ֳ

Rating Action Commentary

ֳ Rates DTE Energy Co.'s $600MM Senior Unsecured Debt 'BBB+'; Outlook Negative

Thu 02 Aug, 2018 - 3:28 PM ET

ֳ-New York-02 August 2018: ֳ has assigned a 'BBB+' rating to DTE Energy Company's (DTE; Issuer Default Rating [IDR] BBB+) $600 million issuance of senior unsecured 2018 Series D 3.70% senior notes due 2023. Proceeds from the issuance will be used to repay short-term borrowings and for general corporate purposes. The Rating Outlook is Negative.

DTE's rating and Negative Outlook reflect the strong credit quality of its two regulated utility subsidiaries, DTE Electric Co. (DTEE; A-/Negative) and DTE Gas Company (DTEG; BBB+/Stable), which are supported by a constructive regulatory environment in Michigan. DTE's regulated utilities anchor the company's credit profile and composed 80% of consolidated EBITDAR for 2017. In addition, the ratings and Negative Outlook primarily reflect the construction risk associated with the NEXUS pipeline project and increased leverage and operating risks from the expansion of DTE's midstream operations.

KEY RATING DRIVERS

Relatively Stable Business Mix: ֳ expects DTE's business risk to remain stable as the growth in the utilities, DTEE and DTEG, keeps pace with growth in the Gas, Storage, and Pipeline (GSP) business segment. The utilities comprise about 75%-80% of cash flow, and future growth will come from its expanded capital program, addressing environmental and safety issues. ֳ expects earnings from the Power & Industrial (P&I) sector to decline as reduced emissions fuel (REF) projects mature and are replaced with additional commercial project and growth in the GSP segment.

Continued Growth of the Midstream Operations: The midstream segment is growing, realizing the full-year cash flow from the Link assets in 2017 and, when complete, the NEXUS pipeline. The NEXUS Gas pipeline project is expected to come online in the third quarter of 2018 and has received Federal Energy Regulatory Commission (FERC) and local approvals. DTE and Spectra Energy Partners, LP are joint developers of the 255-mile 1.5bcf/d Nexus gas pipeline. DTE's $1 billion investment in the pipeline was funded at the parent level and potentially refinanced with project debt after commercial operation. While ֳ views the midstream segment as riskier than the regulated utilities, DTE's midstream assets are largely under long-term contracts averaging 10 years. Approximately 50% of its GSP assets are regulated by the FERC and MPSC.

Midstream Investments Pressure Leverage: The acquisition of the Link assets and the construction of the NEXUS pipeline increased DTE's leverage. ֳ estimates consolidated funds from operations (FFO)-adjusted leverage at DTE will weaken to approximately 5.1x in 2018. Leverage will improve as the Nexus pipeline reaches commercial operation in third-quarter 2018 and $675 million of equity units convert to equity in 2019. ֳ expects the FFO leverage to decline to between 4.5x-4.7x by 2020.

Elevated Utility Focused Capex Program: DTE plans to spend around $10 billion on capital investments in 2018-2020, including its approximate $1.25 billion investment with $600 million remaining in the NEXUS pipeline. This program is about 19% higher than the preceding three-year period. The utilities, which comprise 75% of the total program, are investing in distribution and environmental compliance projects and gas and wind generation to transition to cleaner generation as it retires three coal fired plants with 2GW capacity from 2020-2023. Growing utility and natural gas pipeline investments will render DTE FCF negative in the intermediate term. ֳ expects the program will be funded with internal cash flow, debt and equity support from the parent to maintain the utility's balanced capital structure.

Federal Tax Reform: The reduction in federal corporate tax rate under last December's Tax Cuts and Jobs Act of 2017 will reduce rates by $260 million annually, which will be partially offset by the $300 million AMT tax refunds and higher earnings at the non-regulated companies. ֳ estimates the reduced rates increases FFO leverage by around 15-20 basis points. DTE announced credit supportive measures to issue additional equity to support the capital structure and debt reduction plans.

Constructive Regulatory Environment: The Michigan regulatory environment remains constructive, in ֳ's opinion, as evidenced by general rate case (GRC) outcomes in which the MPSC approved an authorized ROE of 10%, modestly above industry averages. The current regulatory framework allows full pass-through of fuel and purchased power costs, forward-looking test years, and timely resolution of rate proceedings. Furthermore, revenue-decoupling mechanism and infrastructure recovery mechanism (IRM) helps DTEG reduce exposure to regulatory lag.

Michigan Rate Cases: Following the April 18, 2018 rate order, DTEE filed a new rate case in July 2018 requesting a 6.7% rate increase with a 10.5% ROE for the forward test year. Additionally, the case requests modified tariffs for pilot programs for time-of-use and electric vehicles. DTEE received a 1.6% rate increase ($74.4 million) in 2018 based on a moderately above average 10% authorized ROE and a 36.84% regulatory capital structure. DTEE filed the rate case with the MPSC in 2017 and requested a $231 million rate increase based on a 10.5% ROE and a 37.6% equity ratio. ֳ considers the order to be balanced and supportive of credit quality. DTEG requested an $85 million rate increase and 10.5% ROE in its GRC filed with the MPSC in November 2017. ֳ expects a final order in September 2018. DTEG's previous rate case, approved in December 2016, had a 10.1% ROE and a 38.7% equity ratio. DTEG's authorized ROE of 10.1% compares favorably with recent industry averages. ֳ's forecast assumes an earned 10% ROE.

