DBRS Confirms TransAlta Corporation at BBB, Stable Trend

DBRS has today confirmed the ratings of TransAlta Corporation’s (TAC or the Company) Unsecured Debt/Medium-Term Notes at BBB, with a Stable trend based on the Company’s diversified generation portfolio and strong cash flows generated by its generation facilities subject to legislatively mandated Alberta power purchase arrangements (APPAs) and longer-term power contracts on its non-regulated facilities.

The 2009 acquisition of Canadian Hydro Developers, Inc. (Canadian Hydro or CHD) further diversified TAC’s generation portfolio by fuel type, currently dominated by thermal generation. The acquisition is also considered a good strategic fit for TAC as Canadian Hydro has a favourable contract profile which features lengthy tenors and strong counterparties; and a relatively young fleet of primarily wind assets when compared to TAC’s older coal plants.

TAC currently has approximately 75% of its capacity contracted over the next seven years, with over 90% contracted for 2010 and 86% for 2011, in line with its stated objective of having at least 75% of its capacity under medium- and long-term contracts with creditworthy counterparties, thus reducing the Company’s cash flow volatility, especially in the current weak pricing environment.

Though TAC’s earnings have remained reasonably strong over the past 18 months, the decline from 2008 can be attributed to a combination of higher unplanned and planned maintenance at some of its facilities and soft power prices in the markets it operates in. Over the first half of 2010, earnings showed strong improvement as a result of the acquisition of Canadian Hydro and more favourable power pricing compared to 2009. The Company continues to target fleet availability in the high 80s to 90s in the near term.

While the Company’s business risk profile improved with the acquisition of Canadian Hydro, its financial risk increased following the significant increase in debt needed to finance the acquisition, along with its high growth capex. While TAC funded its $750 million purchase of CHD’s equity on approximately a 50/50 equity/debt basis, it also assumed $875 million of CHD’s debt. These two factors as well as lower market prices have led a corresponding decline in the Company’s credit metrics; however, DBRS remains comfortable with the current credit rating.

Growth capital expenditures are expected to continue in the near term with the construction of the following projects: Keephills 3, Keephills Unit 1 and Unit 2 uprates, Ardenville, Bone Creek and Kent Hills 2. These projects are estimated to cost a total of $1.3 billion, of which $1.0 billion has been incurred to date. Growth capex is expected to peak in 2010 with more than 80% of the total project cost for Keephills 3 spent to date and remains on track to be commissioned in the second quarter of 2011. Following the completion of Keephills 3 and its other projects, DBRS estimates that capex will be at levels of between $400 million to $500 million annually in the near to medium term, not factoring in further acquisitions.

As significant assets under construction will be placed in service and begin to generate cash flow in 2011 and 2012, DBRS expects that on a longer-term, normal course basis, the Company’s adjusted net debt-to-capital should remain below 50% and cash flow-to-debt will remain in the 25% range, levels that DBRS considers adequate for the rating, given the largely contracted fleet. The Company had $2.1 billion in committed credit facilities as of June 30, 2010, of which $0.8 billion was available.

DBRS expects that TAC will continue to focus on managing its costs and remains comfortable at this time with the Company’s growth strategy, financial flexibility and adequate liquidity.

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 our website under Methodologies.