Rating Action Overview

• We expect Australian Gas Infrastructure Holdings (AGIH) to derive 85%-87% of its EBITDA from two monopoly, regulated, gas network assets in Australia to fiscal 2024, with the remainder coming from contracted midstream assets. AGI Finance Pty Ltd. (AGIF) is the financing vehicle for AGIH.
• AGIF's financial metrics are likely to be relatively stable over the next few years, supported by good cash flow visibility in its regulated businesses, resulting in funds flow from operations to debt of just above 9%.
• On Nov. 9, 2020, S&P Global Ratings assigned its 'BBB+' long-term issuer credit rating to AGI Finance Pty Ltd.
• The outlook on AGIF is stable, reflecting current and emerging cash flow certainty at AGIH's subsidiaries, Energy Partnership (Gas) Pty Ltd. (EPG) and DBNGP Trust (DBNGP), respectively. We also expect the group to manage its financial profile consistent with the current rating by appropriately balancing its shareholder expectation against growth aspirations in the midstream segment, capital expenditure demands, and future regulatory resets.

Rating Action Rationale

The rating on AGIF reflects the consolidated credit profile of AGIH, which in our view has an excellent business risk profile.  AGIH is newly established as the holding entity for three existing and operating gas assets:

• EPG the financing arm of Multinet Gas, the regulated gas distribution business in Victoria;
• DBNGP, the regulated gas transmission pipeline in Western Australia, and
• Australian Gas Infrastructure Development (AGID), the entity with a small portfolio of unregulated, contracted midstream gas assets predominantly in Western Australia and the Northern Territory.

AGIF will be the sole financing vehicle for AGIH's subsidiaries with all debt at the subsidiaries eventually refinanced at AGIF. Cross guarantees are established among all the entities through a suite of common security and trust deed documents.

AGIH's monopoly position of its regulated assets strengthens the business risk profile.  AGIH derives about 85% of its EBITDA from EPG and DBNGP, which dominate our business risk assessment of AGIH on a consolidated basis. These entities are overseen by Australia's established, transparent, and predictable regulatory regime, which underpins our assessment. We anticipate that the EBITDA contribution from the regulated businesses will be relatively stable over the next few years, supported by modest cash flows from AGIH's midstream operations.

We expect AGIF's consolidated metrics to be relatively stable over 2021-2022, supported by regulated cash flows.  We expect funds from operations (FFO) to debt to trend at around 9.0%-9.5% over the forecast period, with good cash flow visibility due to known and emerging tariff profiles in AGIH's regulated businesses. This should provide AGIF with some headroom to manage EPG's regulatory reset commencing in July 2023, which could prove challenging due to the current low interest rate environment. Further, we do not anticipate any deleveraging at the group level over the forecast period.

In our view, the likely growth in the midstream business will influence AGIH's business profile over the next few years, given the limited growth prospects in the regulated business.  Midstream assets can increase business risks subject to the size and type of assets, tenor and nature of contracts; exposure or not to commodity price and volumes; credit quality of counterparties; and repricing of contracts. Currently, AGIH's midstream gas business contributes around 10%-15% of EBITDA from six contracted gas pipelines and a gas storage facility. Over the forecast period, this will likely be at the upper end of this range as the company completes and cash flows commence from its Turbridgi gas storage expansion project. We currently do not expect the group to undertake any large project. For the current rating level, we would expect any material increase in exposure to the midstream business (such as EBITDA contribution scaling above 25% of the group's) to be progressively offset by better financial metrics.

Business risk

AGIH's regulated gas distribution and transmission businesses (EPG and DBNGP, respectively), their strong regulatory framework, and their stable profitability underpin the excellent business risk. The regulatory building blocks that underpin tariffs and support cash flows of Australian utilities are well established, transparent, and predictable, providing a high level of cash flow certainty and stability throughout the five-year regulatory periods that both these entities operate under.

Table 1

DBNGP's combination of regulated and bilaterally negotiated contracts provides certainty over the medium term. While DBNGP is a regulated asset in Western Australia, historically the management has sought to contract pipeline capacity with large shippers on a bilateral basis using the regulatory building-block approach. Over the next five years to December 2025, about 66% of DBNGP's cash flows will come from such bilateral contracts that have been agreed. The remaining 34% will be derived from regulated tariffs. The draft regulatory decision issued in August 2020 has been incorporated into our forecasts with a final outcome expected in early 2021. Generally, the final outcome is not more onerous than the draft.

The regulator's draft proposed for DBNGP's total revenue over the five-year period is A$1,553 million, compared with A$1,845 million in the current period. This reflects a full-haul unit tariff decline of about 20% (from A$1.337 to A$1.048 [A$/GJ/day]). The drop is largely driven by a decline in the weighted average cost of capital (WACC) from 5.60% in the current regulatory period to 4.03% over 2021-2025, attributable to the current low interest rate environment. Final determination is expected early 2021, and we do not expect downside to the draft outcome.

