Fitch : Affirms Cleco Corp. at 'BBB-' on Cajun Assets Acquisition

24 Jan 2019 02:04 PM ET

Fitch Ratings-New York-24 January 2019: Fitch Ratings has affirmed Cleco Corporate Holdings, LLC's (Cleco Corp.) Long-Term Issuer Default Rating (IDR) at 'BBB-'. The IDR reflects the solid financial position of Cleco Corp.'s core subsidiary, Cleco Power, LLC (Cleco Power; BBB/Stable), a vertically integrated regulated Louisiana utility tempered by Cleco Corp.'s high consolidated leverage and significant parent-only debt. The rating also considers the effect on Cleco Corp. consolidated credit metrics and business profile from the acquisition of the Cajun assets. Fitch expects Cleco Corp. will reduce parent-level debt with cash flows from newly acquired assets to levels commensurate with the current ratings.

KEY RATING DRIVERS

Cleco Corp
Cajun Acquisition: Cajun, a wholly owned subsidiary of Cleco Corp., is acquiring eight plants totalling 3,555MW of generating capacity (74% gas-fired) from NRG Energy for $1 billion. Fitch views the portfolio, which is 86% contracted through April 2025 under long-term contracts with cooperatives and municipals in Louisiana, Texas and Arkansas, as providing predictable cash flows and longer term higher growth prospects. The transaction is expected to close shortly, and will significantly increase Cleco Corp.'s scale and extend the company's service territory into more robust regions. The transaction also benefits Cleco Power, as some overhead previously allocated to Cleco Power will be allocated to the new affiliate.

Credit Metrics Pressured by Acquisition Financing: Cleco Corp. lowered the amount of acquisition debt by applying waived owner dividends and contracted cash flow to the acquisition price accumulated during the delay in closing. However, subsequent to the acquisition of the Cajun assets, the consolidated leverage is expected to be weak for the current rating level. Fitch assumes the long-term contracted cash flow from the electric cooperative and municipally owned contracts will pay off the acquisition debt by 2024. Through 2021, Fitch estimates that FFO-adjusted leverage is expected to decline to around 5.4x-5.6x. The FFO fixed-charge coverage is expected to average around 4.1x during the same time period. Cleco Corp.'s expected metrics incorporate credit supportive measures including a reasonable dividend policy, predictable cash flow from long-term cooperative and municipal electric system contracts, and a favorable rate case outcome.

Predominately Regulated Business: Cleco Corp.'s rating reflects the low business-risk of its regulated electric utility operations and contracted wholesale electric cooperative and municipal business. Cleco Power is a fully integrated regulated electric utility in Louisiana. After the Cleco Cajun LLC (Cajun) acquisition is complete, Cleco Power will contribute around 70% of Cleco Corp.'s consolidated EBITDA with the remaining from the Cajun asset's long-term, wholesale, all requirements contract. Fitch believes these agreements provide stable and predictable earnings and cash flows.

Significant Parent Level Debt: Cleco Corp.'s parent-only debt increased to 50% of consolidated debt from the addition of $1.4 billion acquisition debt when Cleco Power and related entities were taken private by a group of infrastructure investors in 2016. With the acquisition of the Cajun assets from NRG, parent-only level debt will increase to about 53% of total debt, lower than anticipated under Fitch's prior forecast. In line with the previous forecast, Fitch assumes parent leverage at Cleco Corp. will decline to around 50% by 2021, repaid by the cash flow from the electric cooperative and municipal contracts. Additionally, the $400 million acquisition debt will be fully repaid by 2024.

Private Equity Ownership: Cleco Corp. and Cleco Power's ratings consider owner support of the regulatory capital structure. Cleco Power is indirectly owned by a group of long-term infrastructure investors, including Macquarie infrastructure Partners (54% owner), British Columbia Investment Management Corp (37%) and John Hancock Financial (9%). Fitch assumes the dividend policy and the Louisiana Public Service Commission (LPSC) conditions, such as consolidated debt/EBITDA at or below 6.5x and at least one investment-grade rating, will maintain the regulatory capital structure commensurate with the assigned ratings.

Rating Notching: The one-notch difference between the IDRs of Cleco Power and Cleco Corp. reflects Cleco Corp.'s weaker credit profile due to over 50% parent-only debt, as well as ring-fencing measures that the LPSC put in place to approve the 2016 buyout by a consortium of investors. The ring-fencing measures include maintenance of 48% equity capital structure, an independent director and nonconsolidation opinion, among other commitments, and support a one-notch differential in Cleco Power and Cleco Corp.'s long-term IDRs.

