Moody’s downgrades U.S. regulated utility sector as cash flow is reduced by tax cuts
Energize Weekly, June 27, 2018
Moody’s Investors Service has downgraded the U.S. regulated utility sector to negative from stable due to lower cash flows and the highest debt leverage since 2008 as a result of changes to the federal tax laws.
While steps are being taken by some regulators and companies to deal with the challenge, Moody’s said it could be 12 to 18 months before sector-wide metrics improve.
The Tax Cuts and Jobs Act, signed into law in December 2017, reduced the corporate tax rate to 21 percent from 35 percent and also removed bonus depreciation from the tax code. These changes have had a sharp impact on the utility sector, Moody’s said.
“The combination of the loss of bonus depreciation and a lower tax rate as a result means that utilities and their holding companies will lose some of the cash flow contribution from deferred taxes,” Moody’s report said.
Utilities cash flow has been augmented by setting aside revenue for future tax payments. These deferred tax payments accounted for 14 percent of funds from operations (FFO). With the lower tax rates, utilities will be collecting less in deferred tax payments. Moody’s said that their share will drop to 8 percent of FFO from the current 14 percent through 2019.
The drop in cash flow will also affect debt leverage as the FFO-to-debt ratio for a peer group of 42 utility holding companies will drop to 15 percent from 17 percent and for operating utility companies to 20 percent from 24 percent, Moody’s said.
The group of utility holding companies, with about $600 billion of adjusted debt at the end of 2017, have a debt-to-EBITDA (earnings before interest, taxes, depreciation and amortization) that is at a 10-year high and the highest consolidated debt-to-equity ratio since 2008, at the height of the financial crisis.
“High leverage will persist due to growing capital spending and rising dividends,” Moody’s said. “Utility companies continue to spend significant capital on their rate base through smart grid investments, system resilience measures and carbon transition efforts, including renewable generation assets.”
Some state regulatory commissions have taken steps to soften the impact of the reduced cash flow, and several holding companies are moving to strengthen their balance sheets, Moody’s said.
The Florida Public Service Commission, for example, allowed utilities, including Florida Power & Light Co., Duke Energy Florida and Tampa Electric, to use the bulk of customer refunds resulting from the tax cut to offset rate increases to cover the costs from Hurricane Irma. Duke Energy was also allowed to apply a portion of the tax savings to the accelerated depreciation of coal-fired plants.
In May, the Alabama Public Service Commission approved two rate proposals by the Alabama Power Company—one aimed at improving the company’s balance sheet and credit by gradually increasing its equity ratio to 55 percent and another allowing up to $30 million of excess tax liability deferrals to offset under-recovered fuel costs.
“The outlook could return to stable if we expect the sector’s financial profile to stabilize, even if that is at today’s lower levels,” Moody’s said. “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 percent or the ratio of consolidated FFO-to-debt indicates a return to the 17-19 percent range.”