Fitch Ratings has assigned an 'A-' rating to Arizona Public Service Company's (APS) issuance of $250 million of senior unsecured notes, due Jan. 15, 2020. The senior unsecured notes rank pari passu with existing senior unsecured debt. Proceeds will be used to pay down short-term borrowings and for general corporate purposes including the funding of planned capex. The Rating Outlook for APS is Positive.
KEY RATING DRIVERS
--Strong credit metrics;
--Improving customer growth;
--Low leverage;
-- Net Metering Rate Design Evolving;
--Balanced regulatory environment;
--Large capex program.
Positive Rating Outlook: APS' Positive Outlook reflects expectations for continued customer growth, an improving service territory economy and strong projected credit metrics. The rating also considers APS' solid liquidity position, manageable debt maturities, low leverage, and financial support from its corporate parent, Pinnacle West Capital Corporation (PNW; Issuer Default Rating (IDR) 'BBB+'; Rating Outlook Positive by Fitch).
Strong Credit Metrics: APS's EBITDAR-to-interest coverage trended flat at 6.1x for the latest-twelve-month (LTM) ending Sept. 30, 2014 as compared to 2013, and primarily reflects improved customer growth and lower operating and maintenance costs largely offset by cooler than normal summer weather in APS's service territory. Leverage, as measured by debt-to-EBITDAR, was low at 2.6x. Credit metrics are strong compared to Fitch's 'BBB+' guideline ratios and peers. Going forward, Fitch expects EBITDAR coverage and leverage metrics to approximate 6.0x and 3.0x, respectively, through 2016.
Higher Customer Growth: Going forward, Fitch expects customer growth to average about 2% to 3% per year through 2017, reflecting improving economic conditions in Arizona including lower unemployment and rising housing starts and new household formations. As economic conditions improve in Arizona, APS' customer growth appears to be accelerating, approximating 1.4% for the nine-month period ended Sept. 30, 2014, which compares to average annual customer growth of 1% during 2011 - 2013.
Positive Sales Trend: Going forward, Fitch expects that total weather normalized retail electricity sales will resume a positive growth trend, increasing on average about 0.5% to 1.5% per year through 2017 as a result of customer growth partially offset by energy efficiency and distributed generation. Retail electricity sales, adjusted to exclude the effects of weather variations, decreased 0.6% for the nine month period ended Sept. 30, 2014 when compared with the prior year period, reflecting the effects of customer conservation, energy efficiency and distributed generation, partially offset by improving economic conditions and customer growth. Notably, the delta between customer growth and sales growth is roughly negative 1.5% due to the effects of energy efficiency, demand response, and distributed generation.
Net Metering Charge Adopted: Cost shifting issues associated with net metering remains a concern for investors. In Dec. 2013, the Arizona Corporation Commission (ACC) instituted a charge on roof-top solar installations after Dec. 31, 2013 of $0.70 per kilowatt effective Jan. 1, 2014. The ACC, in adopting the fixed charge for residential- rooftop solar customers, recognizes cost shifting associated with the current net metering program in Arizona and has taken a constructive initial step toward addressing the issue. The fixed charge will remain in effect through completion of APS' next general rate case (GRC), is revenue neutral and will be credited to the lost fixed-cost recovery (LFCR) rider.
NM Rate Design Evolving: Rate design regarding DG and NM continues to evolve in Arizona. In Aug., the ACC voted to lift the requirement that APS file its next GRC by June of 2015 and in Sept. ACC staff filed a new docket to permit a utility to request approval of its proposed NM rate design outside of and before GRC proceedings. The proposal is currently pending and is based on an assumed June 2016 revenue requirement filing. Notably, the ACC opened a new docket in Dec. focused on studying solar distributed generation business models and their impacts to corporations and ratepayers with the hearing schedule expected to be determined during the first quarter.
Additionally, the ACC had no objection to APS' plan to implement a 10 MW utility owned residential rooftop solar program focused on low income customers with associated costs to be filed for recovery in the next GRC. For the LTM ended Sept. 30, 2014, APS's earned return on equity (ROE) approximated 9.7%, near its authorized ROE of 10%.
