Talen Energy Supply LLC Downgraded To 'B' On Weakened Credit Measures; Outlook Negative

  • U.S. power and energy supply company Talen Energy Supply LLC's pace of deleveraging has been slower than anticipated, and expected credit measures have weakened such that we believe it is unlikely they will improve significantly during the next two years.
  • We are lowering our issuer credit rating on the company by one notch to 'B'.
  • We are also lowering our ratings on its senior secured debt to 'BB-' from 'BB'. The recovery rating remains '1'.
  • We are revising our recovery rating on senior unsecured debt to '6' from '5'; lowering our issue level ratings to 'CCC+' from 'B'.
  • The negative outlook reflects a 1-in-3 chance for lower ratings, as lower economic growth could put downward pressure on power demand and result in materially lower energy margins than expected in 2021.
NEW YORK (S&P Global Ratings) March 26, 2020—S&P Global Ratings today took the rating actions above.
Talen's credit measures have underperformed our expectations.  When we revised our outlook on Talen to negative in the fall of 2018, we indicated the potential for a downgrade if the company could not reduce leverage to below 6.25x. Talen ended fiscal year 2019 with adjusted leverage greater than 8x, about 1.5x higher than expected. The impact of derivatives and non-operating cash flows is not reflected in this adjusted figure for 2019. We expect adjusted leverage to be 7.8x in 2020 and 6.8x in 2021, declining to about 6.0x in 2022 and beyond. Although Talen is significantly hedged for 2020, recessionary economic conditions that pressure power demand could lead to lower ratings if adjusted leverage remains above 7.5x in 2021 and beyond.
The negative outlook on Talen reflects the 1-in-3 chance for lower ratings, as lower economic growth could put downward pressure on power demand and result in materially lower energy margins than expected in 2021. We expect the company's metrics will remain elevated on persistently weak power prices and uncertainty around capacity prices in PJM. We expect leverage of about 7.8x in 2020 and about 6.8x in 2021, declining to 6.0x in 2022 and beyond. We also expect the company to maintain positive free cash flow and high availability under the revolving credit facility.
We would lower our ratings on Talen if the company's leverage remained above 7.5x on a sustained basis (2021 and beyond) in our forecasts, either due to diminished market conditions or more aggressive financial policies. Weaker market conditions could stem from a variety of factors, including lower-than-expected demand growth or greater-than-anticipated renewable penetration that weakens pricing for baseload generators. Additionally, any dividends to equity in the next couple of years could lead us to lower our ratings.
We could revise our outlook on Talen to stable if the company continues to reduce its leverage to more sustainable levels such that we expect leverage to remain below 6.5x or less in all years.
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