NEW YORK--(BUSINESS WIRE)--Fitch Ratings affirms the following ratings on outstanding Philadelphia, PA Gas Works revenue bonds:
--$188.9 million gas works revenue bonds, various series, (1975 general ordinance), at 'BBB+';
--$907.5 million gas works revenue refunding bonds, various series (senior 1998 general ordinance), at 'BBB'.
The Rating Outlook is Stable.
SECURITY
The 1975 general ordinance bonds are secured by a closed first lien on net revenues of the gas works utility. The 1998 general ordinance bonds are secured by net revenues of the gas works utility subordinate to the prior pledge of the 1975 general ordinance bonds.
KEY RATING DRIVERS
LARGE GAS DISTRIBUTION SYSTEM: Philadelphia Gas Works (PGW) is the largest municipally-owned gas distribution utility in the nation, serving slightly more than 500,000 accounts located entirely within the city of Philadelphia (Fitch rates the city's general obligation bonds 'A-' with a Stable Outlook). The system provides natural gas to a notably diverse and largely residential customer base that exhibits no concentration among users.
SATISFACTORY FINANCIAL PERFORMANCE: Financial performance weakened somewhat in fiscal 2012 due to a sizeable weather-related decline in sales, but financial metrics in general remain acceptable for the rating category due to prior rate increases and sustained improvement in collection of billings. Fitch calculated debt service coverage has averaged a sound 1.4x over the prior three years, and liquidity exceeded 50 days cash at the close of fiscal 2012.
SUPPORTIVE REGULATION: PGW benefits from a supportive relationship with the Pennsylvania Public Utility Commission (PUC), which regulates the utility's retail rates.
REDUCED RELIANCE ON DEBT FUNDING: PGW has generated positive cash flow after debt service in recent years and has not issued commercial paper to fund operations since fiscal 2009. Total debt remains high, but PGW has reduced its reliance on short-term and long-term financing to fund capital expenditures and will benefit going forward from the recent implementation of a distribution system improvement charge (DSIC).
WEAK BUT STABLE DEMOGRAPHICS: Wealth indicators throughout the service area remain weak, contributing to below-average collection rates. Approximately 20% of PGW's customers are enrolled in low-income/senior citizen discount programs.
PRIORITY LIEN RECOGNIZED: The 'BBB+' rating on the 1975 general ordinance bonds reflects their priority lien in the flow of funds, which is closed to future bond issues, as well as the distinct separation between the 1975 and 1998 ordinances.
RATING SENSITIVITIES
WEAKER CASH FLOW: Diminished cash flow leading to additional leverage in excess of what is currently programmed into the current capital program would be viewed negatively.
POTENTIAL SALE OF PGW: The city's ongoing efforts to sell the utility are viewed as credit neutral by Fitch at this time as the city's stated terms would require either repayment or defeasance of all outstanding bonds.
CREDIT PROFILE
LARGE DISTRIBUTION SYSTEM
PGW is the largest municipal gas distribution utility in the nation, providing natural gas through a diverse mix of supply arrangements as well as its own storage and natural gas liquefaction facilities. Ample storage capacity allows the system to lock in and store a sizeable portion of its winter supply during the less expensive summer months.
CHALLENGING DEMOGRAPHICS COMPOUND HIGH RATES
The system's high rates, the city's challenging demographics and the state's regulation of rates continue to constrain PGW's rate flexibility. Residential rates are comparatively higher than all other gas distribution systems operating within the state due to historically weak collections and extensive utility-sponsored discount programs that benefit low-income customers. The city's poverty rate stands at 25%, sixth-highest among the nation's 50 largest cities, and overall income levels approximate just 75% of the state and national averages. The city's June 2013 unemployment rate (10.4%) remains high relative to state and national averages, and weak income indicators persist.
Approximately 95% of the system's 503,000 customer accounts are residential, with the balance comprised of commercial and industrial users. Positively, accounts receivable have shown considerable improvement in recent years and collection of billed revenues has averaged a more stable 96% since 2005. Collections prior to 2005 were significantly weaker.
RATE REGULATED
Rates and charges of PGW are set by the Pennsylvania PUC. The PUC's ratemaking methodology is designed to ensure that PGW recovers its costs, meets its rate covenant of 1.5x on senior and subordinate line obligations, and continues to fund a required $18 million annual utility payment to the city. PGW's relationship with the PUC is reportedly constructive, as evidenced by the timely approval of a distribution system infrastructure charge and the continued approval of quarterly gas rate adjustments.
