NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the long-term Issuer Default Rating (IDR) of Otter Tail Corporation (OTTR) at 'BBB-' and the long-term IDR of its regulated electric utility subsidiary, Otter Tail Power Company (OTP) at 'BBB'. The Rating Outlook for both entities is Stable. A complete list of ratings is provided at the end of this release.
Due to the risks inherent in the diversified business portfolio, Fitch rates OTTR one notch below its regulated subsidiary OTP. OTTR's current IDR of 'BBB-' takes into consideration the company's business mix including a relatively small electric utility and a mix of small cyclical industrial businesses that operate in fragmented, competitive markets.
OTP contributes approximately two thirds of consolidated earnings. The Stable Outlook reflects Fitch's expectations that utility earnings and cash flows will be supported by regulatory mechanisms that afford timely recovery on investments during a period of high capital spending at OTP and the manufacturing and infrastructure businesses will sustain the recent improvement in financial performance.
KEY RATING DRIVERS
--Strong and stable performance at OTP;
--Large capex program at OTP with constructive regulatory recovery mechanisms;
--Lower risk profile with downsizing of diversified business portfolio;
--Modest parent debt balances and low consolidated leverage.
OTTR
OTTR's ratings reflect its higher operating risk profile from its downsized, but still prominent, diversified business portfolio. These diversified operations have been a source of large operating and non-recurring losses and write-downs from 2010 to 2012. Following divestiture of the poor performing businesses, OTTR's remaining non-regulated activities consist of three segments: manufacturing, plastics, and construction. Manufacturing and plastics have performed strongly over the last couple of years reflecting the economic recovery, with the construction segment returning to modest profitability. Management may consider related acquisition opportunities particularly in its manufacturing segments.
Offsetting the higher risks and volatility of the non-regulated businesses, is a relatively low consolidated leverage position. Parent-level long-term debt approximates only $50 million and OTTR's investments in its non-regulated businesses is mostly financed through equity. A conservative capital structure is the anchor to OTTR's credit profile and ratings.
OTTR's earnings rebounded strongly in 2013 reflecting improved performance at the manufacturing businesses and the absence of losses and write-downs on divested businesses. A prior ratings concern was OTTR's common dividend payment which it had failed to earn in 2009 through 2012. Along with the earnings recovery in 2013 and a strong first quarter 2014 (1Q'14) performance by OTP, bolstered in part by cold weather, Fitch expects OTTR's dividend payout ratio in 2014 even with a modest 1.4% increase recently approved, to fall within a typical industry average range of between 60% and 70%.
The earnings recovery is evident in the improvement in key credit metrics. EBITDAR to interest improved to 4.58x for the latest 12 month (LTM) period ended March 31, 2014 from 4.42x and 3.52x for the years 2013 and 2012 respectively. Fitch expects EBITDAR to interest to remain between 4.5x and 5.0x during the 2014 to 2016 forecast period.
OTTR has traditionally employed a low level of leverage, although Fitch expects leverage to trend higher over the forecast period. Fitch expects consolidated debt to EBITDAR, currently averaging around 3.0x, to trend up to 3.3x over the forecast period reflecting higher debt levels to finance the utility's large capex program. Concomitantly, OTTR will be required to raise equity in future years to maintain its own capital structure as well as to downstream equity to support OTP's capital structure during the capex build-out period.
OTP
OTP continues to perform strongly but faces pressures from a large capex program that management projects will increase rate base from $727.9 million in 2013 to $1,151.6 million in 2018 a compounded 9% growth rate over the five year period. In February 2014, OTP completed a $150 million private placement debt but additional external financing will be required. Fitch expects OTP's capital structure will be maintained with an approximate 50%/50% debt/equity mix and OTTR will downstream additional equity to support the capital structure balance.
During the capex cycle which is centered on new transmission projects as part the broader regional CapX2020 Program and the Big Stone Generating Station environmental upgrade including dry scrubbers. OTP's 54% share of the Big Stone project is expected to be around $207 million and the project is expected to be completed late in 2016.
OTP's capex recovery mechanisms provide for timely recovery of invested capital and operating earnings and cash flows are expected to be supported by construction work in progress (CWIP) on the transmission projects as well as recovery riders on the Big Stone environmental upgrade.
Other regulatory mechanisms are considered constructive and OTP authorized return on equity (ROE) in its largest jurisdictions are above industry average. OTP enjoys full commodity and purchased power recovery across its three state service area. OTP's rural service area in Minnesota, North Dakota, and South Dakota has been economically stable and Fitch considers the regulatory oversight as reasonably balanced.
Credit metrics are strong although Fitch expects modest deterioration in coverage and leverage due to higher debt levels beginning in 2014. Measures strengthen throughout the forecast period as the capex cycle matures. EBITDAR to interest, 5.4x for the 12 months ended Dec. 31, 2013 is expected to fall to 4.9x in 2014, but recover to an average of 5.4x in 2015 and 2016. Debt to EBITDAR, 3.6x at Dec. 31, 2013 remains fairly stable and averages 3.6x over the forecast period.
Parent Subsidiary Linkage
Fitch's ratings of OTTR and OTP take into consideration some modest ring-fencing of the utility subsidiary from the parent and other affiliates, a factor that reduces but does not eliminate linkage between the ratings of OTTR and OTP. The utility's IDR of 'BBB' is one-notch higher than OTTR. Fitch typically notches diversified parent holding companies lower than their regulated subsidiaries.
Despite the downsizing of the non-regulated business investments, OTTR management expects to derive 15% to 25% of consolidated earnings from non-regulated businesses. Consequently, Fitch expects to maintain at least a one notch rating differential between OTTR and OTP.
Liquidity
Liquidity is strong for both OTTR and OTP. OTTR has a $150 million bank credit facility with pricing at LIBOR plus 175 basis points (bps) and OTP has a $170 million facility with pricing at LIBOR plus 125bps. There are no debt maturities.
RATING SENSITIVITIES
Execution and funding of a large capital investment program limits positive rating action for OTP and OTTR over the near term. Maturation of the capex cycle and positive cash flow generation could lead to a rating upgrade of OTP.
Events that individually or collectively could result in a negative rating action include:
OTTR:
--A downturn in the economically sensitive non-regulated higher risk businesses could pressure earnings and consolidated leverage;
--An acquisition that is debt financed and/or heightens the business risk profile;
--Debt to EBITDAR above 4x (Fitch forecast models average 3.3x) on a sustained basis could result in a downgrade.
OTP
--A change in the regulatory structure which limits timely and full recovery of invested capital during this large capex cycle would likely result in a negative rating action;
--Failure to maintain a balanced equity component in its capital structure. Debt to EBITDAR above 4.25x (Fitch forecast models average 3.6x) could result in a downgrade.
Fitch affirms the following ratings with a Stable Outlook:
Otter Tail Corporation (OTTR)
--Long-term IDR at 'BBB-';
--Short-term IDR at 'F3';
--Senior unsecured at 'BBB-'.
Otter Tail Power Company (OTP)
--Long-term IDR at 'BBB';
--Short-term IDR at 'F3';
--Senior unsecured at 'BBB+'.
Additional information is available at www.fitchratings.com.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology Including Short-Term Ratings and Parent and Subsidiary Linkage', May 28, 2014;
--'Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)', March 11, 2014;
--'Recovery Ratings and Notching Criteria For Utilities', Nov. 19, 2013.
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
Recovery Ratings and Notching Criteria for Utilities
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=722085
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=843316
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