INNERGEX RENEWABLE ENERGY INC. RATING 'BBB-'
FITCHRATINGS - 02 Dec 2020: Fitch Ratings has assigned Innergex Renewable Energy Inc. a first-time Issuer Default Rating (IDR) of 'BBB-' with a Stable Rating Outlook. Fitch has also assigned a rating of 'BB' to Innergex's cumulative preferred shares. The preferred shares are afforded a 50% equity credit due to the cumulative nature of the dividends and the perpetual nature of the preferred stock. Fitch calculates Innergex's credit metrics on a deconsolidated basis, as its operating assets are largely financed with nonrecourse project debt held at the project subsidiaries.
The ratings of Innergex reflect the relatively stable and predictable nature of contracted cashflows generated by its portfolio of wind, hydroelectric and solar assets that are well diversified with respect to geographical exposure and asset class. Nearly three fourths of Innergex's revenues are derived from long-term contracts with strong creditworthy counterparties that include large municipal- and investor-owned utilities, which helps to minimize commodity risk. The remainder of revenues are provided by the sale of production tax credits from wind assets and merchant projects whereby Innergex enters into financial hedges to eliminate exposure to spot power prices. Innergex's ratings consider the structural subordination of Holdco debt to the substantial amount of project debt at the nonrecourse project subsidiaries.
The ratings also consider Innergex's strengthening credit metrics and management's commitment to its investment-grade ratings. Fitch expects Innergex's Holdco debt/parent-only FFO ratio to range from 3.0x to 3.6x through the 2020-2024 financial forecast. Finally, Fitch does not expect coronavirus pandemic-related concerns to have a material impact on Innergex's operations and access to capital due to the contractual nature of its renewable portfolio.
KEY RATING DRIVERS
Creditworthy Counterparties Underpin Contracted Cashflows: Innergex's existing portfolio of renewable assets produces stable and predictable cashflows underpinned by long-term contracts, with a remaining weighted average contract life of 14.4 years. A majority of the counterparties have strong investment-grade ratings, with a weighted average counterparty credit rating of 'AA-', based on Fitch's and other publicly available ratings. The contracts are typically fixed price with annual escalation mechanisms. Innergex's portfolio does not bear material resource availability risk or commodity risk.
Geographic and Asset Diversification: Innergex currently owns 75 assets (with eight additional projects in development) comprising 3,694MW of renewable energy generation. The renewable portfolio benefits from diversification by geography and asset type, which limits geographic exposure and weather variability. For 2019, revenues by asset type were 55% wind, 39% hydroelectric generation and 6% solar. Fitch does not expect the asset mix to change materially through the forecast period. While wind resources can be intermittent, nearly half of project distributions to Holdco are generated from hydroelectric and solar projects, which typically enjoy strong and predictable resource availability. Historically, the resource availability of Innergex's portfolio of renewable assets has been 98% of projected levels. Geographically, revenues are predominantly derived from Canada (78%), followed by France (17%) and the U.S. (5%) as of 2019.
Strategic Alliance With Hydro Quebec: Fitch views Innergex's strategic alliance with Hydro Quéebec (IDR: 'AA-'/Stable), the largest public utility in Canada, as a credit positive. Innergex benefits from the financial strength that Hydro-Quebec provides, as both companies seek to accelerate investments in renewable energy. In February 2020, Hydro Quebec, Innergex's largest counterparty, formed a strategic alliance with the company and completed a $661 million equity investment. In doing so, Hydro-Quebec has made an initial commitment of $500 million dedicated to co-investment in renewable energy assets in North America, Latin America and Europe. Hydro Quebec is now the company's largest shareholder, with a 19.9% ownership stake and the potential to increase their equity position over time. The investment helps to mitigate market access concerns as the company continues to scale the business and achieve its 10% adjusted EBITDA proportionate growth target.
Acquisitions and Organic Opportunities Underpin Growth Strategy: Management's strategy is to supplement organic growth with targeted acquisitions in key markets with attractive growth opportunities. Innergex's most recent transactions were in regions where they are already present and highlight management's acquisitive growth strategy. In 2020, Innergex acquired a 68MW solar farm in Chile for $47 million and six 23MW wind farms in Idaho for $57 million. There were no acquisitions in 2019. In 2018, Innergex acquired renewable assets in Iceland, British Columbia and the U.S. totaling 840MW from Alterra Power Corp. for $451 million (CAD); bought out TransCanada's joint venture interests in multiple wind farms totaling 365MW in Quebec for $621 million (CAD); and acquired a 250MW solar farm in Texas for $132 million (CAD). In 2019, Innergex divested all of its Icelandic assets for $401 million (CAD).
