DBRS Downgrades EnerCare Solutions Senior Notes to BBB (high), Stable Trend

DBRS has today downgraded the Senior Notes of EnerCare Solutions Inc. (EnerCare or the Company) to BBB (high) from A (low), and changed the trend to Stable from Negative. This rating downgrade is predominantly driven by the structural change in the continued challenging water heater rental market environment. The rising competition has ultimately weakened EnerCare’s business profile materially.

On March 29, 2012, DBRS changed the trend on EnerCare’s rating to Negative from Stable. This rating action reflected DBRS’s concern that the ongoing competitive pressures facilitated in part by the Competition Bureau’s Consent Order would not be lessened materially with its expiry in February 2012 as previously thought. As an example, the Company ceased a new re-contracting campaign intended to help retain customers. As a result, a large percentage of customers will still be able to terminate their respective contracts without penalty. DBRS is concerned that this development will add to the Company’s existing challenges in its efforts to reduce its attrition rate back to the historical level of 2% to 3% that was prevalent during periods of low competition.

Structural changes in the water heater rental industry have significantly lowered the barriers to entry. Accordingly, competition flourished and became quite intense. EnerCare’s customer base has decreased significantly from 1.4 million units in 2008 to 1.2 million units in June 2012 (a gross attrition rate of 8.0% in 2009, 6.4% in 2010, 6.0% in 2011, and 6.9% annualized in the first half of 2012, albeit trending downward from the first quarter 2012 as the negative impact of the re-contracting campaign dissipated). Going forward, this high attrition rate is expected to remain a challenge. The rating assumes that EnerCare’s attrition rate will decrease gradually and its customer base to be stabilized as a result of a number of initiatives to defend its market position (it still has nearly 50% of the market in Ontario). If the high attrition rate persists in the medium term, this could trigger further negative rating implications.

The Company’s key credit metrics remained stable for the six months ended June 30, 2012, as increased rental rates and higher margin products entering the portfolio largely offset the decrease in earnings from the smaller customer base. In April 2012, EnerCare repaid its $60 million long-term debt with cash and debt from the parent (EnerCare Inc.). Despite this, the Company still faces refinancing risk in 2013 and 2014 as all of its remaining external debt ($510 million) comes due.

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

DBRS’s rating on EnerCare Solutions Inc. is based on the DBRS Methodology: Rating the Consumer Products Industry. However, DBRS views EnerCare’s strong franchise as having a superior business risk profile than that of a traditional consumer products company. As a result, the Company is able to manage higher leverage metrics.

Overall, in DBRS’s assessment of the credit quality of EnerCare, DBRS factors in the following key items: (1) competition arising from regulatory changes; (2) effects of attrition on customer base; (3) stability of cash flow generated from customer base; (4) flexibility to increase rental rates; (5) limited operational risk through a co-ownership agreement; and (6) dependency on new home developments for growth.