DBRS Confirms Westcoast Energy Inc. at A (low), Pfd-2 (low) and R-1 (low), Stable Trends

DBRS has today confirmed the Unsecured Debentures, First Preferred Shares and Commercial Paper ratings of Westcoast Energy Inc. (Westcoast or the Company) at A (low), Pfd-2 (low) and R-1 (low), respectively, all with Stable trends.

(1) Westcoast’s business risk profile remains relatively strong. The Company derived 89% of its segment EBIT from low-risk, mostly regulated operations in 2010 (2009 – 87%), up from approximately 80% in 2007–2008. The main non-regulated business is Empress NGL Marketing (Empress; 11% of 2010 segment EBIT; 21% of 2008 segment), which is subject to earnings and cash flow volatility associated with exposure to commodity prices, fractionation spreads and throughput volumes. Empress benefited from strong industry conditions in 2008. However, reversal of this trend, beginning in Q4 2008, resulted in a substantial EBIT decline and a higher proportion of low-risk segment EBIT beginning in 2009, a trend that is likely to continue.

Earnings and cash flow from Empress generally benefit from low natural gas prices relative to crude oil prices, while Westcoast’s British Columbia (B.C.) Pipeline and Field Services Divisions (BCPFS), Spectra Energy Facilities L.P. (Midstream) and Union Gas Limited (Union Gas; 46% of 2010 segment EBIT) businesses can be negatively affected by lower throughput under that scenario, resulting in a natural hedge and diversification benefits for the Company.

While some of the BCPFS and Midstream facilities are mainly located near the most promising natural gas exploration and development fields in western Canada, exploration and drilling activity in some of the other operating areas of BCPFS and Midstream have been relatively low in recent years. If low gas prices persist, BCPFS and Midstream EBIT could be negatively affected, although this would be partly mitigated by strong regulatory and contractual arrangements and strong activity in the Montney and Horn River basins of B.C. DBRS believes that these low-risk operations will benefit over the medium to long term from strong exploration and drilling activity in Westcoast’s key areas given the Company’s plan to bring approximately $1.7 billion in growth projects with long-term contractual commitments (see below) into service in stages through 2013, supporting a high component of low-risk EBIT for the Company.

(2) Westcoast’s financial profile remains relatively strong despite rising capex related to its medium-term growth program. Increasing earnings and cash flow from Empress from expansions placed in service to date have resulted in relatively strong credit ratios. On July 10, 2009, Westcoast borrowed $500 million from an affiliate on a subordinated basis, paid a common stock dividend of $524 million to its shareholders, and issued a new class of preferred stock to an affiliate for $50 million. While the transaction contributed to weaker credit metrics in 2009 (with cash flow-related metrics also affected by a significant future income tax reversal that year), Westcoast’s key external credit metrics recovered in 2010 and in the first nine months of 2011 (9M 2011).

On a consolidated basis (excluding the intercompany transaction), the Company’s external debt-to-capital ratio (52% at September 30, 2011; 54% at year-end 2008) and cash flow-to-external debt (19% for both the 12 months ending September 30, 2011, and in 2008) were relatively unchanged, while external fixed charges coverage (2.8 times, up from 2.5 times) improved marginally, partly due to contributions from expansions placed in service as noted above.

On a non-consolidated basis, Westcoast’s direct ownership of BCPFS fully supports its ability to meet its direct debt obligations. Its credit metrics are enhanced by cash dividends from several sources, the largest of which is Union Gas, which generate approximately 50% of the Company’s non-consolidated cash flow. Excluding the intercompany transaction, Westcoast’s non-consolidated external debt-to-capital ratio increased to 36% in 2010 from 32% in 2008, while cash flow-to-external debt (25%, up from 16%) and external fixed charges coverage (3.2 times, up from 2.2 times) improved significantly, mainly as a result of contributions from expansions noted above.

Given its focus on mostly low-risk regulated operations in which it has a controlling interest, Westcoast should generate sufficient cash flow to meet a significant portion of its capex and dividend payments going forward, with manageable funding needs at both Union Gas and the Company. Westcoast’s consolidated credit metrics will likely be pressured over the medium term as a result of its significant growth capex (see below). DBRS expects the Company to manage its medium-term capex program so that it has only a marginal impact on its key credit ratios.

(3) The Company’s 2011 capex program is expected to total approximately $1,100 million, distributed between growth ($700 million) and maintenance ($400 million), of which $700 million (including $505 million for expansion) was spent during 9M 2011. The 2011 program includes capex of $800 million for its natural gas transmission and processing (T&P) segment (for expansion of processing and associated pipeline capacity primarily in the Montney, Horn River and North Montney areas of B.C. as well as for maintenance) and $300 million for Union Gas (mostly for maintenance). This compares with 2010 capex of $700 million.

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

The applicable methodology is Rating North American Pipeline and Diversified Energy Companies, which can be found on our website under Methodologies.