Rating Action Commentary
ֳ Affirms Black Hills Corp. and Black Hills Power at 'BBB+'
Thu 29 Aug, 2019 - 2:56 PM ET
ֳ - New York - 29 Aug 2019: ֳ has affirmed the Long-Term Issuer Default Rating (IDR) of Black Hills Corporation (BKH) at 'BBB+' with a Stable Outlook. ֳ has also affirmed the Long-Term IDR of Black Hills Power, Inc. (BHP), BKH's primary electric utility subsidiary, at 'BBB+' with a Stable Outlook. ֳ has also affirmed the short-term IDR and commercial program (CP) of BKH at 'F2'. Finally, ֳ has affirmed the short-term IDR of BHP at 'F2'.
The rating affirmations reflect the predictable earnings and cash flows from the companies' predominately regulated operations. The low-risk business profile, in ֳ's opinion, can support the current ratings despite the delayed progress on deleveraging due to the impact of tax reform and an elevated capital program focused on safety projects recovered through infrastructure mechanisms during the general rate case (GRC) stay-out periods. With the divestment of BKH's unregulated exploration and production (E&P) operations completed in 2018, nearly all of BKH's cash flows and earnings are from regulated activities or nonregulated businesses that have long-term contracts with BKH affiliates. ֳ expects that Black Hills Corp will reduce leverage to below 5.0x on a FFO adjusted-leverage basis by 2021 and the regulatory environment will remain constructive across BKH's eight regulatory jurisdictions.
Key Rating Drivers
Low-Risk Business Profile: BHK benefits from ownership of several low risk, regulated utility businesses. It eliminated its higher-risk oil and gas operations in 2018 and expanded the regulated operations with the Black Hills Gas Holdings, LLC (BHGH; formerly SourceGas Holdings LLC) acquisition in 2016. The contribution of regulated utility operations increased to approximately 86% of consolidated EBITDA for the TTM ended June 30, 2019, from 80% previously. BHK is filing for regulatory approval to simplify its Colorado (CO), Wyoming (WY) and Nebraska gas jurisdictions, and focus on organic growth from the higher growing gas utilities in CO, WY and Arkansas.
Deleveraging Expected: While the BHGH acquisition and acceleration of safety-focused capital projects are pressuring credit metrics, ֳ expects consolidated FFO-adjusted leverage to strengthen to approximately 4.7x-5.0x by 2021, bringing metrics back in line with the current rating category. Deleveraging will be a function organic growth from the integration of BHGH, completion of the elevated capital investment, timely recovery of utility investments under rate rider mechanisms and management's commitment to a capital structure commensurate with current ratings.
Constructive Regulation: BKH's regulated electric and natural gas utility operations span eight states, all of which allow for pass-through of commodity and/or purchased power costs, with several of the states allowing other riders or recovery mechanisms that enhance timely recovery of expenses and invested capital. Transmission investments are regulated by the Federal Energy Regulatory Commission (FERC) or state regulatory commissions, with most investment eligible for rider recovery. ֳ 45% of cash flow is from gas local distribution companies, which are considered lower risk and, in ֳ's opinion, generally receive more favorable regulatory treatment than electric utility peers. BKH's electric utilities comprise about 40% of cash flow.
Utility Focused Capex: Capital investment for 2019-2022 totals about $2.4 billion with over 90% for the regulated utilities, split between gas (58%) and electric (34%) utilities. The peak spending occurs in 2019-2020 for gas system safety and reliability focused projects in the BHGH systems, averaging $400 million, well above the $275 million annual run rate. The capital program reflects management's strategy to focus on utility investments that are recoverable through rate riders and capital trackers. ֳ three quarters of the utility capital receives timely recovery under rate rider mechanisms, mitigating concerns about regulatory lag and regulatory stay-out periods in place following the BHGH acquisition. However, ֳ expects BKH to be FCF negative through 2022.
Coal Generation Exposure: A credit concern is BKH's exposure to coal generation and changing customer preferences, operating about 900MW of generation with the balance provided under power purchase contracts. Approximately one-third of BKH's generation capacity is coal-fired, of modern vintage, with modest future environmental expenditures. Driven by lower renewable energy costs, commercial and industrial customers' clean energy goals, and growth in behind the meter generation, BHK is moving toward renewable generation. BHP is in compliance with the 30% renewable requirements in CO. The $57 million, 40 MW Corriedale Wind Farm to be sold under a renewable energy tariff for commercial customers, meets half of South Dakota's voluntary renewable production standard when it is operational in 2020. However, wind remains less than 10% of BHK's generation.
