DBRS Confirms Capital Power at BBB and Pfd-3 (low), Trends Stable

DBRS has today confirmed the Senior Unsecured Debt rating of Capital Power L.P. (CPLP or the Partnership) at BBB and the Preferred Shares rating of Capital Power Corporation (CPC) at Pfd-3 (low), both with Stable trends. The confirmation reflects the Partnership’s stable cash flows generated by facilities subject to legislatively mandated Alberta power purchase arrangements (APPAs), other long-term contracts and its low-cost baseload facilities. CPLP also has a relatively young fleet of generating assets, with an average age of approximately 12 years, and a good track record in terms of operating performance. The average age of the Partnership’s generation plants is expected to decline as more plants come on line in 2012 and 2014.

While the APPAs, long-term contracts and relatively young age of CPLP’s assets support the Partnership’s credit profile and ratings, the ratings also incorporate the lack of diversification in fuel and geography. CPLP is expected to maintain a target of at least 50% of its total EBITDA from contracted plants as it continues to pursue growth opportunities through targeted acquisitions and development in Canada and the United States, with a focus on natural gas and renewable technologies over the medium term.

Though CPLP continues to demonstrate significant experience in the construction of large generation projects, the Partnership remains exposed to execution risk relating to issues such as labour, materials and equipment. DBRS expects CPLP to continue to take appropriate steps to mitigate this risk as it pursues its growth strategy. It currently has 487 megawatts (MW) under construction or development.

The Partnership commissioned the much-anticipated 495 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 CPLP, which led the construction, and TransAlta Corporation (rated BBB, Stable), 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 in 2008, which also set back the completion date.

CPLP will continue to generate reasonably strong and stable earnings and cash flow as major generating assets are placed in service. DBRS expects that the Partnership’s cash flow from operations will remain sufficient to cover only maintenance capex and distributions; however, potentially significant growth capex (including acquisitions) will lead to cash flow deficits, putting modest pressure on the balance sheet and credit metrics. Acquisitions are expected to be funded with an appropriate mix of debt and equity in such a way that CPLP maintains debt-to-capital ratio of less than 50%, cash flow-to-debt of at least 20% and EBITDA-to-interest of greater than 4.0 times in the medium to longer term. The Partnership has stated that it remains committed to maintaining an investment-grade rating.

The Partnership’s exposure to refinancing risk has declined since its inception in 2009, when it initially had $896 million of back-to-back loans to EPCOR Utilities Inc. (EUI), of which approximately $517 million would have come due by the end of 2011. CPLP has been able to successfully refinance its maturities in both the debt and equity capital markets, thus keeping its debt-to-capital ratio below 50%. The Partnership has also sufficient credit facilities totalling $1.22 billion to meet its obligations as they come due.

DBRS has historically assessed CPLP’s financial profile on a stand-alone basis and, as such, deconsolidated the results of its 29.2% ownership interest in Capital Power Income LP (CPILP; rated BBB (high), Under Review with Negative Implications). The strategic review process initiated by CPILP in the fall of 2010 resulted in an agreement (the Agreement) in which Atlantic Power Corporation (ATP) will acquire all the outstanding units of CPILP. Upon closing of the transaction in early November 2011, CPLP is expected to receive total consideration of approximately $320 million for its ownership interest in CPILP, in a mix of cash, ATP shares and assets. As part of the Agreement, CPILP will sell its Roxboro and Southport facilities, located in North Carolina, to CPLP for a purchase price of $121 million (forming a portion of combined consideration received).

The PPAs for CPILP’s North Carolina plants were finalized with Progress Energy Resources Corp. in June 2011 and DBRS expects their contribution to CPLP’s earnings to be modest, although they should also reduce uncertainty. Closing of the transaction is not expected to have any impact on the ratings of CPLP or CPC, given the modest cash contribution of CPILP to CPLP, and the consideration to be received.

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

The applicable methodology is Rating Companies in the Non-Regulated Electric Generation Industry, which can be found on our website under Methodologies.