Fitch Ratings-New York-07 January 2014: Fitch Ratings has assigned an ‘A-‘ rating to Arizona Public Service Company’s (APS; Issuer Default Rating [IDR] ‘BBB+’) issuance of $250 million 4.7% coupon senior unsecured notes, due Jan 15, 2044. The senior unsecured notes will rank pari passu with existing unsecured debt.
Proceeds will be used to fund the purchase of Southern California Edison Company’s 48% interest in each of units 4 and 5 (770MW each) at the Four Corners coal-generating facility for $182 million and to refinance $64 million of variable-rate tax exempt pollution control revenue bonds (PCRBs). The unsecured tax exempt bonds are comprised of $31.5 million of PCRBs, 1994 Series C, due 2024 and $32.7 million of PCRBs, 1994 Series A, due 2029. The Rating Outlook for APS is Stable.
KEY RATING DRIVERS –Constructive settlement of 2010 General rate case (GRC); –Four-year GRC stay-out through May 2015; –Low leverage; –Large capex program including environmental upgrades at coal plants.
Stable Rating Outlook: The Stable Outlook reflects the predictable earnings and cash flows of APS, a regulated vertically integrated electric utility. The rating also considers APS’ solid liquidity position, manageable debt maturities, low leverage, and the financial support from its corporate parent, Pinnacle West Capital Corp. (PNW, IDR ‘BBB+’, Stable Outlook), including anticipated equity infusions agreed to in APS’ settlement of its 2008 GRC.
Strong Operating Performance: APS’ EBITDA to interest coverage improved to 6.3x for the LTM period ending Sept. 30, 2013 as compared with 6.0x for year ending 2012, and primarily reflects new rates effective July 1, 2012 as per APS’ 2010 GRC. The improved earnings also reflect slightly warmer weather in APS’ service territory, improved customer growth, and new transmission rates. Leverage, as measured by debt to EBITDA, was low at 2.5x. Credit metrics compare well to Fitch’s ‘BBB+’ guideline ratios and peers. Going forward, Fitch expects EBITDA and FFO coverage metrics to approximate 5.0x-6.0x, and for FFO/Debt leverage metrics to remain above 22% through 2015.
GENERAL RATE CASE SETTLEMENT Constructive 2010 GRC Settlement: On May 15, 2012, the Arizona Corporation Commission (ACC) approved the regulatory settlement agreement as proposed by APS and other parties in APS’ 2010 GRC without material modifications. The ACC approved an increase in nonfuel base rates of $116.3 million, which represented roughly 60% of APS’ requested amount based on an authorized return on equity (ROE) of 10% for new rates effective July 1, 2012. Additionally, per the terms of the settlement, APS agreed to a four-year stay-out and is prohibited from filing its next rate case before May 31, 2015, for rates effective on or after July 1, 2016, at the earliest. Controlling operating costs will be key to maintaining credit quality.
Good Liquidity: As of Sept. 30, 2013, APS had total consolidated liquidity available of $1.1 billion including $113 million of cash and cash equivalents. APS maintains liquidity through two $500 million unsecured credit facilities, which mature in November 2016 and April 2018, respectively. Additionally, APS can upsize the credit facilities to $700 million with consent of the lenders. Fitch notes that there were no borrowings against these facilities as of Sept. 30, 2013. The credit facilities are subject to a maximum debt to capitalization covenant of 65% and as of Sept. 30, 2013, APS was in compliance with a debt to capitalization ratio of 41.8%.
Manageable Maturities: APS’ long-term debt maturities are sizable, with $1.2 billion scheduled to mature through 2016 as follows (includes capital lease obligations): $540 million in 2014, $345 million in 2015, and $358 million in 2016. Fitch expects APS to refinance these maturities on a timely basis.
CAPITAL EXPENDITURES Large Capital Spending Program a Key Growth Driver: Capex at APS is projected to average $1.1 billion per annum through 2016 and includes investments associated with the purchase of Southern California Edison Company’s interest in units 4 and 5 at the Four Corners power plant and emissions control upgrades at APS’ coal fired generating facilities. Other investments include the construction of new transmission capacity, increased efficiency programs, installation of advanced meters, and increased renewable generation, specifically under the AZ Sun program. APS is increasing its renewable generation capacity to meet renewable portfolio standard targets in the state. For the LTM period ending Sept 30, 2013, Fitch notes that APS generated positive FCF. Fitch expects APS to fund the majority of forecasted capex internally and the balance with external financing. While Fitch anticipates external funding requirements to be financed via a balanced mix of equity and debt, regulatory lag will moderately pressure leverage metrics. Fitch expects leverage, as measured by debt to EBITDA, to moderately increase to 3.0x by 2015.
Positive Rating Action: Given the stay-out features of APS’ 2010 GRC, no upside rating catalysts are evident over the near to intermediate term.
Negative Rating Action: Greater than anticipated increases in operating and other expenses could erode credit quality. An unexpected, prolonged base load generating facility outage could lead to adverse credit rating actions.
Primary Analyst Daniel Neama Associate Director +1-212-908-0561 Fitch Ratings, Inc. One State Street Plaza New York, NY 10004
Secondary Analyst Philip W. Smyth, CFA Senior Director +1-212-908-0531
Committee Chairperson Glen Grabelsky Managing Director +1-212-908-0577