DBRS Confirms Terasen Gas Inc. at “A” and R-1 (low)

DBRS has today confirmed the Purchase Money Mortgages and the MTNs & Unsecured Debentures ratings of Terasen Gas Inc. (TGI or the Company) at “A” and its Commercial Paper rating at R-1 (low), all with Stable trends. The rating confirmations reflect TGI’s low business risk natural gas distribution operations; a favourable regulatory environment, with strong ring-fencing provisions; a strong franchise area, with a large customer base; and a modestly improved financial profile.

In late 2009, TGI executed a negotiated settlement that established rates for 2010 and 2011. The settlement excluded the performance-based rate (PBR) mechanism, under which the Company had operated for the 2004 to 2009 period. The PBR had allowed TGI the opportunity to share earnings above the allowed return on equity (ROE) with customers on a 50/50 basis and had been beneficial to TGI as it had provided more than $11 million per year in earnings, on average, in 2008 and 2009. While the loss of this PBR income would have negatively affected TGI’s financial results, this was largely offset by an improvement in regulatory allowed ROE (to 9.50% from the 8.43% that would otherwise have been in effect) and equity thickness (from 35.01% to 40%). The regulatory environment also continues to provide for a number of cost-recovery mechanisms that, when combined with the general rate-setting methodology, allow for a full recovery of all prudently incurred operating expenses and capital expenditures within a reasonable time frame.

The Company’s credit metrics have historically remained consistent and are expected to continue to do so, with a modest lift from the recent regulatory changes. With the increases in approved ROE and equity thickness, partially offset by the loss of PBR, DBRS estimates an increase in the EBIT coverage metric of approximately 0.25 times and an increase of approximately 150 basis points in cash flow-to-debt over recent historicals. However, TGI’s coverage metrics are expected to remain moderately lower than those of similarly rated gas distribution companies, even factoring in the improvements, a differential DBRS views as being offset by the Company’s more stable credit metrics and business risk profile.

Minimal to modest free cash flow deficits are expected over the medium term, attributable to the replacement and refurbishment of existing infrastructure (which is expected to go into the rate base in a timely manner) and modest customer growth. Any deficits would be expected to be financed with a combination of the $500 million revolving bank facility ($414 million available at March 31, 2010) and long-term debt issuance. TGI’s balance sheet is expected to remain stable over the medium term as the Company is expected to manage its dividends to maintain its capital structure within the recently revised regulatory-approved debt-to-equity ratio of 60%-to-40%.

DBRS expects the lower customer growth trend to continue, with fewer new housing starts and a shift in the housing mix to more multi-family dwellings. TGI is expected to focus on retaining customers through expanded energy conservation and efficiency programs.

The Company continues to maintain a price advantage relative to electricity, the primary competitor to natural gas. The current weaker gas pricing environment both improves TGI’s competitiveness and reduces working capital and liquidity requirements. TGI’s financial strength and credit profile over the longer term will depend to some extent on the continued competitiveness of natural gas relative to alternative energy sources (mainly electricity).

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating North American Energy Utilities (Electric, Natural Gas and Pipelines), which can be found on the DBRS website under Methodologies.

This is a Corporate (Utilities & Independent Power) rating.