Fitch Ratings has affirmed at 'A' the following
The Rating Outlook is Stable.
RATING ACTIONS
Entity / Debt
Rating
Prior
LT
A
Affirmed
A
Page
of 1
VIEW ADDITIONAL RATING DETAILS
SECURITY
The bonds are secured by a first lien on net revenues of Citizens Thermal Energy System (Citizens Thermal), which consist of steam and chilled water sales and certain other pledged funds under the master indenture.
ANALYTICAL CONCLUSION
The affirmation of Citizens Thermal 'A' rating reflects the system's stronger financial profile, characterized by consistently strong operating margins, which has allowed the utility to pay down its long-term debt and cash fund its capital investments. This results in a very low leverage calculation of 1.3x in 2022. However, the rating is also reflective of significant revenue concentration within the top 10 customers, comprising approximately 86% of total operating revenues, as well as rate regulation of the steam system. The top 10 customers are a mix of university centers, governmental agencies, and large corporations, with the majority of the contracts containing one-, five-, or 10-year auto-renewal clauses.
KEY RATING DRIVERS
Revenue Defensibility: Midrange
Revenue defensibility is constrained at midrange due to a very concentrated customer base with the top 10 customers accounting for approximately 86% of combined revenues and due to rate-regulated revenues for the steam business. However, the utility benefits from the competitive advantage of operating in a dense metro service territory with favorable pricing, including high alternative provider costs that make competition unlikely. The utility has engaged in multiple negotiations for various growth opportunities that are expected to begin service in the next few years.
Operating Risk: Stronger
The system's stronger operating risk assessment is driven by midrange cost flexibility and stronger resource management with further planned capital investments to address growth initiatives.
Financial Profile: Stronger
The system's financial profile is assessed as stronger. Leverage continues to decline as the system pays down debt and maintains consistently strong margins. Liquidity is down slightly over the past five years, with 129 days of cash on hand from 171 days in 2018, but is up from 114 days in 2021. Coverage of full obligations is healthy at 1.7x. Additional borrowing capacity increases overall liquidity to 212 days. The financial profile, while stronger, is less of a consideration in the final rating given minimal debt, as well as the above discussed revenue concentration that constrains the overall rating.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Continued measurable decline in leverage, notwithstanding the continued rating constraint imposed by customer concentration and the potential loss of customers, given the limited nature of the business.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Insufficient rate recovery that leads to a substantial measurable decline in financial metrics and reduces financial flexibility.
A loss of a top customer and a resulting strain on margins and increase in leverage.
Best/Worst Case Rating Scenario
International scale credit ratings of Sovereigns, Public Finance and Infrastructure 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 three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from '
CREDIT PROFILE
Citizens Thermal provides regulated steam and unregulated chilled water services for commercial and industrial heating and cooling to 131 steam and 66 chilled water customers in
The thermal system is a division of the city of
The steam and chilled water funds are separately reported in Citizens's financial audit but issue debt on the combined thermal system security. Fitch's analysis is based on the consolidated financial metrics of the steam and chilled water funds.
Revenue Defensibility
Revenue defensibility is mixed given the weaker demand characteristics, with midrange pricing characteristics. Revenue defensibility and upward rating potential is limited by the system's small customer base (just 131 steam and 66 chilled water customers) and high concentration of revenue among the top ten customers.
Favorably, the customer base has been very stable and the largest customers are well-established entities that are likely to continue to anchor the
Most of the utility's top customers are signed to contracts of varying terms, with most expiring within 10 years or less and prior to the maturity of the bonds (final maturity 2034), adding renewal risk. The high costs of switching to self-generating services, including capital expenses, operation and maintenance costs, and building space requirements, are substantial and help ensure an adequately reliable revenue stream that somewhat offsets contract renewal risk.
Sustained customer retention trends will remain an important rating factor. Only one customer elected against renewal among the top ten customers for both steam and chilled water, with their current contract expiring on
Fitch believes these risks are partially mitigated by the system's competitive rates and the prohibitively high costs customers face switching to in-house services. Demand is primarily influenced by the number of heating and cooling days in a year given the essentiality of business heating and cooling in
Midrange Pricing Characteristics with Partial Rate Regulation
Rates for the steam customers are regulated and set according to the
Steam system customers are distributed into three tariff rate classes set under the IURC's 2016 rate order. Steam rates include temperature adjusters and quarterly fuel cost adjustments to recover changes in estimated fuel costs, which Fitch believes contributes to the midrange assessment for the legal framework to recover commodity price volatility and offset some level of inflationary driven cost increases. Under Indiana Code (*) 8-1-2-42.5(a), rates are reviewed by the IURC at least every four years to ensure they meet operating and debt service costs among other reasonable charges to keep the system in sound physical and financial condition. The steam system filed a base rate case on
Unregulated chilled water is sold to retail customers pursuant to bilateral contracts with varying terms for renewal and cancellation. Rates are generally fixed plus variable usage charges.
Operating Risk
Operating cost flexibility is considered midrange as the ability to vary marginal cost with fluctuation in demand is somewhat limited given the fixed costs associated with supplying steam and chilled water. Positively, the more variable cost drivers like commodity costs shift with demand and are recovered in regular fuel cost adjustments.
Steam System Resource Management
Roughly 65% of the system's steam is purchased (Covanta long-term contract) and the rest is produced at two owned steam productions facilities centered around downtown
The steam system serves the
Citizens Thermal converted the Perry K plant to run on natural gas in 2015 from coal for cost savings and to address the
Chilled Water System Resource Management
The unregulated chilled water system has ample combined capacity totaling 59,200 tons for chilling services to meet a peak load of about 46,500 tons in 2022. The primary source of cooling services is the West Street System, one of the largest district cooling systems in the
Additionally, the chilled water system purchases approximately 8 million therms of steam per year from the steam division to fuel the system's water chillers.
Capital planning is considered neutral to the rating. Management reviews capacity requirements on an annual basis. The utility is currently pursuing or have solidified a number of growth opportunities that are expected to begin service within the next few years. Citizens reviewed the 2023 capital plan and decided to increase spend by approximately
The combined system's estimated age of plant has remained stable at 22 years over the prior five years. Capital investment appears adequately addressed in the five-year capital improvement plan that totals over
Financial Profile
The utility's financial performance in 2022 was strong. The utility has been paying down its long-term debt, reducing debt from over
The steam system contributes roughly 65% of total operating revenues but is a thinner-margin business than chilled water. In 2022, steam had a net income of
Forward Look and Fitch Stress Scenario
With the amortization of debt and no new debt projected, cash (including investments restricted for debt service) could exceed debt by fiscal 2024, driving Fitch's net leverage ratio, which balances debt outstanding and net pension obligations again cash reserves, below zero. The utility expects net income to rise above historical levels in the
The increased margin is primarily driven by increased base rates that are expected to be approved by the end of 2023, as well as a new service agreement with Eli
The system's liquidity profile is neutral to the rating. The utility has 129 days of cash on hand, with about 75% of cash being held in the chilled water business. Total liquidity, which includes lines of credit, is ample at 212 days, and COFO is very healthy at 1.7x.
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
Additional information is available on www.fitchratings.com
(C) 2023 Electronic News Publishing, source