Fitch Ratings has affirmed the Long-Term Issuer Default Rating (IDR) of
Fitch has also affirmed the Short-Term IDR of OTTR at 'F3' and the Short-Term IDR of OTP at 'F2'. The Rating Outlooks for both OTTR and OTP is Stable.
The rating affirmation and Stable Outlook reflects the predictable earnings and cash flows from the company's predominately regulated operations and strong performance at its manufacturing businesses. 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 small regulated electric utility serving a rural service territory and two relatively small manufacturing industrial business segments that operate in fragmented, competitive markets.
Key Rating Drivers
Key Rating Drivers -
Improved Business Risk Profile: OTTR's ratings and Stable Outlook reflect the higher operating risk profile and earnings volatility of its economically sensitive nonregulated business. OTTR's business risk profile has improved in recent years and nonregulated activities consist of two segments: manufacturing and plastics. The risks inherent in OTTR's diversified business portfolio are mitigated by their strong financial profile including low levels of debt and positive FCF.
Shift Towards Regulated Operations Expected: OTP is historically the main driver of consolidated earnings and cash flows although its contribution to consolidated earnings has diminished primarily due to continued strong performance from OTTR's non-regulated PVC plastics business and to a much lesser extent, its metal stamping manufacturing business. OTP comprised approximately 51% of consolidated 2021 EBITDA with OTTR's nonregulated operations accounting for the remainder. Going forward, OTTR's business mix is expected to move back in line with historical levels with the utility segment projected to approximate up to two-thirds of consolidated earnings due to increased utility investments over the forecast.
Parent-Subsidiary Linkage: Fitch has applied a weak parent/strong subsidiary approach in rating OTTR and OTP. OTP is considered stronger than its parent, OTTR, due to the low business risk of its regulated utility operations and relatively low leverage. OTP's ratings reflect its standalone credit profile, while OTTR's ratings reflect a consolidated credit profile. Emphasis is placed on OTP's status as a regulated integrated electric utility company.
Strategic and operational ties between OTTR and OTP are strong and include a shared treasury team while legal ring fencing is considered porous given the general protections afforded by economic regulation including an authorized regulatory capital structure. Access and control are evaluated as open. OTTR is the sole source of equity; however, OTP issues their own debt. Due to the aforementioned linkage considerations, Fitch will limit the difference between the ratings of OTTR and OTP to a maximum of one notch.
Strong Credit Metrics: Fitch projects OTTR's credit metrics to remain strong through the forecast period and projects FFO fixed charge coverage to average 7.2x and FFO adjusted leverage to average 3.6x through 2022-2026. Fitch assumes OTTR will issue equity as needed to support the utility's statutory capital structure
Strong Earnings from Nonregulated Operations: OTTR's plastic segment has continued to perform strongly due to robust housing demand over the last few years. As a result, the contribution of earnings from the plastics segment increased by 16% to 55% of consolidated EBITDA for the LTM ending
BTD, a metal fabrication company and OTTR's largest manufacturing business, has also benefited from increased sales volumes and improved operating margins resulting from an increase in production volumes. OTTR's nonregulated businesses are not expected to grow materially from current levels and are supported by low levels of parent only long-term debt approximating 10% of total indebtedness as of
Key Rating Drivers -
Balanced Regulatory Environment: OTP's ratings reflect the relatively stable earnings and cash flows provided by its regulated electric utility operations. Fitch expects the regulatory environment to remain supportive of credit quality across its three-state jurisdictions in
Concerns around regulatory lag during a period of high capital spending are mitigated by relatively recent GRC's in all three of its jurisdictions, the use of fully forecast forward looking test years in OTP's two largest jurisdictions,
Constructive GRC Outcome in
Fitch view OTP's prior GRC outcomes in
Strong Credit Metrics: Fitch expects OTP's credit metrics to remain strong despite a large capital spending program that will modestly pressure leverage metrics through the forecast period. OTP's FFO leverage is projected average 4.3x in 2022-2026 and FFO fixed charge coverage is expected to average approximately 5.9x over the next five years.
Timely Return on
Large Utility Capex Program: Fitch expects OTTR to spend
Transition to Clean Energy Generation: The utility is planning to continue to retire older coal-fired generation and replace it with a combination of renewables including new wind and solar to meet its self-imposed goal of achieving a 30% renewable resource mix by 2022 and
FCF Negative: Fitch expects OTP to remain FCF negative through the forecast period, with future funding needs met by a balanced mix of debt and equity, and that parent
Derivation Summary
The credit profile of
OTTR's financial metrics are strong and in line with higher rated peers, but its ratings are constrained due to the higher operating risk profile of its nonregulated businesses. OTTR's FFO leverage approximated 2.7x in 2021, stronger than MDU at 3.6x but materially better than Xcel at 5.5x and BKH at 6.6x. While OTP remains the main driver of consolidated earnings and cash flows the earnings from OTTR's nonregulated operations can be volatile and are projected to continue to comprise at least one-third of consolidated earnings. Consequently, Fitch expects to maintain a one notch rating deferential between OTTR and OTP.
The credit profile of OTP is well positioned compared with that of peers,
OTP's FFO leverage approximated 4.2x in 2021, worse than NSPC at 3.9x, equal to BHP at 4.2x, but better than
Key Assumptions
Fitch's Key Assumptions Within Our Rating Case for the Issuer
Balanced regulatory environment;
9.2% Earned ROE at OTP;
Large capex program at OTP totaling 1.1 billion on capex in 2022-2026;
Anticipated equity infusions from OTTR to OTP to preserve balanced capital structure;
Long-term debt maturities including
RATING SENSITIVITIES
For OTTR
Factors that could, individually or collectively, lead to positive rating action/upgrade:
While an upgrade is not anticipated given OTTR's current business mix, the further downsizing of nonregulated businesses could warrant a positive rating action;
Retirement of parent-only debt;
An upgrade at OTP;
Sustained FFO leverage below 4.3x.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
A sustained downturn in the economically sensitive nonregulated businesses;
An acquisition that is debt-financed or that materially heightens the business risk profile;
Sustained FFO leverage above 5.0x.
For OTP:
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Better-than-expected regulatory outcomes in future GRC proceedings;
Sustained FFO leverage below 4.5x;
Successful execution and balanced funding of the large capital investment program.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Adverse future regulatory outcomes;
Failure to maintain a balanced equity component in its capital structure;
Sustained FFO leverage above 5.5x.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from '
Liquidity and Debt Structure
OTTR's liquidity is sufficient with
The credit facilities contain a maximum debt-to-capitalization ratio covenant of 60%, and both OTTR and OTP were in compliance with balanced debt-to-capitalization ratios of 41% and 45% as of
Under the MPUC order, total capitalization for OTP cannot exceed
Issuer Profile
OTTR is the parent holding company of its utility subsidiary, OTP, and two small cyclical industrial businesses that operate in fragmented, competitive markets. OTTR's nonregulated activities consist of two segments: manufacturing and plastics. OTP is a small, regulated, integrated electric utility serving over 130,000 rural customers in
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
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