Fitch Ratings-New York-June 13:
Fitch Ratings has assigned a first time Long-Term Issuer Default Rating (IDR) of 'BBB' to Emera Incorporated. In addition, Fitch has assigned Emera US Finance LP (Emera Finance) a 'BBB' senior unsecured debt rating.
Emera Finance does not own any assets and is a financing vehicle for Emera. Emera provides full guarantee of Emera Finance's debt and, as such, the unsecured debt ratings of Emera Finance reflect Emera's credit quality. Finally, Fitch has assigned an 'A-' Long-Term IDR to Tampa Electric Company (TEC), which operates regulated electric and gas utilities in Florida and is Emera's largest subsidiary. The Rating Outlook is Stable for both Emera and TEC. Emera's ratings and Stable Outlook reflect its successful integration of TECO Energy (NYSE:TE), ownership of financially sound regulated utilities operating in favorable regulatory environments, exit from riskier non-regulated power generation business in the U.S., and a commitment to strengthen the balance sheet and reduce parent-level debt, which has culminated in a recent announcement to sell its Maine utility. Fitch believes that the issuance of equity and equity linked securities following the acquisition of TECO Energy and the recently announced and completed asset sales is a positive sign that management will be able to hit its capital structure target in 2020. Management is targeting an overall capital structure of 55% debt, 35% equity and 10% preferred, which translates to approximately 6.0x FFO adjusted leverage.
KEY RATING DRIVERS
Deleveraging On Track: Fitch believes Emera's resolve to de-lever and focus on parent-level debt reduction is supportive of its credit profile. Management remains committed to its capital structure target of 55% debt, 35% equity, 10% preferred equity in 2020 and has taken several constructive steps to achieve its target. Supporting its willingness to reduce leverage, the company issued C$1.3 billion of common shares and C$300 million of preferred shares since the closing of the acquisition of TECO Energy. In addition, management announced a reduction in the dividend growth rate to 4% to 5% through 2021 (from 8% through 2020) in the second quarter 2018 earnings call. Management recently completed the sale of its non-regulated power plants in the U.S. for C$792 million; the sale has improved Emera's risk profile by further shifting the business mix toward regulated operations.
In March 2019, Emera announced the sale of its Maine utility for a total transaction value of USD 1.3 billion, which includes $959 million of cash proceeds, transferred debt of approximately $350 million and working capital adjustment at close; the timing and transaction value of Emera Maine exceeded Fitch's expectations. Fitch expects the proceeds from these asset sales to be directed toward parent debt reduction, of which C$1.33 billion is due in 2019-2020, facilitating further de-leveraging. Furthermore, in May, Emera filed a preliminary shelf prospectus to allow for up to C$600 million equity issuance over a period of 25 months.
Good Regulatory Diversity: Emera's credit profile benefits from regulatory scale and diversity provided by the ownership of regulated operations in the U.S., Canada, and the Caribbean. Emera's quality of earnings mix improved significantly with the addition of TECO Energy and its main subsidiary, TEC, which operates in a favorable regulatory environment in Florida. For the LTM 1Q19, the Florida utilities (electric and gas divisions) contributed roughly half of consolidated operating earnings. Favorably, Emera's proportion of regulated earnings has increased to 95%+ from the low 70% pre-TECO acquisition when Emera's unregulated business, mainly consisting of merchant generation and marketing and trading, represented between 20% to 30%. Fitch expects Florida operations to be the main drivers of Emera's financial performance over the forecast period, supporting management's guidance of a 6% compound annual growth rate (CAGR) in rate base over 2019-2021.
Constructive Regulation: Emera's two largest subsidiaries, TEC and Nova Scotia Power (NSP), operate regulated businesses in Florida and Nova Scotia, both of which Fitch considers to be strong regulatory environments. Authorized returns on equity (ROEs) of Florida utilities have been above the national average in recent years. TEC enjoys an authorized midpoint ROE of 10.25% (+/- 100bps) based on a 54% common equity ratio. The utility currently operates under a multi-year rate settlement that extends through 2021.
Fitch considers Nova Scotia regulation (UARB) to be generally constructive, as illustrated by NSP's good track record in achieving balanced outcomes in rate cases. Proceedings tend to be less adversarial than in the U.S. and NSP has had success reaching settlements in previous filings. NSP is not subject to a general annual rate review process but participates in hearings held periodically at NSP's or UARB's request. The utility operates under a multi-year fuel stability plan that allows for a true-up in over or under recovery in fuel costs in the subsequent year. On a more negative note, authorized ROEs in Canada are typically lower than average. NSP operates under an authorized ROE range of 8.75% to 9.25% based on an equity ratio of 40%.
