DBRS Confirms ENMAX Corporation at A (low), R-1 (low), Stable Trends

DBRS has today confirmed the Unsecured Debentures rating of ENMAX Corporation (ENMAX or the Company) at A (low) and its Commercial Paper rating at R-1 (low), both with Stable trends. The ratings reflect ENMAX’s earnings and cash flow stability from its regulated transmission and distribution operations and a well-hedged non-regulated business, offset by increased business risk stemming from growth in owned generation. ENMAX’s regulated segment, which accounts for 30% of its adjusted EBIT, continues to experience growth as a result of major Alberta Electric System Operator (AESO)-directed transmission projects required to meet both load growth within Calgary and to replace aging infrastructure. The non-regulated segment which currently represents about 70% is well hedged by the Company’s owned or low cost contracted generation. At the same time, the Company continues to expand its non-regulated activities, particularly in acquiring or building additional energy supply to meet expected retail demand and/or maturing supply contracts.

ENMAX continues to maintain its strong presence in the Alberta retail electricity market, contracting or acting as an agent for more than 44% of the market as measured by volume, driven by the continued success of its EasyMax program which was launched in 2005, offering residential and small business customers a competitive five-year fixed electricity rate, without a complex contract or cancellation penalties. Electricity margins remain strong, with a material amount derived from long-term fixed-price sales contracts with weighted-average term of four years, thus reducing earnings volatility and mitigating the increased business risk. However, the rate of margin growth slowed in 2009 and for the 12-months ended September 30, 2010 due to the impact of lower commodity prices and lower realized sales prices on fixed and mixed variable price retail contracts.

ENMAX Energy generates or has access to generation volumes that exceed its retail fixed sales volumes; the modest surplus has been sold at market prices lower than in previous years. The Company’s fixed-priced portfolio is hedged either by ENMAX’s owned or contracted generation capacity, thus limiting exposure to both volume and price risk.

ENMAX’s strategy continues to employ a vertically integrated business model in the non-regulated business, where the Company controls the production, delivery and customer interface for its electricity products. Currently, ENMAX produces or has exclusive access to approximately 2,083 megawatts (MW) of low-cost generation following the acquisition of the final 15% interest in the Battle River Power Purchase Agreement (PPA) in January 2010 and the completion of the 120 MW gas-fired Crossfield Energy Centre at the end of 2009.

In 2010, the Company received regulatory approval for the $1.25 billion, 800 MW Shepard Energy Centre (Shepard), which, if successful, will commence construction in 2011 for commercial operation in 2015 (commercial operation date was pushed out further from the original date of 2013). The Company is also developing the 165 MW natural gas-fired co-generation Bonnybrook Energy Centre, which if successful, will begin commercial operation in early 2013.The arrangement for two of the Battle River units (295 MW) runs until December 2013 and a portion of ENMAX’s proposed generation facilities is expected to replace this capacity. These proposed generation projects, if built according to plan and schedule, in addition to the expected higher capex in the regulated business, will result in moderate-to-large free cash flow deficits for the Company, putting significant pressure on its balance sheet. DBRS expects that regulated capex could go as high as $190 million annually in the medium term due to increased investment in the Company’s rate base, further resulting in higher debt levels.

DBRS expects ENMAX to remain prudent as it deploys capital to its non-regulated business. ENMAX has stated that it is examining all its options for the potential Shepard project, including equity partners and asset sales. Given the significant size of Shepard and the lack of an extensive track record of managing large-scale greenfield generation build-out projects, DBRS would expect ENMAX to take the appropriate steps to minimize its impact on creditworthiness in order to maintain its current ratings. Furthermore, as a significant portion of capital expenditures are expected to be funded out of cash flow, any cash flow weakness could affect the amount of debt utilized and negatively impact the financial profile. Under this scenario, DBRS would expect the Company to support its financial profile by some combination of reduced capital expenditures, asset sales, etc. DBRS also expects that the projects could be deferred if the Company’s demand forecast does not materialize as expected.

The Company has stated that its long-term target debt-to-capital ratio and EBITDA coverage ratios are 45% and greater than 5.0x, respectively. DBRS notes that the Company may not meet either one of these targets during periods of high capital expenditures associated with significant construction projects. However, these targets are expected to improve once the assets enter service. As debt is used to partially fund non-regulated growth, the ability of the stable cash flows derived from the regulated utility business to support the Company’s total debt load will diminish.

The Company’s ability to maintain a stable credit profile and manage the risk associated with growth in its non-regulated businesses remains important for the current rating level to be maintained. A non-regulated growth strategy more aggressive than currently expected and/or any material sustained weakness in cash flow from the existing business would likely pressure the ratings. DBRS does not expect the Company’s consolidated debt-to-capital to exceed 50% during the build-out stage.

ENMAX liquidity remains adequate with access to $750 million in credit facilities at the end of September 30, 2010.

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.