News Column

Fitch Affirms Sempra, Southern California Gas and San Diego Gas & Electric's Ratings; Outlook Stable

August 7, 2014

NEW YORK--(BUSINESS WIRE)-- Fitch Ratings has affirmed Sempra Energy's (Sempra) Long-term Issuer Default Rating (IDR) at 'BBB+'. Fitch has also affirmed the IDR of Sempra's subsidiaries, Southern California Gas Company (SoCalGas) and San Diego Gas & Electric Company (SDG&E) at 'A'. The IDR of Sempra Global, whose obligations are guaranteed by Sempra, has also been affirmed at 'BBB+'. The Outlook for all ratings is Stable. A complete list of affected ratings follows at the end of this release.

KEY RATING DRIVERS

--Predictable earnings and cash flows from regulated utility operations and contracted energy infrastructure investments;

--Credit metrics consistent with rating category and relative to peers;

--Cameron liquefied natural gas (Cameron LNG or Cameron) project expected to be a long-term earnings driver;

--Constructive regulatory environment at its core California utility and South American utility operations;

--Sizeable capital expenditure program at the California utilities;

--Significant parent level debt.

Sempra Energy

Sempra's ratings primarily reflect its financial strength supported by its regulated utilities in California and its contracted energy infrastructure investments. Approximately 80% of the earnings in the next several years will be regulated.

The Cameron LNG project will potentially provide another source of stable earnings given its highly contracted revenues, limited commodity 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. Sempra will contribute the existing terminal and provide only a small amount of upfront cash equity to the project, which Fitch views favorably. Along with the partners, Sempra will guarantee the project debt until construction is completed. The extent to which the guarantee will be utilized is mitigated by a fixed-price, date-certain construction agreement with experienced contractors. Sempra has indicated that the Cameron project could be a first step toward developing a master limited partnership (MLP) strategy. The credit impact for Sempra in forming an MLP depends upon the ultimate structure, which Fitch cannot predict at this time.

The international operations are expected to represent an increasing share of Sempra's consolidated earnings, driven primarily by robust economic growth, energy infrastructure expansion and relatively supportive regulatory framework. In Sempra's South America regulated segment, 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.

Since 2013, Sempra has begun repatriating earnings in Mexico and Peru and plans to distribute $200 million to $300 million per year, which represents approximately 30% of dividends it receives from all subsidiaries. Meanwhile, Fitch expects Sempra's international subsidiaries to begin to tap local debt and equity markets, reducing future funding needs from Sempra.

Historically, Sempra's credit metrics have been consistent with its ratings. In the last three years, Sempra produced, on average, FFO fixed-charge coverage of 5.2x. For the last 12 months (LTM) ended June 30, 2014, FFO fixed charge coverage was 5.4x. For the same periods, FFO adjusted leverage averaged 4.3x and 4.4x respectively. Going forward, Sempra's FFO fixed-charge coverage is expected to range from 5x to 5.5x from 2014 to 2018, consistent with its rating. FFO adjusted leverage is expected to range from 4x to 4.3x for the same period. These ratios excludes Sempra's portion of Cameron's project debt guarantee at Cameron, which is consistent with the accounting treatment. If Sempra's share of the Cameron project debt is included in Sempra's total debt, the FFO adjusted leverage could increase to mid-5x during the forecast period.

The Stable Outlook reflects the expectation that Sempra's financial performance will be primarily driven by the consistent performance of its relatively low-risk California-based regulated utilities. SDG&E and SoCalGas benefit from constructive regulation in California that includes various mechanisms providing for timely recovery of costs and a reasonable opportunity to earn their authorized returns on equity. The Stable Outlook also assumes that the Cameron LNG project will be completed and that its international segment will continue to experience robust growth while maintaining proper consolidated capital structure. Fitch also expects that future investments in the non-regulated businesses will be financed in a manner consistent with the current capital structure and supported by long-term contracts.

San Diego Gas & Electric and Southern California Gas Company

The credit quality at the California utilities is supported by the rate increase authorized by the last General Rate Case (GRC) order. In May 2013, SDG&E and SoCalGas received final decision on the 2012 GRC, including attrition-year rate increases through 2015. The rate increase is retroactive to the beginning of Jan. 1, 2012.