Robust Renewable Pipeline Drives Growth: Innergex has a strong project pipeline of key renewable projects that will support its growth targets in the near term. In addition to its new solar farm in Chile and anticipated acquisition of wind assets in Idaho in late 2020/early 2021, these projects include: Hillcrest, a 200MW solar farm in Ohio with an expected in-service date in late 2020; and Griffin Trail, a 226MW merchant wind farm in Texas with an expected in-service date in 2021. Future growth is focused on the U.S., specifically in the coal-heavy Midwest and Southern regions. In the U.S., ERCOT remains a key market, and in late 2019 Innergex commissioned two of its largest projects to date in Texas, including Phoebe, a 250MW solar farm, and Foard City, a 350MW wind farm.
Higher Business Risk Than Yieldco Peers: Unlike many U.S. yieldcos that pursue an acquisition-based growth strategy, Innergex actively develops new projects in addition to acquisitions. However, Innergex's new development track record (typically small sized projects), the maturity of the renewable industry and the fact that nearly all of its revenues are derived from projects in developed markets in the U.S., Canada and France mitigate construction and execution risks.
Concerns Regarding Curtailment by BC Hydro: As a result of reduced demand resulting from the impact of the pandemic, BC Hydro reduced purchases of electricity from Innergex by up to 6MWh for the period of May 22, 2020 through July 20, 2020, resulting in a loss of revenues of $11 million through June 30 and $20 million in aggregate. BC Hydro has characterized the curtailment as a "Force Majeure" event under its power purchase agreement (PPA), while Innergex disputes the assertion. Innergex contends "take or pay" provisions under the agreement require BC Hydro to compensate the company for electricity produced in the absence of the curtailment. A resolution is expected next year.
At this time, Fitch does not expect the current curtailment of energy purchases by BC Hydro under its PPA to have a significant financial impact on the company. However, future curtailments of energy purchases that begin to have a material effect on expected earnings and cashflows could warrant negative rating actions. BC Hydro is Innergex's second largest customer and accounted for 28% of total revenues for 2019.
Credit Supportive Financial Policy: Innergex has a credit supportive financial policy rooted in expectations for low leverage and maintenance of a modest dividend growth target of 2% to 3%. A majority of debt at Innergex consists of nonrecourse project debt held at ringfenced project subsidiaries. The debt typically matures within the expiration date of the long-term contracts on any project. Currently, the most recent DSCRs provided to Fitch by Innergex indicate that all projects with limited recourse project debt financings are performing well in excess of their DSCR thresholds.
Improvement in Credit Metrics: Management decreased debt at the Holdco level in 2Q20 by approximately 30%, using about half of the proceeds from the $661 million investment by Hydro Quebec. Consequently, Innergex's Holdco debt/parent-only FFO ratio is projected to strengthen to 3.6x in 2020 from 5.4x in 2019. Fitch defines parent-only FFO as run rate project distributions less Holdco G&A expenses, fees for the management service agreement, credit fees and Holdco debt service costs. In its calculation of Holdco debt, Fitch includes revolver borrowings and the convertible debentures and assigns a 50% equity credit to its cumulative preferred stock.
Fitch expects Innergex's Holdco debt/parent-only FFO ratio to range from 3.0x to 3.6x over the next five years. Projected leverage reflects cash available for distribution (CAFD) growth from 2020 acquisitions and the use of available cash and other capital allocation decisions to bring down revolver borrowings.
Approximately 96% of the long-term interest exposure is either fixed or hedged, thereby mitigating any impact in a rising interest rate environment. Innergex typically hedges its USD and Euro exposure on a one-for-one basis by entering into foreign exchange (FX) forward contracts to minimize FX currency risk. Although Innergex is incorporated as a C corporation, it is not expected to pay significant cash taxes through the forecast period because of the use of renewable tax credits and net operating losses (NOLs) generated through modified accelerated cost recovery system (MACRS) depreciation benefits.
Fitch views Innergex's ratings as positively positioned compared to those of Atlantica Sustainable Infrastructure Plc (AY; 'BB'/Stable) and NextEra Energy Partners (NEP; 'BB+'/Stable). The ratings consider asset and geographic diversification, long-term contractual cashflows with minimal regulatory risk, the strong creditworthiness of counterparties, modest distribution growth targets and expectations for robust credit metrics.
