Fitch Ratings has downgraded Energy Harbor Corporation's Long-Term Issuer Default Rating (IDR) to 'BB+' from 'BBB' and placed the rating on Rating Watch Negative.
The downgrade reflects Energy Harbor's willingness to pursue a permanent capital structure that will result in materially higher leverage than Fitch's original expectation, as evidenced by the company's agreed-to-acquisition by Vistra Corp (BB/Stable).
The Rating Watch Negative indicates additional negative action is likely as Fitch expects to equalize Energy Harbor's IDR with Vistra's IDR. If the transaction does not close, Fitch will affirm the 'BB+' IDR, remove the Negative Rating Watch and assign a Stable Rating Outlook to Energy Harbor.
Key Rating Drivers
Acquisition by Vistra Increases Financial Risk Profile: Vistra will acquire Energy Harbor in a transaction valued at $3.43 billion and 15% equity interest in a Vistra subsidiary called Vistra Vision. Given the complimentary asset base, and Vistra's existing experience with nuclear generation, Fitch believes there is a high likelihood that the approval process will proceed as planned and the merger will close successfully. Upon close of the transaction, Energy Harbor's nuclear and retail businesses will combine with Vistra's nuclear, retail, renewables and storage businesses under a newly formed subsidiary holding company, that is currently referred to as 'Vistra Vision'.
While the acquisition provides modest improvement to the combined enterprise's business position, the proposed acquisition results in a weaker financial profile. Vistra would fully control the legal, strategic and operational aspects of the combined business, and as a result, Fitch will likely equalize Energy Harbor's IDR with Vistra's. Fitch expects Vistra's EBITDA leverage (defined as total debt with equity credit/operating EBITDA) will remain above its current negative sensitivity threshold of 3.5x until 2026 following the acquisition.
Weaker Standalone Financial Policy: In the low probability event that the merger fails, Fitch views Energy Harbor's financial policy, including target leverage and capital allocation policy as being somewhat uncertain. The company has not significantly changed its capital structure since it emerged from bankruptcy. In establishing a permanent capital structure, Fitch estimates Energy Harbor's leverage could be materially higher than Fitch's previous expectation of around 1.0x over the 2023-2025 period. The current rating action incorporates this assumption.
Energy Harbor's only existing debt is approximately $430 million in municipal bonds, which will be assumed by Vistra Vision upon close of the transaction. Fitch does not rate this debt.
Derivation Summary
Energy Harbor and Vistra Corp. (BB/Stable) have similar business strategies of combining generation and retail businesses and a load match book. While Vistra has a larger generation portfolio than Energy Harbor, it is predominately in ERCOT, which does not benefit from capacity prices, and includes coal fired-generation in addition to natural gas assets. In comparison, Energy Harbor is in the process of divesting its thermal assets and thereafter will have a nuclear-baseload profile, which runs at nearly 92% capacity.
Fitch views Ontario, Canada based nuclear generator Bruce Power (BBB+/Stable) as having slightly stronger profile as its generation capacity at 6.5GW is larger than Energy Harbor's, and the output from its facilities is sold on a wholesale basis to the Independent Electricity System Operator (IESO) under favorable contractual terms including a supportive rate of return and escalators, resets, and pass-throughs for most cost items.
Both Vistra and Energy Harbor benefit from their ownership of large retail electricity businesses, which are typically countercyclical to wholesale generation given the length and stickiness of customer contracts. Vistra benefits from its incumbent position in Texas with a high-margin mass retail market, while Energy Harbor's retail unit serves a mix of C&I, residential, small and medium-sized business, Provider of Last Resort and government aggregation customer base with margins that are generally lower and a customer base that is more stable. Bruce Power does not have any retail operations for physical delivery.
In the interim period before the transaction closes, Fitch expects Energy Harbor and Vistra to maintain leverage in-line with current expectations: around 1.0x at Energy Harbor compared with around 3.5x at Vistra and around 2.0x at Bruce Power.
Key Assumptions
The acquisition closes as per the stated terms;
Vistra receives approvals in a timely manner;
No material impact from Energy Harbor's planned disposition its fossil fuel assets.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
The Rating Watch could be removed and the ratings affirmed if the transaction fails to close and the company states its financial policy such that leverage (as defined earlier) is sustained between 2.0x and 3.0x;
Further positive rating action could be considered if the transaction fails to close and the company states its financial policy such that leverage is less than 2.0x on a sustained basis.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Transaction closes as per currently understood terms;
Transaction fails to close and leverage exceeds 3.0x on a sustained basis.
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
Adequate Liquidity: Energy Harbor has adequate liquidity, given its substantial cash on-hand as of Dec. 31, 2022. The company is expected to be FCF positive, and Fitch projects cash on-hand will continue to increase over the next 12-18 months. The company also has a Zero Carbon 366-day LC facility. The facility is due for renewal on Oct. 5, 2023. Fitch believes liquidity is sufficient for collateral posting given likelihood of volatility in natural gas prices. Absence of a long-term credit facility is a slight weakness, but Fitch expects the company can access additional bank lending to bridge short-term liquidity needs.
Other uses of cash could include payments related to fossil fuel asset disposal. There are no long-term debt maturities over the next five years.
Issuer Profile
Energy Harbor Corp. is a privately held energy producer and retailer, headquartered in Akron, Ohio. The company owns and operates four nuclear power generation units in Ohio and Pennsylvania totaling about 4.0GW. The company also serves nearly one million residential, commercial and industrial customers.
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.
VISTRA CORP. 
