Moody’s Investors Service has lowered its outlook for U.S. regulated utilities from stable to negative. The credit rating service said Monday, “This marks the first time the regulated utilities sector has carried a negative outlook since Moody’s began conducting sector outlooks.”
The source of the revised outlook is the Trump administration-Republican federal tax reform, which cuts the overall corporate income tax rate from 35% to 21%. Moody’s said, “the change in outlook primarily reflects a degradation in key financial credit ratios, specifically the ratio of cash flow from operations to debt, funds from operations (FFO) to debt and retained cash flow to debt, as well as certain book leverage ratios.
Moody’s said that under the new tax law, “utilities will collect less revenue from customers and thus retain less cash. The loss of bonus depreciation means that most companies will start paying cash tax earlier than under the previous law. Lowering the tax rate also means that utilities will have over-collected for tax expenses in the past because they charged for future tax expense assuming a 35% rate. As utilities fund excess collection to customers, cash flow will be further reduced.”
Many utility managements have started seeking regulatory relief from the next tax law, but Moody’s says it believes it “will take longer than 12-18 months for the majority of the sector to show any improvement from such efforts.” The group of 44 utility holding companies that Moody’s monitors has “a 10-year high ratio of debt to EBITDA (5.1X in 2017) and the highest debt to equity ratio since 2008 (1.5x).”
Moody’s analyst Ryan Wobbrock said, “Regulated utilities will be exposed to a higher level of financial risk for the next 12 to 18 months. For utility holding companies, the consolidated ratio of FFO to debt has been on a steady decline, from 19% in 2013 to 17% at year-end 2017, and we expect it to decline further toward 15% through 2019.”
As for company response to the changing financial picture, Wobbrock said Moody’s sees “more activity in the pursuit of regulatory cost recovery relief than we do with management teams executing changes to financial policies. Thus far, there has been no discernible adjustments to dividend policies and most utilities will ontinue to incorporate a heavy reliance on debt financing for their sizeable negative free cash flow funding needs.”
Moody’s says it could return the utility sector to stable if it sees evidence “that the sector’s financial profile will stabilize at today’s lower levels, with cosolidated FFO to debt matrics remaining steady at 15%. A positive outlook could be considered if we expect a recovery in key cash flow metrics where consolidated cash flow starts to improve by roughly 15%-20% or the ratio of consolidated FFO to debt indicates a return to the 17%-19% range.”
Last Friday, Moody’s released a new report finding that the current list of coal and nuclear plants scheduled to go out of service in the next five years won’t have much of an impact on power markets. The shuttering of 35 GW of coal and nuclear capacity will be offset by about 32 GW of new, mostly gas-fired capacity now under construction. Another 72 GW of renewable generation is “either in advanced development or under construction, with the majority slated for activation by 2020,” said the credit rating firm.
Moody’s said, “Excess capacity will continue to be a negative credit driver, particularly for power plant operators in deregulated markets. In PJM, for example, the 5,400 megawatts of nuclear power and 8,000 megawatts of coal power are set to retire through 2021will be more than offset by the addition of around 17 gigawatts of new capacity to be added over the next five years.”
–Kennedy Maize