Fitch Affirms AES and U.S. Subs; Outlook for DPL and DP&L Remains Negative
Fitch Ratings has affirmed the 'BB-' Long-Term Issuer Default Ratings
(IDR) of the AES Corporation (AES), 'BB+' IDR of IPALCO Enterprises,
Inc. (IPALCO) and 'BBB-' IDR of Indianapolis Power & Light (IPL), all
with a Stable Outlook. Fitch has also affirmed the 'B+' IDR of DPL, Inc.
(DPL) and 'BB+' IDR of Dayton Power Light & Company (DP&L). Rating
Outlooks for DPL and DP&L continue to be Negative. A complete list of
rating actions is provided at the end of this release.
KEY RATING DRIVERS
AES Corporation
Debt Reduction
AES continues to execute on its debt reduction goals. In 2016, AES
repaid approximately $300 million recourse debt, exceeding its initial
target of $200 million for the year. Since 2011, AES has repaid
approximately $1.8 billion or 28% of total recourse debt. As a result,
the Recourse Debt/Adjusted Parent-Only Cash Flow (APOCF) metric has
improved to 5x in last 12 months from 6x in 2011. Over the next three
years, Fitch expects AES to make discretionary debt repayment at a
modest pace of approximately $100 million per year in the next two years.
Growth in Cash Flows as Contracted Projects Reach Completion
New contracted projects coming on line in 2017 and 2018 are expected to
provide stable cash flows to AES. Approximately 2,966 MW of new capacity
additions have been completed year to Sept. 30, 2016. 10 MW will come
online in the fourth quarter of 2016 (4Q16). From 2017 to 2021, 4,773 MW
of new capacity additions will be completed. In total, 7,739 MW will be
in service from 2016 to 2021. Completion of projects under construction
is the primary driver for management's estimate of 10% parent free cash
flow growth in 2017 and 2018. Additionally, by 2020, these new projects
will extend the remaining average life of contracts to 10 years from
seven years.
Pruning of Portfolio
In June 2016, AES agreed to sell AES Sul, a distribution company in
Brazil for approximately $440 million, as the company has suffered from
declining demand and poor hydrology conditions while as higher market
purchased power prices cannot be passed through. AES has received
portion of the proceeds and the remaining will be distributed to AES in
2017, after meeting the required notice period for distributions. Fitch
views the sale as credit positive as it reduces exposure to Brazil and
provides liquidity for other cash needs including debt reduction and
growth projects. Since 2011, AES has exited 11 countries, raising $4
billion in asset sales proceeds including over $500 million in 2016
alone. In 2015, AES announced that it plans to sell $1 billion of assets
in the next few years.
Alto Maipo Completion Risk Manageable
In August 2016, AES's subsidiary AES Gener SA announced that its Alto
Maipo hydro project will likely experience a six-month delay and could
cost 10% to 20% over budget ($200 million to $400 million and AES's
indirect ownership is 40%) due to geological conditions and issues in
excavating the tunnel. The delay will push the in-service date to first
half of 2019. AES is currently in negotiation with contractors and
lenders to fund the additional cost. Negotiation is expected to conclude
in 1Q17. At this juncture, Fitch believes that the issue is manageable
primarily due to AES's diversified investment portfolio. Alto Maipo
represents 11% of the remaining construction projects from 2017 to 2021.
Credit Metrics to Improve
Fitch expects AES's Recourse Debt/APOCF to decline to low-mid 4x in 2018
from 5x in 2016, primarily driven by completion of new projects, modest
debt reduction and cost cutting. The APOCF interest coverage is expected
to improve to mid-3x in 2018 from high 2x in 2016. These metrics are
strong for the 'BB-' rating. Fitch applies a deconsolidated approach
when assigning AES's ratings and Outlook due to its unique corporate
profile and structure as an investment holding company that owns a
diverse portfolio of regulated utilities and power generation assets.
Approximately 77% of AES's consolidated debt is non-recourse as of Sept.
30, 2016.
Shareholder Focus Expected to Moderate
Given management's focus on achieving a stronger credit profile and
emphasis on reinvesting in the business, Fitch expects AES's share
repurchases to moderate. AES purchased $79 million of equity in 2016,
compared to an average of $338 million annually from 2011 to 2015. AES
has publicly expressed its intention to prioritize spending on
investments, debt repayments and dividends, instead of share buybacks,
which Fitch views favourably. Fitch expects the dividend to grow by 10%
in 2017 and 2018, in line with the expected growth rate of the parent
free cash flow.
Sufficient Liquidity
AES has adequate liquidity. As of Sept. 30, 2016, AES had $42 million of
cash on hand and $519 million revolver availability at the parent level
after drawing down $181 million to prepay the 2017 senior notes which is
expected to be paid down by year end 2016. From 2012 to 2015, total cash
on hand and revolver availabilities averaged approximately $1.1 billion.
