DBRS Updates Its Report on Hydro Ottawa Holding

DBRS has updated its report on Hydro Ottawa Holding Inc. (Hydro Ottawa or the Company). The update is based on the Company’s third quarter 2011 results. Hydro Ottawa’s credit quality has continued to benefit from its low-risk business profile, with approximately 90% of EBIT generated from the regulated power distribution business, and its strong credit metrics.

Hydro Ottawa’s low business risk profile is underpinned by a reasonable regulatory system. Hydro Ottawa’s distribution rates are set by the Ontario Energy Board (OEB) using a combination of an annual incentive regulation mechanism (IRM; 2009 to 2011) and periodic cost of service (COS) reviews (2008 and 2012 in the rebasing year). In DBRS’s view, the IRM typically creates higher cost-cutting pressure than the COS does; however, the cost pressure has not resulted in a material reduction in the Company’s earnings and cash flows. Hydro Ottawa’s exposure to non-regulated businesses is manageable at around 10% of consolidated EBIT. The non-regulated assets are largely low-risk hydro power generation facilities, and its power price risk has been effectively mitigated by having long-term contracts with creditworthy parties such as Ontario Power Authority (rated A (high) by DBRS).

Hydro Ottawa’s credit metrics have remained strong for the current rating category. Although the regulatory capital structure is 60% debt and 40% equity, Hydro Ottawa has maintained its leverage in the low-40% range, providing significant financial flexibility. For the twelve months ended September 30, 2011, EBIT interest coverage (4.35 times) and cash flow ratios (29.6%) were also strong and supportive of the “A” rating for Hydro Ottawa.

Cash flow levels are expected to increase moderately in 2012, benefiting from a higher allowed return on equity and a larger rate base (although the OEB has not made a final decision on 2012 rates). However, a modest amount of negative free cash flow is expected in the foreseeable future, due largely to a high level of capex to improve system capacity, reliability and facilities. DBRS believes that expected cash deficits will be manageable, given the Company’s strong financial profile.

Notes:
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.