MRO Magazine

Fitch Affirms Otter Tail Corp and Otter Tail Power’s IDRs; Outlook Stable


July 31, 2015
By Business Wire News

NEW YORK

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 OTTR and OTP 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 small regulated electric utility and two small cyclical industrial businesses that operate in fragmented, competitive markets.

OTP is the main driver of consolidated earnings and cash flows and comprised 75% of consolidated EBITDAR for the LTM period ending March 31, 2015. Going forward the utility segment is expected to approximate roughly three-fourths of consolidated earnings. The Stable Outlook reflects Fitch’s expectations that utility earnings and cash flows will be supported by regulatory recovery mechanisms that afford timely recovery on investments during a period of high capital spending at OTP.

OTTR – KEY RATING DRIVERS

OTTR’s ratings and Stable Outlook reflect its higher operating risk profile from its diversified non-regulated business portfolio. Following the divestiture of its poorly performing business over the last couple of years, including the sale of its construction businesses earlier this year, OTTR’s remaining nonregulated activities consist of two segments: manufacturing and plastics. While OTTR’s business risk profile has improved since the last review, earnings at the nonregulated businesses can be volatile and Fitch expects these businesses to comprise roughly one-fourth of consolidated earnings.

Challenges at Non-regulated Businesses: OTTR’s non-regulated manufacturing and plastics businesses did face cyclical challenges in the first quarter of 2015, particularly at OTTR’s metal and fabrication company, BTD. BTD was negatively impacted by a reduction in demand from the agriculture, oil and gas and energy (wind) industries due to lower commodity prices and significantly lower scrap metal sale prices as compared to last year. Fitch expects OTTR may consider related acquisition opportunities in its manufacturing segment to drive growth.

Low Consolidated Leverage: 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 $53 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.

Credit Metrics Modestly Pressured: Recently, challenges at OTTR’s non-regulated businesses along with mild winter weather at OTP have modestly pressured credit metrics. EBITDAR-to-interest weakened to 3.9x for the LTM ended March 31, 2015 from 4.2x and 4.5x for 2014 and 2013, respectively. Going forward, Fitch assumes continued growth at the utility and BTD and projects EBITDAR-to-interest to remain between 4.5x and 5.0x during the 2015 to 2018 forecast period.

Solid Credit Metrics: OTTR has traditionally employed a low level of leverage, and debt-to-EBITDAR leverage approximated 3.6x for the LTM ending March 31, 2015. Going forward, Fitch expects leverage to remain under 3.5x through the forecast period. Concomitantly, OTTR will be required to raise and downstream equity to OTP in future years to support the utility’s capital structure during the capex build-out period.

OTP – KEY RATING DRIVERS

Otter Tail Power’s (OTP) Stable Outlook reflects the regulated nature of its electric utility operations across its three state jurisdictions in Minnesota, North Dakota, and South Dakota. OTP continues to perform strongly but faces pressures from a large capex program that will put modest pressure on credit metrics over the next four years.

Constructive Regulatory Environment: Fitch expects OTP’s regulatory environment to remain constructive throughout the forecast period and notes that OTP’s authorized return on equity (ROE) in its two largest jurisdictions, Minnesota and North Dakota, are above industry averages at 10.74% and 10.75%, respectively. The states accounted for 91% of 2014 electric retail sales.

Timely Return on Invested Capital: OTP benefits from tariff recovery mechanisms that provide for a timely return on invested capital and purchased power recovery across its three state jurisdictions. OTP has capex rider recovery mechanisms for new transmission and environmental compliance investments that provide for earnings and cash flow growth between general rate case (GRC) proceedings. Additionally, transmission projects are supported by construction work in progress (CWIP).

Large Capex Program: Fitch expects average rate base growth of 9% through 2019, driven by capital investments totalling $665 million, levels approximately 35% higher than the preceding five years. Notably, two-thirds of capex is recoverable under rider mechanisms. Capex is focused on new transmission and renewable investments, environmental compliance investments at the coal-fired Big Stone Power Plant, and new gas generation associated with the planned retirement of the coal-fired Hoot Lake plant in 2020. Fitch expects OTP to remain free cash flow (FCF) negative through the forecast period, that future funding needs will be met by a 50%/50% mix of debt and equity, and that OTTR will downstream additional equity as needed to support the balanced capital structure.

Solid Credit Metrics: Fitch expects OTP’s large capex program to modestly pressure credit metrics through the forecast period. EBITDAR coverage is expected to average 4.5x-5.0x and debt-to-EBITDAR leverage is expected to increase moderately and be approximately 4.0x through 2018, in line with the current rating category.

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 due to the increased risk typically associated with nonregulated operations.

Lower Business Risk Profile: Despite the downsizing of the non-regulated business investments, Fitch projects OTTR to derive roughly one-fourth of consolidated earnings from non-regulated businesses. Consequently, Fitch expects to maintain at least a one notch rating differential between OTTR and OTP.

KEY ASSUMPTIONS

Fitch’s key assumptions within the rating case include:

–Assumes a GRC filing in 2017 for rates effective in 2018 based on a 10% ROE;

–Large capex program at OTP totalling $665 million through 2019;

–Anticipated equity infusions from OTTR to OTP to preserve balanced capital structure;

–Long-term debt maturities of $53 million in 2016, $33 million in 2017, and none in 2018.

RATING SENSITIVITIES

Rating Sensitivities for OTTR

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:

–An upgrade at OTP;

–Further downsizing of non-regulated businesses;

–Retirement of Parent Only Debt.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

–A sustained downturn in the economically sensitive nonregulated higher-risk businesses;

–An acquisition that is debt-financed or that materially heightens the business risk profile;

–Sustained debt-to-EBITDAR above 4.0x.

Rating Sensitivities for OTP:

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:

–Constructive regulatory outcomes in future GRC proceedings;

–Sustained debt-to-EBITDAR in the 3.5x-3.75x range;

–Successful execution and balanced funding of the large capital investment program.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

-Adverse future regulatory outcomes;

-Failure to maintain a balanced equity component in its capital structure;

-Sustained debt-to-EBITDAR leverage above 4.25x.

LIQUIDITY

Sufficient Liquidity: OTTR has $271 million of consolidated liquidity available as of March 31, 2015. OTTR and OTP maintain liquidity though separate revolving credit facilities totalling $150 million and $170 million, respectively. The unsecured credit facilities mature on Oct. 28, 2019 and the companies may increase the size to $250 million with the consent of the lenders. The credit facilities contain a maximum debt-to-capitalization ratio covenant of 60%, and both OTTR and OTP were in compliance with debt-to-capitalization ratios of 48% and 49% as of March 31, 2015. Long-term debt maturities are minimal over the next four years and include: none in 2015, $53 million in 2016, $33 million in 2017, and none in 2018. Fitch expects the maturing debt to be refinanced on a timely basis.

FULL LIST OF RATING ACTIONS

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 on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology – Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Recovery Ratings and Notching Criteria for Utilities (pub. 05 Mar 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=863298

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=988865

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=988865

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY’S PUBLIC WEBSITE ‘WWW.FITCHRATINGS.COM‘. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH’S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE ‘CODE OF CONDUCT’ SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

Fitch Ratings
Primary Analyst/Lead Surveillance Analyst
Daniel Neama
Associate Director
+1-212-908-0561
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Secondary Analyst
Philippe Beard
Director
+1 212-908-0242
or
Committee Chairperson
Philip W. Smyth, CFA
Senior Director
+1-212-908-0531
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com