DBRS Updates Its Report on EPCOR Utilities Inc.

DBRS has today updated its report on EPCOR Utilities Inc. (EUI or the Company). EPCOR’s key financial metrics remained relatively stable through the six months ended June 30, 2013 (H1 2013), despite the continued high level of growth capital expenditures (capex), including the Heartland Transmission project and, to a lesser extent, incremental capex associated with the U.S. water acquisition in 2012. As a result, EUI generated a cash flow deficit of $104 million in H1 2013. The Company has prudently managed its growth strategy by funding its free cash flow deficit and acquisitions largely with cash proceeds from the continual sell down of its economic interest in Capital Power L.P. (Capital Power; rated BBB) over the past five years. In October 2013, EUI sold approximately 10% of its remaining 29% equity interest in Capital Power for approximately $202 million, which should fund the majority of EUI’s cash flow deficit for 2013. DBRS estimates the remaining economic interest in Capital Power (19%) and loans receivable to be approximately $750 million, and this is expected to continue to be used to pursue growth opportunities, while keeping credit metrics in line with the current rating range.

Under its new leadership, EUI intends to further expand geographically through its core water and wires utility business outside of Alberta. DBRS views the regulatory framework in EUI’s key states, specifically New Mexico and Arizona, to be more challenging when compared to EUI’s primary service franchise in Alberta. DBRS notes that regulatory processes in both states require that each utility uses a historical test year when filing a rate application, as opposed to a prospective test year. This raises uncertainty regarding the recovery of capital that is invested during the year, and as a result could affect the actual realized return of the utility. Historically, there has been evidence that earning the allowed return on equity (ROE) has been very challenging, and so it remains to be seen whether EUI can successfully generate adequate returns for the businesses. As a result, although the sell down of Capital Power decreases EUI’s business risk profile, DBRS believes that this will be partially offset by its increased investment in the U.S. water utilities business, until EUI is able to create a track record of success with its U.S. assets. Regulation in Alberta, the single most important province for EUI, is viewed as supportive of the credit quality of EUI. Although there are uncertainties related to the capital tracker mechanism for electricity distribution and stranded cost recovery, they are expected to be resolved within the next six months.

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

The applicable methodology is Rating Companies in the North American Energy Utilities (Electric and Natural Gas) Industry, which can be found on our website under Methodologies.