DBRS Comments on TransAlta Corporation’s Acquisition and Equity Offering Announcement

DBRS notes that TransAlta Corporation (TAC or the Company; rated BBB with a Stable trend) has today announced its acquisition of Fortescue Metals Group Ltd.’s (FMG) 125 megawatt (MW) power plant (the Project) for approximately US$318 million and a subsequent common equity offering of approximately $275 million through a bought deal with underwriters. This transaction is expected to close by the end of September 2012 and is subject to normal closing conditions. The transaction is expected to be accretive to earnings and generate cash flow upon commercial operation.

The Project is a 125 MW power plant located in Western Australia that uses a combination of diesel and natural gas as fuel for generation. It is currently under construction and is expected to begin commercial operations in late 2012. The proposed acquisition includes a 21-year initial power purchase agreement (PPA) with FMG Solomon PTY LTD (FMG Solomon) to supply power to their iron ore mining operations in the Pilbara region of Western Australia. The final five years of the PPA are an extension option and, if unexercised, TAC is paid out in equivalent value. TAC is expected to earn capacity payments once the Project begins commercial operations.

In its review, DBRS’s analysis will focus on (1) the business risk profile of TAC and (2) the financial impact of the deal on the Company’s credit profile. Overall, DBRS views this transaction as credit neutral.

(1) BUSINESS RISK PROFILE – Negative
Based on its preliminary review, DBRS views the proposed acquisition as negative with respect to TAC’s business risk profile. Although the PPA reduces earnings and cash flow volatility, the PPA is with a weaker counterparty. FMG Solomon operates in a cyclical industry and is significantly exposed to pricing volatility and geographic and product concentration risk. However, given the relative size of the Project’s incremental cash flow to TAC’s cash flow from operations (approximately 5% of fiscal 2011 cash flow from operations), the proposed acquisition is viewed as non-material to TAC’s overall business risk profile.

(2) FINANCIAL RISK PROFILE – Positive

Based on DBRS’s review of the proposed acquisition and financing strategy, pro forma the proposed acquisition and equity offering (i.e., post-acquisition), DBRS estimates an improvement in TAC’s key credit metrics. DBRS expects the Company to fund the majority of the proposed acquisition with common equity, which will improve the Company’s capital structure going forward. The proposed acquisition is also expected to generate annual incremental cash flow of approximately $40 million for TAC under a stable PPA framework. Pro forma post-acquisition (including TAC’s preferred shares issuance on August 10, 2012; see the related DBRS press release on August 10, 2012), DBRS estimates that the debt-to-capital ratio will be approximately 54% and that the interest coverage and cash flow-to-debt ratios will improve modestly.

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 our website under Methodologies.