DBRS Confirms Canadian Utilities Limited at “A”, R-1 (low) and Pfd-2 (high)

DBRS has today confirmed the ratings of Canadian Utilities Limited’s (CU or the Company) Unsecured Debentures, Commercial Paper and Cumulative Preferred Shares at “A”, R-1 (low) and Pfd-2 (high), respectively, all with Stable trends. The ratings are based on the Company’s stable portfolio of regulated, low-risk utilities and strong cash flows from its non-regulated operations. The Company’s regulated subsidiary, CU Inc. (CUI), continues to benefit from growth in its rate base and a more supportive regulatory environment, while risk in CU’s non-regulated generation portfolio is mitigated by a high proportion of long-term contracts. The diversity of CU’s asset base also provides stability to overall earnings and cash flow, with earnings split approximately 56/44 between CUI’s regulated operations and CU’s non-regulated businesses.

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 permitting ATCO Electric to recover federal future income tax in customer rates for its transmission operations and allow construction work in progress (CWIP) amounts for direct assigned transmission assets to be included in rate base during the high construction period. This support is expected to become more important as CUI enters into an intensive build-out phase, necessitated by the long-term need to build critical transmission infrastructure in its service area. CUI could experience significant growth in capital expenditures, reaching a level of approximately $5 billion to $6 billion between 2011 and 2013, a significant portion of which will be allocated to critical transmission infrastructure assigned to CUI by the AESO (Alberta Electric Systems Operator).

CU is expected to support CUI in this build-out phase with a combination of equity injection (use of its large cash balances) and dividend management in such a way that debt-to-capital remains below 60%. Furthermore, DBRS expects dividends flowing up to CU from CUI to be appropriately managed to preserve the utility’s credit profile.

Though the Company’s non-regulated businesses continue to generate strong earnings and cash flow, they remain exposed to the volatility in natural gas prices and electricity prices in Alberta and the United Kingdom. This risk is largely mitigated by the high contracted portion of its non-regulated generation portfolio and minimal double leverage at the CU level, as all the projects are financed on a non-recourse basis. In addition to commodity price risk, CU also remains exposed to contract renewal risk, as highlighted by the expiry of the 255 megawatt (MW) Barking plant contract (United Kingdom) in September 2010. Having contracted 45 MW under a tolling contract for one year, CU continues to explore alternative commercial arrangements for the output at this plant, as the U.K. electricity market is expected to be depressed over the near- to medium-term.

CU’s consolidated cash flow from operations is expected to continue to grow in the medium term as the rate base of its utility operations (CUI) increases and modest growth occurs in its non-regulated businesses. CU remains in a strong liquidity position, with large cash balances and the financial flexibility needed to support both its regulated and non-regulated operations. Furthermore, debt levels at the holding company remain low, at only $100 million. DBRS expects the Company to continue to pursue this conservative strategy of primarily raising debt at the CUI level, with moderate usage of debt and preferreds at the CU level.

While DBRS expects the current capital build-out to put modest pressure on the Company’s balance sheet in the medium term as it generates large free cash flow deficits, the metrics should remain commensurate with the current credit ratings. DBRS anticipates that the Company will exhibit continued financial and strategic discipline throughout the process, and maintain the financial flexibility and liquidity required to support CUI during its capital build-out.

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.