DBRS Confirms Hydro One at A (high), R-1 (middle)

DBRS has today confirmed the Senior Unsecured Debentures rating of Hydro One Inc. (Hydro One or the Company) at A (high) and its Commercial Paper rating at R-1 (middle), both with Stable trends. The rating confirmations reflect Hydro One’s low level of business risk, stemming from its regulated electric power transmission and distribution operations, and its solid financial profile.

Hydro One continues to invest in its significant capital program, which will be the greatest challenge for the Company over the medium term. The capital program is focused on sustaining aging infrastructure, development projects for growth and government-led initiatives. Hydro One anticipates that its capital expenditure for 2011 was budgeted to be approximately $1.8 billion; however, the Company expects capital expenditures to be lower than budget by approximately $200 million, mainly due to lower costs and the timing of investments, as well as lower distributed generation capital expenditures and higher investments by generators. The extensive capital program is projected to result in manageable free cash flow deficits over the medium term. The capital expenditures are expected to be approximately $5.5 billion over the next three years. Based upon these levels of capital expenditures, DBRS expects cash flow deficits of approximately $700 million to $850 million per year, allowing for rate base growth throughout the build-out cycle.

The free cash flow deficits are expected to be entirely debt financed, continuing to restrain the Company’s balance sheet and coverage ratios during the build-out period as the invested capital is not included in the rate base until projects are completed. Also, given that a material portion of Hydro One’s capital expenditures are for large transmission projects that involve lengthy construction times and the potential for delays caused by the intervenor process, timely project completion within budget is important. DBRS views the pressure on the Company’s balance sheet and coverage metrics as temporary, with the expectation of a modest improvement over the medium term. Financial metrics are expected to remain within a range supportive of the assigned ratings given the extent of the capital projects in the medium term. DBRS expects Hydro One to continue to manage dividends in order to support its heightened capital program.

While credit metrics have trended modestly downward over recent years, the Company has witnessed a slight improvement in metrics for 2010 and the last 12 months ending June 30, 2011, as a result of favourable rulings by the Ontario Energy Board (OEB), which has allowed for recovery of assets from prior years as well as a higher rate of return for utilities. The increase in rate of return is a result of the OEB changes in methodology for calculating return on equity.

In August 2011, Hydro One renewed its $3.0 billion Medium Term Note (MTN) Program under the Preliminary Short Form Base Shelf Prospectus dated August 16, 2011. The proceeds from the MTNs issuance are used to finance Hydro One’s working capital requirements; repay outstanding bank loans/credit facilities, debentures, notes or other indebtedness; make advances to subsidiaries of the Company; for capital expenditures; acquisitions and for other general corporate purposes. Liquidity remains strong for Hydro One, supported by the $3.0 billion MTN Program, its $1.0 billion commercial paper program, which is supported by a total of $1,500 million in liquidity consisting of $1,250 million of committed revolving credit facilities with a syndicate of banks, and $250 million of Province of Ontario floating-rate notes.

Note:
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 the DBRS website under Methodologies.