EPG's current regulatory period is set until June 2023, providing tariff certainty and cash flow visibility over this period. EPG will most likely face lower returns upon reset if the interest rates remain low. The current WACC of 5.67% will likely decline, reducing revenues derived from the regulated asset base (RAB).

Recent determinations for ATCO Gas Australia Pty Ltd. (BBB+/Stable) (gas distribution reset in November 2019) and ETSA Utilities Finance (A-/Stable) (electricity distribution reset in June 2020) set WACCs of 4.16% and 4.75%, respectively. The new WACCs demonstrate the likely step-change AGIH will need to manage. Additional clarity regarding regulatory parameters will emerge once the determination process commences closer to the expiry of the current period.

We view the staggered regulatory resets for the two assets provide AGIH with sufficient time to adjust and accommodate a lower return path attributable to lower WACCs. We anticipate AGIH's regulated businesses will operate at or below their operating cost allowances. This is supported by both companies' simple operations, good operating track records, and ongoing synergies from common management.

AGIH's regulated businesses serve large and diverse population centers in their respective areas of operations. DBNGP is the key gas transmission asset in the State of Western Australia servicing the state capital of Perth, the state's primary population center. It also derives the majority of its revenues (about 85%) from contracted full-haul capacity that are on a take-or-pay basis, supporting cash flow stability. EPG services around 705,000 customers in the eastern and southeastern suburbs of the Victorian state capital of Melbourne, around 98% of which are residential. This somewhat offsets the volume risk that EPG is exposed to under its price cap regulatory mechanism.

AGID operates primarily contracted gas transmission pipelines and gas storage facilities, mainly in the state of Western Australia. We regard these as midstream assets, and they would contribute about 10%-15% of AGIH's total EBITDA. Currently, we don't regard the composition of counterparties or the unregulated footprint as posing a risk to the business profile. This is based on our assessment of current known projects and their comparatively small contribution to group EBITDA.

However, any material increase in AGID's footprint, whereby it contributed more than 25% of group EBITDA, would add incremental business risk. Dilution of cash flows from any of the existing AGID assets that is not offset by debt reduction can affect the financial metrics. Further, AGID's contribution to the total group can move depending on the change in regulated cash flows upon resets.

We have captured the unregulated nature of AGID, the company's aspirations to grow midstream, and the relatively higher leverage of the group through the use of our negative comparable rating assessment. Further, the uncertainty in the level of financial headroom due to the regulatory reset at EPG in July 2023 and management's FFO-to-debt target of greater than 8% is captured through our negative financial policy modifier.

AGIH is fully owned by CK Infrastructure Holdings Ltd. (CKI; A/Stable/--). We consider AGIH to be a moderately strategic asset to CKI as:

• The group is unlikely to sell down its interests in AGIH in the near term.
• AGIH is likely to receive support from the group should it fall into financial difficulty.
• AGIH has been successful in its Australian operations and has realistic medium-term prospects of success relative to the group management's specific expectations.

We therefore factor in a degree of group support (one notch up from the stand-alone credit profile of the group). We expect that the owners will manage dividends in a disciplined way and offer support to the group to maintain the credit profile, if needed, particularly for growth in the midstream segment.

Financial risk

Given the dominance of regulated revenues within AGIH's cash flows (more than 85% EBITDA in calendar 2020), we consider AGIH to have lower volatility in its financial metrics compared with other industries. Consequently, we assessed AGIH's financial profile against our low-volatility metrics table, similar to other regulated peers in the Australian market. AGIH has an internal target of operating with an FFO to debt of at least 8% over the medium term.

We anticipate that AGIH's consolidated FFO-to-debt metrics will strengthen slightly from around 9% in calendar 2020 to 9.0%-9.5% over the next few years. This is due to tariff escalation under the EPG business to 2022, much reduced interest payments following recent reset of the debt swaps under the DBNGP business in line with upcoming reset, and no expectation of cash tax payments.

Our assessment incorporates the draft determination which DBNGP Trust received in August 2020 and AGID's expansion of the Turbridgi gas storage facility. This provides AGIH with a degree of headroom against its target FFO-to-debt ratio of above 8% in advance of the EPG reset in July 2023. Based on subdued WACC parameters for EPG from 2023, current capital expenditure (capex) profile, and no cash taxes over the forecast period, we estimate FFO to debt will settle around 8.5%-8.8% beyond 2023.

The group's investment (about 55% of total capex) in the EPG business, mainly replacement of pipelines, will dominate capex. Investment in DBP will be modest (about A$40 million to A$45 million per year) to ensure asset reliability and maintenance. Capex in midstream is about A$45 million, toward expansion of AGID's existing Turbridgi gas storage facility. We have not assumed any material midstream project over the forecast period. Given the trend-line in the financial profile, we see limited ability to fund any large projects on balance sheet. If a new potential project were to arise, we would expect management to manage its funding appropriately and not fund the project to the detriment of the metrics.

