DBRS Confirms Hydro Ottawa Holding Inc. at “A,” Stable

DBRS has today confirmed the Issuer Rating and the rating of the Senior Unsecured Debt of Hydro Ottawa Holding Inc. (Hydro Ottawa or the Company) at “A,” both with Stable trends. The ratings reflect the Company’s low business risk profile and are underpinned by a supportive regulatory environment, relatively stable earnings and cash flow from the regulated electricity distribution operations and a strong franchise area.

Hydro Ottawa’s business risk profile is viewed as strong, as approximately 91% of EBIT (2012) is generated from its low-risk regulated power distribution business operating under a reasonable, albeit evolving, regulatory system. Hydro Ottawa is currently operating under the 3rd Generation Incentive Regulatory Mechanism (IRM) after rebasing in 2012 using a cost-of-service methodology. Parameters set under the 3rd Generation IRM are viewed as reasonable, including an approved return on equity (ROE) of 9.42%. In October 2012, the Ontario Energy Board (OEB) released its report on the renewed regulatory framework for electricity distributors in Ontario. Given Hydro Ottawa’s large planned capex program, DBRS expects Hydro Ottawa to either transition to the new Custom Incentive Regulation (IR) or the 4th Generation IR framework at the end of its current IRM period (2013–2015). Although these frameworks have a longer IR period (four plus years versus three years), which increases regulatory risk, Hydro Ottawa is provided with downside protection as it has the option to initiate a regulatory review of the IR application if actual ROE is 300 basis points less than the approved ROE. However, there are some uncertainties relating to key factors within the IR framework. The OEB is expected to release details on these factors in mid-2013 and, should the factors increase regulatory risk (e.g., aggressive efficiency targets), it could have negative rating implications.

Hydro Ottawa’s exposure to non-regulated generation businesses is manageable at around 9% of consolidated EBIT. The Company’s power price risk has been effectively mitigated by having long-term contracts with creditworthy parties, such as Ontario Power Authority (rated A (high)). In November 2012, Hydro Ottawa closed the acquisition of three hydroelectric plants and a 38.3% interest in the Ring Dam at Chaudière Falls (the Acquisition) for $46 million. DBRS views the Acquisition as credit neutral with respect to Hydro Ottawa’s business risk and financial risk profiles (see DBRS press release, DBRS Comments on the Closing of Hydro Ottawa’s Acquisition, dated November 23, 2012). Although the Acquisition, along with the free cash flow deficit in 2012, resulted in a moderate increase in the debt-to-capital ratio and a moderate decrease in the cash flow-to-debt ratio, the Company still has significant financial flexibility. Going forward, DBRS expects key credit metrics to remain in line with the current “A” rating.

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 North American Energy Utilities (Electric and Natural Gas) Industry (May 2011), which can be found on our website under Methodologies.