DBRS Confirms Toronto Hydro at A (high) and R-1 (low), Trend Stable

DBRS has today confirmed the Senior Unsecured Debentures & MTNs and Short-Term Issuer ratings of Toronto Hydro Corporation (Toronto Hydro or the Company) at A (high) and R-1 (low), respectively. The trends are both Stable. The rating confirmations reflect Toronto Hydro’s low level of business risk, stemming from its regulated distribution business, its stable financial profile (despite a heightened capital expenditure program, which had resulted in consistent free cash flow deficits), and the expectation of near-term rate base growth, which should primarily be funded with cash flow and cash on hand.

Toronto Hydro’s continued financial and operating performance over the years is attributable to the strong financial performance of its regulated distribution business and its growing rate base and favourable rate decisions made by the Ontario Energy Board (OEB).

In 2010, the City of Toronto monetized its remaining $490 million loans (City Note) to the Company by converting the City Note into $490 million of debentures (Series 4 and 5), which were sold to third-party investors. Toronto Hydro received no proceeds from the conversion.

DBRS notes that in December 2009, the OEB changed its methodology for calculating return on equity (ROE) and subsequently updated the parameters in February 2010, which has resulted in an increase in the ROE to 9.85%.

In April 2010, the OEB issued its final decision regarding Toronto Hydro’s electricity distribution rates for the rate year beginning May 1, 2010, and ending April 30, 2011. The decision provided for capital expenditures of $350 million and operating expenses of $204.1 million. The OEB also increased the ROE from 8.01% in 2009 to 9.85% for 2010, as it transitioned to the new ROE formula guidelines. The distribution revenue requirement and rate base were set at $518.7 million and $2.14 billion, respectively. In August 2010, Toronto Hydro filed a rate application with the OEB seeking approval of revenue requirements and corresponding rates for the rate year commencing on May 1, 2011 and ending on April 30, 2012. The requested distribution revenue requirement and rate base for this period are $578.4 million and $2.34 billion, respectively.

Toronto Hydro continues to invest in its capital program to modernize the electricity distribution system and to meet government-led initiatives. DBRS expects capital investment to average approximately $350 million to $400 million per year over the near term. The capital expenditure program is projected to result in manageable free cash flow deficits over the medium term. However, the Green Energy Act, passed by the Ontario legislature in May 2009, could lead the Company to invest more in its current system.

While the Company will continue to incur free cash flow deficits (in the expected range, on average, of $100 million to $150 million per year), current cash on hand ($371 million as of September 30, 2010) should be sufficient to internally fund the majority of cash flow deficits through 2012. This will allow for rate base growth, with a modest addition of incremental debt. This, in conjunction with higher base rates to recover significant capital investments and the potential for lower interest expense from the refinancing of higher-cost maturing issues, should have a positive impact on the Company’s financial metrics through the build-out cycle.

Note:
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.