SoCalGas and SDG&E are expected to file their 2016 GRC by the end of 2014 with the California Public Utility Commission (CPUC) and a new cost-of-capital (CoC) application in April 2015. Fitch's forecasts reflect the commission-approved rate increases in the 2012 GRC order. In addition, Fitch's projection assumes no change in the authorized 10.3% and 10.1% Return on Equity (ROE) for SDG&E and SoCalGas, respectively, and the 52% common equity ratio for both utilities.

Fitch believes that the proposed settlement agreement regarding the retirement of San Onofre Nuclear Generating Station (SONGS) reached by SDG&E, Southern California Edison (SCE, A-'/Stable Outlook) and the CPUC Office of Ratepayer Advocates and other relevant parties in March 2014 is a constructive development that supports SDG&E's current rating. The settlement, if approved, would resolve all outstanding issues relating to the CPUC's SONGS order initiating investigation.

The settlement disallowed the recovery of the replacement steam generators since February 2012 and approved recovery of remaining SONGS investments albeit at a reduced rate of return. The settlement also approved all other costs such as replacement power costs, non-steam generator investments, construction working in progress (CWIP), materials and supplies, O&M and nuclear fuel. Total impairment loss is estimated to be $187 million pre-tax and $128 million after tax compared to previously recorded $200 million pre-tax loss or $119 million after-tax.

SDG&E may consider adding more generation capacity or secure more power purchase agreements due to the retirement of SONGS. Fitch notes that in 2011 (the last year that SONGS was operational), SONGS provided a relatively small portion of the total generated and contracted power at SDG&E (11% or 430MW). The completion of the Sunrise Power Link - a 500kV transmission line linking San Diego to Imperial Valley, a renewable-rich region in the state - helps relieve the loss of SDG&E's portion of power from SONGS. The line brings 800MW to 1,000MW of power into San Diego.

SDG&E's stand-alone coverage ratios are expected to remain strong with FFO fixed-charge coverage projected to average 6.4x from 2014 to 2018; FFO adjusted leverage is projected to average 3.7x over the same time period. These ratios have incorporated the $5.5 billion capital spending program, the expected increase in upstream dividend (average of $320 million annually), and estimated negative impact from SONGS.

SoCalGas's ratings reflect the gas distribution 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 $6.2 billion (doubling the capex in the previous five years), 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 3.3x from 2x and FFO fixed-charge coverage declining to an average of 8.8x from 11x, SoCalGas's financial profile remains strong to support its rating.

Risks associated with the large capital investment program are partially mitigated by the balanced regulatory structures at both the state and federal levels, including pre-approval of construction projects. In addition, the California framework includes bifurcation of GRC 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. Longer term credit concerns include the potential for customer rate pressure given the significant planned expenditures and relatively high renewable goals.

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's 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.

RATING SENSITIVITIES

Sempra:

Positive:

--A positive rating action seems unlikely given its relatively high leverage and large unregulated and regulated capex programs.

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 4.8x on a sustained basis;

--If the company executes aggressive stock buyback program or acquires substantial amount of unregulated businesses and finances the transactions mostly by debt, thus causing the credit metrics to deteriorate to the level aforementioned;

--If its California utilities are downgraded.

SDG&E & SoCalGas:

Positive:

--In light of the capital program and/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;

--As SDG&E and SoCalGas are managed as one entity, 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'.

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

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (Aug. 8, 2012);

--'Parent and Subsidiary Rating Linkage' (Aug. 8, 2012);

--'Recovery Ratings and Notching Criteria for Utilities' (May 3, 2012);

--'Rating North American Utilities, Power, Gas and Water Companies' (May 16, 2011).

Applicable Criteria and Related Research:

Recovery Ratings and Notching Criteria for Utilities

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

Parent and Subsidiary Rating Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685552

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

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=847275

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:

Julie Jiang, +1-212-908-0708

Director

Fitch Ratings, Inc.

33 Whitehall St.

New York, NY, 10004

or

Secondary Analyst:

Philip W. Smyth, CFA, +1-212-908-0531

Senior Director

or

Committee Chairperson:

Shalini Mahajan

Senior Director

or

Brian Bertsch, +1-212-908-0549

Media Relations, New York

brian.bertsch@fitchratings.com


Source: Fitch Ratings


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