Fitch Affirms TerraForm Power Operating's IDR at 'BB-'; Outlook Stable
(The following statement was released by the rating agency)Fitch Ratings-New York-05 February 2021:
Fitch Ratings has affirmed TerraForm Power Operating LLC's (TERPO) Issuer Default Rating (IDR) at 'BB-' with a Stable Rating Outlook. The rating affirmation considers TERPO's relatively stable long-term contracted and regulated cash flows from a diversified portfolio of renewable projects.
TERPO's publicly-traded parent Terraform Power, Inc. (TERP) was taken private by Brookfield Renewable Partners and affiliates in July 2020. Fitch believes the transaction is largely positive as it reduces administrative costs, removes the pressure of meeting public distribution targets and provides enhanced operational efficiencies as part of a larger renewable platform. However, private ownership can lead to less transparency on financial and operational data.
Expected benefits from privatization partially offset the weak performance at the project level. TERPO's generation assets continue to perform below expectations due to resource and availability issues which remains a key risk.
Fitch expects the company's growth trajectory to moderate in the future. TERPO's rating and Outlook incorporate Fitch's expectation that TERPO will implement its operating plans and capital recycling initiatives in a credit-supportive manner. Fitch expects holding company (HoldCo)-only FFO leverage to hover around 6x over the next two years. We calculate TERPO's credit metrics on a deconsolidated basis as its operating assets are largely financed with nonrecourse project debt.
Key Rating Drivers
Contracted and Regulated Portfolio: TERPO owns and operates 4.2GW of diversified wind and solar assets located primarily in the U.S. and Spain. Approximately 59% of cash flows are long-term contracted with over 90% investment-grade off-takers, and 35% is regulated under a fixed return-on-investment regime in Spain. TERPO's long-term contracts have a 12-year average remaining life, shorter than peers.
Privatization Largely Credit Supportive: TERP was taken private by Brookfield Renewable Partners and Brookfield affiliates in July 2020. TerraForm Power NY Holdings, Inc. (TERP NY) is the successor of TERP. The transaction removed administrative costs associated with a publicly listed company, approximately $4 million per year, and TERP NY will no longer pay management fees to Brookfield of approximately $27 million in 2019.
This arrangement also eliminates the need to meet the 5%-8% dividend growth target and 80%-85% dividend payout ratio and allows management to focus on organic growth and improving project performance in the future. However, private ownership usually will lead to less transparency on financial and operational data, a credit concern. The sponsor credit line provided by Brookfield Asset Management Inc. (A-/Stable) is terminated.
Organic and Low Growth: The privatization transaction has not led to meaningful change in TERPO's capital structure at this time. However, Fitch expects TERPO to shift toward an organic and low growth model from more aggressive growth through acquisitions. TERPO acquired Saeta Yield in 2018 and Alta Gas' distributed generation (DG) assets in 2019. Future growth will come from redevelopments (including repowering), expansions and improving asset availability. TERPO signed several contracts related to the repowering of the 160MW Cohocton and Steel Winds facilities in New York.
Fitch also expects TERPO to continue to evaluate accretive capital recycling activities. TERP closed on the sale of a 49.9% minority stake in an 836MW North American wind portfolio for net proceeds of approximately $250 million in October 2020. Proceeds from the sale were used to repay the revolver and finance the equity component of the NY Wind repower development costs.
Weak Asset Performance: TERPO's generation assets continue to perform below expectations due to resource and availability issues. TERPO experienced lower resource in the North America wind and solar segments and in Spain wind in 2020. Inverter issues on the Mt. Signal solar project led to lower availability, which Fitch understands will be resolved in early 2021. Merchant prices in Spain and Texas were weak in 2020.
In Spain, power prices are depressed due to lower demand and oversupply of renewable generation. Market revenue is estimated to comprise 25% of TERPO's regulated revenue in Spain and 8% of consolidated revenues. The return on investment adjustment partially mitigates the effects of low market prices.
However, the adjustment only takes place every three years. The next reset is expected to take place in December 2022. When wholesale market prices are outside a price band around the market price projected by the regulator during the preceding three years, the difference in revenues assuming average generation accumulates in a tracking account. The return on investment is then increased or decreased in order to amortize the balance of the tracking account over the regulatory life of the assets.
Service Contracts Mitigate Availability Issues: TERPO expects the wind operations and maintenance (O&M) to achieve approximately $20 million in run-rate savings following the implementation of the Full-Service Agreement (FSA) with General Electric Company (GE; BBB/Stable) on the North American wind fleet, except for one project.
TERPO has also executed Long-Term Service Agreements (LTSA) for European wind, which could achieve $4 million savings annually. TERPO signed a LTSA for its North America solar fleet, except for Arcadia, which could achieve $5 million savings. LTSA for Arcadia is currently under way.
Weak Credit Metrics: TERPO's 2019 HoldCo-only FFO leverage ratio exceeded the downgrade guideline ratio of 6.5x and Fitch expects the ratio in 2020 to continue to hover around 6.5x. We expect TERPO's credit metrics to improve to a level that is more consistent with the 'BB-' rating. In the next two years, Fitch projects that HoldCo-only FFO leverage will average approximately 6x, considering savings from the privatization transaction, service contracts and moderate improvement of asset performance.
TERPO's ratings are assigned based on a deconsolidated approach. TERPO's subsidiaries are project subsidiaries that have been largely funded by nonrecourse debt. Fitch applies a similar approach to NextEra Energy Partners LP (NEP; BB+/Stable) and Atlantica Sustainable Infrastructure plc (AY; BB/Stable), both of which own and operate portfolios of nonrecourse projects.
TERPO is similar in terms of generation capacity to NEP but is larger than AY. TERPO's long-term contracted fleet has a remaining contract life of 12 years, lower than NEP's 15 years and AY's 17 years. NEP and AY are publicly-traded yieldcos and are targeting 12%-15% and 8%-10% distribution growth, respectively. TERPO has been taken private and is no longer subject to public growth targets.
AY's renewable portfolio benefits from a large proportion of solar generation assets (63%) that exhibit less resource variability, versus NEP's 14% and TERPO's 43%. Fitch considers NEP better positioned than TERPO owing to NEP's primary presence in the U.S., stronger credit metrics and its association with NextEra Energy Inc. (A-/Stable). Similar to AY, TERPO is exposed to the Spanish regulatory framework. TERPO's credit metrics are weaker than those of AY but ownership by Brookfield is more favorable providing stability and expertise in executing business strategies.
Fitch's Key Assumptions Within Its Rating Case for the Issuer Include
- Wind O&M to achieve about $20 million in run-rate savings following the implementation of the FSA with GE that wraps O&M and major maintenance and guarantees production on a MWh basis;
- NY Wind repowering to be financed with retained cash flow;
- Moderate revenue growth assumed in 2021.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- HoldCo-only FFO leverage below 5.0x on a sustainable basis;
- A track record of a conservative and consistent approach in executing the business plan and managing growth from a credit perspective.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- HoldCo-only FFO leverage above 6.5x on a sustainable basis;
- Underperformance in project assets that lends material variability or shortfall to expected project distributions on a sustained basis and without a clear path to recovery;
- Growth strategy underpinned by aggressive acquisitions and/or addition of assets in the portfolio that bear material volumetric, commodity, counterparty or interest rate risks;
- Lack of access to funding that may lead TERPO to deviate from its target capital structure.
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.
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 Environmental, Social and Corporate Governance (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.
TerraForm Power Operating, LLC; Long Term Issuer Default Rating; Affirmed; BB-; Rating Outlook Stable
----senior unsecured; Long Term Rating; Affirmed; BB
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