In terms of scale, Innergex's generation portfolio comprises 3.7 gigawatts (GW), larger than that of Atlantic Yield at 1.5GW but smaller than NEP's at 5GW. Fitch views Innergex's portfolio of assets as favorably positioned due to the asset type compared to those of NEP and AY, anchored by Innergex's large concentration of low cost hydroelectric and solar generation assets (approximately 29% and 14% of power generation, respectively) that exhibit less resource variability. Wind generation accounts for the remainder. In comparison, NEP's and AY's generation portfolios consist of a larger proportion of wind projects, accounting for 84% and 59% of total MWs, respectively.
Innergex's generation portfolio also benefits from its diverse geographic footprint. Fitch views Innergex's geographic exposure in Canada and the U.S. (86% of MWs) favorably as compared to AY (30%) and in line with NEP (100%). While 8% of Innergex's generation portfolio is in France, cashflows are supported by feed-in tariffs. By contrast, approximately 33% of AY's power generation portfolio is in Spain, although it likewise benefits from regulations supporting minimum cost-based compensation for renewable energy. Innergex's long-term contracted fleet has a remaining contracted life of 14.4 years, similar to NEP at 16 years and AY at 18 years.
Innergex's forecast credit metrics are modestly better than those of its peers. Fitch forecasts NEP's Holdco debt to parent-only FFO ratio to be between 3.0x and 3.6x during 2020-2024, slightly better than mid-to-high 3.0x for AY and 3.6x to 3.7x for NEP.
Unlike its yieldco peers, Innergex does not benefit via support from a financially stronger parent sponsor. Fitch considers NEP as best positioned owing to NEP's association with NextEra, which is the largest renewable developer in the U.S., while AY benefits from its association with Algonquin Power & Utilities Corp. (BBB/Stable), which has a 44.2% ownership interest. However, Innergex's more conservative distribution policy obviates the need for frequent acquisitions and mitigates the lack of sponsor support to a certain extent. Innergex targets dividend growth of 2% to 3% per annum, significantly less than distribution per unit growth targets of 12% to 15% at NEP and 8% to 10% at AY.
Fitch rates Innergex, NEP and AY on a deconsolidated approach since their portfolios comprise assets that are financed using nonrecourse project debt or with tax equity. Fitch's Renewable Energy Project Rating Criteria uses one-year P90 as the starting point in determining its rating case production assumption. However, Fitch has used P50 to determine its rating case production assumption for Innergex, NEP and AY since they own diversified portfolios of operational wind and solar generation assets. Fitch believes asset and geographic diversity reduces the impact that a poor wind or solar resource could have on the distribution from a single project. Fitch has used P90 to determine its stress case production assumption. If volatility of natural resources and uncertainty in the production forecast is high based on operational history and observable factors, a more conservative probability of exceedance scenario may be applied in the future.
--Fitch has used P50 to determine its rating case production assumption and P90 to determine its stress case production assumption.
--Development of renewable assets during 2020-2022 to meet a 2% to 3% dividend growth target.
--No material acquisitions in the near term.
--Exclusion of nonrecourse project debt.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
--Longer term visibility on acquisitions and distribution per share growth.
--Holdco debt/parent-only FFO leverage below 3.0x for several quarters and a payout ratio at or below 80%.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
--A growth strategy underpinned by aggressive acquisitions or the addition of assets in the portfolio that bear material volumetric, commodity, counterparty or interest rate risks.
--Material counterparty or asset underperformance resulting in a shortfall of expected CAFD versus Fitch's projections.
--A material increase in concentration of earnings and cashflows from emerging market economies.
--Lack of access to equity markets to fund growth that may lead Innergex to deviate from its target capital structure.
--A Holdco debt/parent-only FFO leverage ratio exceeding 4.0x and a payout ratio exceeding 80% for several quarters.
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Non-Financial Corporate 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 four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
LIQUIDITY AND DEBT STRUCTURE
Fitch views Innergex's liquidity position as sufficient, with approximately $544 million of available liquidity under its $700 million revolving credit facility (RCF) as of Sept. 30, 2020, including $156 million of unrestricted cash and cash equivalents. The credit facility is secured by a first priority lien on 12 unencumbered assets and matures in December 2023. Innergex also has a $150 million subordinated, unsecured five-year term loan outstanding that was used as part of the acquisition financing of renewable assets in 2018. The credit facility provides flexibility for Innergex to finance acquisitions partly through revolver borrowings, which can be subsequently termed out through equity and debt capital market issuances. As of Sept. 30, 2020, Innergex had approximately $253 million of borrowings drawn and $60 million of letters of credit outstanding against its RCF. Long-term debt maturities are minimal until 2023, when $403 million is due to mature. This includes outstanding borrowings under the revolver and the $150 million subordinated term loan.
As of Sept. 30,, 2020, Innergex was in compliance with all financial covenants under the RCF.
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.
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.