DBRS Comments on TransAlta’s Potential Centralia Contract and Asset Write-down

DBRS notes that TransAlta Corporation (TAC or the Company; rated BBB and Pfd-3) announced on July 25, 2012, that it expects to enter into a long-term power sales contract (the Contract) for its Centralia Plant (Centralia) in Washington State, for the period of 2014 to 2025. Centralia’s generation capacity, TAC’s largest merchant plant, currently accounts for 16% of total generation capacity (excluding Sundance Units 1 and 2; see DBRS press release dated July 23, 2012). Upon the successful execution of the Contract, TAC expects Centralia’s contracted output to increase to 35% of capacity from 2014 to 2020, and to 65% from 2021 to 2025. This Contract is awaiting approval from the Washington Utilities and Transportation Commission.

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 and production volumes. Although TAC’s contracted output will benefit upon successful execution of the Contract, the fixed contract price is expected to be lower than its previously entered contracts, given the continued weak wholesale pricing environment in the Pacific Northwest region. However, contracted prices are expected to be sufficient to generate positive free cash flow for Centralia. Overall, DBRS views the Contract as modestly credit positive.

The Company also expects to record asset impairments of approximately $350 million, $170 million and $45 million for Centralia, tax asset, and Sundance A, respectively. This is expected to directly affect retained earnings/equity. DBRS will add this adjustment back into the equity base for leverage ratios, given the non-cash nature of these items under International Financial Reporting Standards (IFRS). The DBRS-adjusted leverage will not be affected by the accounting charge, and as a result, this asset impairment is not expected to have any impact on cash flow in the foreseeable future.

Notes:
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 the DBRS website under Methodologies.