Moody’s Investors Service Monday placed the ratings for Dominion Resources, Inc. and its principal subsidiaries, Virginia Electric and Power Company (VEPCO) and Consolidated Natural Gas Company (CNG), on review for possible downgrade, citing weaker than expected recent financial performance and a higher degree of risk than most utilities due to its E&P operations, its non-regulated merchant generation business and a sizeable commodity risk management business.
The possible downgrade could affect about $20 billion of debt and preferred securities, including Dominion’s Baa1 senior unsecured and (P) Baa2 trust preferred and (P) Baa3 preferred stock ratings; VEPCO’s A2 senior secured, A3 senior unsecured, Baa1 trust preferred, Baa2 preferred stock and Prime-1 commercial paper ratings, and CNG’s A3 senior unsecured, Baa1 trust preferred and (P) Baa2 preferred stock ratings. The Prime-2 commercial paper ratings for both Dominion and CNG have been affirmed.
Moody’s noted a decline in funds from operations and higher than expected leverage. “In our opinion, Dominion has a relatively high degree of business risk in comparison to most companies in the utility sector,” the ratings agency said.
The ratings had previously incorporated an expectation that Dominion would improve its financial profile by lowering its over-all debt capitalization to less than 60%, increase its funds from operations (FFO) to an adjusted total debt ratio over 20% and reverse its negative free cash flow generation. But the company failed to realize these goals for the latest twelve months ended September 2005, and financial performance in 2006 is not projected to be significantly better than in 2005, Moody’s said.
Funds from operations have deteriorated from approximately $3.3 billion for the year-end of 2004 to approximately $2.9 billion for the latest twelve months ended September 2005. ” Since capital expenditures are estimated at approximately $3.0 billion and shareholder dividends are projected to grow to approximately $925 million, this would result in another year of sizeable negative free cash flow in 2006,” the ratings agency said.
The affirmation of Dominion’s P-2 commercial paper rating reflects the likelihood that the rating review will not result in a downgrade of the long term rating by more than one notch. The affirmation also incorporates the expectation that Dominion will maintain sufficient reliable liquidity. The company has approximately $7.7 billion of total committed credit facilities. However, this total includes about $3.1 billion of short term bilateral facilities that expire within the next few months.
Moody’s review will focus on Dominion’s expected financial profile and projected credit metrics over the next 12 to 18 months and the expected adjustments or refinements to its available liquidity capacity. The review for potential downgrade is expected to be completed within approximately three months, but may be completed after Moody’s evaluates certain information expected to be filed in Dominion’s 2005 SEC form 10-K.
The review for possible downgrade for VEPCO is primarily related to the review for possible downgrade at its parent company, Dominion. Given limited regulatory insulation and relatively unrestricted flow of funds in a centralized money pool, the notching among Dominion’s rated entities are expected to remain close (Dominion rated one notch below its primary subsidiaries CNG and VEPCO).
Meanwhile VEPCO’s financial performance “may weaken due to limitations on its ability to pass through higher fuel costs during the term of its current rate freeze. VEPCO is expected to commence a fuel recovery re-set proceeding in late 2006 (to be in effect for mid-2007), which could help alleviate fuel cost leakage.”
For the period ended September 2005, Dominion made an approximately $200 million equity infusion into VEPCO through the forgiveness of inter-company debt. And effective Dec. 31, 2005, Virginia Power Energy Marketing (VPEM), will no longer be a subsidiary of VEPCO, thereby eliminating any future mark to market fluctuations from VPEM on VEPCO’s financial statements.
The review for possible downgrade at CNG reflects shortfalls in oil and gas production and weaker than expected financial performance. Production has been below expectations for oil and gas operations at CNG as well as the operations that are directly held by Dominion. Due to production curtailments following hurricanes Katrina and Rita, CNG’s production volumes will be noticeably lower than previous expectations in 2005 and early 2006. The company expects meaningful insurance recoveries to partially mitigate the loss of cash flow, but the timing and amount of recovery remains uncertain.
CNG also faces large liquidity demands from margin requirements on its out-of-the-money hedges, Moody’s said.
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