DPL Inc. and Dayton Power and Light
Regulatory Uncertainties Continue
In October 2016, DP&L filed an amended Electric Security Plan 3 (ESP 3)
application supporting a $145 million annual Distribution Modernization
Rider (DMR) from 2017 to 2023. The funds will be used to pay interest
and make discretionary debt payments at DP&L and DPL, and allow DP&L to
invest in T&D infrastructure modernization projects. An order is
expected in the first quarter of 2017. Since ESP 2 was overturned by
Ohio Supreme Court, DP&L currently has no obligation to separate its
generation from transmission and distribution operations. If DP&L
proceeds with the separation, it will require regulatory support to
right-size its capital structure over time to a more appropriate level
for a regulated utility. At time of separation, DP&L's debt to
capitalization is expected to be approximately 75%. Fitch continues to
believe that the Public Utilities Commission of Ohio (PUCO) will likely
authorize the amended ESP 3, albeit with a shorter term than requested,
given the approval of a similar DMR for FirstEnergy in October 2016.
ESP 1 Provides Near Term Relief
PUCO's approval of DP&L's request to implement the rate stabilization
charge (RSC) from its first electric security plan (ESP 1) mitigates
negative rating pressure in the near term. On Aug. 26, 2016, the PUCO
granted DP&L's request to withdraw ESP 2, and revert to ESP 1 rates that
had been previously approved and that included a RSC of approximately
$74 million per year (compared to $110 million "service stability rider"
(SSR) in ESP 2). The charge will stay effective until a new ESP is
approved.
Rating Linkages
Fitch currently maintains a three-notch separation between the IDRs of
DPL and DP&L, driven by a regulatory enforced capital structure for DP&L
by the PUCO that requires the long term debt ratio to maintain at 50%.
PUCO prohibits DP&L from guaranteeing or extending credit to a
nonregulated affiliate or DPL to facilitate its divesture of generating
assets.
Debt Refinancing Mitigates Liquidity Concerns
The recent refinancing of DP&L's first mortgage bonds mitigates near
term liquidity concerns amidst regulatory uncertainty. On Aug. 24, 2016,
DP&L secured a $445 million term loan facility maturing Aug. 24, 2022
and used the proceeds to repay the $445 million 1.875% first mortgage
bonds due on Sept. 15, 2016. DPL's $57 million senior secured notes
matured on October 15, 2016 and were redeemed with cash. There are no
maturities until DPL's $200 million senior unsecured notes due in 2019.
AES Ownership Credit Neutral
DPL's IDR is not directly linked to the ratings of AES, due to weak
legal linkages. AES has not extended any guarantees to DPL's debtholders
nor indicated commitment of any future liquidity support to DPL,
including equity infusions. Fitch has assumed future funding of DPL's
capital needs will come from internally generated FFO and access to debt
markets.
Recovery Analysis
The debt instrument rating at DPL is notched above or below the IDR as a
result of the relative recovery prospects in a hypothetical default
scenario. Fitch affirms the instrument rating for DPL based on a
recovery analysis. Fitch values the power generation assets using a net
present value (NPV) analysis and the equity value in DP&L is added to
derive DPL's enterprise value for the recovery analysis. Fitch assigned
a 'BB/RR2' rating to DPL's senior secured revolving credit facility and
term loan. The 'RR2' rating reflects a two-notch differential from the
'B+' IDR and indicates that Fitch estimates superior recovery of
principal and related interest of between 71% to 90%. Fitch also
assigned a 'BB-/RR3' rating to DPL's senior unsecured notes, reflecting
a one-notch differential from the 'B+' IDR, implying good recovery of
principal and related interest of between 51% to 70%.
Indianapolis Power Light Company (IPL) and IPALCO
Constructive Rate Case Outcome
Fitch views favourably the approval of IPL's electric rate case. In
March 2016, IPL received the regulatory approval for its first electric
rate case since late 90s which allows for annual revenue requirement
increase of $30.8 million with an ROE of 9.85%. The order also, among
other things, authorized IPL to collect $117.7 million of previously
deferred regulatory assets related to IPL's participation in MISO over
10 years. Rates became effective in April 2016. Fitch believes IPL will
file another rate case by year end 2016 to recover environmental and
replacement generation capex including the Eagle Valley combined cycle
gas turbine (CCGT) power plant which is expected to be in service in the
first half of 2017. The project was pre-approved by the utility
commission in 2014 and is estimated to cost approximately $590 million.
