Fitch Affirms Sempra, Southern California Gas & San Diego Gas & Electric's Ratings; Outlook Stable
KEY RATING DRIVERS
--Predictable earnings and cash flows from regulated utility operations and contracted energy infrastructure investments;
--Credit metrics consistent with rating category;
--Regulatory environment and recent general rate case (GRC) settlement constructive at its California utilities;
--Balanced expansion in the unregulated business segments;
--Sizeable capital expenditure at the California utilities;
--Significant parent-level debt.
Sempra's ratings primarily reflect its financial strength supported by its regulated utilities in California and South American and its contracted energy infrastructure investments. Approximately 80% of the earnings in the next several years will be regulated including California and South America.
Sempra's California utilities - SDG&E and SoCalGas - benefit from the California regulatory framework which includes bifurcation of GRC orders and cost-of-capital proceedings, forward-looking test years and attrition rate increases, revenue decoupling, and the use of balancing accounts to manage cost fluctuations and reduce regulatory lag.
Fitch views the rate reform in California favorably. The two-tiered structure better aligns utilities' fixed costs with rates, in light of declining net usage and customer base. It is a proactive step to mitigate the unsustainable cycle of customer departure and higher monthly bills for remaining ratepayers on the grid, which could ultimately result in political pushback on rate increases and pressure utilities' financial health.
Fitch believes the recent settlement of SDG&E and SoCalGas' 2016 GRC is constructive and reasonably within expectations. A final order is expected by end of 2015 or early 2016. The existing cost-of-capital (CoC) rates will remain in place until the end of 2016. The two utilities currently operate under the authorized 10.3% return on equity (ROE) for SDG&E and 10.1% for SoCalGas, and 52% common equity ratio.
Though low oil price environment will likely deter new, especially greenfield, natural gas liquefaction projects, it has little impact on the incumbent Cameron LNG (Cameron) project. Cameron is a source of stable earnings given its highly contracted revenues, low commodity price exposure, high-investment-grade sponsors and off-takers. Sempra estimates that its share of the project will provide earnings of \\$300 million to \\$350 million beginning 2019.
The contracting of the contemplated train 4 and 5 could be affected somewhat by the oil price, in Fitch's opinion. However, the relatively low marginal development cost as an expansion could offset some of the negative financial impact.
For the construction of first three trains, Sempra will guarantee its portion of the project debt until construction is completed. The extent to which the guarantee will be used is mitigated by a fixed-price, date-certain construction agreement with experienced contractors.
Sempra has announced its intent to establish a master limited partnership (MLP). Fitch believes that management will take a measured approach when utilizing the MLP IPO proceeds. Fitch will view it positively if Sempra uses IPO proceeds partially to reduce parent debt or for general corporate purposes including funding the capex programs at the California utilities. Conversely, a sizeable share buyback program or disproportionately large dividend increase could have negative rating implications. The size of the MLP is expected to be fairly small for several years based on management's public disclosure. The MLP is expected to hold a right of first offer (ROFO) on certain LNG-related infrastructure projects, including Sempra's 50% interest in the first three trains of the Cameron natural gas liquefaction terminal. Cameron, which Fitch believes will be the primary earnings contributor for the MLP, is not expected to generate meaningful earnings until the 2019-2020 timeframe. By then Cameron is expected to represent approximately 15%-20% of Sempra's total earnings.
The international operations will account for an increasing share of Sempra's consolidated earnings, driven primarily by robust economic growth, energy infrastructure expansion and relatively supportive regulatory framework. At Sempra's South America utilities, energy costs and transmission charges are pass-through, tariffs are set based on geography, population density and average demand, reviewed periodically, and can be adjusted to reflect inflation. Earnings growth in Mexico is fueled by the existing expansion in natural gas pipeline infrastructure and electric transmission, and also by the aggressive energy reform to increase hydrocarbon production and transportation capacity. Sempra is expected to repatriate \\$200 million to \\$300 million per year in earnings from Mexico and Peru, which represents approximately 30% of dividends it receives from all subsidiaries. Over time, Fitch expects Sempra to increase financing from local debt and equity markets, reducing future funding needs at the parent level.
Sempra's funds from operations (FFO) fixed-charge coverage is expected to range from 5x-5.3x in the next five years, consistent with its rating. FFO adjusted leverage is expected to range from 3.7x-4.3x for the same period. These ratios exclude Sempra's portion of Cameron's project debt guarantee at Cameron due to a remote likelihood of the guarantee being exercised.