Parent Subsidiary Rating Linkage: Fitch considers Cleco Power to be stronger than Cleco Corp. due to Cleco Corp.'s weaker credit profile due to over 50% parent-only debt. However, Cleco Power remains the primary driver of cash flow and earnings to support parent-level dividends and leads to a strong rating linkage. The ring-fencing measures that the LPSC put in place to approve the 2016 buyout by a consortium of investors, which includes maintenance of 48% equity capital structure, an independent director and nonconsolidation opinion, among other commitments, allows the IDR of Cleco Power to be notched above Cleco Corp. Cleco Power's rating reflects its stand-alone credit profile, while Cleco Corp's ratings reflect a consolidated credit profile. Fitch has applied a bottom-up approach in rating Cleco Corp and Cleco Power and would limit the notching difference between the IDRs to one notch.

Cleco Power:
Stable Regulated Business: Cleco Power is a vertically integrated utility serving 290,000 retail customers in rural areas of Louisiana and 157,000 wholesale end-use customers in Louisiana and Mississippi. The company owns 3,310MW of generation capacity, 66% of which is natural gas-fired and the remainder is coal-fired. As a result of the LPSC hearings regarding the Cajun assets approval, Cleco Power will reduce production from its lignite-fired generation Dolet Hills power station. Cleco Power has a favorable customer mix, with residential customers comprising 45% of 2017 revenue, 30% commercial, 14% industrial and 2% other public authorities/lighting. Wholesale, accounting for approximately 9% of the utility's revenue, is composed of long-term, full-requirements contracts to municipalities and rural electric cooperatives. Cleco Power benefits from the supportive regulatory environment under the LPSC and Federal Regulatory Commission (FERC).

Constructive Louisiana Regulation: Fitch views Louisiana regulation as supportive of utility credit quality. The utility's commission-approved formula rate plan (FRP) has a target ROE of 10.0% with a band up to 10.9% before customer revenue-sharing on a capital structure with 51.0% equity. The FRP provides rate stability until June 30, 2020. Cleco Power benefits from fuel, purchased power and environmental cost recovery mechanisms, riders for major capital projects through its FRP and securitization of storm costs. In conjunction with the 2016 transaction taking the company private, the Louisiana Public Service Commission (LPSC) imposed various ring-fencing provisions, which further support the credit quality of the utility.

Tax Reform: With the passage of the Tax Cuts and Jobs Act of 2017 and the reduction in the corporate tax rate to 21% from 35%, Cleco Power refunded $31 million to customers in 2018 and the remainder of the impact, the refund of the excess deferred income taxes, is being considered by the LPSC. The impact of tax reform, in Fitch's estimation, increases FFO-adjusted leverage by 50-60 basis points. Fitch expects leverage will moderate as a result of equity contributed in 2019 for the Cajun acquisition and a favorable FRP in 2020.

Large Capex Program: The 2019-2021 capex program is $795.8 million with about 90% for the utility ranging from $220-260 million annually. The projects are largely for reliability and efficiency improvements and most are recoverable under recovery mechanisms. Fitch estimates free cash flow will be modestly negative after funding the capital program and dividends with a mix of internal cash and debt.

Strong Financial Performance: Cleco Power's stand-alone credit metrics are strong for the rating. Fitch ratings expects adjusted debt/EBITDAR to average around 3.5x - 3.6x and FFO adjusted leverage to average around 3.8 - 4.3x and FFO fixed-charge coverage to average around 4.8x -5.4x.

DERIVATION SUMMARY

Cleco Corp.is well positioned compared with similarly rated peer parent holding companies Centerpoint Energy, Inc. (CNP; BBB/Stable), NiSource (NI; BBB/Stable) and Puget Energy Inc. (PE; BBB-/Stable). Cleco Corp., NI and PE operate low business-risk, fully regulated businesses, while CNP's business model is more volatile due to its investment in Enable and other non-utility businesses. The majority of NI and PE's operating revenue is from regulated utilities, while approximately 85% of Cleco Corp.'s 2018 consolidated operating income is from its core Louisiana-based utility, with the balance from stable sales of electricity to cooperatives and municipal electric systems. Like NI and CNP, Cleco Corp. enjoys supportive utility regulation. However, CNP and NI's utilities are more geographically diversified and serve a larger customer base, while Cleco Corp. and PE's utilities operate in a single jurisdiction. All have significant parent-only debt. Cleco Corp.'s pro forma, FFO-adjusted leverage is estimated by Fitch to approximate 6.1x in 2019, in line with expectations for NI but higher than CNP projected FFO-adjusted leverage of min 5.0x's and PE's 4.0x ranging to just over 5.0x during the same time period.