Declining Capex
By end of 2016, IPL will complete a large capex program to retrofit most
of its economical coal-fired electricity generation units with the new
emission control equipment and to build the CCGT at Eagle Valley as a
replacement for its retiring generating capacity. In the next five
years, capex is expected to total $1.5 billion or $300 million per year,
compared with $658 million annually from 2015 to 2016. Out of the $1.5
billion, $300 million will be spent in environmental capex, $400 million
in growth capex including $150 million in programs eligible for the
Transmission, Distribution and Storage System Improvement Charge
(TDSIC), and $800 million in maintenance capex.
Cleaner Generation
IPL's generation fuel source diversity has substantially improved in the
last 10 years through new build and retirements. In 2007, 79% of its
generation capacity was from coal, 14% natural gas and 7% oil. By 2017,
IPL's generation capacity will include approximately 44% of coal, 45%
natural gas, 10% wind and solar and 1% oil.
Strong Equity Sponsor
Fitch views positively CDPQ's (Caisse de depot et placement du Quebec)
ownership of IPALCO. CDPQ is a Canadian institutional investor with a
long term buy-and-hold investment philosophy with a strong credit
profile. The ownership helped alleviate debt financing needs partially
during the heavy capex cycle. In April 2015, IPALCO received an equity
capital contribution of $214.4 million from CDPQ to invest in the capex
program. CDPQ made an additional $148.2 million contribution in 2016,
$134.3 million of which increased CDPQ's direct and indirect ownership
to 30% from 15%.
Supportive Regulations
IPL benefits from the stable regulatory environment in Indiana. IPL has
minimal commodity price exposure due to a regulatory pass-through
mechanism that allows the utility to recover fuel and purchased power
costs on a timely basis. Legislative measures exist for IPL to recover
environmental compliance related investments in a timely manner. Even
with the installation of new emission controls, the long-term policy
challenges to coal-fired generation remains a threat to the long-term
viability of these assets. In assigning the IDR, Fitch relies on
Environmental Compliance Cost Recovery Adjustment (ECCRA) and the
Indiana Senate bills 29 and 251 to reduce regulatory lag partially. The
Senate bills allow the recovery of federally mandated environmental
compliance costs and the installation of clean coal technologies
reducing airborne emissions associated with the use of coal. The TDSIC
statute provides for cost recovery outside of a rate case proceeding for
new or replacement for gas or electric safety, reliability and
modernization. The statute requires a seven-year plan of eligible
investments. Once the plan is approved by the Indiana Utility Regulatory
Commission (IURC), 80 percent of eligible costs can be recovered using a
periodic rate adjustment mechanism. IPL's seven year program begins
recovery in 4Q, 2018 with total spend of $350 million.
Rating Constraint for IPL
The one notch difference between IPL and IPALCO reflect the high level
of parent level debt and IPL's low-risk business profile and moderate
capital structure. IPL's rating is upward constrained by IPALCO. IPL is
the sole source of dividend for IPALCO. IPALCO's parent level debt
represents approximately 33% of total debt as of Sept. 30, 2016. Fitch
views IPALCO's consolidated leverage as a primary rating driver for both
companies, along with IPALCO's reliance on IPL to support debt-service
and the subordination of IPALCO's debt to that of IPL's debt. Stability
of upstream cash flow from IPL and a currently constructive regulatory
environment in Indiana partially alleviate the credit concerns arising
from high leverage at IPALCO.
IDR Not Linked to AES
The terms of IPALCO's notes provide a modest degree of separation
between IPALCO and its parent, AES. IPALCO's total debt is limited to $1
billion ($805 million currently outstanding). The ratio of IPALCO's
EBITDA to interest must exceed 2.5x, and debt cannot exceed 67% of total
capitalization on an adjusted basis to make a distribution or
intercompany loan to its parent, according to IPALCO's articles of
incorporation. Changing the articles of incorporation would require AES
approval, IPALCO board approval (CDPQ maintains two seats on the board),
and filing the revision with the secretary of state. IPALCO and IPL
maintain separate identities from AES and do not mingle their cash with
that of AES. These factors separate the ratings of IPALCO and IPL from
the IDR of AES.
KEY ASSUMPTIONS
AES:
--APOCF CAGR 5% from 2017-2019;
--Debt repayment $300 million in 2016; $100 million in 2017 and 2018;
--Stock buyback $79 million in 2016.
DPL and DP&L:
--On Jan. 1, 2017, generation is separated from DP&L and moved under
Ohio Genco and transmission and distribution are the remaining
operations of DP&L;
--Cleared Capacity Prices: $134/MW-day for 2016-2017, $151.5/MW-day for
2017-2018, $164.77/MW-day for 2018-2019, $100/MW-day for 2019-2020 and
estimated $120/MW-day for 2020-2021;
--Certain amount of DMR is assumed per year for 2017-2019;
--No equity support from AES.
