Overview -- Rapid City-based multiple-utility energy company Black Hills Corp. (BKH) has continued to strengthen its business risk profile with the recent sale of 85% of its Bakken and Three Forks shale assets for $243 million. The company intends to use the proceeds to redeem $225 million 6.5% senior unsecured notes due May 15, 2013, which will help to improve the financial risk profile. -- We have affirmed our ratings on BKH and its subsidiary Black Hills Power Inc. (BHP), including the 'BBB-' corporate credit rating and the 'BBB-' senior unsecured rating at BKH and the 'BBB+' senior secured issue rating at BHP, which is based on a '1+' recovery rating. -- We have revised the rating outlook to positive from stable. -- The positive outlook reflects the potential for a one-notch upgrade over the next 12 to 18 months based on the strengthening of the business risk profile and the expected improvement in the company's financial condition. Rating Action On Oct. 16, 2012, Standard & Poor's Ratings Services affirmed its ratings on multiple-utility energy company Black Hills Corp. and its subsidiary Black Hills Power Inc., including the 'BBB-' corporate credit rating and the 'BBB-' senior unsecured rating at BKH and the 'BBB+' senior secured issue rating at BHP, which is based on a '1+' recovery rating. We have revised the outlook to positive from stable. Rationale The outlook revision reflects our expectation that there is at least a one-in-three probability that the company will continue to achieve modest improvements in its financial metrics that would support a one-notch upgrade over the next 12 to 18 months. Higher ratings are possible if the company follows through on its intention to reduce debt with the proceeds of the shale assets and continues to strengthen its financial condition. Standard & Poor's bases its rating on Black Hills Corp. on the company's consolidated credit profile. This includes a business risk profile we consider "excellent" and a financial risk profile we consider "aggressive" under our criteria. Black Hills is a multiple-utility energy company that includes electric utility Black Hills Power Inc. (BHP; BBB-/Positive/--), electric and natural gas utility Cheyenne Light, Fuel, & Power Co. (not rated), other regulated utilities that are owned by Black Hills Utility Holdings Inc. (not rated) and operate as Black Hills Energy, and various unregulated businesses. Black Hills has geographic and economic diversity, with utilities operating from Midwestern states to the Rocky Mountains. We project that the company will effectively manage its operations and construction program. Our rating on Black Hills reflects a mostly regulated utility strategy that includes ongoing capital spending and dependence on continuous and timely cost recovery. We project that this should lead to robust cash flow measures and manageable debt leverage. We expect its unregulated operations in oil and gas exploration to be managed prudently and not increased in size beyond existing levels. The excellent business profile incorporates Black Hills' strategy to be an energy company mostly composed of regulated utilities that have more than 200,000 electric customers in Colorado, Montana, South Dakota, and Wyoming and more than 500,000 natural gas customers in Colorado, Iowa, Kansas, Nebraska, and Wyoming. Diversity of markets and regulation strengthen credit quality, but the widely dispersed operations and numerous regulatory jurisdictions require diligently filing for rate recovery. In addition, Black Hills' business profile reflects various risky unregulated energy ventures that comprise approximately 30% of consolidated operating income and include oil and gas exploration and production, unregulated power generation, and coal mining. Although these businesses are unregulated, the power generation, such as in Colorado, and coal mining operations are mostly contracted with affiliate utilities or power plants, so we view them as having lower risk. Black Hills sold its energy marketing business, Enserco Energy Inc., earlier this year. The completed sale of this higher risk business helped to improve the company's business risk profile. The company received net proceeds of about $160 million to $170 million. The company used the proceeds pay down short-term debt. The consolidated financial profile, which we consider aggressive, reflects adjusted financial measures that are in line with the rating. We expect that financial measures will strengthen over 2012 as the company incorporates cost recovery of the completed construction projects in Colorado in operating cash flow. For the 12 months ended June 30, 2012, funds from operations (FFO) relative to total debt was 14%, total debt to total capital was 59%, and debt to EBITDA was 4.6x. In addition, net cash flow (FFO after dividends) to capital spending was 51%. As capital spending decreases and expected cost recovery is put in place, cash flow should increase and permit Black Hills to internally fund almost all of its capital requirements. FFO interest coverage was 3x. Our expectation is that financial measures will strengthen as growth in capital spending recedes and capital investments are reflected in revenues. Our baseline forecast includes FFO to total debt of 16%, total debt to total capital of 59%, and adjusted debt to EBITDA of about 4.7x over the intermediate term, all in line with an aggressive financial profile. The consolidated adjustments for Black Hills reflect purchased-power obligations, operating leases, and pension-related items. Liquidity Liquidity is "adequate" under Standard & Poor's liquidity methodology, which categorizes liquidity in five standard descriptors. Adequate liquidity supports our 'BBB-' issuer credit rating on Black Hills. The company's projected sources of liquidity, mostly operating cash flow and available bank lines, exceed its projected uses, mainly necessary capital expenditures and debt maturities, by more than 1.2x. Black Hill's ability to absorb high-impact, low-probability events with limited need for refinancing, its flexibility to lower capital spending or sell assets, its sound bank relationships, its solid standing in credit markets, and its generally prudent risk management further support our assessment of its liquidity as adequate. We base our liquidity assessment on the following factors and assumptions: -- We expect Black Hills' liquidity sources, including cash, FFO, and parent credit facility availability over the next 12 months, to exceed uses by about 1.2x. Uses include necessary capital spending, working capital, debt maturities, and shareholder distributions. -- Debt maturities are manageable over the next 12 months. -- We believe liquidity sources would exceed uses even if EBITDA were to decrease by 15%. -- In our assessment, Black Hills has good relationships with its banks and has a good standing in the credit markets, having successfully issued debt during the recent credit crisis. In our analysis of liquidity over the next 12 months for Black Hills, we assume $615 million of liquidity sources consisting of FFO and credit facility availability. We estimate liquidity uses of $450 million for capital spending, maturing debt, working capital, and shareholder distributions. Black Hills' credit agreement includes financial covenants requiring a recourse leverage ratio no greater than 65%. As of June 30, 2012, the company was in compliance with the covenants. Debt maturities are minimal through 2012. However, 2013 and 2014 maturities are $229 million and $262 million, respectively. We expect the company to redeem the 2013 maturity with the proceeds from the shale assets. Outlook The positive outlook on Black Hills reflects our view that we could raise the ratings one notch within the next 12 to 18 months with sustained financial performance above our base case forecast level of adjusted FFO to total debt of 16% and lower than our adjusted debt to total capital of 59%. Fundamental to our forecast are expectations of the redemption of debt and continued improvement in financial measures based on the reduction of capital spending and the reflection of capital investments in revenues. Our baseline forecast includes FFO to total debt of more than 15%, debt to EBITDA of about 4.7x, and debt to total capital of 60%. We could revise the outlook back to stable if financial performance stalls or deteriorates, such that FFO to total debt falls below 14% and debt to capital rises above 63% on a sustained basis. Related Criteria And Research -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- Analytical Methodology, April 15, 2008 -- Ratios And Adjustments, April 15, 2008 Ratings List Ratings Affirmed; Outlook Action To From Black Hills Corp. Black Hills Power Inc. Corporate Credit Rating BBB-/Positive/-- BBB-/Stable/-- Ratings Affirmed Black Hills Corp. Senior Unsecured BBB- Black Hills Power Inc. Senior Secured BBB+ Recovery Rating 1+ Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. 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