Regulation for Emera's New Mexico gas distribution company is less constructive than in Florida, but has shown signs of improvement. Emera's Caribbean integrated utilities all benefit from fuel adjustment mechanisms and relatively attractive returns on rate base ranging from 8.44% to 15%.
Sizeable Capex: Management expects to spend a sizeable capex of C$6.5 billion over 2019-2021. Approximately 68% of consolidated capex is projected to be allocated at TEC. TEC is spending approximately $850 million to install 600MW of solar generation by 2021 and benefits from timely recovery through the Solar Base rate Adjustment (SoBRA) rider. The utility also plans to spend $850 million toward the modernization of the Big Bend coal plant, and to allocate a portion of capex toward natural gas pipe replacement at the gas division, recovered through a rider.
The Big Bend modernization is a large capital undertaking, which will depress both TEC's and the consolidated credit metrics until the modernization is complete (expected in 2023). TEC intends to file a rate case in 2021 for new rates to be effective January 2022. Fitch expects capex to be funded in a balanced manner through parent equity infusions, internal cash flows, and utility debt.
Improving Credit Metrics: Fitch forecasts Emera's FFO-adjusted leverage and FFO-fixed charge coverage to average 6.0x and 3.2x, respectively, over 2019-2021. In contrast, FFO adjusted leverage stood at 6.6x and 7.4x at YE 2018 and 2017, respectively. An improved financial profile coupled with the qualitative features of strong utilities, position Emera well at the 'BBB' rating level. Sizeable rate base growth in Florida, constructive settlements at TEC and NSP, and balanced treatment of tax reform support Emera's business profile. Although not rated by Fitch, Fitch would consider NSP's credit profile to be in line with the 'BBB' to 'BBB+' rating range.
Sale of Emera Maine: Fitch believes the execution risk in closing the sale of Emera Maine to ENMAX is similar to other M&A transactions in the U.S. There have been several M&A transactions involving Maine investor owned utilities and most have received approvals within four to eight months of application. Fitch does not expect the pending legislation in Maine that seeks to change the regulatory approval statute to 'Net Benefit' standard from the current 'No Harm' standard for ratepayers to pose any challenge for the transaction's regulatory approval. Emera Maine has already withdrawn its pending rate case and has offered incentives to support economic development in its service area and other customer benefits. In Fitch's view, another pending legislation that seeks public ownership of state utilities does not seem to have broad political support. ENMAX has indicated that the City of Calgary (which owns ENMAX) will have no decision-making authority regarding Emera Maine's operations and management, and no director or officer of ENMAX, or any of its subsidiaries, including BHE Holdings, Emera Maine and its subsidiaries, will be a council member of the City or otherwise a designee of the City. Emera Maine filed its request for regulatory approval for the sale on May 9th. The Maine Public Utilities Commission is expected to render its decision by Nov. 5, 2019. The transaction is also subject to obtaining regulatory approvals by the Federal Energy Regulatory Commission and pursuant to the Hart-Scott-Rodino Antitrust Improvements Act.
KEY RATING DRIVERS FOR TEC
Low-Risk Business Model: TEC, an integrated electric and gas utility, enjoys a supportive regulatory environment in Florida and an improved local economy that translates into above-average utility sales and customer growth trends. TEC is the largest contributor to Emera's earnings and cash flows and represented approximately half of consolidated EBITDA and FFO as of YE 2018. TEC's sales volume mix was 48% residential, 32% commercial, 10% industrial and 10% other in 2018. Fitch expects TEC to continue to be the main driver of consolidated earnings over the forecast period, driven by healthy rate base growth. Constructive Florida Regulation: The Florida regulatory compact is supportive of utility credit quality. The utility has several rate riders that provide timely recovery of all prudent costs related to fuel, purchased power, environmental expenditures, conservation costs, a storm recovery clause, and gas pipeline replacement. The use of a SoBRA for TEC's planned solar investments provides timely cost recovery of projects outside of regulatory proceedings. The regulatory compact also features a generation base rate adjustment (GBRA) rider to timely recover generation-related investments that TEC was able to use for the completed Polk power plant expansion project. TEC enjoys rate predictability through 2021, as reflected in a multi-year rate settlement that replaced the settlement agreement reached in 2013 with the Florida Public Service Commission (FPSC).
