The notes are senior, unsecured obligations of Alabama Power and will rank equally with all other unsecured and unsubordinated obligations of the company and junior to all secured indebtedness, which stood at approximately
KEY RATING DRIVERS
The ratings and Stable Outlook for Alabama Power reflect Fitch's view that the utility will continue to generate strong credit metrics over the next three years driven by a gradual improvement in industrial sales and potential rate increases under the Rate Stabilization & Equalization (RSE) mechanism and environmental cost recovery clauses. Alabama Power enjoys a constructive regulatory environment and has consistently earned more than 13% ROE over the last five years. Cost-of-service recovery mechanisms provide timely recovery of all prudent costs through various rates/cost trackers, such as those incurred for fuel, purchased power, storm costs, environmental expenditures and new generation facilities.
Alabama Power received a favorable outcome from the Alabama PSC in 2013 regarding review of its RSE mechanism. The PSC voted to replace the current ROE range of 13%-14.5% and allowed equity ratio of 45% with a weighted cost of equity (WCE) provision. The WCE range was established by the PSC at 5.75%-6.21% with an adjusting point of 5.98%, which is modestly lower than the implied WCE range under current rates of 5.85%-6.53% with an adjusting point of 6.19%. In addition, Alabama Power will be eligible for a performance-based adder of 0.07% if it is rated 'A' by at least one of the major credit rating agencies or is in the top one-third in customer satisfaction survey. The resolution of the RSE review was in line with Fitch's expectation and removes a key source of regulatory uncertainty for Alabama Power.
Rating concerns for Alabama Power include a high reliance on the industrial sector, which makes up for approximately 38% of its total MWH sales. The dominant industrial customers in its service territory comprise primary metals, chemicals, pulp and paper, and transportation. Fitch sees enough room in the credit metrics to absorb a prolonged period of economic slowdown in Alabama Power's service territory; this was demonstrated during the stressed economic conditions of the year 2009. For the last 12 months (LTM), funds from operations (FFO) adjusted leverage was a robust 3.1x. Fitch expects this metric to average 3.5x over 2014-16 as the benefits of bonus depreciation subside. LTM Debt to EBITDRA was 2.8x and Fitch expects this metric to be approximately 3.0x over the next three years. FFO fixed charged cover is expected to average 6.0x over the same period.
Other rating concerns include Alabama Power's large coal mix (approximately 55% of total generation), which leaves the utility exposed to potential higher environmental expenditures. While Alabama Power has an environmental clause that allows for recovery of all prudent and mandated expenditures, the retail electricity rates would rise, reducing the flexibility for Alabama Power to increase the base rates to earn an attractive ROE.
Weak Industrial Sales: Sharp industrial slowdown in Alabama Power's service territory that depresses margins as well as curtails its flexibility to continue to earn attractive ROEs would lead to downward rating actions.
Unexpected negative regulatory developments that cause a mismatch between incurrence and recovery of capital and operating expenses could lead to unfavorable rating actions.
Additional information is available at 'www.fitchratings.com'.
--'Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage',
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis',
--'Recovery Ratings and Notching Criteria for Utilities',
--'Rating U.S. Utilities, Power and Gas Companies',
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis
Recovery Ratings and Notching Criteria for Utilities
Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
Source: Fitch Ratings
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