-- 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
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.
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
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
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
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
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
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.
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.
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
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,
-- Assessing U.S. Utility Regulatory Environments, Nov. 7, 2007
Temporary contact numbers: Barbara Eiseman 516-639-1471; Michael Ferguson
Ratings Affirmed; CreditWatch/Outlook Action
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
Laclede Gas Co.
Senior Secured A
Recovery Rating 1
Commercial Paper A-1