Fitch Affirms Otter Tail Corp and Otter Tail Power; Outlook Stable
NEW YORK -- July 31, 2014
Fitch Ratings has affirmed the long-term Issuer Default Rating (IDR) of Otter
Tail Corporation (OTTR) at 'BBB-' and the long-term IDR of its regulated
electric utility subsidiary, Otter Tail Power Company (OTP) at 'BBB'. The
Rating Outlook for both entities is Stable. A complete list of ratings is
provided at the end of this release.
Due to the risks inherent in the diversified business portfolio, Fitch rates
OTTR one notch below its regulated subsidiary OTP. OTTR's current IDR of
'BBB-' takes into consideration the company's business mix including a
relatively small electric utility and a mix of small cyclical industrial
businesses that operate in fragmented, competitive markets.
OTP contributes approximately two thirds of consolidated earnings. The Stable
Outlook reflects Fitch's expectations that utility earnings and cash flows
will be supported by regulatory mechanisms that afford timely recovery on
investments during a period of high capital spending at OTP and the
manufacturing and infrastructure businesses will sustain the recent
improvement in financial performance.
KEY RATING DRIVERS
--Strong and stable performance at OTP;
--Large capex program at OTP with constructive regulatory recovery mechanisms;
--Lower risk profile with downsizing of diversified business portfolio;
--Modest parent debt balances and low consolidated leverage.
OTTR's ratings reflect its higher operating risk profile from its downsized,
but still prominent, diversified business portfolio. These diversified
operations have been a source of large operating and non-recurring losses and
write-downs from 2010 to 2012. Following divestiture of the poor performing
businesses, OTTR's remaining non-regulated activities consist of three
segments: manufacturing, plastics, and construction. Manufacturing and
plastics have performed strongly over the last couple of years reflecting the
economic recovery, with the construction segment returning to modest
profitability. Management may consider related acquisition opportunities
particularly in its manufacturing segments.
Offsetting the higher risks and volatility of the non-regulated businesses, is
a relatively low consolidated leverage position. Parent-level long-term debt
approximates only $50 million and OTTR's investments in its non-regulated
businesses is mostly financed through equity. A conservative capital structure
is the anchor to OTTR's credit profile and ratings.
OTTR's earnings rebounded strongly in 2013 reflecting improved performance at
the manufacturing businesses and the absence of losses and write-downs on
divested businesses. A prior ratings concern was OTTR's common dividend
payment which it had failed to earn in 2009 through 2012. Along with the
earnings recovery in 2013 and a strong first quarter 2014 (1Q'14) performance
by OTP, bolstered in part by cold weather, Fitch expects OTTR's dividend
payout ratio in 2014 even with a modest 1.4% increase recently approved, to
fall within a typical industry average range of between 60% and 70%.
The earnings recovery is evident in the improvement in key credit metrics.
EBITDAR to interest improved to 4.58x for the latest 12 month (LTM) period
ended March 31, 2014 from 4.42x and 3.52x for the years 2013 and 2012
respectively. Fitch expects EBITDAR to interest to remain between 4.5x and
5.0x during the 2014 to 2016 forecast period.
OTTR has traditionally employed a low level of leverage, although Fitch
expects leverage to trend higher over the forecast period. Fitch expects
consolidated debt to EBITDAR, currently averaging around 3.0x, to trend up to
3.3x over the forecast period reflecting higher debt levels to finance the
utility's large capex program. Concomitantly, OTTR will be required to raise
equity in future years to maintain its own capital structure as well as to
downstream equity to support OTP's capital structure during the capex
OTP continues to perform strongly but faces pressures from a large capex
program that management projects will increase rate base from $727.9 million
in 2013 to $1,151.6 million in 2018 a compounded 9% growth rate over the five
year period. In February 2014, OTP completed a $150 million private placement
debt but additional external financing will be required. Fitch expects OTP's
capital structure will be maintained with an approximate 50%/50% debt/equity
mix and OTTR will downstream additional equity to support the capital
During the capex cycle which is centered on new transmission projects as part
the broader regional CapX2020 Program and the Big Stone Generating Station
environmental upgrade including dry scrubbers. OTP's 54% share of the Big
Stone project is expected to be around $207 million and the project is
expected to be completed late in 2016.
