Fitch Ratings has assigned a 'BBB' rating to AltaGas Ltd.'s (AltaGas) issuance of medium-term notes.
The medium-term notes will be unsecured obligations ranking pari passu with AltaGas's other unsecured, unsubordinated debt. Proceeds from the debt offering will be used to repay debt including borrowings under the company's credit facility and for general corporate purposes. AltaGas's Issuer Default Rating is 'BBB' with a Stable Rating Outlook.
Key Rating Drivers
Strategic U.S. Utility/Canadian Midstream Focus: Since its acquisition of WGL Holdings, Inc. (WGLH; BBB/Stable) in July 2018, the company has implemented a strategy focused on measured expansion of its core U.S. gas utility and Canadian midstream business in the Montney shale, while divesting noncore midstream, power and utility assets. Pro forma for the acquisition, Fitch expects the midstream segment to account for roughly 50% of EBITDA, which is weak for the ratings. More stable utility operations will contribute approximately 55%-60% of cash flow over the long term, with the remainder largely coming from increasingly contracted midstream operations. Fitch expects corporate strategy and priorities to follow a similar path under the leadership of Vern Yu, who took over as CEO on July 1, 2023.
Pipestone Acquisition Bolsters Midstream Segment: AltaGas' proposed acquisition of the Pipestone facility assets adds two gas-processing plants totaling 11,500 barrels/day of liquified petroleum gas (LPG) supply and 105 billion cubic feet of gas storage capacity to AltaGas' midstream segment. The Pipestone I gas processing plants and Dimsdale storage facilities are already operational, generating roughly CAD60 million of EBITDA annually. Once Pipestone II is constructed, Fitch expects midstream EBITDA to be in the CAD120 million-CAD 140 million range, an approximately 15% increase from YE 2022.
The company expects to fund the construction of Pipestone II with internally generated funds and cash. Permits for construction are largely in place, which lowers development risk. More than 90% of the Pipestone assets' EBITDA is contracted under 10-year take-or-pay or fixed-fee contracts with established producers in the region, including Ovintiv Inc. (BBB-/Stable) and unrated entities Pipestone Energy Corp., Kelt Exploration Ltd., TamarackValley Energy Ltd. and Advantage Energy Ltd.
Improving Leverage Expected: FFO leverage was higher than expected at 7.4x in 2022, largely due to higher gas purchase costs, delayed late fee collections and slightly higher O&M costs than expected. Fitch expects financial performance to improve over the next two years, largely from debt reduction, but also from improving cash flows. Fitch expects future utility growth to be driven by customer growth of approximately 1% and significant infrastructure investments. Fitch also expects midstream EBITDA to be relatively flat in 2023.
AltaGas recently sold utility and utility-related operations in Alaska, with the resulting proceeds of approximately CAD1.1 billion applied toward debt reduction. Fitch expects the potential sale of AltaGas' share of noncore assets, such as the Mountain Valley Pipeline, will be used to lower debt. Fitch expects deleveraging from these transactions will result in meaningful improvement in FFO leverage, averaging 5.3x in 2023-2026, which is below Fitch's downgrade threshold of 5.5x.
Elevated Midstream Capex: Fitch projects capex over the next three years to approximate CAD1.3 billion/year, not including the initial purchase price for the Pipestone acquisition. Management delayed or eliminated some nonessential capex from the 2023-2024 budget to manage the company's financing needs. Over the near term, approximately one-third of capex will be allocated toward the ongoing and planned midstream projects, including construction of the Pipestone II facility for an estimated CAD355 million, and continued optimization and expansion of the Ridley Island Propane Export Terminal export facility.
AltaGas is also considering a potential investment in Ridley Island Energy Export Facility (REEF), a 50/50 joint venture with Vopak Development Canada Inc. (Vopak; not rated), a wholly owned subsidiary of Koninklijke Vopak N.V. (Royal Vopak; not rated), which would include a large-scale LPG and bulk liquids terminal, and marine infrastructure development on Ridley Island. The costs associated with this project, expected to be developed over the next four years, would be approximately CAD450 million. Once completed, REEF would further develop AltaGas's existing Asiafocused LPG export strategy.
Fitch expects AltaGas to prioritize balance sheet improvements. Capex associated additional midstream asset development, including REEF and Pipestone II, will be credit supportive, such that leverage is maintained below Fitch's downgrade sensitivities.
Variability in Midstream Revenue Likely: Approximately 78% of midstream EBITDA is derived from investment-grade counterparties, lending stability to cash flow. Contractual structure is strong, with 31% of expected 2023 EBITDA derived from take-or-pay contracts and 18% from fixed-fee contracts. Approximately 68% of expected global export volumes for the remainder of 2023 are hedged, including tolling agreements and financial hedges.
However, year-to-year cash flow is exposed to pricing differentials between the U.S. and Asia. Failure to lock in this differential in 3Q22 squeezed butane margins, adversely affecting midstream EBITDA. Management modified its hedging strategy by locking in a higher percentage of firmly committed and merchant volumes in a timely manner, and managing the propane-butane product mix, which improved margin realization. Future inefficient hedging or increased exposure to market risk may result in negative rating action.