Large Cap Ex Driving Growth: Fitch expects rate base growth of 6% - 7% through 2016, driven by average annual capex of $1.1 billion through the same time period. Capex is focused on generation, distribution and transmission investments and includes emissions control upgrades at APS' coal-fired generating facilities, new transmission capacity, installation of advanced meters, and the AZ Sun program. APS is increasing its renewable generation capacity to meet renewable portfolio standard (RPS) targets in the state and is on track to double its 2015 RPS requirement of 5% of retail sales to be supplied by renewable energy resources in 2015.
Ocotillo Plant Modernization Project: APS plans to increase the capacity of its gas fired Ocotillo power plant to 620MW to help maintain service reliability in the growing Phoenix area. APS plans to install five new 102 MW combustion turbines and simultaneously retire two older and inefficient 110MW steam generators. The project is expected to cost between $600 to $700 million and construction is expected to begin in 2016 with a projected in service date during the summer of 2018.
Four Corners Rate Rider Approved: In December 2014, the ACC authorized APS to establish a rate rider to collect $57.1 million of costs related to the acquisition of the additional interests in Units 4 and 5 and the related closure of Units 1 - 3 of the Four Corners coal-fired generating facility effective Jan 1. 2015. ACC approval of the rider is a constructive development from a credit point-of-view.
AZ Regulatory Compact: GRC orders have been more balanced for APS in the past several years and more timely adjudication of rate filings is a constructive development from an investor point-of-view in that has enabled the utility to improve its earned returns. Regulators have adopted several regulatory mechanisms to facilitate cost recovery outside of and in between GRCs. Such cost recovery mechanisms include the power supply adjustor, renewable energy surcharge, transmission cost adjustor, demand-side management adjustor charge, the environmental improvement surcharge, and the lost fixed cost recovery mechanism.
Moderate Leverage Increase: Due to its large capex program, Fitch expects APS to remain moderately free cash flow (FCF) negative through 2016 and expects the utility to fund the majority of forecasted capex internally. The balance is expected to be funded with a balanced mix of debt and equity. Fitch expects modest regulatory lag to pressure credit metrics, with leverage as measured by debt-to-EBITDAR estimated to weaken moderately and to approximate 3.0x by 2016.
Financial Flexibility
Solid Liquidity: As of Sept. 30, 2014, APS had total consolidated liquidity available of $986 million including $5 million of cash and cash equivalents. APS maintains liquidity through two $500 million unsecured credit facilities which mature in April 2018 and May 2019, respectively. Additionally, APS can upsize their $500 million credit facilities to $700 million with consent of the lenders. The credit facilities backstop the company's commercial paper program and are subject to a maximum debt-to-capitalization covenant of 65% and as of Sept. 30, 2014 APS was in compliance with debt-to-capitalization ratio of 41%. APS' long-term debt maturities are manageable with $703 million scheduled to mature through 2016 as follows (includes capital lease obligations): $345 million in 2015 and $358 million in 2016.
RATING SENSITIVITIES
Future developments, individually or collectively, that could lead to a positive rating action include:
--Continued sales growth reflecting improving economic conditions in APS' service territory;
--Sustained debt-to-EBITDAR leverage metrics under 3.3x;
--Continued credit supportive regulatory outcomes in future GRCs
--Constructive resolution of rate design issues associated with distributed generation and energy efficiency.
Future developments, individually or collectively, that could lead to a negative rating action include:
--Deterioration in the regulatory compact in Arizona.
--Given the stay-out provision of APS' last GRC, higher than expected operating and other costs could erode credit quality.
-- An inability to recover lost revenues from lost electricity sales due to net metering.
--Sustained debt-to-EBITDAR leverage metrics over 3.75x.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Rating U.S. Utilities, Power and Gas Companies'(March 7, 2014);
--'Corporate Rating Methodology'(May 28, 2014);
--'Recovery Ratings and Notching Criteria for Utilities'(Nov. 18, 2014).
Applicable Criteria and Related Research:
Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=735155
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Recovery Ratings and Notching Criteria for Utilities
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=813608
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=964935
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