NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has affirmed the long-term Issuer Default Rating of UGI Utilities, Inc. (UGIU) at 'A-' and senior unsecured debt at 'A'. The Rating Outlook is revised to Negative from Stable. The rating action affects approximately $600 million of long-term debt.
Key Rating Drivers
--Earnings and cash flow impact from proposed settlement of the Allentown gas explosion;
--Standalone credit profile;
--Historically strong earnings and cash flow generation;
--Elevated capital spending program;
--Limited commodity exposure.
Outlook Revised to Negative: The Negative Outlook reflects Fitch's concerns related to the ability of UGIU to return cash flow and profitability levels to fiscal 2011 levels following the unusually mild weather in fiscal 2012. Incurred expenses and accelerated capital investment associated with replacement of aging cast iron pipe and a protracted recovery period for such items as stipulated in the proposed settlement with the Pennsylvania Public Utility Commission may pressure earnings and cash flows over the next two years.
UGIU's UGI Gas division will not benefit from Pennsylvania's recently enacted HB 1294 which establishes a Distribution System Investment Charge (DSIC) that permits timely recovery of infrastructure investments. The DSIC is eligible to utilities who have filed a base rate case within the last five years. UGI Gas operates under a tariff that dates back to 1995. Should UGI Gas file a new General Rate Case, earnings and cash flows will likely vary from current and historical performance.
Standalone Credit Profile: UGIU's credit profile is strong and exhibits modest leverage and historically strong earnings and cash flows. Credit concerns are centered on timely recovery of the elevated capex spending over the next few years. Fitch rates UGIU independently of UGI Corporation's (not rated) other businesses including AmeriGas (rated 'BB', with a Negative Outlook by Fitch).
Strong Credit Profile: The mild 2011/2012 winter heating season depressed sales and earnings at UGIU in the absence of weather normalization or decoupling tariff mechanism. Still, for the LTM period ended June 30, 2012, key earnings coverage measures, including EBITDA-to-interest and fund from operations (FFO)-to-interest, at 5.4% and 4.9%, respectively, remain well within rating category peers and Fitch's utility rating guideline ratios.
Normal Weather Would Bolster Fiscal 2013: Fitch expects EBITDA/interest and FFO/interest for the fiscal year ended Sept. 30, 2013 could grow to 6.1% and 5.1%, respectively, based on a normal winter heating season. Less visibility is afforded in outer years as higher capex and operating expenses may pressure earnings and cash flows. Leverage is modest and debt-to-EBITDA is expected to range between 2.6x and 2.7x through 2014 despite an elevated capital spending program.
UGIU has flexibility in financing the higher capital investments. UGIU has historically generated strong cash flows and the higher capex spending could be financed through internal cash flows and a more modest upstream dividend which has approximated 100% of net earnings recently.
Elevated Capital Spending Program: Capital expenditures, which averaged approximately $80 million in 2009 and 2010, climbed to $99 million in 2011 and reached $119 million for the LTM period ended June 30, 2012. A preliminary settlement with the Pennsylvania Public Utilities Commission (PUC) regarding the Allentown explosion in 2011 will require an $18 million acceleration of aging gas main replacement. Fitch expects capex to remain elevated at approximately $120 million over the next few years.
Limited Commodity Exposure: UGIU's exposure to commodity price fluctuations is limited by the ability of the utility to pass along such costs to its customer. The gas utility has a Purchased Gas Cost (PGC) mechanism that allow for periodic modification of rates to reflect current natural gas costs. On the generation side, generation and congestion costs are similarly passed through to customers and balanced annually.
What Could Lead to a Negative Rating Action:
--Inability to recover an adequate and timely return on planned higher capital investment;
--Increased utility leverage by financing higher capex spending with debt;
--Issuance of debt at the parent level.
What Could Lead to a Positive Rating Action:
--Fitch would consider revising the Outlook to Stable if debt-to-EBITDA leverage is maintained at 2.8x to 3.0x or below.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
Corporate Rating Methodology, Aug. 8, 2012;
Recovery ratings and Notching Criteria For Utilities, May 3, 2012;
Parent and Subsidiary Rating Linkage, Aug. 8, 2012.
Applicable Criteria and Related Research:
Parent and Subsidiary Rating Linkage
Recovery Ratings and Notching Criteria for Utilities
Corporate Rating Methodology
Glen Grabelsky, +1 212-908-0577
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Kevin Beicke, +1 212-908-0112
Philip Smyth, +1 212-908-0531
Brian Bertsch, +1 212-908-0549
Source: Fitch Ratings