DBRS Confirms TransAlta Corporation at BBB and Pfd-3 with Stable Trends

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 (1) the Company’s high level of contracted output with reasonable fuel hedging positions and (2) increased geographical and fuel diversification. These strengths have lowered TAC’s business risk level to below the industry average. A well-hedged portfolio and/or contractual position are key to reducing the volatility of earnings and cash flow as power generators generally operate in competitive environments where profitability varies with commodity pricing (both output and inputs) and production volumes. TAC’s contracted output is expected to remain high, at over 65% of net generating capacity, at least until Alberta purchase power arrangements (APPA) expire in 2020.

DBRS is increasingly concerned about the continued challenging merchant power market environment that could materially add to the Company’s existing challenges in the medium term. The continued downward pressure on natural gas prices, which make natural gas combined-cycle plants more cost effective in terms of both capital and fuel costs, are expected to pressure TAC’s merchant power earnings, particularly coal-fired plants. Natural gas-fired combined-cycle generation has continued to move up in the regional supply curve, increasingly displacing coal-fired generation. TAC’s coal-fired power facilities account for 52% of total net capacity (21% merchant, 31% APPA). DBRS views that the current low natural gas prices make it difficult for TAC to enter into new high-margin long-term sales contracts. If this negative natural gas market outlook continues in the medium term, TAC’s total portfolio contractedness will likely decrease significantly when APPA expires in 2020. This scenario will have negative credit implications on TAC.

TAC faces a number of other challenges, including aging coal plants in Alberta, which could continue to result in a high level of unplanned outages as evidenced by the Sundance coal-fired generation Unit 1 and Unit 2 shutdown since December 2010. The ultimate outcome of the Sundance arbitration process remains uncertain. An unfavourable resolution of this matter (i.e., accrued penalties and repair costs) could have material financial impacts. The Company has limited financial flexibility to withstand any adverse events due to its high leverage and dividend payout ratio. Any further significant increase in leverage could cause TAC’s credit risk profile to deteriorate to a level that is no longer commensurate with the current BBB rating. DBRS expects TAC to fund the majority of any unexpected material costs primarily with equity (including preferred shares and the dividend re-investment program) to maintain its current leverage level.

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.