DBRS Confirms Capital Power L.P. at BBB, Stable Trend

DBRS has today confirmed the Senior Unsecured Debt rating of Capital Power L.P. (CPLP or the Partnership) at BBB, with a Stable trend, based on the Partnership’s stable cash flows generated by facilities subject to legislatively mandated Alberta power purchase arrangements (APPAs), other long-term contracts and its low-cost baseload facilities. The Partnership also has a relatively young fleet of generating assets, with an average age of approximately 13 years, which have solid operating track records. These strengths are offset by the current high level of capital expenditures and lack of fuel and geographical diversification.

Approximately 56% of CPLP’s net generation capacity is sold forward through long-term contracts or legislatively mandated APPAs, which, together with a further 26% of uncontracted baseload coal generation capacity, provide a degree of stability to the Partnership’s earnings and operating cash flows. CPLP is expected to maintain a target of at least 50% of its total EBITDA from contracted plants. Currently, DBRS estimates that approximately 60% of the Partnership’s operating margin is generated from contracted plants, with a weighted average remaining life of ten years. In addition to the long-term contracts, CPLP sold a significant amount of its commercial portfolio forward in 2010 and approximately 70% has been sold forward for 2011.

CPLP is undertaking significant growth capital expenditures in the near term, including one major project (Keephills 3) currently under construction. The Partnership is also developing two wind projects in Ontario and British Columbia. These growth capital expenditures are expected to lead to significant free cash flow deficits. Capex is expected to total $361 million in 2010 following the completion of the two new units at the Partnership’s Clover Bar Energy Centre at the end of 2009.

During this growth phase, DBRS expects that cash flow deficits will be financed with a combination of debt and equity, which will put modest pressure on the balance sheet and credit metrics until major generating assets are placed in service. CPLP’s credit metrics are expected to be affected in 2010 by lower margins from its Alberta contracted plants due to planned outages and transmission system upgrades in Alberta, soft power prices in Alberta and the final sale of the remaining portion of its Battle River APPA. CPLP is expected to continue to pursue growth through targeted acquisitions and development in Canada and the United States.

Furthermore, the Partnership’s cash flow stream is reasonably concentrated, with considerable reliance on Alberta-based coal-fired generation. With the addition of Keephills 3 in 2011, a significant portion of CPLP’s cash flow will be derived from non-contracted coal-fired generation in Alberta, further highlighting a lack of diversification. Though the additional generation will be baseload, the portfolio remains exposed to power price risk. The volatility and softness in Alberta power prices has caused earnings and cash flow derived from CPLP’s commercial plants to be more volatile. Mitigating this risk is the stable cash flow produced by the Partnership’s Genesee 1 and Genesee 2 facilities, which operate under APPAs that are in place until 2020. The Partnership’s generation portfolio is also heavily weighted toward coal-fired facilities, exposing it to environmental risks as federal and provincial standards continue to evolve.

The Partnership remains exposed to refinancing risk as internally generated cash flow from operations may not be sufficient to cover the upcoming maturities, especially with the significant capex in the near term. The amount outstanding on the back-to-back loans to EPCOR Utilities Inc. as at June 30, 2010, was $613 million, down from the initial $896 million. The Partnership has sufficient credit facilities totalling $1.22 billion to meets its obligations as they come due.

DBRS expects CPLP to maintain a reasonably stable financial profile, with debt-to-capital of less than 50%, cash flow-to-debt of at least 20% and EBITDA-to-interest of greater than 4.0 times in the medium to longer term. The Partnership has stated that it remains committed to maintaining an investment-grade rating.

In a press release published on October 5, 2010, DBRS noted that the joint announcement made by Capital Power Corporation (CPC) and Capital Power Income L.P. (CPILP, rated BBB (high), Under Review with Negative Implications) to initiate a process to review CPILP’s strategic alternatives has no impact on the rating of CPLP, given the modest contribution of CPILP to CPLP and the uncertainty as to the outcome of the review. DBRS would assess the impact of any resulting transaction on CPLP’s credit profile if and when such a transaction is announced.

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.