Moody’s Investors Service downgraded the ratings of Port Huron, MI-based gas utility company SEMCO Energy Inc. to Ba2 from Baa3 and said it was continuing a review for possible further downgrade because of the company’s “very high leverage, weak capitalization, low profitability and cash flow relative to its debt and refinancing risk.” About $534 million in debt was affected.

SEMCO’s construction services business, its only non-utility business of a significant size, has performed poorly in the last few years, and it “remains to be seen whether recent restructuring efforts will be sufficient to overcome the weak economic conditions and capital constraints of its customers that continue to challenge the segment,” Moody’s said. “Further rating action would result if SEMCO is unsuccessful in refinancing the ROARS [Remarkable and Redeemable Securities] as planned, construction services fails to turn around, or credit measures continue to be weak.”

Moody’s said the refinancing of a $105 million original principal amount of the company’s ROARS debt, which represents 14% of its total capitalization, poses “a major liquidity hurdle for SEMCO.” The company has a number of alternative plans for the refinancing but each will depend on receptive capital market conditions. It does not have sufficient unused capacity on its existing bank facility to redeem the ROARS.

Moody’s estimates that the company’s leverage is in the low 80% range. Moody’s estimates that by August the company’s leverage will be reduced to about 70%, but it will still be higher than levels commensurate with investment-grade utilities.

SEMCO is actively pursuing the sale of non-core assets, but has yet to announce any sales that would meaningfully reduce debt in the near term, Moody’s noted. Historically, the company has not generated excess cash flow to pay down debt, and Moody’s expects little change going forward.

Substantially all of SEMCO’s earnings before interest and taxes are generated by its gas utility divisions in Michigan and Alaska. SEMCO’s consolidated returns reflect the utilities’ returns, which, at around 7% return on equity, are well below their allowed levels (10% in Michigan, 12% in Alaska), Moody’s noted. Low returns are due to a large amount of goodwill. The construction services unit, which accounts for about a quarter of consolidated revenues, has reported net losses in each of the last two years. The company has downsized the organization, but it remains to be seen whether it will generate the revenues anticipated.

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