TEXT-Fitch affirms PPL & subsidiaries;revises PPL Supply's outlook to negative

Thu Dec 6, 2012 9:23am EST

Dec 06 - Fitch Ratings has affirmed the Issuer Default Ratings (IDR) and individual security ratings of PPL Corp. (PPL) and each of its domestic subsidiaries. Fitch also revised PPL Energy Supply's (PPL Supply) Outlook to Negative from Stable. Simultaneously, Fitch affirmed the Stable Outlook for all other domestic subsidiaries. A full list of rating actions appears at the end of this release.

PPL:

PPL's ratings and Outlook reflect its transformation from a company heavily reliant on commodity sensitive businesses to one that is highly regulated with substantially less business risk. Driven by the acquisitions of Central Networks in April 2011 and LG&E and KU Energy, LLC (LKE) in November 2010, regulated operations are expected by Fitch to provide over 75% of consolidated EBITDA by 2013. By comparison regulated operations accounted for approximately 30% of EBITDA prior to the two acquisitions. The proposed ratings also reflect credit metrics that are generally consistent with the rating and lower risk profile.

Rising capital expenditures in PPL's regulated segment pose a potential credit risk. PPL is investing heavily in its regulated businesses and expects to grow the regulated rate base by approximately 7.6% annually over the next five years. The investments will require on-going rate increases in both Kentucky and Pennsylvania and equity support from PPL. Expenditures in Kentucky are primarily to install environmental upgrades to comply with new Environmental Protection Agency (EPA) standards. In Pennsylvania the new investments are largely to replace aging infrastructure and for transmission upgrades. The risk associated with the magnitude of the capital expenditure program is mitigated by regulatory provisions that provide near real time cost recovery of invested capital for about two-thirds of projected expenditures, including FERC jurisdictional transmission in Pennsylvania, environmental compliance in Kentucky and all capital investments in the UK.

In PPL's merchant power generation segment, a weak power price environment is the primary challenge in the next two to three years. Additionally, several unplanned plant outages due to hardware failure adds more downward pressure and raise concern with regard to the chronic nature of these incidents. However, Fitch believes that the weak performance in this business segment is manageable for PPL as the segment becomes less critical to PPL's consolidated financial strength going forward.

Historically, PPL positions well within the rating category. Over the last three years, on average, it produced funds from operations (FFO)/debt of 19.8% and FFO interest coverage of 4.6x. Going forward, Fitch expects these metrics to decline while remaining in line with its rating, with average FFO/debt in mid-teens and FFO interest coverage of 4x. Fitch's projection has taken into consideration the mandatorily convertible debt issued in 2010 and 2011 of approximately $1.2 billion and $1 billion which currently receive 100% equity credit.

PPL and its subsidiaries have ample liquidity and manageable debt maturities. Internal cash flow is supplemented by committed bank lines at each of its domestic operating subsidiaries aggregating $4.698 billion. PPL's UK subsidiaries maintain separate bank credit facilities of GBP1.079 billion. Available cash and equivalents at Sept. 30, 2012, were $942. There are $750 million and $300 million senior notes due in 2013 and 2014 at PPL Supply and $10 million in 2014 at PPL Electric Utilities (PPLEU). Fitch believes that with internal cash flow and available credit facilities, PPL will have sufficient liquidity to cover all required cash needs in the next 12 to 18 months.

PPL Energy Supply, LLC (PPL Supply)

PPL Supply's Negative Outlook reflects the expected decline in credit ratios over the next two to three years due to lower hedge prices and gross margin, despite anticipated deleveraging and modest capital requirements. The Outlook also reflects Fitch's concerns over plant performance and required compliance costs at PPL Supply's nuclear generating plant Susquehana. The plant has experienced series of outages due to hardware failure in the past two years and is expected to receive more permanent solution starting 2013. Given the importance of Susquehana to PPL Supply as a generation source (it represents 33% of power output in 2011), its performance is crucial to credit quality especially during the market downturn. Albeit to a lesser degree, the Negative Outlook also considers the uncertainty associated with safety related compliance cost. The weak positioning of PPL Supply in its rating category makes it vulnerable to any substantial compliance requirements.

Fitch believes that over the long term, PPL Supply is well positioned to benefit from any power price rise associated with environmental compliance costs. The company has invested heavily in pollution control equipment and its generating fleet is well positioned on the dispatch curve. Earnings and cash flow also benefit from operation of the PJM capacity market and the hedging policy that limits earnings volatility.

PPL Supply's liquidity position is strong. The combination of relatively short duration hedges (no more than three years) and low commodity prices have limited collateral postings and use of credit facilities. As of Sept. 30, 2012, it has committed credit facility of $3.2 billion ($3 billion of which expires in November 2017 and $200 expires in March 2013), of which $594 million was utilized. Additionally, it maintains an $800 million hedging facility. Fitch believes these credit facilities should be sufficient to cover all cash needs including debt maturities, capital spending, upstream dividend and reasonable amount of collateral posting requirements.

PPL Electric Utilities Corp (PPLEU)

PPL Electric Utilities (PPLEU)'s ratings are supported by leverage, interest coverage and cash flow measures that are well positioned within the 'BBB' rating category and comparable to its peer group of electric distribution utilities with similar risk characteristics. Over the last three years, on average, PPLEU produced FFO to debt of 23%. For LTM Sept. 30, 2012, FFO to debt was 21%. Going forward, we expect the metric to decline to high teens in the next three years, as it invests in a large capital spending program.