Favorable Tax Reform and Storm Settlement: On March 1, 2018, the FPSC approved a settlement agreement that Fitch views as constructive and supportive of TEC's credit quality. The FPSC authorized TEC to offset the benefits of tax reform in 2018 against $47 million (net of storm reserve and costs allocated to O&M and capex) of an existing storm recovery asset that was the result of Hurricane Irma which impacted TEC's service territory in 2017. The full impact of tax reform on TEC's rates became effective January 2019.
High Capex: Management expects to spend $3.5 billion on capital investments over 2019-2021. Investments in utility-scale solar generation and the modernization of the Big Bend power station represent the core of capex. Favorably, these investments will change the generation mix to approximately 75% natural gas, 12% coal, 7% solar, and 6% from other sources in 2023. Fitch expects capex to be conservatively funded and in line with the authorized statutory capital structure, using debt, internal cash flows, and equity injections from Emera.
Solid Credit Metrics: For 2018, TEC's FFO-adjusted leverage and FFO-fixed charge coverage were 3.1x and 7.4x, respectively. Fitch forecasts credit metrics to moderately weaken over the forecast period as a result of the elevated capex. Fitch expects FFO-adjusted leverage and FFO-fixed charge coverage to average 3.7x and 6.3x, respectively, over 2019-2021, which remains strong at recommended rating levels. Parent-Subsidiary Linkage: Fitch considers rating linkages between Emera and TEC to be weak to moderate. Legal ties are considered weak due to the absence of guarantees and cross-default provisions. Other weak linkage considerations include an authorized regulatory capital structure provision, a local operating board, a maximum debt-to-capitalization ratio in debt indentures, and access to own utility financing that provide some level of ring-fencing around TEC. However, strategic ties are strong as TEC is a core source of earnings and cash flows to Emera. TEC's reliance on parent equity infusions to support a heavy capex program over the forecast period supports the weak to moderate rating linkage. As a result, Fitch would allow a maximum two-notch differential between the Long-term IDRs of Emera and TEC. Fitch has applied a bottom-up approach in rating TEC. Fitch considers TEC to be a stronger entity than its parent company due to the utility's low business risk nature of its regulated operations, strength of its regulatory environment, and stronger credit metrics and leverage. TEC's stand-alone business profile and credit metrics warrant a higher rating but Fitch has constrained its rating by one notch. Fitch has applied a consolidated approach to rate Emera.
DERIVATION SUMMARY
Emera's business risk profile as a Canadian utility holding company is moderately weaker than U.S. utility holding companies Duke Energy Corp (NYSE:DUK). (Duke; BBB+/Stable) and FirstEnergy Corp. (NYSE:FE; BBB-/Positive) and stronger than its Canadian peers, AltaGas Ltd (BBB/Stable) and Algonquin Power & Utilities Corp. (APUC; BBB/Stable). Both Duke and FE benefit from greater regulatory diversification and scale than Emera, with their regulated utilities operating in multiple jurisdictions with generally constructive regulation. However, Duke is facing execution risks related to its large pipeline construction project and higher regulatory scrutiny driven by coal ash remediation issues. Like Emera, AltaGas owns a strong regulated utility that operates in Virginia and Michigan, but its other investments in commodity-sensitive midstream operations carry higher risk. APUC benefits from regulatory diversification, but owns utilities that are significantly smaller in scale than Emera's Florida and Nova Scotia utilities and operate in somewhat less constructive regulatory environments, with APUC's largest utility operating in Missouri. Emera derives more than 95% of its earnings from regulated operations compared to AltaGas' 50% and APUC's 80%. Emera's strong business profile versus its Canadian peers is offset by its weaker credit metrics. Emera's forecasted FFO-adjusted leverage at approximately 6.0x is higher than 5.0x-5.2x at Duke, 4.9x-5.4x at AltaGas, and 4.8x-5.2x at APUC and comparable to 6.0x at FE. Emera's sizeable holding company debt (forecasted at 42% pro forma for sale of Emera Maine and debt reduction) compares to 34% at Duke and 36% at FE.