Additional Regulatory Risks: AltaGas's diversified group of relatively low-risk U.S. gas-distribution utilities serve 1.5 million customers in parts of Maryland, Virginia, DC and Michigan under generally credit-supportive economic regulations. Fitch believes the regulatory compacts in Maryland and Virginia remain balanced. Election changes in Maryland introduced some uncertainty. A significant unexpected deterioration in rate regulation could result in future credit rating downgrades.
Parent-Subsidiary Rating Linkage: Fitch analyzed parent-subsidiary rating linkage between AltaGas and intermediate holding company subsidiary WGLH by utilizing the strong subsidiary path laid out in Fitch's Parent and Subsidiary Linkage Rating Criteria. Legal ring-fencing and access and control are each evaluated as open, resulting in a consolidated rating for AltaGas and WGLH. WGLH, unlike AltaGas's utility subsidiaries, is not subject to rate regulation. Its strategy and treasury functions are centrally managed by AltaGas.
There is also a parent-subsidiary linkage between WGLH and Washington Gas Light Company (WGL; A-/Stable). The linkage follows a weak parent/strong subsidiary approach. In this case, the conclusion to use WGL's Standalone Credit Profile is based on the determination that legal ring-fencing is insulated and access is porous. Among the key ringfencing provisions supporting the insulated ring-fencing include restrictions on WGL's capital structure as put forth in the 2018 merger approval.
Derivation Summary
AltaGas is somewhat weakly positioned at its 'BBB' rating. With operating EBITDA of approximately CAD1.4 billion at YE 2022, it is smaller than Emera Incorporated (Emera; BBB/Negative), but larger than Algonquin Power & Utilities Corp. (APUC; BBB/Stable). Emera and APUC had operating EBITDA of approximately CAD1.8 billion and CAD1.0 billion, respectively, at YE 2022. Fitch estimates AltaGas' FFO leverage will average 5.3x during 2023-2025, comparable with APUC's approximately 5.5x and better than Emera's 6.5x over the same period.
Canadian utility holding company APUC benefits from regulatory diversification but owns utilities that operate in somewhat less constructive regulatory environments, in Fitch's view, with APUC's largest utility operating in Missouri. Fitch expects utility operations to account for approximately 75% of consolidated APUC EBITDA. Emera de-emphasized unregulated investments to focus on utility operations in the U.S., Canada and the Caribbean in recent years.
Fitch believes regulation in Emera's two largest jurisdictions-Florida and Nova Scotia-are balanced. Emera derives roughly 95% of its earnings from regulated operations. AltaGas generates only 57% of its cash flow from regulated utility operations.
Like Emera and APUC, AltaGas's operations include significant low-risk utility operations. AltaGas, through WGL, provides gas utility services to affluent populations in parts of Virginia, Maryland and DC, with prospective customer growth estimated at 1% per year. AltaGas also provides gas distribution service to parts of Michigan. Collectively, AltaGas's U.S. utilities experienced customer growth of 1%, and approximately 70% of their customers are residential. Emera and APUC, unlike AltaGas, have meaningful electric utility operations.
Key Assumptions
Continuation of reasonable economic regulation across AltaGas' jurisdictional service territory;
One percent annual customer growth at AltaGas' U.S. gas utility segment on average;
Maintenance of normalized annual sales at WGL in 2023-2024;
Midstream export volumes increasing 5%-10% over the next three years, while increasing the proportion of export volumes from the facility to take-or-pay contracts from merchants;
Current business mix between regulated entities and midstream segment is sustained;
Additional asset sales in 2024, with proceeds used for reducing parent-level debt;
Capex averages CAD1.3 billion per annum during 2023-2025;
Incremental midstream capex executed in a credit-supportive manner.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Credit-supportive regulatory trends and better than expected final decisions at AltaGas's and WGLH's U.S. utility subsidiaries compared with Fitch's rating case;
Stronger than expected performance at AltaGas's midstream businesses;
Sustained FFO leverage of 4.5x or better on a consistent basis.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
FFO leverage above 5.5x post 2024, and on a sustained basis thereafter;
Significant deterioration across AltaGas's jurisdictional service territory;
Additional debt-financed midstream capex resulting in higher leverage;
Failure to raise adequate and timely financing from asset sales or other sources, if required to lower leverage.
Liquidity and Debt Structure
Adequate Liquidity: Fitch believes liquidity is adequate at AltaGas and WGL. AltaGas negotiated consolidated credit facilities with total borrowing capacity of CAD3.5 billion. AltaGas drew CAD708 million and had remaining borrowing capacity of approximately CAD2.8 billion as of Sept. 30, 2023. It had cash and cash equivalents of CAD43 million on its balance sheet as of Sept. 30, 2023.
Maturities in 2024 include senior notes totaling CAD550 million and a CAD450 million term loan. CAD800 million is due in 2025.
WGL's USD450 million credit facility had approximately USD118 million available as of Sept. 30, 2023. The revolving credit facility expires July 17, 2026. Fitch expects WGL to be cash flow negative in 2023-2025 due to the utility's large capex program, with external funding provided through a balanced mix of equity and debt. Maturities are manageable, with USD294 million maturing over the next five years.
Issuer Profile
AltaGas is a Canada-based energy infrastructure company with operations in the U.S. and Canada with CAD20 billion of total assets. The company has two primary business segments: Utilities and Midstream.
ALTAGAS LTD. 