The ratings also benefit from the absence of commodity price exposure and incorporate our expectations that PPLEU will receive a reasonably constructive decision on its latest distribution rate filling. On March 20, 2012, PPLEU requested that the PAPUC approve a distribution base rate increase of $104.6 million or approximately 2.9% and an 11.25% ROE. Commission decisions are expected in the near future. 1% change in ROE will result in reduction in revenue of approximately $23 million. PPLEU's last rate case authorized a $77.5 million (1.6%) rate increase, equal to about two-thirds of its $115 million rate request. The allowed return on equity (ROE) was 10.7%, which is marginally above the industry average.

Capital expenditures are expected to rise substantially over the next five years (2012-2016). The higher capital expenditures are primarily to replace an aging infrastructure and to enhance the transmission network. Favorably, approximately 55% of the expenditures are subject to the Federal Energy Regulatory Commission's (FERC) formula rate regulation, which provides timely recovery of invested capital and operating costs including a return on equity.

Kentucky Utilities Co. (KU) and Louisville Gas & Electric Co. (LG&E)

The ratings of the two Kentucky utility subsidiaries, Kentucky Utilities Company (KU) and Louisville Gas and Electric Company (LG&E) reflect strong credit metrics and constructive regulatory policies that limit cash flow volatility and business risk. The ratings also benefit from the Kentucky Public Service Commission's (KPSC) track record for timely rate increases. Constructive regulatory policies include a monthly fuel adjustment clause (FAC) and an environmental cost recovery mechanism. Regulatory statutes also permit the inclusion of construction work in progress (CWIP) in rate base.

The ECR mechanism is particularly important given the two utilities' reliance on coal-fired electric generation and the substantial investment that will be required to meet the Environmental Protection Agency's (EPA) newest regulations. The ECR provides for recovery of and a return on environment investments required as a result of coal combustion emissions. The ECR permits the approved environmental costs to be reflected in rates two months after incurred. In June 2011, KU and LG&E filed an ECR plan requesting recovery of the expected $2.5 billion of environmental compliance costs as well as operating expenses as incurred. In December 2011, $2.3 billion of the plan was approved.

Additionally, the utilities' results could also benefit from the recent rate case settlement. If approved, it will allow for LG&E's electric rates to increase by $33.7 million and gas rates to increase by $15 million and allow for KU's electric rates to increase by $51 million with a 10.25% ROE.

Finally, the ratings of LG&E and KU Energy LLC's (LKE), an intermediate holding company and parent of KU and LG&E reflect the predictable cash flow and strong credit profile of its two regulated utility subsidiaries as well as the debt level at the holding company.

What Could Trigger a Rating Action:

PPL

Positive:

--Unlikely given the large capital spending program.

Negative:

--PPL's ratings could be downgraded if capital resources are allocated disproportionally in the relatively weak unregulated business, resulting in increasing leverage and FFO to debt below 16% and Debt to EBITDA above 4x beyond the heavy utility spending period;

--Any material adverse development in the regulatory framework in the states or in U.K. that PPL's regulated utilities operate in, such as change in commodity cost recovery provisions in Pennsylvania.

PPLEU

Positive:

--Unlikely given the large capital spending program.

Negative:

--A materially unfavorable distribution rate case decision;

--Any material adverse development in the regulatory framework in Pennsylvania such as change in commodity cost recovery provisions or return of rate freeze (though unlike in currently low power price environment) could pressure the ratings.

KU and LG&E

Positive:

--Unlikely given the large capital spending program.

Negative:

--Any material adverse development in the regulatory framework in Kentucky.

PPL Supply

Positive:

--An upgrade in the next two to three years is unlikely given the Negative Outlook.

--The Negative Outlook can be stabilized if its FFO to debt ratio reaches approximately 25% and Debt to EBITDA at low 3x, if the magnitude of the permanent repair at Susquehana is manageable and plant performance stabilizes.

Negative:

--If the permanent repair period becomes prolonged and costly at Susquehana;

--Fukushima compliance cost remains uncertain and could affect the ratings negatively.

Fitch affirms the following ratings with a Stable Outlook:

PPL Corp

--Long-term IDR at 'BBB';

--Short-term IDR at 'F2'.

PPL Capital Funding Inc.

--Long-term IDR at 'BBB';

--Senior unsecured debt at 'BBB';

--Junior subordinated notes at 'BB+';

--Short-term IDR at 'F2'.

PPL Electric Utilities Corp.

--Long-term IDR at 'BBB';

--Secured debt at 'A-';--Short-term IDR at 'F2';

--Commercial paper at 'F2'.

LG&E and KU Energy LLC

--Long-term IDR at 'BBB+';

--Senior unsecured debt at 'BBB+';

--Short-term IDR at 'F2'.

Kentucky Utilities Company

--Long-term IDR at 'A-';

--Secured debt at 'A+';

--Secured pollution control bonds at 'A+/F2';

--Senior unsecured debt at 'A';

--Short-term IDR at 'F2';

--Commercial paper at 'F2'.

Louisville Gas and Electric Company

--Long-term IDR at 'A-';

--Secured debt 'A+';

--Secured pollution control bonds at 'A+/F2';

--Senior unsecured debt at 'A';

--Short-term IDR at 'F2';

--Commercial paper at 'F2'.

Fitch affirms the following ratings and revises the Outlook to Negative from Stable:

PPL Energy Supply, LLC

--Long-term IDR at 'BBB';

--Senior unsecured debt at 'BBB';

--Short-term IDR at 'F2';

--Commercial paper at 'F2'.

Fitch withdraws the following rating due to redemption:

PL Electric Utilities

--Preferred stock at 'BBB-'.