News Column

Fitch Affirms Mountaineer Gas Company's IDR at 'BB+'; Outlook Stable

July 3, 2014

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has affirmed the long-term Issuer Default Rating (IDR) of Mountaineer Gas Company (MGC) at 'BB+' and senior unsecured debt rating at 'BBB-'. The Rating Outlook is Stable. Approximately $90 million of long-term debt is affected by this rating action.

The affirmation reflects the lower risk nature of MGC's regulated utility business offset by normal seasonal as well as weather related gas delivery volume volatility that adds a sizable and somewhat unpredictable measure to MGC's financial results. Driven by a relatively cold 2013/2014 winter heating season, MGC reported strong earnings in its key first quarter ended March 31, 2014 which typically represents 70% or more of total annual earnings. Consequently, MGC's financial results and credit metrics in 2014 will be strong against historical performance periods although 2015 and 2016 will weaken (assuming a relatively average winter heating season) as MGC prepares to file its 2015 General Rate Case (GRC).

KEY RATING DRIVERS

--Substantially Improved Financial Profile;

--Elevated Capex Spending;

--2015 GRC Outcome;

--Adequate liquidity;

--Ownership Structure.

Strong First Quarter 2014 Earnings

MGC reported substantially higher earnings in the first quarter of 2014 as colder than average weather conditions drove higher volumes of natural gas sales. EBITDA, driven principally by higher natural gas sales, grew 14% to approximately $27 million from the prior year period.

For the latest 12 months (LTM) period ended March 31, 2014, EBITDAR-to-interest widened to 4.6x as compared with 4.1x at year-end Dec. 31, 2013, reflecting the higher earnings in 1Q14 modestly offset by slightly higher interest expense related to larger bank line borrowings. MGC will likely experience margin pressure in 2015 ahead of its GRC filing as operating expenses increase. Routine expense items including pensions and property taxes are not on riders. Also, MGC's margins are largely volume based subjecting it to weather as well as customer conservation and efficiency volume losses.

Assuming normal weather conditions, Fitch expects coverage measures such as EBITDAR-to-interest to be pressured in 2015 and 2016 falling to approximately 3.6x over that time period in part reflecting higher interest expense for working capital needs.

Funds from operations (FFO) fixed charge coverage at 4.3x in 2013 is expected to remain strong into 2014. Fitch models produce FFO fixed charge coverage at 4.1x in 2014 and then weakening in 2015 and 2016 to approximately 3.0x.

Elevated Capital Investments

MGC's capex spending increased substantially 2013 with further growth expected. From 2010 to 2012, capex averaged $13 million per annum. In 2013, capex spending jumped to $17 million and MGC expects capex spending to average $20 million per year from 2014 to 2016. 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. MGC does not have riders that allow for contemporaneous recovery of such investments which are recovered through GRCs.

2015 General Rate Case

Fitch expects MGC to file a new GRC in 2015 with 2014 as its historical test year. Fitch expects MGC to seek recovery riders for pipe replacement that is more typical of the gas industry. MGC had a constructive outcome of the last GRC. The Public Service Commission of West Virginia (PSCWV) approved a $6.265 million rate increase effective Nov. 1, 2012 representing approximately 60% of MGC's revised revenue request. The new rates were based on an authorized return on equity of 9.9%. The revenue increase is collected through higher monthly customer charges providing modestly greater stability to earnings and cash flows which are modestly less dependent on sales volumes and seasonal consumption patterns. In April 2013, the PSCWV authorized an additional $522 thousand annual revenue increase.

Adequate Liquidity

MGC's assumed responsibility for its seasonal gas supply needs following the expiration of the Asset Management Agreement with Sequent (a subsidiary of AGL Resources) in 2013. The arrangement with Sequent relieved MGC of most of its working capital requirements related to gas inventory and supply. Despite a cold winter with requiring higher gas volumes as well as higher gas prices, MGC managed its greater liquidity needs through its committed $70 million bank facility. Draws against the bank facility peaked at around $40 million and $5 million was outstanding at March 31, 2014.

The bank facility matures in 2014 and MGC is currently seeking a new and larger facility which Fitch expects to be obtained on similar or better terms. MGC's next long-term debt maturity is in 2017.

Ownership Structure

MGC is jointly owned by managing partner IGS Utilities, LLC and by private equity investors DB Nexus American Investments UK Limited and ICON Infrastructure Partners LP. Fitch considers the ownership structure as limiting financial flexibility in the form of capital access especially in a period of rapidly rising capex. Financial management policies can be aggressive. MGC has paid dividends representing almost 100% of net income in recent years and MGC's operating cash flows will likely be insufficient to sustain the higher capex spending forecasted without external financing and/or lower dividends.

RATING SENSITIVITIES

--A Positive rating action is not likely over the next two years ahead of the outcome of the 2015 GRC. Fitch would view recovery riders for pipe replacement and weather normalization clauses or other riders that permit timely expense recovery and add stability to earnings and cash flows favorably.

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

--An inability to earn an adequate and timely return on invested capital.

--Deterioration in operating performance from unfavorable regulatory outcomes or inability to recover in a timely manner higher operating or capital expenditures.

--Increase in leverage or distributions to owners.

--Failure to maintain on a sustained basis an FFO fixed charge coverage ratio of 3.5x.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology - Including Short-Term ratings and Parent and Subsidiary Linkage', May 28, 2014;

--'Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)', March 11, 2014;

--'Recovery Ratings and Notching Criteria For Utilities', Nov. 19, 2013;

--'2014 Outlook: Utilities, Power, and Gas,' Dec. 12, 2013.

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=735155

Recovery Ratings and Notching Criteria for Utilities

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=722085

2014 Outlook: Utilities, Power, and Gas (Electricity Sales Unplugged)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=726603

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=837857

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst

Glen Grabelsky, +1 212-908-0577

Managing Director

Fitch Ratings, Inc.

33 Whitehall Street

New York, NY 10004

or

Secondary Analyst

Philippe Beard, +1 212-908-0242

Director

or

Committee Chairperson

Shalini Mahajan, +1 212-908-0351

Senior Director

or

Media Relations:

Brian Bertsch, +1 212-908-0549

brian.bertsch@fitchratings.com

Source: Fitch Ratings


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