December 17, 2012 / 8:55 PM / 5 years ago

TEXT - S&P revises Laclede Group outlook to negative

Overview
     -- Utility holding company Laclede Group Inc. (LG) plans to acquire 
Missouri Gas Energy and New England Gas Co. for $1.035 billion.
     -- We are revising the rating outlook on LG and its subsidiary Laclede 
Gas Co. to negative from stable. We are affirming the 'A' corporate credit 
ratings on both LG and Laclede Gas and the 'A' senior secured debt rating, 
'A-1' commercial paper rating and '1' recovery rating on Laclede Gas.
     -- We would expect the combined companies to have an "excellent" business 
risk profile, with the bulk of EBITDA derived from relatively low risk 
regulated natural gas distribution operations.
     -- The negative outlook can be traced to our expectation that there is at 
least a one-in-three probability that the LG's consolidated financial risk 
profile post transaction may erode to a point that would no longer support 
current ratings.

Rating Action
On Dec. 17, 2012, Standard & Poor's Ratings Services revised the rating 
outlook on St. Louis-based LG and subsidiary Laclede Gas to negative from 
stable. We affirmed the 'A' corporate credit ratings on both LG and Laclede 
Gas and the 'A' senior secured debt rating, 'A-1' commercial paper rating and 
'1' recovery rating on Laclede Gas. Approximately $405 million of total debt 
was outstanding on Sept. 20, 2012.

The negative outlook reflects the potential impact on LG's financial profile 
in light of the company's announcement to acquire Missouri Gas Energy and New 
England Gas for $1.035 billion. Although LG plans to use a mix of debt and 
equity to fund the transaction, the company's current financial position has 
little cushion at the current rating. A downgrade would be warranted if the 
consolidated adjusted FFO to total debt ratio were to fall to less than 20% 
and total debt to total capital rose to more than 50% on a sustained basis.

The parties aim to complete the transaction by the end of the third quarter of 
2013, with approvals required from the Missouri Public Service Commission, the 
Massachusetts Department of Public Utilities, and Hart-Scott-Rodino. 
Shareholder approval is not needed.

Rationale
Standard & Poor's Ratings Services' ratings on Laclede Group Inc. (LG) are 
currently based on the consolidated business and financial risk profiles of 
the company and its subsidiaries. Laclede Gas Co., a regulated natural gas 
distributor contributed about 85% to consolidated EBITDA in fiscal year 2012. 
Laclede Energy Resources (LER), an unregulated gas marketer and the primary 
unregulated subsidiary of LG, and other smaller units accounted for the 
remainder.

LG's ratings reflect an excellent business risk profile and an "intermediate" 
financial risk profile. The company's business risk profile benefits from a 
diverse and stable service area, with a largely residential and commercial 
customer base that limits the utility's susceptibility to economic 
cyclicality, diverse gas supply sources, and ample natural gas storage 
capacity. Generally, we view Missouri's regulatory climate as "less credit 
supportive". However, with regard to Laclede Gas, it is more responsive to the 
company's needs, as demonstrated by approval of settlement agreements and 
timely cost recovery mechanisms such as a purchased gas adjustment clause, an 
infrastructure system replacement surcharge (ISRS), a pension cost tracker, 
largely decoupled rate design, and weather-mitigation rate design. Laclede Gas 
is also permitted to retain a portion of profits generated by off-system 
sales. These characteristics are tempered by investment in the riskier and 
more volatile unregulated businesses, acquisitive strategy, and lackluster 
customer growth.

Although LG has invested in riskier unregulated operations, management has 
done a good job in implementing risk management strategies and controlling 
expenses. The company also effectively manages regulatory risk and continually 
provides high-quality service, in our view. Furthermore, it has demonstrated 
access to the debt and equity markets. Debt leverage has decreased in recent 
years, and the company has a relatively clean balance sheet. Its growth 
strategy includes developing and investing in emerging technologies, investing 
in infrastructure, acquiring business that fit into its operating model, and 
leveraging its current competencies. With regard to the pending acquisition of 
Missouri Gas Energy and New England Gas, a balanced funding approach would be 
required to preserve creditworthiness. Generally, we believe that management 
has demonstrated sufficient depth, specificity, and transparency in its 
financial goals and view its management and strategy assessment as 
satisfactory.

Laclede Gas' last base rate case became effective in September 2010, when the 
Missouri Public Service Commission approved a settlement agreement calling for 
a $31.4 million (4.1%) rate increase. However, the net customer impact was 
$20.5 million, after the transfer to rate base of $10.9 million of 
ISRS-related revenues. In October 2012, the company filed with the Missouri 
Public Service Commission a 60-day notice for a general rate case. Therefore, 
a new rate application is likely to be filed shortly, for new rates to become 
effective in 2013. Given increasing costs and infrastructure investments, the 
company's ability to continue to effectively manage regulatory risk will be 
critical to credit quality.

LG's unregulated businesses are riskier than the regulated operations due to 
greater variability in cash flow generation. We view the unregulated 
operations as unfavorable for credit because of this potential volatility. LER 
provides gas-marketing services to large industrial and wholesale clients. 
LER's financial performance can vary dramatically with changes in commodity 
prices and price volatility, effectiveness of the company's hedging program, 
and competition. The unregulated operations accounted for approximately 20% of 
consolidated earnings in fiscal 2012. Notably, consummation of the pending 
acquisition would result in more than 90% of regulated EBITDA. However, the 
company is also focused on expanding its unregulated operations. A higher 
proportion of unregulated activities would weaken the company's business risk 
profile.

