Rating Action: Moody's changes Hawaiian Electric Industries and Hawaiian Electric Company outlooks to negative
Global Credit Research - 21 Aug 2015 (With explanatory notes written in English.)
NOTE: Ige's LNG Edict was delivered August 24--three days after this ratings outlook from Moody's.
New York, August 21, 2015 -- Moody's today revised Hawaiian Electric Industries' (HEI) and its utility subsidiary Hawaiian Electric Company (HECO)'s rating outlook to negative from stable due to concerns about the execution risk inherent in transforming its oil-dominated generation base to renewables. The ratings of HEI and HECO are affirmed at Prime-2 short-term rating for commercial paper and Baa1 Issuer Rating, respectively. The rating and outlook of HEI's bank subsidiary, American Savings Bank (Baa1 stable), is unaffected by today's action. We continue to evaluate HEI and HECO on a standalone basis, despite HEI's pending merger with NextEra Energy, Inc. (Baa1 stable). If the merger is successful, we could reevaluate HEI and HECO's ratings and outlooks upon closing....
HECO's Baa1 senior unsecured and issuer rating reflects the relatively stable earnings and cash flow historically provided by the vertically integrated utility business. The negative outlook reflects the challenges of having some of the highest retail electric rates in the country and the heavy pressure from regulators and stakeholders to reduce rates, as well as the company's dependence on fuel oil. The company has responded by proposing to transform its generation base that is currently dominated by fuel oil to 65% renewables by 2030, using liquefied natural gas (LNG) as a bridging fuel. In June 2015, the Governor of Hawaii signed into law the first 100% renewable portfolio standard in the nation, to be achieved by 2045. We expect HECO will modify its plans accordingly to comply with the new law.
(Therefore Ige's rejection of LNG makes HEI less attractive to NextEra.)
While rate reduction initiatives involving infrastructure improvements and new generation may present investment opportunities for the utility, they also present the potential for under-recovery. The company's Power Supply Improvement Plan (PSIP) filed on August 26, 2014, includes $3.8 billion of capital expenditure over the next five years. And in the most recent earnings call, the company has indicated that its planned capital expenditure will be about $700 million and $720 million in 2016 and 2017. The plan will also likely require the company to sign large liquefied natural gas (LNG) supply contracts that are likely worth a substantial $7 billion. In contrast, HECO's total rate base at the end of 2014 was about $2.7 billion.
(HEI bet everything on LNG and now ... ???)
In terms of financial metrics, HECO traditionally has maintained a three-year average CFO/debt of 17% and RCF/debt of 12%, which are in the middle of the range of our Baa benchmarks. With the large capital expenditures and the attendant regulatory lag, the three-year average CFO/debt and RCF/debt is like to fall to the lower end of our Baa benchmarks as outlined in Moody's Regulated Electric and Gas Utilities Rating Methodology. For reference, the CFO/debt methodology standard grid Baa benchmark for regulated utilities is between 13% and 22%, while the benchmarks for RCF/debt is between 9% to 17%.
Both HEI and HECO's liquidity will be strained due to the large planned capital expenditures for 2016 and 2017. Negative free cash flow at HEI is likely to be in range of about $500 million a year for 2016 and 2017. In contrast, HEI's negative free cash flow was about $160 million on average over the 2012 to 2014 period. As of June 30th, 2015, HEI reported a total cash balance of $300 million and non-bank short-term borrowing of $125 million ($36 million of commercial paper at HEI and $89 million at HECO.) The $150 million and $200 million revolving credit facilities at HEI and HECO respectively, were undrawn, though they are necessary to support the commercial paper program. There are no long-term debt maturities for the remainder of 2015 but there is about $200 million due at HEI in 2016 and none in 2017.
HECO and HEI's negative outlook reflects the high level of capital expenditures planned for 2016 and 2017, the attendant liquidity strain and the deterioration of cash flow to debt metrics. However, conditions could change if the pending merger with NextEra is completed, at which point we could re-evaluate HEI and HECO's ratings or outlook. With NextEra as the new owner, there could be a different business strategy or additional support provided for HECO. HECO's rating could also be affected by the terms and conditions of the HPUC merger approval.
What Could Change the Rating -- Up
Notwithstanding a new set of circumstances that may develop following a successful merger with NextEra, there are limited near-term prospects for the rating to be upgraded in light of the very sizeable capital investment program at the utility and pressure to reduce electricity prices.
What Could Change the Rating - Down
Barring a new set of circumstances that may develop following a successful merger with NextEra, we could downgrade HECO and HEI if the capital spending plan goes forward as currently envisioned.
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