SDG&E's stand-alone coverage ratios are expected to remain strong with FFO fixed-charge coverage projected to average 6.3x from 2015 to 2019; FFO adjusted leverage is projected to average 3.5x over the same time period. These ratios have incorporated the \\$5.8 billion capital spending program and the expected increase in upstream dividend (average of \\$360 million annually).
SoCalGas' ratings reflect the utility's strong credit metrics and a balanced California regulatory environment, while also considering risks associated with significant planned capital expenditures. As SoCalGas' capex began to ramp up in 2013 and over the next five years is expected to total \\$6 billion, its credit metrics are expected to weaken noticeably compared to 2012. To offset such decline, SoCalGas plans to decrease the dividend significantly. Despite FFO adjusted leverage increasing to an average of 3.2x from 2x in 2012 and FFO fixed-charge coverage declining to an average of 7.8x from 11x, SoCalGas' financial profile remains strong to support its rating.
The notching between SDG&E, SoCalGas and Sempra is supported by the regulatory restrictions in place in California that limit distributions to Sempra and the view that maintenance of the capital structure at both entities continues to be in the best interest of the parent from an economic perspective. Conversely, SDG&E and SoCalGas' ratings are upwardly constrained by their parent due to Sempra's investments in the unregulated U.S. Gas and Power segment and in the international operations, as well as by the degree of leverage that exists at the parent to support these investments.
KEY ASSUMPTIONS
SDG&E:
--Total capital expenditure \\$5.8 billion over five years;
--Incorporates the settlement rate increase and escalation of 3.5% from 2017-2018.
SoCalGas:
--Total capital expenditure \\$6 billion over five years;
--Incorporates the settlement rate increase and escalation of 3.5% from 2017-2018.
U.S. Gas and Power:
--\\$1.3 billion capex spending over five years;
--Cameron to achieve commercial operation of all three trains in 2018, and have the first year of full operations in 2019.
International:
--\\$1.5 billion capex spending over five years;
--Average of \\$250 million in annual dividends over the next five years.
RATING SENSITIVITIES
Sempra:
Positive:
--In light of the large capital spending program at its California utilities, investments in the non-regulated segment, and the pending MLP, it is unlikely that Sempra's ratings will be upgraded in the foreseeable future.
Negative:
--Sempra could be downgraded if the Cameron LNG project experiences substantial cost overrun or delays requiring a substantial amount of equity, or the project is terminated, resulting in the exercise of the guarantee;
--If the consolidated FFO adjusted leverage is above 5x on a sustained basis;
--The MLP transaction, if executed, leads to material structural subordination, cash leakage and/or substantial increase in MLP or sponsor debt such that credit metrics breach the negative guideline ratios outlined above;
--If its California utilities are downgraded.
SDG&E & SoCalGas:
Positive:
--In light of the capital program and/or absent an upgrade at Sempra, it is unlikely that their ratings will be upgraded in the foreseeable future.
Negative:
--If the capex program is not prudently financed or experiences significant cost overruns or regulatory delay in cost recovery, thus causing the FFO adjusted leverage to be above 4.5x during construction. Post-construction, if the FFO adjusted leverage is above 4x on a sustained basis;
--If there is a downgrade at their parent;
--A downgrade at one entity could result in a downgrade at the other.
Fitch has affirmed the following ratings, with a Stable Outlook:
Sempra Energy (Sempra)
--Long-term IDR at 'BBB+';
--Senior unsecured at 'BBB+'.
Sempra Global
--Long-term IDR at 'BBB+';
--Bank facility (unsecured) at 'BBB+';
--Short-term IDR and CP at 'F2'.
San Diego Gas & Electric (SDG&E)
--Long-term IDR at 'A';
--Senior secured at 'AA-';
--Senior secured pollution control and industrial revenue bonds at 'AA-';
--Senior unsecured at 'A+';
--Senior unsecured pollution control and industrial revenue bonds at 'A+';
--Short-term IDR and CP at 'F1'.
Southern California Gas (SoCalGas)
--Long-term IDR at 'A';
--Senior secured at 'AA-';
--Senior unsecured at 'A+';
--Preferred stock at 'A-';
--Short-term IDR and CP at 'F1'.
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