DBRS Confirms TransAlta Corporation at BBB and Pfd-3

DBRS has today confirmed the ratings of TransAlta Corporation’s (TAC or the Company) Unsecured Debt/Medium-Term Notes and Preferred Shares at BBB and Pfd-3, respectively, both with Stable trends. The confirmation reflects the Company’s strong cash flow generated by its generation facilities, which are subject to legislatively mandated Alberta power purchase agreements (APPAs), longer-term power contracts on its non-regulated facilities and its diversified generation portfolio.

TAC’s credit profile and ratings are supported by its highly contracted diversified portfolio of assets. TAC currently has approximately 70% of its capacity contracted over the next seven years, with over 95% contracted for 2011 and up to 90% for 2012, in line with its stated objective of having at least 75% of its capacity under medium- and long-term contracts with creditworthy counterparties, thus reducing the Company’s cash flow volatility. DBRS remains comfortable with this strategy as it allows TAC to participate in any upside potential to improving market conditions.

The Company recently commissioned the much-anticipated 450 megawatt (MW) Keephills 3 supercritical coal plant (50% owned) on September 1, 2011, at approximately $1.98 billion. Costs for the plant, excluding mine capital, are being equally shared by its owners – Capital Power L.P (rated BBB, Stable) which led the construction, and TAC, which will operate the plant. The original estimate for the plant when it was announced in 2007 was $1.6 billion. The cost overrun can be attributed to higher-than-expected labour costs in Alberta, which also set back the completion date. The Company’s growth capital expenditure is expected to be lower following the commission of Keephills 3.

In 2009, TAC’s growth capex, including the acquisition of Canadian Hydro Developers, Inc. (CHD, rated BBB, Stable; see separate press release), peaked at $1.3 billion and is estimated to be approximately $185 million in 2011, $54 million of which had been spent as of June 30, 2011. DBRS estimates that capex will return to more normal levels of between $400 million and $500 million annually in the medium term, not factoring in any acquisitions. Maintenance capex is estimated to be between 70% and 80% of total capex.

While high growth capex (including the acquisition of CHD) combined with higher unplanned and planned maintenance at some of its facilities and soft power prices contributed to the decline in TAC’s credit metrics in 2009, the Company’s credit metrics have started to trend upward. For first time in several years, cash flow from operations was sufficient to cover both capex and dividends in 2010, resulting in modest positive free cash flow. TAC also repaid $225 million in medium-term notes that came due in June 2011 with the proceeds from the $300 million preferred share offering in December 2010.

In the near to medium term, DBRS expects earnings at TAC to continue to improve significantly, due to the completion of its Keephills 3 project, incremental production from its renewable growth projects and higher contract pricing, while also pursuing cost-containment initiatives. DBRS expects that TAC’s renewable portfolio will continue to contribute to overall earnings, as the Company tries to mitigate impending environmental regulatory challenges by investing in renewables.

Although capacity from Keephills 3 is not contracted, the base load plant is expected to replace lost base load generation from the fully retired Wabamun plant and the sale of the smaller 55 MW gas-fired Meridian plant. TransAlta issued a notice of termination for destruction on its Sundance 1 and 2 coal-fired generation units under the terms of the Sundance APPA at the beginning of 2011, based on the conclusion that the units cannot be economically restored to service under the terms of the PPA. A binding arbitration process to resolve the dispute with the PPA buyer (TransCanada Corp.) is underway, with a decision expected in mid-2012. The annual cash flow reduction is not expected to be material to TAC. However, this highlights one of the challenges that TAC faces with a higher risk of unplanned outages at its Alberta thermal plants, due to the age of the plants and the potential severity of the outages.

As the Company starts to generate more cash flow from new assets placed in service in 2011 and 2012, DBRS expects that on a normal course basis, the Company’s adjusted net debt-to-capital should remain below 50% and cash flow-to-debt will remain in the 25% range, levels that DBRS considers adequate for the rating, given the largely contracted fleet. The Company had $2.0 billion in committed credit facilities as of June 30, 2011, of which $0.8 billion was available.

At this time, DBRS remains comfortable with the Company’s disciplined growth strategy, financial flexibility and adequate liquidity. It is expected that TAC will maintain a low-to-moderate risk profile, underpinned by a more diversified and contracted portfolio of assets. DBRS expects the Company to continue to finance growth in line with its credit metrics.

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

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