OREANDA-NEWS. U.S. natural gas distribution utilities are well-positioned from a credit perspective, despite challenges including muted consumption, rising fixed costs, and declining allowed return on equity (ROEs), according to a Fitch Ratings special report.

Gas local distribution companies (LDCs) have typically enjoyed high investment-grade ratings, primarily driven by low operational risks, supportive regulatory treatment, favorable capital market conditions, and low commodity prices that alleviate pressure on customer bills and accommodate robust capex and rate base growth.

Gas utilities are usually allowed adequate ROEs relative to their business risks and they have often been early beneficiaries of revenue decoupling or stabilization mechanisms. Although authorized ROEs have continued to inch downwards, Fitch's study shows that gas LDCs typically fare better than their electric peers. Additionally, 38 states now have rate mechanisms that allow partial recovery of preapproved pipe upgrade and replacement costs between rate cases, according to the American Gas Association.

The divergence of residential gas customer growth and gas consumption will continue to be a challenge for the sector. Natural gas consumption has largely lagged behind customer growth primarily as a result of energy conservation and efficiency over the past decade. However, many states have rate stabilization mechanisms such as decoupling or weather normalization, which partially insulates LDCs from volume declines.

Fitch expects mergers and acquisitions activity to continue in the sector as gas utilities seek scale and diversity to offset muted consumption patterns and drive earnings growth. Aggressive valuations and increased use of debt in acquisition financing are credit concerns. Since 2010, the enterprise value/earnings before interest, tax, depreciation and amortization (EV/EBITDA) multiples for gas LDC acquisitions have often exceeded 10.0x. In comparison, electric utility transactions generally reflect 7.0x-8.0x EV/EBITDA multiples.

LDCs' capex growth will continue to be robust. Fitch's data indicates that aggregate capex will grow by 17% in 2015 following a 13% growth in 2014. Although current data suggests capex will decline in 2016, a likely scenario is that forecasts will be revised upwards for 2016 and beyond. Pipeline safety programs and aging infrastructure replacement are primary drivers of growth, supported by widely adopted infrastructure cost recovery mechanisms.