Outlook

The stable outlook on AGIF reflects our view of the group's high cash flow certainty from its regulated and contracted revenues and known tariffs for the majority of its cash flows. This will allow the company to operate with an FFO to debt of around 9%-9.5% over the next two to three years. In addition, we expect management to appropriately balance shareholder expectations against group capex demands, any potential growth in midstream business, and future resets to maintain metrics consistent with current ratings.

Downside scenario

Ratings downside will likely occur if FFO to total debt were to fall below 8%, with no remedial action forthcoming to restore the metrics. This could occur if the company's distribution profile were not adjusted against capex needs or tariff resets or volumetric risk were to pressure cash flows.

Rating transition could also emerge if the group's industry risk profile were to diverge materially from the current dominant regulated nature without a compensating improvement to the financial risk profile. For example, this could happen if the group were to undertake a significantly large unregulated or contracted project.

Upside scenario

We believe there is limited rating upside given the trend-line in the metrics and potential growth in the midstream segment. Yet, the rating could be higher if AGIG were to operate with an FFO-to-debt ratio of above 10% on a sustained basis and management is committed to maintaining this profile.

Company Description

AGI Finance Pty Ltd is the common funding vehicle for Australian Gas Infrastructure Holdings Pty Ltd., which consists of the operating subsidiaries Energy Partnership (Gas) Pty Ltd. (BBB+/Stable), DBNGP Trust (BBB+/Stable), and AGI Developments (not rated). AGIF is 100% owned by Australia Gas Infrastructure Holdings Pty Ltd., which is in turn 40% owned by CK Infrastructure Holdings Ltd. (A/Stable/--), 40% owned by CK Asset Holdings Ltd. (A/Stable/--) and 20% owned by Power Assets Holdings Ltd. (A/Stable/--).

Our Base-Case Scenario

Assumptions

• EBITDA to be about A$500 million-A$530 million in 2020, and between A$450 million andA$480 million in 2021-2022, driven by the current regulated profile for EPG, draft regulated profile for DBNGP, and known midstream projects.
• DBNGP regulatory reset to result in EBITDA step-change in 2021.
• Capex of around A$140 million-A$160 million in 2020, A$180 million-A$200 million in 2021 driven by Turbridgi storage expansion, and A$130 milloin-A$150 million in 2022. We anticipate EPG's and DBNGP's capex to be in line with regulatory allowances.
• Distribution to shareholders of around A$210 million-A$240 million over the forecast period.
• Effective interest rates of around 4.5%-4.7% 2020 and 2.7%-3% thereafter, with moderation driven by refinancing synergies at the group level and the reset of DBNGP's hedging swaps.
• No cash taxes over the forecast period.
• Steady-state business and no new developments beyond the Turbridgi storage expansion.

Key metrics

Liquidity

We assess AGIF's liquidity as adequate. This is based on our expectation that liquidity sources will exceed uses by more than 1.1x over the next 12 months and that sources would remain sufficient even if EBITDA were to drop by 10% on a six-month debt maturity basis. Our assessment factors in the group's well-established relationships with banks and generally strong standing in the credit markets, and prudent refinancing management policies.

While there are some modest debt maturities in April/May 2021, we believe AGIH is well advanced in placing appropriate facilities to manage any refinancing as part of the transition in the structure. We also expect the group to manage any refinancing well in advance of the maturities and with appropriate tenor given the long-term nature of the asset.

Principal liquidity sources:

• Cash on hand of about A$30 million as of June 30, 2020;
• Undrawn bank lines of around A$100 million as of June 30, 2020; and
• Cash FFO of about A$330 million to A$350 million over the course of the next 12 months.

Principal liquidity uses:

• Capex of around A$160 million to A$170 million over the next 12 months ending June 30, 2021;
• Dividends of about A$210 million to A$240 million over the next 12 months ending June 30, 2021; and
• No debt maturities over the course of the next six months ending Dec. 31, 2020.

Ratings Score Snapshot

Issuer Credit Rating: BBB+/Stable/--

Business risk: Excellent

• Country risk: Very low
• Industry risk: Very low
• Competitive position: Strong

Financial risk: Significant

• Cash flow/Leverage: Significant (Low volatility)

Anchor: a-

Modifiers

• Diversification/Portfolio effect: Neutral (no impact)
• Capital structure: Neutral (no impact)
• Liquidity: Adequate (no impact)
• Financial policy: Negative (-1 notch)
• Management and governance: Satisfactory (no impact)
• Comparable rating analysis: Negative (-1 notch)

Stand-alone credit profile: bbb

• Group credit profile: a
• Entity status within group: Moderately strategic (+1 notch)

Related Criteria

• General Criteria: Group Rating Methodology, July 1, 2019
• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019
• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014
• Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013
• General Criteria: Methodology: Industry Risk, Nov. 19, 2013
• General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013
• Criteria | Corporates | Utilities: Key Credit Factors For The Regulated Utilities Industry, Nov. 19, 2013
• General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012
• General Criteria: Principles Of Credit Ratings, Feb. 16, 2011
• General Criteria: Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010

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