Fitch Affirms Mountaineer Gas at 'BB+'; Outlook Stable

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has affirmed Mountaineer Gas Company's (MGC) Long-Term Issuer Default Rating (IDR) at 'BB+' and Senior Unsecured Debt rating at 'BBB-'. A complete list of rating actions follows at the end of this press release.

The Rating Outlook is Stable.

These rating actions affect $90 million of long-term debt.

The ratings on MGC primarily reflect balanced recent rate case outcomes in an otherwise challenging regulatory environment in West Virginia. The ratings also incorporate an elevated capex program and a private equity ownership structure with an aggressive financial policy.

KEY RATING DRIVERS

Pending Approval of 2015 General Rate Case Settlement

Fitch considers the 2015 general rate case (GRC) settlement agreement to be balanced and consistent with prior rate case outcomes. In July 2015, MGC, the Public Service Commission of West Virginia (PSCWV) staff, the Consumer Advocate Division of the Commission, and selected commercial customers that have collectively intervened as the West Virginia Energy Users Group joined in a joint stipulation and agreement for settlement regarding MGC's 2015 GRC. The joint stipulation is subject to the PSCWV's acceptance and approval, which Fitch expects to occur by the beginning of November.

The joint stipulation would result in a base rate increase of $7.7 million, or 3.0%, which is based on a historical test year ended Sept. 30, 2014, and an authorized return on equity (ROE) of 9.75%. MGC had requested a $12.2 million base rate increase based on a forecasted test year ending Sept. 30, 2016. The joint stipulation includes MGC's proposal to decrease its purchased gas adjustment (PGA) rate, which would result in a net decrease in overall rates even after factoring in the proposed base rate increase. The requested effective date of implementation for the base rate increase and PGA rate decrease is Nov. 1, 2015.

MGC received a balanced ruling in its last GRC. The PSCWV approved a $6.265 million rate increase effective Nov. 1, 2012, representing approximately 60% of MGC's revised revenue request. The rates were based on an authorized ROE of 9.9%. In April 2013, the PSCWV authorized an additional $522,000 annual revenue increase.

Challenging Regulatory Environment

Fitch considers the West Virginia regulatory environment to be challenging, despite MGC receiving relatively constructive base rate increases and slightly better than average authorized ROEs for gas distribution utilities during its recent rate cases. The PSCWV does not currently allow MGC the use of many regulatory mechanisms authorized in more-supportive regulatory jurisdictions, which would provide greater stability and predictability to cash flows.

MGC does not have revenue decoupling or weather normalization, nor does it have riders for infrastructure replacement costs, pension expense, bad debt expense, or property taxes. In addition, the PSCWV uses a historical test year, as opposed to a forecasted test year, for determining rate increases. As a result, MGC is expected to continue to under-earn on its authorized ROE and experience significant volatility in cash flows.

Elevated Capex

MGC projects annual capex spending to range between $19 million and $21 million from 2015 through 2018, about 40% higher than the average capex over 2011-2013. MGC, similar to the rest of the natural gas distribution industry, is incurring higher spending for pipe integrity and safety inspections as well as replacement of older bare steel pipe, which accounts for roughly a quarter of its pipeline system. The full replacement of MGC's bare steel pipe is expected to take several decades at the current rate.

MGC has requested approval of a multi-year infrastructure improvement rider that would allow for contemporaneous recovery of replacing, upgrading, and expanding gas infrastructure. Fitch would view approval of such a rider as credit-supportive in its ability to help reduce regulatory lag associated with MGC recovering its infrastructure investment costs. Legislation was signed by West Virginia Governor Tomblin in March 2015, and Fitch expects a PSCWV decision before the end of 2015.

Private Equity Ownership Structure

MGC is owned by Mountaineer Gas Holdings Limited Partnership (MGH), which is composed of general partner MGH LLC and limited partner Mid Mountain Holdings II LLC. IGS Utilities LLC, a partner in MGH LLC, provides general management oversight of MGC. Fitch considers the private equity ownership structure to present an increased level of credit risk due to an aggressive dividend payout policy and weak financial flexibility.

