DBRS Confirms Gaz Métro inc. at “A” and R-1 (low)

DBRS has today confirmed the ratings of Gaz Métro inc.’s (GMi or the Company) First Mortgage Bonds and Commercial Paper at “A” and R-1 (low), respectively, both with Stable trends, based on the continued strong performance and stability of its principal operating entity, Gaz Métro Limited Partnership (GMLP or the Partnership), which guarantees the First Mortgage Bonds and a secured credit facility that backs up the commercial paper. GMi is the general partner of GMLP and serves as its financing entity, and the funds that it raises are loaned to the Partnership on similar terms and conditions.

In June 2010, DBRS confirmed the ratings of GMi following the announcement that all publicly held units of GMLP (representing a 29% interest in GMLP) would be exchanged for common shares of a new company named, Valener Inc. (Valener). GMLP became a privately held limited partnership and continues to maintain the flow of pre-tax cash flows to GMi and Valener. The reorganization resulted in no change with respect to GMi’s 71% ownership interest in GMLP, GMI’s status as GMLP’s general partner, nor GMLP’s guarantee of GMI’s First Mortgage Bonds and its credit facility which backs up the commercial paper program. The stability rating on GMLP was subsequently discontinued following the closing of the transaction.

A significant portion of the Partnership’s earnings and cash flow continue to be generated from its regulated natural gas distribution activities in Québec and other regulated activities, with approximately 87% of its consolidated EBITDA derived from the natural gas and electricity distribution activities in Québec and Vermont. As such, regulation tends to have a significant impact on GMLP’s financial performance as earnings remain sensitive to interest rates through approved return on equity (ROE) levels.

Even though the Partnership continues to have a good command of its regulatory processes in Québec and Vermont, and has been able to achieve incentive returns higher than the authorized rate of return, the 2011 rate case decision by the Régie de l’énergie (the Régie) saw GMLP’s authorized ROE fall to 9.09% for the 2010-2011 fiscal year from 9.20% in the previous year. The decision had the effect of reducing GMLP’s Quebec distribution activities distribution rates by 4.7%. GMLP’s Quebec distribution activities have an incentive mechanism in place till September 2012 and have started negotiations with intervenors to put a new incentive mechanism in place in 2013.

The Partnership also continues to face limited organic growth in its gas distribution system in Québec, where the price of electricity in the residential market is low. However, the current level of natural gas prices has allowed GMLP to remain competitive in the albeit volatile industrial and commercial market, where regular and short term interruptible service sales remain high. In fiscal 2010, the Partnership experienced an overall rise in natural gas deliveries of 6% in the commercial and industrial market due to relatively favourable economic growth and low natural gas prices. The Partnership continues to pursue its efforts to increase natural gas market share in the residential markets, where margins are higher, thereby reducing its reliance on the more volatile industrial and commercial markets.

Currently, GMLP’s core gas distribution business is mature, with 73% of its EBITDA derived solely from its gas distribution operations in Quebec as of September 30, 2010. DBRS therefore expects that GMLP will continue to explore ways to diversify its operations through targeted acquisitions with similar risk profile and new project developments with long-term agreements with creditworthy counterparties in order to grow and diversify its cash flows.

Some growth in earnings and cash flow could come from the completion of the $800 million 272 MW Seigneurie de Beaupré wind projects in Québec after 2013. Following the reorganization and in accordance with the option granted to it by GMLP, Valener acquired 49% interest of GMLP’s 50% interest in the Seigneurie projects, thereby reducing the Partnership’s future cash commitment and interest in the project to 25.5%. GMLP will be applying for construction permits, signing the final agreement with turbine supplier Enercon Canada Inc. (Enercon) and implementing appropriate financing in the coming months. The project is expected to be financed with 75% debt and 25% equity. DBRS expects that the Partnership will finance its share of the equity in the project in a manner that will keep its credit profile in line with current ratings.

The Partnership continues to generate strong cash flow from operations sufficient to internally finance both maintenance capital expenditures and distributions to its partners, which DBRS expects to continue. GMi has access to $545 million in term credit facilities, $400 million of which backs up its commercial paper program. The facility is also available to fund the Company’s growth strategy. GMi will continue to turn to the capital markets to raise any financing it needs for major investment projects that are not part of its ongoing business requirements. In 2010 GMLP completed an anticipated $100 million unit offering, thereby reducing leverage back to historical levels.

Notes:
The First Mortgage Bonds are guaranteed by Gaz Métro Limited Partnership.

All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Companies in the North American Energy Utilities (Electric and Natural Gas) Industry, which can be found on our website under Methodologies.