Fitch: Solid Growth, M&A Focus for US Gas Distribution Utilities

NEW YORK--(BUSINESS WIRE)-- Merger and acquisition (M&A) activity and strategic trends will be among key topics of discussion at the American Gas Association's 2016 Financial Forum, according to Fitch Ratings. Other trends and topics will likely include industry growth initiatives, infrastructure replacement, capex, political and regulatory developments and rate-basing of natural gas reserves.

We believe M&A is a trend that is likely to persist, driven by low current interest rates and investor thirst for earnings growth. Discussion surrounding acquisition of gas distribution companies by large diversified energy and electric utility holding companies, as well as potential expansion by gas distribution companies into riskier businesses such as pipelines and other midstream assets, is expected to be front and center at the conference.

Fitch expects the trend of large diversified electric utility holding companies acquiring gas distribution companies, as exemplified by the pending acquisition of AGL Resources, Piedmont Natural Gas and Questar Gas by Southern Co., Duke Energy and Dominion Resources, respectively, will continue along with horizontal expansion activity. Richly valued, debt-funded acquisitions, as well as meaningful forays into unregulated businesses, are among the events most likely, in Fitch's view, to result in adverse credit rating actions. M&A activity will continue to be a key potential credit rating risk, as industry constituents across the utility supply chain seek to bolster earnings growth.

Capex in 2016 for Fitch-rated natural gas utility distribution companies (UDC) is estimated at $5 billion, a 15% increase from 2015 levels. Driven in large part by infrastructure replacement, modernization and reliability investment, Fitch believes that execution risk associated with the industry's large capex program is manageable given the generally balanced US jurisdictional regulatory compact. Moreover, pipeline replacement investment mitigates safety and reliability risks associated with pipeline infrastructure and is currently politically uncontroversial.

Continued focus on investment in core distribution assets, such as pipeline replacement and modernization is credit supportive, while the ratings impact of investment in regulated natural gas reserves is more uncertain. Fitch anticipates discussion regarding the impact of energy efficiency and the ascendancy of natural gas as the preferred source of electricity generation, the emergence of renewable and other technologies, investment in liquefied natural gas export terminals and compressed natural gas development in transportation.

The aggregate credit quality of the natural gas UDC subsector is strong with an average 'A-' credit rating and predominantly Stable Rating Outlooks prevalent among Fitch-rated gas UDCs. Credit quality for gas distribution companies is supported by low natural gas prices and interest rates and a relatively benign US regulatory compact. The subsector's strong credit profile also reflects the companies' relatively low business risk and predominantly regulated earnings and cash flows. In Fitch's opinion, the US regulatory construct is generally credit supportive for gas distribution companies. Many jurisdictional cost of service items are recovered through special tariffs outside of general rate cases, providing a reasonable opportunity for the utilities earn close to their authorized returns on equity.

High estimated 2016-2018 capex, combined with the bottoming of natural gas prices and interest rates, present potential headwinds to credit quality. Fitch believes these factors will prove manageable in the near to intermediate term. However, a sharper-than-expected, sustained reversal of natural gas prices, interest rates and inflation, which tend to be positively correlated, could challenge sector ratings. In this scenario, higher monthly bills due to meaningful uptick in commodity price and other costs could trigger political resistance to revenue increases needed to sustain creditworthiness.

Additional information is available on www.fitchratings.com.

The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.

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Fitch Ratings
Philip W. Smyth, CFA
Senior Director
Corporate Ratings - U.S. Utilities, Power & Gas
+1 212-908-0531
Fitch Ratings
33 Whitehall Street
New York, NY
or
Kellie Geressy-Nilsen
Senior Director
Fitch Wire
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Source: Fitch Ratings

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