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Moody's sees low debt refinancing, lack of M&A reducing utilities' capital needs

After weathering the financial impact of a federal tax overhaul in 2018, Moody's expects North American regulated electric and gas utilities to see a reduction in external financing needs despite ramping up capital spending.

"The North American regulated electric and gas utilities sector is in the midst of a period of high capital spending to grow rate base," Moody's analysts wrote in an Aug. 12 report. "However, despite the steady growth in capital expenditures and dividends paid, sharply lower debt refinancing and the absence of M&A financing will drive a decline in external capital needs."

The rating agency said the "use of cash" in the sector will hit $197.7 billion in 2019, down from $234.5 billion in 2018, "largely driven by lower debt refinancing requirements and a lack of M&A activity."

Moody's projects maturing debt will hit $38 billion in 2019, a steep drop from $65 billion in 2018.

In addition, the declining external capital needs among regulated utilities will reduce aggregate negative free cash flow to about $40 billion in 2019 from $58.2 billion in 2018, Moody's said, describing the reduction as "credit positive" for the sector.

The rating agency in June 2018 downgraded its outlook on the U.S. regulated utilities sector to "negative," citing lower cash flows and higher debt levels from federal tax reform along with increased capital spending.

This outlook remains negative as Moody's expects utilities to lean more on debt following an equity spike to support credit quality.

"The industry responded to the negative cash flow impact of US tax reform by issuing $23 billion of new equity in 2018, nearly equal to the combined $24 billion that the industry issued from 2015 to 2017, which was credit positive," analysts wrote. "The absolute level of equity issuance will likely moderate from 2018 levels over the next few years as we expect approximately 75% of the sector's negative free cash flow to be funded with new debt capital through 2021."

Moody's analyst Robert Petrosino said some of the things the rating agency has observed companies doing "around the periphery is re-institute their DRIP [dividend reinvestment programs] or institute some small ATM [at-the-market] equity issuance plans as well."

"So, they may not be doing it in big slugs ... they are kind of doing it more in dribs and drabs through those DRIPs and through those ATM programs," Petrosino said in an Aug. 13 phone interview.

And while the type of offerings may not impact credit ratings, "anything that is on the margin that is utilizing more equity than debt would be credit positive, in lieu of the alternative of course," Petrosino said.

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Moody's expects capital spending, another factor driving external needs, to "remain robust in 2019" with the potential to moderate in 2020 and 2021.

"The need for regulated utilities to attract new external capital stems from the fact that capital spending will continue to exceed [cash from operations]," Moody's said.

"Usually these CapEx plans are revised up more than revised down" as the forecast year approaches, Petrosino said.

Meanwhile, funding for acquisitions among regulated utilities is expected to "drop sharply this year to about $1.5 billion from $19.2 billion in 2018."

"We do not expect any additional acquisition funding needs among regulated utilities through the rest of 2019," analysts wrote.

The $4.3 billion takeout of El Paso Electric Co. by an investment vehicle advised by J.P. Morgan Investment Management Inc. represents one of the few significant transactions in what has been a relatively sleepy year for M&A so far. The deal, however, was announced in June and is not expected to close until 2020, the rating agency noted.

Pressed on their interest in Florida municipal utility JEA, Duke Energy Corp. executives told analysts and investors on an Aug. 6 earnings call that the company is focused on organic growth.

"We evaluate opportunities, as you would expect, as we see things that are in our service territory that we think are a fit for us," Duke Energy Chairman, President and CEO Lynn Good said. "But that would be evaluated within the broad context of our business plan, and we feel like our organic growth opportunities are quite strong, and that would be our highest priority."

Asset sales, however, are a tool that has helped utilities fill external capital needs whether they are funding M&A or stabilizing the balance sheet, according to Moody's.

Sempra Energy unit Oncor Electric Delivery Co. LLC's acquisition of InfraREIT Inc. was "funded largely with proceeds from assets sales," the rating agency wrote.

Meanwhile, Southern Co. sold Gulf Power Co. and other Florida interests to NextEra Energy Inc., while also offloading a number of smaller assets in 2018, to shore up the company's balance sheet.

At the macroeconomic level, Petrosino noted a change in interest rates could have an impact on external financing plans "given that this is a highly capital intensive industry."

"[I]n the previous years [of 2016, 2017 and 2018], there was a pretty high reliance on the use of short-term debt which, in effect, kind of funded the acquisitions of 2016 and [2018] or in part funded those acquisitions in 2016 and [2018]," Petrosino said. "So, given that those are kind of remaining short-term balances or [commercial paper] outstanding, given this current low interest-rate environment, we might see some of these companies term out those short-term debt balances and take advantage of the low interest rate."