Transition to Clean Energy Generation: The utility is retiring coal-fired generation and replacing the generation with wind and natural gas-fired plants. The new generation will meet the requirements under the environmental law enacted in 2016 for a Renewable Portfolio Standard of 15% by 2021 and the company's pledge to reduce CO2 emissions by 45% in 2030 and 80% by 2050. Additionally, under an agreement with a climate action lobbying group, Clean Energy, Healthy Michigan, DTEE agreed to provide 25% generation from renewable sources with another 25% from energy efficiency by 2030. Three coal-fired plants with 2GW capacity are scheduled to be retired in 2020-2023 and will be replaced with a 1,100MWnatural gas-fired plant (costing around $1 billion) and additional wind projects.

Solid Utility Operating Performance: ֳ forecasts strong credit metrics at DTEE consistent with the current 'A-'rating through the forecast period. ֳ estimates FFO interest coverage ratios will remain above 6.0x and debt/EBITDAR will range from 3.6x to 3.8x through 2020. DTEG's current and projected credit measures are supportive of the company's current rating. ֳ forecasts FFO interest coverage ratios to remain above 5.0x and debt/EBITDAR will modestly increase to 4.3x-4.6x due to the company's large capex program. Concerns over the modest increase in leverage are mitigated by the utility's IRM cost recovery mechanism.

Parent/subsidiary linkage: There is strong rating linkage between the IDRs of DTE Energy and its electric utility subsidiary DTEE. DTEE remains the primary driver of earnings and cash flow to support parent-level dividends. ֳ would consider up to a one-notch maximum differential between the Long-Term IDRs of DTEE and DTE.

DERIVATION SUMMARY



The credit profile of DTE is similar to peers Dominion Energy, Inc. (BBB+/Stable), Sempra Energy (BBB+/Stable), and WGL Holdings, Inc.(BBB/Stable), which are parent holding companies anchored by regulated utility operations with significant midstream assets. Additionally, all have significant parent-level debt. The scale of the consolidated operations is similar at DTE, Dominion and Sempra, while WGL is smaller. The proportion of DTE's consolidated EBITDA from regulated utilities at 80% is similar to Sempra (80% pro forma for the Energy Future Holdings acquisition and the Cameron LNG facility completion) and WGL (about 80%) and more favorable than Dominion (60%-65% pro forma for the Cove Point LNG facility completion). For the trailing twelve months ended March 31, 2018, adjusted debt/EBITDAR and FFO-adjusted leverage at DTE were 4.6x and 3.8x, respectively, better than Sempra at 7.4x and 6.6x and Dominion at 6.0x and 5.9x, respectively, and similar to WGL at 5.0x and 3.8x, respectively.


KEY ASSUMPTIONS

ֳ's Key Assumptions Within the Rating Case for the Issuer
--Constructive regulatory environment in Michigan;
--GRC for DTEE at 10% ROE and DTEG at 10% ROE;
--Nexus pipeline enters service in the third quarter of 2018;
--Capex program totalling $10 billion ($2.6 billion non-utility) through 2018-2020;
--Long-term debt maturities of $1.5 billion in 2019 and $683 million in 2020;
--O&M is flat during forecast.

RATING SENSITIVITIES

Developments that May, Individually or Collectively, Lead to Positive Rating Action
While an upgrade is not anticipated given the Negative Rating Outlook, any developments, such as unexpected constructive developments, resulting in FFO-adjusted leverage of 4x or better could lead to future rating upgrades. Additionally, the outlook may be revised when the NEXUS pipeline is complete, eliminating the risk of construction overruns.

Developments that May, Individually or Collectively, Lead to Negative Rating Action
Material delays and cost overruns of the NEXUS pipeline construction, sustained weakening in FFO-adjusted leverage of 5.0x or higher through the forecast period or inability to carry through on the announced equity issuance could lead to a negative rating action.

LIQUIDITY

DTE's liquidity position is sufficient with approximately $1.1 billion of liquidity available under three credit agreements and $63 million of unrestricted cash and cash equivalents as of June 30, 2018. DTE's letter of credit and revolving credit facilities mature from 2019-2022 and include $1.4 billion at DTE, $400 million at DTEE and $300 million at DTE Gas. The facilities have a maximum debt/capitalization covenant of 65% and DTE Energy, DTE Electric and DTEG were in compliance with consolidated debt/capitalization of 54%, 51% and 45%, respectively, as defined under the credit agreement, as of June 30, 2018. Debt maturities over the next four years are manageable and are expected to be refinanced at maturity.

FULL LIST OF RATING ACTIONS

ֳ currently rates the following:
DTE Energy Company
--Long-term IDR 'BBB+'/Negative Outlook;
--Short-term IDR 'F2';
--Senior Unsecured debt 'BBB+';
--Commercial Paper 'F2';
--Junior Subordinated debt 'BBB-'.

Contact:

Primary Analyst
Jodi Hecht
Director
+1-646-582-4969
ֳ, Inc.
33 Whitehall Street
New York, NY 10004

Secondary Analyst
Daniel Neama
Associate Director
+1-212-908-0561

Committee Chairperson
Sharon Bonelli
Senior Director
+1-212-908-0518

Date of Relevant Rating Committee: April 5, 2018.

Media Relations: Elizabeth Fogerty, New York, Tel: +1 212 908 0526, Email: elizabeth.fogerty@fitchratings.com

Additional information is available on
Applicable Criteria
Corporate Hybrids Treatment and Notching Criteria (pub. 27 Mar 2018)
Corporate Rating Criteria (pub. 23 Mar 2018)
Corporates Notching and Recovery Ratings Criteria (pub. 23 Mar 2018)
Parent and Subsidiary Rating Linkage - Effective from 15 February 2018 to 16 July 2018 (pub. 15 Feb 2018)

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