IPALCO and IPL:
--Implemented the approved rate case beginning April 2016;
--$1.5 billion capex from 2017-2021;
--Eagle Valley CCGT comes online in the first half of 2017;
--Seven year TDSIC program begins in 4Q, 2018.
RATING SENSITIVITIES
AES:
Positive:
--AES could be upgraded if the debt-to-APOCF ratio sustains below 5x and
the APOCF-to-interest ratio improves to 3.2x on a sustainable basis;
--If the large majority of the construction projects can complete on
time and on budget.
Negative:
--Ratings and Outlook could be pressured if AES fails to achieve
APOCF/interest higher than 2.5x and Recourse Debt/APOCF lower than 5.5x
on a sustainable basis;
--If construction projects experience additional unexpected cost overrun
or delays that require material equity injection;
--If AES increases shareholder distributions without an absolute
reduction in debt, rating could also be pressured;
--A change in strategy to invest in more speculative, non-contracted
assets or material decline in cash flow from contracted power generation
assets;
--If AES executes merger and acquisition transactions largely with debt,
causing its credit metrics to breach the guideline ratios above.
DPL and DP&L:
Positive:
--DPL and DP&L's rating Outlook can be stabilized if prospective rate
relief is forthcoming, such that consolidated adjusted debt-to-operating
EBITDAR can sustain comfortably below 6x and/or FFO-lease adjusted
leverage below 6.5x.
Negative:
--Rating downgrades could be triggered by the absence of timely
regulatory support in Ohio and/or continued challenging market
conditions for its merchant generation business;
--Deterioration of DPL's consolidated adjusted debt-to-operating EBITDAR
ratio on a sustained basis to above 7x or FFO-lease adjusted leverage
sustained above 7.5x without a visible path for recovery could result in
rating downgrades;
--Other factors that could cause negative rating actions include
lower-than-expected cash flow at DP&L or the inability to execute
deleveraging at DP&L, such that the future transmission and distribution
utility's stand-alone debt-to-operating EBITDAR and FFO-lease adjusted
leverage sustain above investment grade guideline ratios of 5x and 6x,
respectively.
IPL and IPALCO:
Positive:
--Positive rating action is unlikely over the foreseeable future given
the upcoming rate case related to Eagle Valley CCGT plant.
Negative:
--Fitch would consider negative rating action on IPALCO in the event of
certain adverse regulatory developments, such as materially negative
rate case outcome primarily associated with the Eagle Valley CCGT;
--Negative rating pressure could mount if regulatory changes reduce the
likelihood of timely recovery of operating costs (fuel, purchased power
or environmental costs);
--A material increase in debt at IPALCO would also result in a negative
rating action.
Fitch has affirmed the following ratings with Stable Outlook:
The AES Corporation
--Long-Term IDR at 'BB-'
--Short-Term IDR at 'B';
--Senior secured debt at 'BB+/RR1';
--Unsecured debt at 'BB/RR3';
--Trust preferred stock issued by AES Trust III at 'B+/RR5'.
IPALCO Enterprise, Inc.
--Long-Term IDR at 'BB+';
--Senior secured debt at 'BB+/RR2'.
Indianapolis power and Light Company
--Long-Term IDR at 'BBB-';
--Senior secured debt at 'BBB+';
--Senior secured tax-exempt pollution control bonds at 'BBB+';
--Preferred stock at 'BB+'.
Fitch has affirmed the following ratings with a Negative Outlook:
DPL, Inc.
--Long-Term IDR at 'B+';
--Short-term IDR at 'B';
--Secured debt at 'BB/RR2'
--Senior unsecured debt at 'BB-/RR3'.
Dayton Power & Light Company
--Long-Term IDR at 'BB+';
--Short-Term IDR at 'B';
--Senior secured debt at 'BBB/RR1'.
DPL Capital Trust II
--Junior subordinate debt at 'B/RR5'.
Date of Relevant Rating Committee: Dec. 14, 2016
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
https://www.fitchratings.com/site/re/885629
Parent and Subsidiary Rating Linkage (pub. 31 Aug 2016)
https://www.fitchratings.com/site/re/886557
Recovery Ratings and Notching Criteria for Non-Financial Corporate
Issuers (pub. 21 Nov 2016)
https://www.fitchratings.com/site/re/890199
Recovery Ratings and Notching Criteria for Utilities (pub. 04 Mar 2016)
https://www.fitchratings.com/site/re/878227
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT
Credit Analysis (pub. 29 Feb 2016)
https://www.fitchratings.com/site/re/878264
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1016505
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1016505
Endorsement Policy
https://www.fitchratings.com/regulatory
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