OREANDA-NEWS. June 16, 2015. Fitch Ratings has affirmed the 'BBB-' Issuer Default Rating (IDR) and security ratings of Empire District Electric Company (EDE). Fitch has also affirmed EDE's short-term IDR at 'F3'. The Rating Outlook is Stable. A full list of rating actions follows at the end of this release.

EDE's ratings affirmation reflects a balanced settlement achieved in the pending Missouri rate case and strengthening credit metrics as capex requirements start to moderate after 2016 with the completion of environmental projects. Fitch is concerned somewhat with regulatory fatigue setting in, given prospects of back-to-back rate filings. In addition, the perceived improvement in Missouri regulation appears to be stalling with the elimination of various previously approved trackers in the pending rate case. However, these regulatory concerns are currently not putting any material pressure on EDE's ratings given the sufficient headroom in credit metrics.

KEY RATING DRIVERS

Missouri Rate Settlement: the rate settlement provides for recovery of EDE's prior environmental spending at its coal-fired Asbury plant and should enhance earnings and cash flows beginning in the second half of 2015, in Fitch's view. The settlement reflects a \\$17.1 million electric base rate increase, representing approximately 70% of the utility's original rate request. The environmental retrofit at Asbury, the primary driver of EDE's pending rate case, was completed in December 2014 with a total cost of approximately \\$112 million, which was at the lower end of the range estimated by management at the onset of the project. The settlement is subject to final approval by the Missouri Public Service Commission (MPSC) with new rates expected to be effective at the end of July 2015.

Regulatory Challenges Remain: Fitch believes the elimination of trackers for vegetation management and Iatan and Plum Point maintenance costs should be manageable within EDE's current financial profile, but more concerning is the regulatory treatment of Southwest Power Pool (SPP)-related transmission charges. To reduce the negative effect of regulatory lag, EDE has requested that SPP-related transmission charges, a relatively sizeable component of total operating expenses, be included in its Fuel Adjustment Clause (FAC) and a decision will be made in the context of the MPSC's review and approval of the rate settlement. Union Electric Co.'s (UE) recent rate order also resulted in the elimination of certain trackers and the removal, in large part, of MISO-related transmission charges from UE's FAC.

Moderate Risk of Regulatory Fatigue: Due to the absence of an environmental cost recovery rider in Missouri, management is planning on filing another full-blown rate case shortly after the conclusion of the pending rate proceeding in order to recover costs related to the conversion of the Riverton 12 natural gas plant to combined cycle. EDE plans on completing the \\$165 million-\\$175 million project in early to mid-2016 and would seek to implement a base rate increase in the near term.. While regulatory fatigue, created by the expectation of back-to-back increases in customer retail rates is a credit concern, Fitch believes the mandated nature of the Riverton environmental capital spending should allow for balanced regulatory treatment, in line with the outcome related to Asbury. A less than constructive rate order would change Fitch's perception of the improving regulatory regime in Missouri..

Capex Winding Down: Capex is projected to amount to \\$115 million in both 2016 and 2017 compared with a peak of \\$223 million in 2014 and \\$178 million in 2015. The capex wind-down reflects the completion of environmental spending at the Asbury and Riverton plants. EDE became fully compliant with existing environmental regulations with the completion of the environmental retrofit at the Asbury plant in late 2014, and the utility estimates the project to convert the Riverton Unit 12 plant from a simple cycle combustion turbine to a combined cycle unit to be about 73% complete. Concurrently with the conversion of Riverton Unit 12, EDE will retire older Riverton units. Management projects capex to bounce back post 2017 and estimates spending of \\$164 million in 2018 and \\$160 million in 2019, primarily driven by investments in customer reliability and communication.

Efficient cost control during the capex cycle and between rate cases will continue to be a key driver of the financial profile. Fitch expects EDE to use a balanced mix of internally generated cash flows, debt and equity to finance capex and manage to a 50%-50% debt-to-equity mix. Fitch forecasts EDE's internally generated funds to fund on average 85% of capex requirements over the next five years.

Adequate Credit Metrics: Fitch projects adjusted debt/EBITDAR to approximate 4x in both 2015 and 2016 and improve to 3.6x by 2017. FFO-adjusted leverage is estimated to stand at 4.3x in 2015 and 4.6x in 2016 before improving to 4.2x by 2017. Credit protection measures should experience some pressure through 2016 due to persistent regulatory lag, but subsequently improve, boosted by tariff increases in all jurisdictions, efficient cost control, and lower capex levels which are less reliant on financing outlays. For the LTM period ended March 31, 2015, the ratios of adjusted debt/EBITDAR and FFO lease-adjusted leverage were 4.1x and 3.7x, respectively.

Low-Risk Business Model: EDE's relatively predictable earnings and cash flows are derived from its regulated electric and gas businesses that operate in the regulatory jurisdictions of Missouri, Kansas, Arkansas, and Oklahoma. EDE generates the majority of its earnings from Missouri, which represented approximately 86% of operating revenue in 2014. All jurisdictions feature fuel adjustment mechanisms that allow for timely recovery of fuel costs and purchased power expense, and stabilize cash flows.

KEY ASSUMPTIONS

--Incremental rate relief over 2016-2019;
--O&M expenses relatively flat over 2016-2019;
--Electric sales growth between 0%-0.5%;
--Projected capex of \\$732 million over 2015-2019;
--Normalized cash tax payments starting in 2016 following expiration of bonus depreciation and other tax credits.

RATING SENSITIVITIES
Future developments that may, individually or collectively, lead to a positive rating action include:
--A material improvement in Missouri regulation in the form of reduced regulatory lag and reinstatement of trackers, including favorable treatment in rates of SPP-related transmission charges, along with adjusted debt/EBITDAR between 3.75x-4.0x or FFO-adjusted leverage maintaining between 4.5x-5.0x.

Future developments that may, individually or collectively, lead to a negative rating action include:

--Any material cost disallowances on capex or the removal of additional trackers including EDE's FAC.
--Adjusted debt/EBITDAR at or above 5.0x on a sustained basis.
--Inability to recover incremental costs stemming from potential weather-disruptive events such as tornadoes.

SUFFICIENT LIQUIDITY

EDE has access to a total capacity of \\$200 million under a five-year credit facility that matures in October 2019. The facility was renewed and upsized from \\$150 million in 2014. The credit facility includes, subject to bank approval, a \\$75 million accordion feature and two one-year extensions of the maturity date. At March 31, 2015, there were \\$53 million of borrowings outstanding under the facility and \\$2.7 million of cash and cash equivalents. The credit agreement includes a financial covenant that total debt/cap should be no greater than 65%, and EDE was in compliance with the covenant. Long-term debt maturities are considered manageable with \\$25 million due in 2016 and \\$90 million due in 2018. Fitch expects EDE to refinance the 2018 obligation at maturity.

FULL LIST OF RATING ACTIONS

Fitch has affirmed EDE's ratings as follows:

--IDR at 'BBB-';
--Senior secured debt at 'BBB+';
--Senior unsecured debt at 'BBB';
--Short-term IDR and CP at 'F3'.

The Rating Outlook is Stable.