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Costly utility M&A, asset investments may pose credit risks, Fitch says


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Costly utility M&A, asset investments may pose credit risks, Fitch says

?Credit-strainingendeavors, including costly mergers and high-dollar infrastructure investments,are expected to feature prominently in utility decision-making in 2016, FitchRatings said in a May 10 analyst note.

Withpersistently low interest rates and investor interest in earnings growth, theutility mergers and acquisition trend is set to continue, but these oftenhigh-premium deals could negatively affect the purchasing companies' creditratings, analyst Philip Smyth wrote in the note. Still, as power companiescontend with the growth in rooftop solar and other forms of distributedgeneration, gas utilities likely will remain attractive ways to grow, he addedduring a May 10 interview.

"They'relooking around for ways to provide growth to investors, and so I think that'swhat's going to keep driving the phenomenon," he said. "We do haveconcerns about the amount of debt. We'd like to see acquisitions done in abalanced manner."

Fitchand other ratings agencies have previously expressed concern about the sector'shigh-leverageacquisitions, and some of the buying as aresult. Despite the high price tags on deals, industry executivesalso expect M&Ato continue.

Meanwhile,gas utilities' own expansions remain a prominent and evolving aspect of thesector. Local distribution companies continue to eye riskier assets as possibleadditions to their traditional business. These decisions carry potentialadverse credit implications, Smyth wrote. These "forays into unregulatedbusinesses" are some of the events that are most likely to result innegative credit ratings actions, he wrote. However, the level of risk of coursedepends on which specific assets gas utilities chose to add, he said in theinterview.

"I'dhave to look at it on a case-by-case basis. ... By and large … pipelines areless risky than processing [assets]. It depends on where in midstream the[investments] are," he said. "But generally ... [when] you have ratebasing of natural gas or E&P, that I think can come back to haunt you alittle bit and just brings in other elements that can be riskier."

Gasutilities are pouring money into their existing systems as well. Across the gasutility distribution sector, CapEx in 2016 is expected to reach $5 billionamong Fitch-rated companies, representing a 15% uptick from 2015, according toSmyth. The expected spending is driven in large part by infrastructureintegrity work, including pipe replacement and modernization. The sector isprepared for the high CapEx, and with adequate regulatory support, thesignificant spending should be manageable, he wrote.?

"Moreover,pipeline replacement investment mitigates safety and reliability risksassociated with pipeline infrastructure and is currently politicallyuncontroversial," Smyth wrote. "Continued focus on investment in coredistribution assets, such as pipeline replacement and modernization[,] iscredit supportive."

Ifthe high CapEx continues and market conditions change, utilities might face adifferent credit reality than their current one, he observed. For instance, ifcommodity prices rise and drive up customers' monthly bills, regulators may beless inclined to grant utilities the rate increases needed to pursue theexpensive capital investments companies have planned. ?

"Iwouldn't expect [gas prices] to rise dramatically, but still, it's just anotherheadwind and makes things more difficult," Smyth said during theinterview. "It's always harder to do things in a rising commodityprice/interest [environment]."