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July 3 (The following statement was released by the rating agency)
Fitch Ratings has affirmed the long-term Issuer
Default Rating (IDR) of Mountaineer Gas Company (MGC) at 'BB+' and senior
unsecured debt rating at 'BBB-'. The Rating Outlook is Stable. Approximately
$90 million of long-term debt is affected by this rating action.
The affirmation reflects the lower risk nature of MGC's regulated utility
business offset by normal seasonal as well as weather related gas delivery
volume volatility that adds a sizable and somewhat unpredictable measure to
MGC's financial results. Driven by a relatively cold 2013/2014 winter heating
season, MGC reported strong earnings in its key first quarter ended March 31,
2014 which typically represents 70% or more of total annual earnings.
Consequently, MGC's financial results and credit metrics in 2014 will be strong
against historical performance periods although 2015 and 2016 will weaken
(assuming a relatively average winter heating season) as MGC prepares to file
its 2015 General Rate Case (GRC).
KEY RATING DRIVERS
--Substantially Improved Financial Profile;
--Elevated Capex Spending;
--2015 GRC Outcome;
Strong First Quarter 2014 Earnings
MGC reported substantially higher earnings in the first quarter of 2014 as
colder than average weather conditions drove higher volumes of natural gas
sales. EBITDA, driven principally by higher natural gas sales, grew 14% to
approximately $27 million from the prior year period.
For the latest 12 months (LTM) period ended March 31, 2014, EBITDAR-to-interest
widened to 4.6x as compared with 4.1x at year-end Dec. 31, 2013, reflecting the
higher earnings in 1Q14 modestly offset by slightly higher interest expense
related to larger bank line borrowings. MGC will likely experience margin
pressure in 2015 ahead of its GRC filing as operating expenses increase.
Routine expense items including pensions and property taxes are not on riders.
Also, MGC's margins are largely volume based subjecting it to weather as well as
customer conservation and efficiency volume losses.
Assuming normal weather conditions, Fitch expects coverage measures such as
EBITDAR-to-interest to be pressured in 2015 and 2016 falling to approximately
3.6x over that time period in part reflecting higher interest expense for
working capital needs.
Funds from operations (FFO) fixed charge coverage at 4.3x in 2013 is expected to
remain strong into 2014. Fitch models produce FFO fixed charge coverage at 4.1x
in 2014 and then weakening in 2015 and 2016 to approximately 3.0x.
Elevated Capital Investments
MGC's capex spending increased substantially 2013 with further growth expected.
From 2010 to 2012, capex averaged $13 million per annum. In 2013, capex
spending jumped to $17 million and MGC expects capex spending to average $20
million per year from 2014 to 2016. MGC, similar to the rest of the natural gas
distribution industry is incurring higher spending for pipe integrity and safety
inspections as well as replacement of older bare steel pipe. MGC does not have
riders that allow for contemporaneous recovery of such investments which are
recovered through GRCs.
2015 General Rate Case
Fitch expects MGC to file a new GRC in 2015 with 2014 as its historical test
year. Fitch expects MGC to seek recovery riders for pipe replacement that is
more typical of the gas industry. MGC had a constructive outcome of the last
GRC. The Public Service Commission of West Virginia (PSCWV) approved a $6.265
million rate increase effective Nov. 1, 2012 representing approximately 60% of
MGC's revised revenue request. The new rates were based on an authorized return
on equity of 9.9%. The revenue increase is collected through higher monthly
customer charges providing modestly greater stability to earnings and cash flows
which are modestly less dependent on sales volumes and seasonal consumption
patterns. In April 2013, the PSCWV authorized an additional $522 thousand
annual revenue increase.
MGC's assumed responsibility for its seasonal gas supply needs following the
expiration of the Asset Management Agreement with Sequent (a subsidiary of AGL
Resources) in 2013. The arrangement with Sequent relieved MGC of most of its
working capital requirements related to gas inventory and supply. Despite a
cold winter with requiring higher gas volumes as well as higher gas prices, MGC
managed its greater liquidity needs through its committed $70 million bank
facility. Draws against the bank facility peaked at around $40 million and $5
million was outstanding at March 31, 2014.
The bank facility matures in 2014 and MGC is currently seeking a new and larger
facility which Fitch expects to be obtained on similar or better terms. MGC's
next long-term debt maturity is in 2017.
MGC is jointly owned by managing partner IGS Utilities, LLC and by private
equity investors DB Nexus American Investments UK Limited and ICON
Infrastructure Partners LP. Fitch considers the ownership structure as
limiting financial flexibility in the form of capital access especially in a
period of rapidly rising capex. Financial management policies can be
aggressive. MGC has paid dividends representing almost 100% of net income in
recent years and MGC's operating cash flows will likely be insufficient to
sustain the higher capex spending forecasted without external financing and/or
--A Positive rating action is not likely over the next two years ahead of the
outcome of the 2015 GRC. Fitch would view recovery riders for pipe replacement
and weather normalization clauses or other riders that permit timely expense
recovery and add stability to earnings and cash flows favorably.
Future developments that may, individually or collectively, lead to negative
rating action include:
--An inability to earn an adequate and timely return on invested capital.
--Deterioration in operating performance from unfavorable regulatory outcomes or
inability to recover in a timely manner higher operating or capital
--Increase in leverage or distributions to owners.
--Failure to maintain on a sustained basis an FFO fixed charge coverage ratio of