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer
- $1 billion acquisition of Cajun assets funded through $400 million debt and the balance equity;
- Deconsolidation of $32m CKR Storm securitization;
- Full implementation of tax reform including a $30m refund in 2018;
- Electric load growth for Cleco Power and the Cajun assets of less than 1.0% through 2021;
- 10% ROE for Cleco Power with 51% equity structure until 2020, and a favorable FRP outcome thereafter;
- Capex program of $800 million from 2019-2021;
- Dividend policy adjusted as needed to achieve a capital structure commensurate with the assigned rating;
- Parent-level debt repayment of more than $260 million through 2022.

RATING SENSITIVITIES

Cleco Corp.
Developments That May, Individually or Collectively, Lead to Positive Rating Action
- No positive action is anticipated in the near term given the integration of the Cajun acquisition and limited flexibility at the current rating level. However, parent-level debt reduction that is greater than is currently anticipated by Fitch coupled with adjusted debt/EBITDAR at 4.0x or below on a sustained basis could lead to positive rating action.
Developments That May, Individually or Collectively, Lead to Negative Rating Action
Any material weakness to credit ratios due to higher than forecast leverage deviating from the current forecast could have an adverse effect on ratings. Adjusted debt/EBITDAR 5.8x or higher by 2021 on a sustained basis could also lead to negative rating actions.

Cleco Power
Developments That May, Individually or Collectively, Lead to Positive Rating Action
Cleco Power
Absent an upgrade at Cleco, it is unlikely that Cleco Power's will be upgraded in the foreseeable future.

Developments That May, Individually or Collectively, Lead to Negative Rating Action
- While not currently anticipated by Fitch, any material weakness in credit ratios due to higher than forecasted leverage or upstream dividend distributions could have an adverse effect on ratings. Adjusted debt/EBITDAR and FFO leverage weakening above 3.8x on a sustained basis by 2021 could also lead to negative rating actions;
- An unexpected deterioration in Louisiana regulation;
- Material weakness in Cleco Power's financial profile.

LIQUIDITY

Liquidity at Cleco Corp. is sufficient with available cash and its $100 million credit facility. As of Sept. 30, 2018, there was no short-term debt outstanding with a cash balance of $126 million. The facility is used for working capital and matures in 2021.

Cleco Power has a $300 million facility maturing in 2021, which as of Sept. 30, 2018, was fully available. Additionally, it has an uncommitted line of capital for up to $10 million to finance working capital needs. The cash balance was $59 million as of Sept. 30, 2018.

There are no consolidated debt maturities until the term loan matures in 2021 and the remaining balance is expected to be refinanced. However, under the LPSC Regulatory Commitments, Cleco Corp will repay $67 million annually on the $400 million acquisition debt. Separately, Cleco Power has a $32 million securitization as of Dec. 31, 2018 for the costs associated with the Katrina and Rita storms, secured by dedicated revenues, and matures in 2020. Fitch deconsolidates the securitization from the consolidated company.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings with a Stable Outlook:
Cleco Corporate Holdings, LLC.
--Long-term IDR 'BBB-';
--Senior unsecured 'BBB-'.

Cleco Power, LLC.
--Long-Term IDR'BBB';
--Senior unsecured 'BBB+'.

Contact:

Primary Analyst
Jodi Hecht
Director
[phone]
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004

Secondary Analyst
Barbara Chapman, CFA
Senior Director
[phone]

Committee Chairperson
Shalini Mahajan, CFA
Managing Director
[phone]

Date of Relevant Rating Committee: Jan. 23, 2019

Media Relations: Elizabeth Fogerty, New York, Tel: [phone], Email: [e-mail]

Additional information is available on www.fitchratings.com
Applicable Criteria
Corporate Rating Criteria (pub. 23 Mar 2018)
Corporates Notching and Recovery Ratings Criteria (pub. 23 Mar 2018)
Parent and Subsidiary Rating Linkage (pub. 16 Jul 2018)

Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
Solicitation Status
Endorsement Policy

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