PGW's most recent base rate filing was approved in July 2010. The approval permitted PGW to maintain virtually all of a $60 million extraordinary rate increase granted by the PUC in 2008, and to receive an incremental rate increase of $16 million annually to fund other post-employment benefit costs. Management does not anticipate making a request for another base rate increase during the current forecast period, but rate increases beyond 2018 are currently being considered.
SOUND FINANCIAL PERFORMANCE
Financial metrics generated in more recent years are satisfactory for the given rating category and much improved relative to historical results, primarily due to more timely cost recovery and improved collections. Fitch calculated debt service coverage of both senior and subordinate lien obligations has averaged an acceptable 1.4x over the prior three fiscal years, compared to 1.1x between fiscals 2006-2009. Financial performance weakened somewhat in fiscal 2012 as a warmer than normal winter led to a nearly 17% decline in total sales volumes. Fitch calculated debt service coverage declined to 1.2x as a result.
Liquidity diminished some in fiscal 2012, but with 54 days cash on hand, PGW's cash position remains adequate for the system's operating profile and sound for the given rating category. Moreover, the decline in unrestricted cash in fiscal 2012 was attributable primarily to management's prudent decision to reduce leverage by accelerating approximately $20 million in bond principal.
PGW is also authorized, pursuant to a city ordinance, to issue up to $150 million in commercial paper (CP) notes for working capital, although no borrowings under the authorization have occurred since fiscal 2009. Multiple letters of credit available to support up to $60 million of CP are currently in place through March 2015, increasing PGW's days liquidity on hand to nearly 100 days. PGW routinely utilized the CP authorization to fund operations prior to fiscal 2009 when operating margins were notably weaker.
Financial projections through fiscal 2018 include reasonable assumptions which should make financial targets achievable. The forecast reflects a nominal increase in sales, a slight decline in staffing, no change in base rates or the number of customer accounts served and a 96% collection rate of billed revenues. The forecast targets debt service coverage of 1.6x through 2018, which should provide sufficient free cash flow to meet planned capex.
LEVERAGED UTILITY
Leverage ratios are expected to remain high, although management's ongoing commitment to reducing its reliance on short-term and long-term financing to fund capital expenditures is a positive consideration. Despite some improvement in recent years, equity/capitalization (22.3%) and debt to funds available for debt service (8.0x) remain weak, but not inconsistent with the given rating category. Fitch expects leverage ratios to incrementally improve going forward.
The current capital program covers fiscal years 2014-2018 and totals a manageable $420.5 million, the vast majority of which will be for main replacement. PGW's ongoing annual program to reduce its inventory of cast iron mains by a minimum of 18 miles per year will compose about 75% of planned spending through the current planning period.
Recent plans to finance approximately $175 million of projects included in the capital plan with long-term debt have been altered in favour of CP borrowings expected in the latter part of (calendar) 2013. The short-term financing provided by the CP will fund approximately 42% of capital projects planned through 2018. Management expects to eventually take out the CP with long-term debt.
The balance of PGW's capital program will be funded from excess operating cash flow and existing reserves, including the drawdown of an $88 million construction fund balance. The recent imposition (July 1, 2013) of the DSIC, which can be levied pursuant to PUC approval to recover distribution system repair, improvement and replacement costs, is expected to increase excess cash flow needed to sufficiently meet targeted pay-go included in the current financial forecast. PGW's ability to levy the DSIC is considered by Fitch to be a constructive development in a state with a historically challenging regulatory regime.
Additional information is available at 'www.fitchratings.com'.
This rating action was informed by information identified in Fitch's Revenue-Supported Rating Criteria and U.S. Public Power Rating Criteria.
Applicable Criteria and Related Research:
--'U.S. Public Power Peer Study -- June 2013' (June 13, 2013);
--'U.S. Public Power Peer Study Addendum -- June 2013', (June 13, 2013);
--'Revenue-Supported Rating Criteria' (June 3, 2013);
--'U.S. Public Power Rating Criteria' (Dec. 18, 2012).
Applicable Criteria and Related Research:
U.S. Public Power Peer Study -- June 2013
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=710397
Revenue-Supported Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=709499
U.S. Public Power Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696027
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=799097
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