Our financial risk analysis focuses on the consolidated entity, but we expect 
a base level of cash flows to come from the regulated entity. LG's credit 
measures have shown improvement in recent years, with funds from operations 
(FFO) interest coverage of more than 5x, FFO to total debt of greater than 
25%, and adjusted total debt-to-capital of roughly 47%, with our adjustments. 
However, with bonus depreciation diminishing, heavy capital spending, and 
rising costs, we expect key financial measures to decrease somewhat over the 
next few years. In that regard, our current stand-alone LG consolidated 
baseline forecast indicates FFO to total debt falling to the low 20% level and 
debt to capital hovering at about 50% or slightly less. Nevertheless, we 
believe LG's financial measures will remain at levels suitable for current 
ratings--even when capital spending peaks in 2013--because of potential 
additional rate relief, continuation of various rate mechanisms that support 
stable earnings, and credit-supportive actions by management, including the 
maintenance of a balanced capital structure. However, consummation of the 
planned acquisition may result in weaker measures of bondholder protection. 
Depending upon the amount of incremental debt used to fund the transaction, 
the financial risk profile may fall into the significant financial risk 
category.

Liquidity
We view LG's liquidity as "strong" under our corporate liquidity methodology, 
which categorizes liquidity in five standard descriptors (exceptional, strong, 
adequate, less than adequate, and weak). (For more on liquidity, see 
"Liquidity Descriptors For Global Corporate Issuers," published Sept. 28, 
2011.) LG's projected sources of liquidity, mainly operating cash flow and 
available bank lines, exceed its projected uses, mainly necessary capital  
spending, debt maturities, and dividends, by 1.5x or greater for the next 12 
months. Even when measured over the next 24 months, the measure remains more 
than 1x. LG'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 
description of liquidity as strong.

LG has a manageable debt maturity ladder. On Oct. 15, 2012, Laclede Gas paid 
at maturity $25 million of 6.5% first mortgage bonds. The company's next 
maturity of $50 million does not come due until 2019. Over the next 12 months, 
we expect LG to generate FFO of about $115 million. In addition, the company 
has nearly all of the $350 million on its revolving credit facilities 
available for future borrowings. Projected cash uses consist of growth and 
capital spending, which we expect will be about $115 million in fiscal 2013, 
dividends of roughly $37 million, and working capital requirements primarily 
for gas purchases.

The company's debt agreements require a debt-to-capital ratio (as defined) of 
less than 70% for LG and Laclede Gas. As of Sept. 30, 2012, both companies 
were comfortably in compliance, with significant headroom under all its 
covenants. LG's debt-to-total-capital ratio was 37%, and Laclede Gas's was 
47%. We expect the companies to continue to comply with these covenants over 
the forecast horizon.

Recovery analysis
We rate Laclede Gas's first mortgage bonds (FMB) 'A', the same as the 
corporate credit rating (CCR), based on a recovery rating of '1' under our 
recovery methodology for regulated utilities. We assign recovery ratings to 
FMBs issued by U.S. utilities, and this can result in issue ratings being 
notched above the CCR on a utility, depending on the CCR category and the 
extent of the collateral coverage. We base the investment-grade FMB recovery 
methodology on the ample historical record of nearly 100% recovery for 
secured-bond holders in utility bankruptcies and our view that the factors 
that supported those recoveries (the small size of the creditor class, and the 
durable value of utility rate-based assets during and after a reorganization, 
given the essential service provided and the high replacement cost) will 
persist. Under our notching criteria, when assigning issue ratings to utility 
FMBs, we consider the limitations of FMB issuance under the utility's 
indenture relative to the value of the collateral pledged to bondholders and 
management's stated intentions on future FMB issuance, as well as the 
regulatory limitations on bond issuance. FMB ratings can exceed a CCR on a 
utility by up to one notch in the 'A' category, two notches in the 'BBB' 
category, and three notches in speculative-grade categories. However, we do 
not notch FMB ratings for companies with CCRs in the 'AA' category.

Laclede Gas' FMBs benefit from a first-priority lien on substantially all of 
the utility's real property owned or subsequently acquired. Collateral 
coverage of more about 1.43x supports a recovery rating of '1' and an issue 
rating of 'A', which is on par with the CCR.

Outlook
The negative outlook reflects the potential impact to LG's financial profile 
in light of the company's planned announcement to acquire Missouri Gas Energy 
and New England Gas for $1.035 billion. Although LG plans to use a mix of debt 
and equity to fund the transaction, the company's current financial position 
has little cushion at the current rating. A downgrade would be warranted if 
the consolidated adjusted FFO to total debt ratio were to fall to less than 
20% and total debt to total capital were to rise to more than 50% on a 
sustained basis.
Related Criteria And Research
     -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
     -- Use Of CreditWatch And Outlooks, Sept. 14, 2009
     -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
     -- 2008 Corporate Ratings Criteria: Ratios And Adjustments, April 15, 
2008 
     -- Assessing U.S. Utility Regulatory Environments, Nov. 7, 2007 

Temporary contact numbers: Barbara Eiseman 516-639-1471; Michael Ferguson 
917-562-9254

Ratings List
Ratings Affirmed; CreditWatch/Outlook Action
                                        To                 From
The Laclede Group Inc.
 Corporate Credit Rating                A/Negative/--      A/Stable/--

Laclede Gas Co.
 Corporate Credit Rating                A/Negative/A-1     A/Stable/A-1

Ratings Affirmed

Laclede Gas Co.
 Senior Secured                         A
  Recovery Rating                       1
 Commercial Paper                       A-1

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