DBRS Confirms EPCOR Utilities at A (low) and R-1 (low)

DBRS has today confirmed the ratings of EPCOR Utilities Inc.’s (EUI or the Company) Commercial Paper and Senior Unsecured Debentures at R-1 (low) and A (low), respectively, with Stable trends. The ratings are based on EUI’s stable cash flow generated from its portfolio of core regulated assets, following the partial divestiture of its power generation business in 2009. These assets (predominantly electric transmission and distribution and water assets) are expected to contribute approximately 70% to 90% of its cash flow over the next five years and should provide a very stable financial base, being either regulated or contracted on a long-term basis.

With a significant portion of regulated operations expected to contribute to earnings growth and stability, it is imperative that EUI continues to foster strong relationships with regulators, particularly in new regulatory jurisdictions. The regulatory environment in Alberta remains supportive for both the transmission and distribution and water business. DBRS expects the Company will begin to foster a constructive relationship with the Arizona Corporations Commission, following the announcement of its intention to acquire 100% of the stock of Arizona American Water and New Mexico American Water (both subsidiaries of American Water Works Company, Inc.) for US$470 million. The proposed American Water acquisition is to be funded with a combination of cash (from the sale of Capital Power Corporation’s equity) and debt financing, which DBRS believes will preserve the Company’s current financial profile and liquidity.

DBRS expects the electric and water utility businesses to continue to represent a large portion of the Company’s consolidated earnings in the medium to long term, as the equity income from Capital Power decreases. EUI’s strategy is to continue to pursue the development of transmission infrastructure, water and wastewater infrastructure for municipalities and acquisition of water and wastewater utilities. As such, EUI remains exposed to construction risk, regulatory/political risks, integration risks, as well as delays and cost overruns typically associated with transmission and water projects. EUI continues to pursue the development of the proposed Heartland Transmission Project (estimated cost of $400 million) in a joint venture with Altalink L.P. to construct and operate a 500kV transmission line. The capital cost of this project will be split evenly between EPCOR Distribution and Transmission Inc. and Altalink L.P.

The degree and pace of executing the above strategy will depend largely on EUI’s ability to sell additional interests in its retained interest in Capital Power. DBRS expects the Company to continue to monetize its interest over the next five years in alignment with its growth strategy. Since the spin-off of its generation business in 2009, the sale of a partial interest in Capital Power and dilution of interest due to further issuance of common shares by Capital Power in 2011 has reduced EUI’s economic interest to 49.6% from 61% at the end of December 2010.

Even though EUI’s ownership interest in Capital Power Corporation’s (CPC, rated Pfd-3 (low) with a Stable trend) affiliate, Capital Power L.P. (Capital Power, rated BBB with a Stable trend) has been reduced since the spin-off and the Loan Receivable amount has been reduced to $580 million (as of June 30, 2011) from $896 million, the Company still remains exposed to Capital Power’s credit risk for both interest and principal payments of the outstanding amount as these payments are expected to contribute to EUI’s ability to service and retire a portion of its own debt. DBRS remains comfortable with the BBB rated Capital Power’s ability to fulfill its obligations to EUI, given its reasonable credit profile, access to committed bank facilities totalling $1.2 billion and manageable repayment schedule.

DBRS expects that EUI will continue to generate a modest free cash flow deficit in the medium term, which will be funded with debt as it grows its utility business and pays out dividends to the City of Edmonton. The Company remains committed to paying out roughly 60% of its net income in dividends. However, the debt-to-capital ratio is expected to remain in the low- to mid-40% range, while cash flow-to-total debt remains in the low- to mid-teens and EBITDA-to-interest coverage increases to the new range of 2.5 times (x) to 3.0x.

The Company continues to maintain adequate liquidity in the amount of $500 million in committed credit facilities.

Note:
All figures are in Canadian dollars unless otherwise noted.

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