MGC's dividend payout ratio was nearly 90% in 2014, significantly higher than the industry average of roughly 65%. Fitch expects MGC to continue with an above average dividend payout ratio close to 100% in future years. Capital access is limited, although MGC received a $20 million equity infusion in 2014. MGC may require further equity infusions and/or revolver borrowings to fund its elevated capex program and maintain its aggressive dividend policy.

Supportive, But Volatile, Financial Metrics

Fitch expects MGC's financial profile to remain supportive of the ratings, but the company's small size, seasonal working capital borrowings, and exposure to the effects of weather result in significant swings in financial metrics, both on a seasonal basis and year-to-year. Due to the seasonal nature of the winter heating season, short-term debt used to finance natural gas inventories and carry customer receivables normally peaks in late December and then is typically paid down by the end of the first quarter. There were $36 million of short-term borrowings at year-end 2014 and none at June 30, 2015.

For the year ended Dec. 31, 2014 and the LTM ended June 30, 2015, FFO fixed-charge coverage was 4.4x and 3.4x, FFO-adjusted leverage 3.3x and 3.0x, and adjusted debt/EBITDAR 3.6x and 2.9x, respectively. Financial metrics in 2014, and also in 2013, benefited from colder-than-average weather conditions. Assuming normal weather conditions going forward, Fitch forecasts FFO fixed-charge coverage to average 3.7x - 4.1x, FFO-adjusted leverage 4.0x - 4.3x, and adjusted debt/EBITDAR 3.7x - 4.1x. The weaker projected leverage metrics account for increased revolver borrowings associated with the larger capex program.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for MGC include:

--PSCWV approval of the 2015 GRC settlement agreement, with a $7.7 million annual base rate increase effective Nov. 1, 2015;

--Implementation of an infrastructure replacement program rider, effective in 2016;

--O&M increases at an average annual rate of 2.5% over 2015 - 2018;

--Capex averaging $20 million per year over 2015 - 2018;

--Normal weather.

RATING SENSITIVITIES

Positive: A positive rating action is not likely, given the challenging regulatory environment in West Virginia, volatility of MGC's financial metrics, and ownership's aggressive financial policy. However, a positive rating action could occur if the PSCWV were to implement regulatory mechanisms that were sufficient enough to provide a greater level of stability and predictability to cash flows. In addition, Fitch would look for stability and sustainability among the following financial metrics: FFO fixed-charge coverage greater than 4.1x, FFO-adjusted leverage to remain less than 5.0x, and adjusted debt/EBITDAR less than 4.0x.

Negative: Factors that could lead to a downgrade include future unfavorable regulatory orders that restrict MGC's ability to recover costs in a timely manner, a more-aggressive management policy that leads to greater distributions to owners and increased leverage, and a failure to maintain FFO-adjusted leverage of less than 6.0x and FFO fixed-charge coverage of at least 3.5x on a sustained basis.

LIQUIDITY

Fitch considers MGC's liquidity to be adequate, primarily supported by a $100 million unsecured revolving credit facility. The five-year facility expires Dec. 1, 2019, and includes an accordion feature that could expand the size of the facility up to $170 million to account for unusually high natural gas prices and volumes that can occur during the winter heating season. This facility should provide MGC with sufficient availability for its working capital needs following the May 2013 expiration of the utility's gas asset management agreement with Sequent. As of June 30, 2015, there were no borrowings outstanding under the facility, leaving $100 million of availability.

The credit facility includes financial covenants to maintain EBITDA interest coverage of at least 2.0x and a debt/capitalization ratio no greater than 65%. There is also an annual cap of $25 million for capex. MGC is in compliance with all of its financial covenants.

MGC's next long-term debt maturity is in 2017 when its $70 million, 7.58% unsecured senior notes come due.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings with a Stable Outlook:

Mountaineer Gas Company

--Long-Term IDR at 'BB+';

--Senior Unsecured Debt '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=989214

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=989214

Endorsement Policy

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

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Fitch Ratings
Primary Analyst
Kevin L. Beicke, CFA
Director
+1-212-908-0618
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004
or
Secondary Analyst
Philippe Beard
Director
+1-212-908-0242
or
Committee Chairperson
Craig D. Fraser
Managing Director
+1-212-908-0310
or
Media Relations:
Sandro Scenga, +1 212-908-0278
[email protected]

Source: Fitch Ratings

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