Fitch Ratings has assigned a ‘BBB+’ rating to The Southern Company’s $600 million series 2021C floating rate senior notes due May 10, 2023. The net proceeds from the issuance will be used to repay all or a portion of outstanding CPs and for other general corporate purposes, which may include investment by the company in its subsidiaries. Fitch rates Southern Company’s Long-Term Issuer Default Rating ‘BBB+’ with a Stable Rating Outlook.
KEY RATING DRIVERS
Vogtle Risks Begin to Moderate: The execution risks associated with the construction and testing of Vogtle 3 and 4 nuclear units remains high. However, Fitch views as positive the successful completion of the Hot Functional Testing (HFT) at Unit 3, which was the last major milestone before nuclear fuel is loaded. There are a number of construction and testing activities that remain before nuclear fuel can be loaded, but a successful HFT is an indication that the technology works.
Another Delay to In-service Dates: Based on the latest update from Georgia Power Company, Vogtle 3 and 4 units are expected to be in service by the third quarter of 2022 (3Q22) and the 2Q23, respectively. The new estimated capital cost to complete is $9.5 billion, above the $7.3 billion costs deemed reasonable per the Georgia Public Service Commission (PSC) order approving the 17th Vogtle Construction Monitoring (VCM) report in January 2018.
The project continues to face productivity issues related to completing electrical installations and remediation at Unit 3, which has led to craft and support resources being diverted to Unit 3 from Unit 4. Some of the issues are coronavirus-related as COVID-19 cases on-site during the fall of 2021 rose near the levels seen during the first wave of the pandemic. Georgia Power is targeting fuel load for Unit 3 in or before May 2022. Construction remediation and the pace of system turnovers and testing will influence, among other factors, the timing of the fuel load.
The Nuclear Regulatory Commission needs to review and approve the remaining Inspections, Tests, Analyses, and Acceptance Criteria (ITAAC) to insure construction is complete and the plant satisfies the standards identified in the combined license before authorizing Georgia Power to load fuel.
Disputes Emerge in Co-owners Agreement: The 2018 co-owner agreement places a disproportionate share of cost overruns on Georgia Power. Georgia Power is disputing the co-owners’ assertion that the estimated costs have reached a level to trigger tender. An unfavorable resolution of the dispute could lead to additional costs being borne by Georgia Power.
Specifically, if the estimated cost to complete increases by more than $2.1 billion above the estimate in the modified co-owner agreement (i.e. $8.4 billion for Georgia Power), the co-owners have an option to tender a portion of their ownership interest to Georgia Power, and Georgia Power will fund all the excess costs. If costs increase between $800 million and $2.1 billion, Georgia Power’s allocation of the increased costs above its proportional share would be approximately $180 million.
Demonstrated Commitment to Deleveraging: Fitch expects Southern Company’s FFO leverage to weaken to approximately 5.7x in 2022, but improve to 5.2x in 2023. Fitch expects management to continue to fund Vogtle cost overruns in a credit supportive manner. Management remains committed to defending its ratings as demonstrated by its announcement to issue approximately $400 million equity through dividend reinvestment programs and seeks opportunities to monetize non-core assets.
Improvement in Business Profile: Fitch believes the Vogtle project completion risk, while still elevated, is significantly lower after the successful completion of the HFT. In addition, limited growth spend at Southern Power Company, to the tune of approximately $500 million annually, is skewing the business mix toward regulated businesses, a credit positive. The regulated subsidiaries operate in constructive regimes, as evidenced by the successful outcomes achieved in key rate proceedings over 2018-2020 that have resulted in an increase in equity ratio to 54%-56%.
Given the improvement in business profile, Fitch believes Southern Company’s ratings are no longer capped by the ratings of Georgia Power. Excluding Georgia Power, which contributes approximately 40% of the consolidated EBITDA, the other subsidiaries have a weighted average stand-alone rating profile of ‘A-‘. Hence, even if Georgia Power was to be downgraded to ‘BBB’, Southern Company could maintain its ratings at the current level.
Modest Impact from Coronavirus: The impact of coronavirus on the financial performance of Southern Company’s utility subsidiaries has been modest so far. The decline in commercial and industrial sales has been partially offset by growth in residential sales due to work from home trend. The company has been able to offset most of the non-fuel revenues decline by reducing O&M expenses across all its subsidiaries.
The Southern Company’s regulated subsidiaries continue to benefit from customer net in-migration and strong economic development. The company expects weather normal retail sales to increase between 2%-3% in 2021 versus 2020, and Fitch believes the trends in the first nine months of the year are supportive of these assumptions.
DERIVATION SUMMARY
The Southern Company compares favorably with respect to size, scale and geographic diversity with its peer parent holding companies, American Electric Power Company, Inc. (BBB/Stable) and NextEra Energy, Inc. (A-/Stable). The proportion of EBITDA generated from regulated operations at 86% is less favorable compared with AEP (97%), but favorable compared with NextEra (70%).
The project construction risk has diminished at Southern Company due to the cancellation of the Kemper IGCC project, but those related to Vogtle 3 and 4 remain high. The Southern Company’s projected FFO-adjusted leverage metrics (5.2x by 2023) are weaker than the projected metrics for NextEra (4.5x), but stronger than those at AEP (approximately 5.7x).
KEY ASSUMPTIONS
Fitch’s Key Assumptions Within the Rating Case for the Issuer Include:
–At Alabama Power Company, customer bill credits and revision to rate RSE in accordance with recent regulatory order; 4% increases under RSE in 2021 and none anticipated in 2022; $6.3 billion of capex in 2021-2023; ability to exceed its authorized WCE range; and 2021 sales flat compared with 2019 levels and modest increase in 2023;
–At Georgia Power, rebound in 2021 retail sales and growth of 1%-2% in 2022 and 2023; Vogtle 3 and 4 construction costs and schedule per the latest estimates; rate increases as reflected in the Dec. 17, 2019 PSC order; Georgia Power earning its authorized ROE of 10.5% based upon currently authorized equity ratio of 56%;
–At Mississippi Power, rate changes to reflect recent PSC orders on 2021 PEP and ECO filings; modest PEP retail and wholesale base rate increase in 2022; flat to modest declining sales in 2021-2023; and approximately $200 million-$300 million capex annually;
–At Southern Power, committed capex of $1.1 billion over 2021-2023; additional projects in 2021 include 300 MW Deuel Harvest wind project acquisition, 88 MW Garland energy storage project under construction, 72 MW Tranquility energy storage project under construction and the 118 MW Glass Sands wind project under construction; funding of growth capex primarily using internally generated cash and third-party equity;
–At GAS and its subsidiaries, total capex spend to average $1.6 billion annually from 2021-2023; constructive rate outcomes for pending rate cases at Nicor Gas and Atlanta Gas Light; PennEast pipeline project in-service in late 2022.