-- ATCO Gas continues to strengthen its financial profile by suspending dividends and funding almost its entire capital works through internal cash flows.
-- As a result, ATCO Gas’ financial metrics are likely to improve in the next 12 to 24 months to an extent that could support a rating of one-notch higher, all else being equal.
-- We have therefore revised our rating outlook to positive from stable, and affirmed the ‘BBB’ rating on ATCO Gas.
-- We may raise the rating if we believe ATCO Gas can sustainably achieve FFO-to-interest coverage and FFO/debt of better than 2.5x and 12% respectively.
On Jan. 11, 2013, Standard & Poor’s Ratings Services revised its rating outlook on Western Australia-based gas distribution network company ATCO Gas Australia LP (ATCO Gas) to positive from stable. At the same time, we affirmed the ‘BBB’ ratings on the company.
The outlook revision is based on our expectation that ATCO Gas Australia LP’s financial metrics are likely to sustainably strengthen from fiscal 2013 (ending Dec. 31) to a level consistent with a rating one notch higher than the current level. We expect the management’s commitment to reduce leverage through dividend suspension and the funding of nearly all of capital expenditure through internal cash flows will drive the improvement, as the company maintains steady business operations.
ATCO Gas’ operational performance in 2012 remains satisfactory subsequent to its acquisition in mid-2011 by Canadian Utilities Ltd. (A/Stable/A-1), a member of the ATCO Ltd. group (A/Stable/--). Although gas volumes in 2012 have been somewhat lower than our expectations due to lower organic growth and consumption, revenues and EBITDA are expected to remain largely in line with our expectations. In fiscal 2012, revenues and EBITDA are forecast to be about A$190 million and A$115 million respectively, supported by the tariff adjustment due to a favorable outcome from Australian Competition Tribunal (ACT) regarding ATCO Gas’ appeal.
In our view, ATCO Gas’ financial metrics have improved and will be stronger beyond 2013. The recapitalization at the time of ATCO Ltd.’s acquisition, ongoing steps taken to reduce gearing, and the tariff adjustment from the ACT appeal decision implemented from July 2012 will drive the improvement. ATCO Gas expects no dividend payments over the medium term and will continue funding most of its capital works of about A$60 million to A$90 million annually from internal cash flows. Consequently, funds from operations (FFO)-to-interest coverage and FFO/debt are likely to be about 2.4x (1.4x in fiscal 2011) and 11% in fiscal 2012 (3% in fiscal 2011) respectively. Our forecasts for 2013 and beyond are based on:
-- Total annual gas volume of about 28 petajoules (PJ) to 29PJ over the next couple of years, marginally lower than regulatory assumptions by about 4%-5%, reflecting recent volume trends;
-- Regulatory parameters for approved tariffs and capital expenditure;
-- An EBITDA margin of 60%-65%; and
-- No material increase in debt and no dividends.
We note that ATCO Gas is exposed to its next regulatory reset from July 2014 and faces a A$450 million debt maturity in July 2014. Key to a higher rating would be ATCO Gas’ management of these developments satisfactorily and maintenance of its forecast financial profile.
The ‘BBB’ rating on ATCO Gas reflects our opinion of its “excellent” business risk profile, which is supported by the company’s natural monopoly position, regulated cash flows, and stable earnings profile. ATCO Gas faces low bypass risk and high economic barriers to duplicate its assets, and has minimal operational risks typical for underground gas-distribution networks. Partly offsetting these strengths are its exposure to gas volumes variation and high capital expenditure. ATCO Gas operates the Western Australian gas-distribution network. The parent company does not guarantee ATCO Gas’ obligations, and ATCO Gas currently provides a relatively small contribution (about 9% of group EBITDA) to ATCO group earnings.
In our view, ATCO Gas’ liquidity is “adequate”. Our liquidity assessment is based on the following factors and assumptions:
-- We expect the company’s liquidity sources (including cash, FFO, and credit facility availability) over the next 12 months to exceed its uses by more than 1.2x.
-- No debt maturity until June 2014, when its A$450 million bank facility matures.
-- No material additional debt requirement given internal funding of capital works.
-- We believe the company has good relationships with its banks and has a sound standing in the credit markets.
We expect the company to operate comfortably above its debt covenant levels, including:
-- Interest cover ratio (ICR) to be at least 1.6x, against the 1.2x covenant level; and
-- Gearing (defined as net senior debt to regulated asset base) to be less than 70%, against a covenant of 95%.
The positive outlook reflects our view that ATCO Gas will continue to sustain steady state business operations, and that its financial metrics are likely to improve to levels consistent with a ‘BBB+’ rating.
The ratings on ATCO Gas could be raised by one notch in the next two years if we believe that ATCO Gas can achieve and sustain financial metrics that are at, or better than, those expected for fiscal 2013--at above 2.5x FFO interest cover and 12% FFO to total debt, and that the company will be able to satisfactorily manage its regulatory reset due in 2014.
Conversely, if we believe that the financial profile was unlikely to improve in line with our expectations for a higher rating, we would revise the outlook back to stable.
Related Criteria And Research
2008 Corporate Criteria: Analytical Methodology, April 15, 2008
ATCO Gas Australia LP
Senior Unsecured BBB
Ratings Affirmed; CreditWatch/Outlook Action
ATCO Gas Australia LP
Corporate Credit Rating BBB/Positive/-- BBB/Stable/--