level debt as a percentage of total debt, reversing the positive and declining trend over the last few years.
Fitch expects CNP to be well positioned relative to its peers. CNP's pro forma FFO-adjusted leverage is estimated to be in the mid-5x in the next two years, weaker than Sempra Energy's (BBB+/Stable) high 4x and OGE Energy's (BBB+/Stable) 3.8x, but in line with NiSource Inc's 5.5x (BBB/Stable). CNP's business model carries higher risk than NiSource's fully regulated business model, due to its investment in the Enable and other non-utility businesses. Similar to Sempra Energy, approximately 70% of CNP's operating income is from regulated utilities. However CNP's utilities are more geographically diversified and are more insulated from distributed generation and aggressive renewable standards than Sempra's California utilities. CNP and OGE Energy are both exposed to the commodity sensitive midstream business (Enable). CNP's utility operations are diversified and enjoy supportive regulations whereas OGE's utility, Oklahoma Gas and Electric, is concentrated in Oklahoma and has experienced negative regulatory treatment in recent years.
Fitch's key assumptions within its rating case for the issuers include:
--CNP will issue $2.5 billion equity (including common equity and equity content of mandatory convertible equity securities and the series A perpetual preferred stock) and $3.5 billion debt;
--Merger will close in the first quarter of 2019;
--No change in assumptions for the capital investment in each company's regulated and unregulated business segments per recent disclosures;
--Certain amount of sale of Enable's common units is assumed from 2019 to 2021.
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action
--An upgrade is unlikely in the next two years due to the Outlook revision to Stable from Positive because of the merger. Nevertheless, if the FFO adjusted leverage is below 5x on a sustained basis, assuming no change in the business risk profile, CNP could be upgraded.
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action
--CNP and Vectren's utilities' regulatory environment becomes unfavorable to the point that they are unable to
receive timely and reasonable recovery in rates;
--Enable requires a meaningful amount of equity support;
--The inability to execute the planned sale of Enable units due to poor market conditions;
--Inability to issue the sizeable common equity to finance the merger, resulting in material increase in leverage;
--FFO adjusted leverage exceeds 6x on a sustained basis.
FULL LIST OF RATING ACTIONS
Fitch has assigned the following rating:
CenterPoint Energy, Inc.:
--Preferred Stock at 'BB+'
Fitch has affirmed following ratings:
CenterPoint Energy, Inc.:
--Long-Term IDR at 'BBB';
--Senior unsecured notes and pollution control revenue bonds at 'BBB';
--Junior subordinated debenture (ZENS) at 'BB+';
--Short-term IDR/Commercial paper at 'F2';
--Senior secured pollution control revenue bonds at 'A+' (secured by general mortgage bonds of CenterPoint Energy Houston Electric).
The Rating Outlook is Stable.
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|Publication:||Daily the Pak Banker (Lahore, Pakistan)|
|Date:||Nov 21, 2018|
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