DBRS Confirms CU Inc. at A (high), Pfd-2 (high) and R-1 (low)

DBRS has today confirmed the ratings of CU Inc.’s (CUI or the Company) Unsecured Debentures & Medium-Term Notes, Cumulative Preferred Shares and Commercial Paper at A (high), Pfd-2 (high) and R-1 (low) respectively, all with Stable trends. The ratings reflect CUI’s portfolio of strong, low-risk, diversified regulated businesses combined with a relatively stable financial profile. In September 2010, DBRS confirmed the ratings of CUI following the announcement that CUI was transferring its power generating subsidiary, Alberta Power (2000) to its parent company, Canadian Utilities Limited (CU), based on our view that the transfer would result in a modest reduction in CUI’s level of business risk as a result of exiting the power generation business offset by a modest increase in financial risk.

Regulation remains key for CUI’s financial profile especially in its high capital expenditure phase. The Alberta Utilities Commission (AUC) has been reasonably supportive of the utilities in its jurisdiction as evidenced by the 2009 Generic Cost of Capital (GCC) decision and the recent ATCO Electric Decision. This is expected to become more important as ATCO Electric enters into a high build-out phase, necessitated by the long-term need to build critical transmission infrastructure in its service area.

The Company estimates that capital expenditures could total between $5 billion to $6 billion for the 2011 and 2013 period driven primarily by planned capital expenditures required to maintain safe and reliable capacity and meet planned growth in the Company’s service area and for projects identified by the Alberta Electric System Operator (AESO). A significant portion of the anticipated capital expenditures is expected for electric transmission projects, which are assigned to CUI by the AESO. DBRS notes that the timing and scope of the projects may vary from what is currently being proposed.

This poses both opportunity and challenges for CUI. ATCO Electric’s rate base will likely double in the next three years, leading to potential increase in earnings and future cash flow as a result of this growth. Apart from construction and execution risks involved in managing large projects, which DBRS expects that CUI will continue to take appropriate steps to mitigate, this type of growth is also expected to result in significant free cash flow deficits, placing pressure on the balance sheet and coverage ratios until projects are completed and added to the rate base.

Depending on the extent of the capital program, DBRS expects that CUI’s key credit ratios may decline modestly during the significant build-out stage. Using debt to partially finance large capital expenditures with multi-year construction horizons (i.e., major electric transmission projects) negatively impacts credit metrics as cash earnings are not realized until the assets are placed in service. To help offset the negative impact on cash flow and associated credit metrics during this stage, the AUC recently approved ATCO Electric’s request to recover federal future income tax in customer rates for its transmission operations, and suspend the current accounting treatment for construction work in progress (CWIP) for transmission direct assigned assets in favour of including these amounts in rate base. The latter would allow ATCO Electric to recover through rates the financing costs of certain transmission assets while in construction. Both of these measures would serve to buffer credit metric erosion during a significant capital build period. The AUC has stated that granting the relief requested by ATCO Electric is prudent and in the best interest of the public. The decision further supports DBRS’s view that the AUC remains supportive of CUI’s credit profile in this period of significant capital growth. With the aforementioned measures, DBRS expects CUI’s coverage metrics ratios to remain adequate for the current credit rating.

Due to its large capital program, DBRS estimates that CUI will need to finance approximately $3 billion from 2011 to 2013 through a combination of debt issuance, equity injection, management of dividends to CU and other equity forms of funding, while ensuring that it maintains its debt-to-capital ratio at levels approved by the AUC. DBRS believes that CUI’s parent, Canadian Utilities Limited (CU, rated “A”), has the financial flexibility to provide support to CUI during this period of heightened capital expenditures, given its financial strength and strong cash position and, as such, CUI’s current financing plan remains reasonable.

CUI’s ability to continue to adhere to its current financing strategy, maintain access to the debt capital markets and to continue to maintain a constructive working relationship with the AUC remain key in maintaining its strong credit profile and credit rating. The ratings confirmations incorporate the assumption that CUI will ensure that adequate levels of available liquidity are maintained during the capital build program.

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.