TEC's business risk profile as a regulated integrated utility is stronger compared to that of peers, Consumers Energy Company (A-/Stable) and Gulf Power Company (A-/Stable), and slightly weaker than Florida Power & Light Co. (FPL; A/Stable) driven by size. Fitch considers the regulatory compact in Florida to be constructive, which benefits TEC, Gulf Power and FPL. Consumers Energy also benefits from a supportive regulatory environment in Michigan. TEC's financial profile is stronger compared to its peers, albeit it is expected to weaken in midst of a long heavy capex cycle. Once Big Bend modernization is complete, Fitch anticipates TEC's FFO adjusted leverage to return to low 3.0x, reflective of a strong 'A' standalone rating. Fitch has constrained TEC's rating by one-notch due to ownership by a leveraged parent. TEC's forecasted FFO adjusted leverage at 3.5x-4.0x is comparable to mid-3.0x at Gulf Power and 3.5x-4.0x at Consumers Energy, and weaker than 2.7x-3.2x at FPL. The ratings of both Consumers Energy and FPL are constrained due to ownership by CMS Energy (NYSE:CMS) (BBB/Stable) and NextEra Energy (NYSE:NEE), Inc. (A-/Stable), respectively.
KEY ASSUMPTIONS
Fitch's Key Assumptions Within Its Rating Case for the Issuer include:
--For TEC, rate increases reflect settlements and riders, modest sales growth in 2019 and 0.5%-1% sales growth in 2020 and 2021;
--Rate increases at other utilities reflect rate settlements and riders;
--Consolidated capex of C$6.5 billion over 2019-2021;
--Sale of Emera Maine closes by the end of 2019;
--Reduction of C$1.3 billion of Holdco debt over 2019-2021.
RATING SENSITIVITIES
Emera Developments That May, Individually or Collectively, Lead to Positive Rating Action --Further deleveraging that leads to sustained FFO adjusted leverage to less than 5.0x;
--Reduction of parent only holding debt to 30% or below of the consolidated debt. Developments That May, Individually or Collectively, Lead to Negative Rating Action
--Incremental investments in non-regulated operations that increases business risk and lead to incremental leverage;
--A significant deterioration in TEC's financial profile that requires material parental support;
--Inability to reach targeted capital structure of 55% debt, 35% equity and 10% hybrid and FFO-adjusted leverage of 6.0x in 2020. TEC Developments That May, Individually or Collectively, Lead to Positive Rating Action
--Rating upgrade at Emera. Developments That May, Individually or Collectively, Lead to Negative Rating Action
-- A downgrade at Emera;
-- Although not anticipated by Fitch, a material deterioration in the Florida regulatory compact;
--FFO-adjusted leverage above 4.3x on a sustained basis.
LIQUIDITY
Adequate Liquidity: Emera and its subsidiaries have in aggregate access to approximately $3.1 billion of committed syndicated revolving bank lines of credit in either CAD or USD, as of March 31, 2019. Emera's syndicated credit facilities have a financial covenant that the debt to total capitalization ratio should be no greater than 70%. The company was compliant with the covenant as of March 31, 2019. TEC has credit facilities that aggregate $475 million with maturities ranging from March 2021 to March 2022. The facilities carry a financial covenant of 65% debt to capital. TEC was compliant with the covenant as of March 31, 2019.
FULL LIST OF RATING ACTIONS
Fitch assigns the following ratings with a Stable Outlook: Emera Inc. --Long-term IDR 'BBB'; --Senior unsecured debt 'BBB'; --Junior subordinated debt 'BB+'; --Preferred stock at 'BB+'. Emera Finance --Senior unsecured debt 'BBB'.
TEC --Long-term IDR 'A-';
--Senior unsecured debt 'A'.
Contact: Primary Analyst Shalini Mahajan Managing Director +1-212-908-0351 Fitch Ratings, Inc. 33 Whitehall St. New York, NY 10004 Secondary Analyst Michael Ruggirello Associate Director +1-416-644-6586 Committee Chairperson Philip Smyth Senior Director +1- 212-908-0531 Date of Relevant Rating Committee: June 6, 2019 Summary of Financial Statement Adjustments - Fitch allocates 50% equity and 50% debt to the fixed to floating subordinated notes and cumulative preferred stock at Emera. Media Relations: Elizabeth Fogerty, New York, Tel: +1 212 908 0526, Email: elizabeth.fogerty@thefitchgroup.com. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Hybrids Treatment and Notching Criteria (pub. 09 Nov 2018) https://www.fitchratings.com/site/re/10051058 Corporate Rating Criteria (pub. 19 Feb 2019) https://www.fitchratings.com/site/re/10062582 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 Solicitation Status https://www.fitchratings.com/site/pr/10078975#solicitation Endorsement Policy https://www.fitchratings.com/regulatory ALL FITCH
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