NEW YORK, Oct 22 (Reuters) - Standard & Poor’s Ratings Services assigned its ‘BBB-’ long-term corporate credit rating to Ontario-based holding company Algonquin Power & Utilities Corp. (APUC). The outlook is positive.
The rating on APUC reflects Standard & Poor’s opinion on the consolidated credit profiles of its two subsidiaries, Ontario-based independent power generator Algonquin Power Co. (APCo; BBB-/Positive/--) and U.S.-based regulated utility Liberty Utilities Co. (BBB-/Positive/--). The rating on APUC reflects what we view as a strong consolidated business risk profile and significant consolidated financial risk profile. In our view, the strong consolidated business risk profile reflects stable regulated cash flows from Liberty and somewhat less stable cash flows from APCo’s largely contracted electricity generation asset portfolio due to volumetric risk. We believe APCo’s exposure to asset concentration risk mutes the benefits of portfolio diversity.
APCo and Liberty are two wholly owned subsidiaries of APUC. APCo owns a diversified portfolio of more than 460 megawatts (MW), mainly of contracted generating plants (hydro, wind, and thermal) in Canada and Liberty owns water, electrical and gas utilities in the U.S. As of June 30, 2012, APUC’s consolidated reported debt outstanding (including its convertible debentures) was about C$460 million. Convertible debt of C$62 million is the only debt at the holding company level and the remainder resides at APCo and Liberty.
We view rising stable, regulated cash flows as positive to APUC’s consolidated business risk profile. Upon completing its proposed acquisitions and development projects, we expect EBITDA contributions from Liberty will increase to 40%-50% of APUC’s consolidated EBITDA in the medium term from about 18% at Dec. 31, 2010. Consistent with our expectations, EBITDA contributions from Liberty rose to about 35% of APUC’s consolidated EBITDA at Dec. 31, 2011. However, we also view the company’s growth appetite as aggressive, exposing it to execution and integration risk. We understand APCo plans to double its generation capacity through acquisitions and development projects (in wind and solar generation). In addition, Liberty plans to increase its businesses rapidly, tripling its expected EBITDA mainly through acquisitions.
APCo’s earnings are largely insulated from electricity demand and price fluctuations in the markets where its facilities are located, but are exposed to hydrology and wind resource volatility. We estimate long-term power purchasing agreements (PPA) with strong counterparties support 85%-90% of APCo’s EBITDA. The average remaining PPA life is 12 years and most have automatic inflation escalators linked to Canadian CPI.
We believe production volatility from APCo’s portfolio could increase somewhat, given aggressive plans to build wind facilities. As of Dec. 31, 2011, hydro generation (about 47% of the total), wind (about 30%), and thermal generation (about 23%) supported APCo’s EBITDA. Upon completion of its announced wind and solar projects, we forecast wind generation will generate 50%-60% of APCo’s EBITDA, with the balance from hydro (about 30%), thermal, and solar generation. Given limited historical wind data, we view cash flows from wind generation assets as somewhat less predictable than that of hydro generation. We view cash flows from solar and thermal sources as more predictable than those of wind.
APCo’s cash flows are exposed to asset concentration, which we believe limits the benefits of portfolio diversification. We estimate that its 10 largest assets generate 80%-90% of EBITDA. We believe its hydro assets’ geographic diversity is limited. In addition, the complex and dispersed nature of the company’s electricity generation portfolio requires understanding of multiple technologies and markets, which in our view limits operational efficiencies.
We consider Liberty’s regulated utility business risk profile to be excellent, with a favorable competitive position, supportive regulation, and largely stable service territories. The company’s regulatory framework includes what we consider reasonable allowed returns on equity on its rate base. Consistent with our expectations, it recently acquired natural gas distribution assets in Missouri, Illinois, and Iowa; and New Hampshire-based electricity and natural gas distribution utilities. Accordingly, we estimate about 25% of Liberty’s cash flow will come from water and wastewater utilities, 30% from electric utilities, and the remaining 45% from gas utilities. We expect additional regulatory and geographic diversity once the company completes the acquisitions of natural gas and water utilities in Georgia and Arkansas in 2013. Nevertheless, we think variations in usage volumes and cash flows are likely. Liberty will need to manage its regulatory risk effectively to achieve its constructive regulatory goals and earn its allowed rates of return.
In our view, APUC has a significant financial risk profile. We estimate that the company will have adjusted funds from operations (AFFO)-to-total debt of 15%-17% in 2013 and 2014, assuming it executes its announced acquisitions and power generation development projects. On Dec. 31, 2011, its AFFO-to-total debt was 15.7%, and adjusted debt-to-EBITDA was 4.6x. We treat the company’s convertible debentures as 100% debt.
We believe APUC has adequate liquidity to cover its near-term needs. Standard & Poor’s assessment incorporates the following expectations and assumptions:
-- The company’s consolidated liquidity sources, including FFO and credit facility availability, will likely exceed its uses 1.2x or more in the next 12 months.
-- We believe that net sources will remain positive even in the event of an unforeseen earnings decline of 15%.
-- APUC’s liquidity sources include our estimated C$145 million of annual FFO, APCo’s committed credit facility (C$72 million out of C$155 million was available June 30, 2012), and Liberty’s committed credit facility (C$8 million of C$41 million was available June 30).
-- APUC’s liquidity uses include our estimated dividend payment of about C$85 million, immaterial maturing debt, and about C$50 million of maintenance and core capital expenditures.
-- The company has what we consider good relationships with its banks and good standing in the debt market.
The positive outlook reflects our assessment of an increasing proportion of relatively stable cash flows that Liberty’s regulated utilities support. The outlook also reflects our expectations that APUC will achieve sustained AFFO-to-total debt of 15%-20%, with Liberty’s regulated cash flow supporting 40%-50% of its consolidated cash flows by 2014. We could raise the rating a notch upon the company’s meeting these expectations. Conversely, if it does not meet our expectations or its sustained AFFO-to-debt falls below 15% during our two-year outlook horizon, we would revise the outlook to stable.
Related Criteria And Research
-- Algonquin Power Co., Sept. 20, 2012
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Research Update: Liberty Utilities Co. Assigned ‘BBB-’ Corporate Credit Rating; Outlook Is Positive, July 24, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Key Credit Factors: Business And Financial Risks In The Investor-Owned Utilities Industry, Nov. 26, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
Rating Assigned Algonquin Power & Utilities Corp.
Corporate credit rating BBB-/Positive/--