OTP's capex recovery mechanisms provide for timely recovery of invested
capital and operating earnings and cash flows are expected to be supported by
construction work in progress (CWIP) on the transmission projects as well as
recovery riders on the Big Stone environmental upgrade.
Other regulatory mechanisms are considered constructive and OTP authorized
return on equity (ROE) in its largest jurisdictions are above industry
average. OTP enjoys full commodity and purchased power recovery across its
three state service area. OTP's rural service area in Minnesota, North Dakota,
and South Dakota has been economically stable and Fitch considers the
regulatory oversight as reasonably balanced.
Credit metrics are strong although Fitch expects modest deterioration in
coverage and leverage due to higher debt levels beginning in 2014. Measures
strengthen throughout the forecast period as the capex cycle matures. EBITDAR
to interest, 5.4x for the 12 months ended Dec. 31, 2013 is expected to fall to
4.9x in 2014, but recover to an average of 5.4x in 2015 and 2016. Debt to
EBITDAR, 3.6x at Dec. 31, 2013 remains fairly stable and averages 3.6x over
the forecast period.
Parent Subsidiary Linkage
Fitch's ratings of OTTR and OTP take into consideration some modest
ring-fencing of the utility subsidiary from the parent and other affiliates, a
factor that reduces but does not eliminate linkage between the ratings of OTTR
and OTP. The utility's IDR of 'BBB' is one-notch higher than OTTR. Fitch
typically notches diversified parent holding companies lower than their
Despite the downsizing of the non-regulated business investments, OTTR
management expects to derive 15% to 25% of consolidated earnings from
non-regulated businesses. Consequently, Fitch expects to maintain at least a
one notch rating differential between OTTR and OTP.
Liquidity is strong for both OTTR and OTP. OTTR has a $150 million bank credit
facility with pricing at LIBOR plus 175 basis points (bps) and OTP has a $170
million facility with pricing at LIBOR plus 125bps. There are no debt
Execution and funding of a large capital investment program limits positive
rating action for OTP and OTTR over the near term. Maturation of the capex
cycle and positive cash flow generation could lead to a rating upgrade of OTP.
Events that individually or collectively could result in a negative rating
--A downturn in the economically sensitive non-regulated higher risk
businesses could pressure earnings and consolidated leverage;
--An acquisition that is debt financed and/or heightens the business risk
--Debt to EBITDAR above 4x (Fitch forecast models average 3.3x) on a sustained
basis could result in a downgrade.
--A change in the regulatory structure which limits timely and full recovery
of invested capital during this large capex cycle would likely result in a
negative rating action;
--Failure to maintain a balanced equity component in its capital structure.
Debt to EBITDAR above 4.25x (Fitch forecast models average 3.6x) could result
in a downgrade.
Fitch affirms the following ratings with a Stable Outlook:
Otter Tail Corporation (OTTR)
--Long-term IDR at 'BBB-';
--Short-term IDR at 'F3';
--Senior unsecured at 'BBB-'.
Otter Tail Power Company (OTP)
--Long-term IDR at 'BBB';
--Short-term IDR at 'F3';
--Senior unsecured at 'BBB+'.
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.
Applicable Criteria and Related Research:
Rating U.S. Utilities, Power and Gas Companies (Sector Credit Factors)
Recovery Ratings and Notching Criteria for Utilities
Corporate Rating Methodology - Including Short-Term Ratings and Parent and
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Glen Grabelsky, +1 212-908-0577
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
Philippe Beard, +1 212-908-0242
Shalini Mahajan, +1 212-908-0351
Brian Bertsch, +1 212-908-0549
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