Fitch Rates Southern Company Gas Capital's Senior Notes 'BBB+'
Tuesday, September 14th, 2021
Fitch Ratings has assigned a 'BBB+' rating to Southern Company Gas Capital Corporation's $450 million series 2021A 3.15% senior notes due Sept. 30, 2051. The notes are fully and unconditionally guaranteed by Southern Company Gas (GAS), which has a 'BBB+' Issuer Default Rating (IDR) with a Stable Outlook. The net proceeds from the issuance will be used to repay all or a portion of the outstanding short-term debt and for general corporate purposes, including investments in its subsidiaries.
The credit profile of GAS is supported by its natural gas distribution utility operations in four states, which account for approximately 80% of total EBITDA. The balance of GAS's EBITDA is comprised of 10% FERC regulated pipeline investments and 10% of retail natural gas marketing and storage business.
KEY RATING DRIVERS
Minimal Impact from Pandemic: GAS's gas distribution utilities operate in Illinois, Georgia, Virginia and Tennessee. GAS has not witnessed any material impact from the pandemic. The onset of the pandemic coincided with the waning of the peak heating season. In addition, the exposure to commercial and industrial customers, which bore the initial brunt of the economic slowdown, is quite small for GAS. Residential customers account for more than 70% of the operating margin generated by its gas distribution utilities.
The natural gas distribution utilities have various regulatory mechanisms to recover bad-debt expense. Nicor Gas fully recovers its bad-debt expenses, both the gas and non-gas portions, through its purchased gas adjustment mechanism and separate bad-debt rider. Virginia Natural Gas and Chattanooga Gas recover the gas portion of bad-debt expense through their purchased gas adjustment mechanisms and the non-gas portion of bad-debt expense through their base rates in accordance with established benchmarks.
Atlanta Gas Light does not have material bad-debt expense because its receivables are from marketers, rather than end-use customers. Its tariff allows it to obtain credit security support from the marketers in an amount equal to at least two times their estimated highest bill.
Supportive Regulation: Fitch estimates the combined rate base in Illinois and Georgia accounted for over 80% of the total local distribution companies (LDC) rate base at YE 2020. All four LDCs have full recovery of natural gas costs through adjustment mechanisms and are allowed different forms of revenue decoupling or normalization. Illinois and Virginia have riders and infrastructure programs that allow recovery with minimal lag. Illinois gas rates have been decoupled since October 2019 for residential customers based on customer class.
Investments under Georgia's Strategic Infrastructure Development and Enhancement program (STRIDE) are being recovered through the Georgia Rate Adjustment Mechanism (GRAM), which adjusts rates annually based on forward test-year projections. These mechanisms mitigate regulatory lag and provide a reasonable opportunity for gas utilities to earn their authorized returns. ROEs, or midpoint ROE ranges, are below 10.00%, except in Georgia, where the midpoint authorized ROE is 10.25%.
Pending Regulatory Activity: In July 2021, Atlanta Gas Light made its 2021 GRAM filing requesting a base rate increase of $49 million effective Jan. 1, 2022. In April, Atlanta Gas Light filed its first Integrated Capacity and Delivery Plan (i-CDP) to reflect proposed investments in pipeline safety, reliability and growth programs for the period 2022-2031. Recovery of these investments will be included in either subsequent GRAM filings or the new System Reinforcement Rider. The final PSC order is expected in November 2021.
Nicor Gas filed a general rate case in January requesting a rate increase of $293 million based on a 10.35% ROE and 54.5% equity ratio. The rate increase request includes $94 million related to the Investing in Illinois program that will roll-over from rider recovery into base rates. The ICC Staff has recommended a $238 million rate increase based on 9.75% ROE. A final PSC order is expected in December.
On May 10, 2021, Virginia Natural Gas, the Virginia Commission staff, and other intervenors entered into a stipulation agreement related to Virginia Natural Gas' June 2020 general rate case filing, which allows for a $43 million increase in annual base rate revenues, including $14 million related to the recovery of investments under the SAVE program, based on a ROE of 9.5% and an equity ratio of 51.9%. A final order by the Virginia PSC is expected in September.
Large Capex: GAS's capex has been elevated since 2016. The most recent forecast calls for $4.9 billion investment in capex from 2021 to 2023, or approximately $1.6 billion per year. Approximately 95% of the capex will be invested in LDCs primarily expected to be recovered through rider or regulatory mechanisms, thereby growing rate base by a 10% CAGR over the next three years, which Fitch views favorably. Gas pipeline replacement and improvement, driven by increased federal and safety requirements, comprises 67% of the utility spending, with the remaining related to customer growth and maintenance and other.
Unregulated Segment: Gas pipeline investments and gas marketing services make up the majority of the unregulated segment. Gas pipeline investments include 50% interest in Southern Natural Gas, 20% ownership in PennEast Pipeline under development, and 50% ownership interest in Dalton Pipeline. GAS had sold its 5% ownership interest in Atlantic Coast Pipeline to Dominion Energy in March 2020 prior to the project being cancelled. GAS recently sold Sequent, which provided wholesale natural gas marketing and logistics services, to Williams Companies.
GAS's ratings incorporate Fitch's assumption that the company will grow the unregulated segment proportionately with regulated operations and pivot toward long-term contracted gas pipeline investments. Expansion in the pipeline segment with long-term contracts partially offsets the substantial market risks in the gas marketing services business. In February 2020, the FERC approved a two-year extension for PennEast Pipeline to be completed by Jan. 19, 2022. Expected project costs for GAS total approximately $300 million (20% interest), excluding financing costs.
Credit Metrics: GAS's leverage ratio was expected to weaken prior to tax reform legislation, primarily due to the large capex program. Tax reform exacerbated the deterioration of the leverage ratio. FFO-adjusted leverage was particularly weak in 2018 as a result of tax reform refunds and taxes related to the gain on GAS's divestures. In Illinois and Georgia, GAS's largest service territories by rate base, the impact of tax reform at regulated gas LDCs was largely resolved in 2018, alleviating negative pressure. In 2019, GAS's FFO adjusted leverage improved to 4.3x from more than 7.0x in 2018. Fitch expects GAS's FFO leverage to average 5.1x over 2021-2023, assuming a certain amount of equity contribution from Southern Company.
Parent-Subsidiary Linkage: GAS has operational, financial and functional ties to its parent, Southern Company, resulting in a moderate level of ratings linkage. Southern Company's philosophy regarding financing and cross-affiliate support is that each operating company issues its own debt and preferred securities, which are nonrecourse to the parent. There are no cross-defaults among Southern Company and its subsidiaries. Parental and affiliate credit support (i.e. guarantees, indemnifications) are minimized to the maximum extent possible. Fitch typically limits the notching difference between IDRs of Southern Company and its subsidiaries to two notches.
Fitch has applied a bottom-up approach in rating GAS. Fitch considers GAS to be the stronger entity than its parent. However, Fitch has capped Gas's IDR by that of its parent company since we expects GAS to rely on the parent to support its capex program.