DBRS Confirms TransAlta Corporation at BBB, Stable

DBRS has today confirmed the Issuer Rating and the ratings of the Unsecured Debt/Medium-Term Notes and Preferred Shares of TransAlta Corporation (TAC or the Company) at BBB, BBB and Pfd-3, respectively, all with Stable trends. The confirmation reflects the Company’s high level of contracted output, with reasonable fuel hedging positions and geographical and fuel diversification. 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.

The challenging merchant power market environment continues to be a concern for the Company, particularly with the weak spark spreads in the Pacific Northwest and lower power prices in Alberta (the Province) expected over the short term. Power prices in the Province are expected to decline in the short term, as additional capacity is expected to be added in 2013 (Sundance Unit 1 and 2 are expected to increase supply by 560 MW once online), which will be partially offset by the Province’s load growth. In addition, DBRS’s view is that the current low natural gas prices may 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 the Alberta purchase power agreements (APPA) expire in 2020. This scenario will have negative credit implications on TAC.

TAC’s leverage remains high for the current business risk level. Therefore, DBRS expects TAC to fund the majority of any free cash flow deficits primarily with equity (including preferred shares and the dividend re-investment program (DRIP)) to maintain its current leverage level. DBRS expects TAC to reduce its leverage to below 50% by the end of 2014 to be in line with its rating category. Any increase in leverage or delay in reducing leverage could cause the Company’s credit risk profile to deteriorate to a level that is no longer commensurate with the current BBB rating. In addition, to offset the significant level of contracted capacity expiring in 2020, DBRS expects the Company to further decrease its leverage over the medium term, should the level of contracted output decrease significantly. DBRS notes that TAC also has an unsustainable dividend payout ratio (380% in 2012) that negatively impacts its leverage; however, this is mitigated by a high participation rate in the DRIP. DBRS expects TAC to maintain a high participation rate in its DRIP, mitigating the weak dividend payout ratio.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating Companies in the Non-Regulated Electric Generation Industry, which can be found on our website under Methodologies.