The new AGL (which merged with Nicor Inc. in December 2011) is the largest stand-alone gas utility that we rate, with about 4.4 million customers. Its customer base is concentrated in Illinois (about one-half of AGL customers) and Georgia (34%), with smaller numbers in New Jersey, Virginia, Florida, Maryland, and Tennessee. We generally regard Illinois to be a challenging regulatory environment for utilities to manage. However, subsidiary Nicor Gas Co. has historically achieved satisfactory regulatory outcomes due in large part to its competitive rates to customers and good operating efficiency. The utility earns adequate returns and has credit-favorable weather-normalization and cost-recovery mechanisms. We view regulatory risk in Georgia more favorably, where a straight-fixed-variable-rate design structure minimizes revenue risk due to weather and customer usage. Georgia is one of a few states where natural gas supply is deregulated. As such, Atlanta Gas Light is only responsible for distributing natural gas, which lowers the utility’s working capital requirements because independent marketers--including AGL’s Southstar joint venture--buy and sell the natural gas to customers.
The company’s unregulated businesses will contribute about 25% of overall EBITDA and exhibit higher cash-flow volatility. The businesses mainly consist of retail marketing via the Southstar joint venture, marine shipping via the Tropical Shipping subsidiary, wholesale trading and marketing of natural gas via the Sequent subsidiary, and merchant natural gas storage. In general, unregulated operations are currently performing at or near trough levels due to low natural gas price volatility and general macroeconomic weakness. We expect this trend to continue through 2012.
Of the unregulated businesses, retail marketing is the steadiest cash flow generator. Despite low barriers to entry and thin profit margins, Southstar consistently generates EBIT in the $90 million to $100 million area, serving about one-third of the Atlanta Gas Light service territory. Tropical Shipping’s financial performance is highly sensitive to economic conditions and, in our view, is vulnerable given the current market. The subsidiary tends to underperform when tourism declines in its Caribbean operating area. Sequent’s trading profits depend on natural gas price volatility, geographic basis differentials, and the shape of the natural gas futures curve. In recent years, the segment’s EBIT has ranged from a high of $90 million in 2006 to $5 million in 2011. We expect poor performance through at least 2012, given currently stable and low prices. Aside from cash flow variability, Sequent’s operations require robust risk controls to monitor the effectiveness of its hedging strategies and liquidity risks. Sequent enters into numerous financial derivative contracts that offset physical positions. AGL also operates two high-deliverabilty natural gas storage caverns (Jefferson Island and Golden Triangle). Due to low natural gas price volatility and a glut of storage capacity, storage rates have fallen dramatically over the past two to three years, and we expect them to remain low.
In our financial projections, we assume that the regulated utility EBIT grows modestly from current levels and that the company achieves merger-related cost synergies by eliminating duplicate corporate overhead. In the unregulated businesses, we assume further softening at Sequent and Tropical. Under these assumptions, we would expect the company to generate funds from operations (FFO) of roughly $780 million to $800 million in 2012, increasing to slightly over $800 million in 2013. Key projected ratios in 2012 are FFO to debt of 18.5%, debt to EBITDA 3.6x, and debt to capital of 55%. We expect the company to generate modest discretionary cash flow in 2012, with FFO exceeding capital expenditures plus common dividends.
Pro forma adjusted debt of about $4.5 billion consists of about $3 billion in long-term unsecured notes at AGL Capital Corp., $500 million of first mortgage bonds at Nicor Gas, and nearly $400 million of unsecured notes at two AGL utilities, Atlanta Gas Light and Pivotal Utility Holdings. We also include adjustments for operating leases, underfunded pension obligations, and asset retirement obligations as debt, but we reduce short-term working capital debt for the value of natural gas inventories AGL holds at the utilities.
The parent manages liquidity. It is “adequate” under Standard & Poor’s corporate liquidity methodology, which categorizes liquidity in five standard descriptors.
Projected sources of liquidity, mostly operating cash flow and available bank lines, exceed projected uses, mainly necessary capital expenditures, debt maturities, and common dividends, by more than 1.2x. AGL’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.
Debt maturities total about $225 million in the next 12 months. The company has a $1.3 billion, five-year revolving credit facility, with about $550 million currently available.
Liquidity is adequate based on the following factors and assumptions:
-- We expect the company’s liquidity sources (including FFO and credit facility availability) over the next 12 months to exceed its uses by more than 1.2x.
-- Debt maturities over the next year are manageable.
-- Even if EBITDA declines by 15%, we believe net sources will be well in excess of liquidity requirements.
-- The company has good relationships with its banks, in our assessment, and has a good standing in the credit markets.
In our analysis, based on information available as of March 30, 2012, we assumed liquidity of about $1.4 billion over the next 12 months, consisting of projected FFO and availability under the credit facility. We estimate the company could use up to $950 million during the same period for capital spending, debt maturities, and shareholder dividends. NextEra’s credit agreement includes a financial covenant limiting the consolidated debt-to-capitalization ratio, with which the company was compliant as of March 30, 2012.
The outlook for AGL and subsidiaries is stable. We could consider a downgrade if AGL’s performance deteriorates materially below our expectations either due to poor merger integration or adverse regulatory decisions, such that FFO-to-debt falls below 16% to 17%. We would consider an upgrade if FFO-to-debt sustainably improves to 22% to 23% with the current mix of regulated and unregulated activities. While we would not expect to see this improvement soon, the company could achieve these metrics over time with the realization of synergies and debt reduction through free cash flow.
Related Criteria And Research
2008 Corporate Criteria: Analytical Methodology, April 15, 2008