Modest Impact From Tax Reform: The reduction in the federal income tax rate to 21% from 35% reduced cash flow by $35 million-$45 million, including the amortization of accumulated deferred income tax. ֳ estimates the impact is an increase in FFO leverage by approximately 20bps-30bps in the near term. Credit supportive measures include increased equity issuance up to $180 million in 2019-2020 to maintain a capital structure in line with current ratings.
Parent and Subsidiary Linkage: ֳ considers Black Hills Power, Inc. (BHP; BBB+/Stable) stronger than its parent BKH, due to the low-risk, regulated utility operations and predictable cash flow. However, with the presence of a cross-default provision between BKH and BHP, ֳ has determined a strong linkage exists between BKH and BHP. ֳ has applied a top-down approach in rating BHP. The IDR of BHK reflects the consolidated credit profile.
Derivation Summary
Black Hills Corp.'s ratings are in line with the current rating category, with a similar credit profile, albeit on a smaller scale, to its parent holding company peer Duke Energy (Duke; BBB+/Stable) and to a lesser extent, Xcel Energy (Xcel; BBB+/Stable) and WEC Energy Group (WEC; BBB+/Stable). As operators of regulated gas and electric utilities, each benefits from predictable cashflow and earnings. BKH's operations are largely regulated utilities which account for 86% of EBITDA, slightly lower than Xcel and WEC, which solely operate regulated utilities. The remainder of BKH's cash flow comes from nonregulated businesses operating under long-term contracts with BKH's utilities. Duke generates about 95% of EBITDA from regulated utilities with the balance from contracted U.S. renewable energy projects and a 17.5% stake in a methanol production company in Saudi Arabia. In line with the utility subsidiaries of Xcel, WEC and Duke, BKH has multistate operations and benefits from an overall balanced regulatory environment, regulatory diversification and FERC oversite of its electric transmission assets.
Similar to Duke's acquisition of Piedmont Natural Gas in 2016, BKH's credit metrics remain pressured as a result of its BHGH acquisition. By 2021, ֳ projects BKH's FFO-adjusted leverage to decline to 4.7x-5.0x, higher than Xcel at 4.4x-4.8x through 2020, similar to WEC hovering around the high 4.0x through 2022, and more favorable than Duke at 5.0x-5.2x through 2021.
Key Assumptions
ֳ's Key Assumptions Within Our Rating Case for the Issuer Include:
- Revenue growth averaging about 3% driven from slightly above average customer and organic growth;
- Capital investment of about $2.4 billion from 2019-2022;
- Capital structure in line with regulatory capital requirements;
- Rate moratorium in place for Black Hills Power until end of 2023 with the remaining utilities filing under a regular schedule;
- No additional acquisitions;
- Constructive regulatory environment across all jurisdictions.
RATING SENSITIVITIES
Black Hills Corp:
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action
While an upgrade is not anticipated given BHK's increased leverage from the BHBG acquisition, any developments resulting in FFO-adjusted leverage of 3.5x or better over a sustained period may lead to positive rating action.
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action
- A material deterioration in the regulatory environment;
- Sustained FFO-adjusted leverage greater than 5.0x.
Black Hills Power:
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action
Given the strong parent subsidiary linkage, an upgrade of Black Hills Power would not be expected without an upgrade to Black Hills Corp.
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action
- Unexpected adverse regulatory decisions;
- FFO-adjusted leverage sustained above 5.0x.
Liquidity and Debt Structure
Adequate Liquidity: BKH's liquidity is adequate with $637 million of available liquidity under its $750 million unsecured revolving credit facility as of June 30, 2019, including $10.2 million of unrestricted cash and cash equivalents. BKH's credit facility backstops the CP program, and can be upsized up to $1 billion with the consent of the lenders. The facility matures in July 2023. The credit facility is subject to a maximum debt/capitalization ratio covenant of 65% and as of June 30, 2019, BKH was in compliance with a debt/capitalization ratio of 58%, as defined under the agreement. ֳ expects BKH's long-term debt maturities to be manageable through the forecast period and to be refinanced in a timely fashion.
BKH's $400 million term loan contains covenants that trigger a cross-default if BKH or its subsidiaries fail to make timely payments of debt obligations. The default is triggered if the missed payment exceeds $50 million by BKH or its material subsidiaries, including BHP and Cheyenne Light, Fuel and Power (CLFP). Both BHP and CLFP have outstanding first mortgage bonds. The facility matures July 17, 2021.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of 3 - ESG issues are credit neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity.
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PARTICIPATION STATUS
The rated entity (and/or its agents) or, in the case of structured finance, one or more of the transaction parties participated in the rating process except that the following issuer(s), if any, did not participate in the rating process, or provide additional information, beyond the issuer’s available public disclosure.