DBRS Updates Its Report on Toronto Hydro Corporation

DBRS has today updated its report on Toronto Hydro Corporation (THC or the Company). Overall, DBRS views the Ontario Energy Board’s (OEB) decision on THC’s electricity distribution business’s (LDC) 2012 and 2013 incremental capital module (ICM) as supportive. In aggregate, the OEB approved $687.5 million of capital expenditures (capex), which will be in service during those two years, an indication that the OEB is addressing THC’s aging infrastructure. As a result of the use of the future test year in Ontario, which is similar to other jurisdictions in Canada, the LDC faces minimal regulatory lag for capital spending and generally earns a return on equity (ROE) similar to its allowed ROE.

Capex is expected to be around $400 million for 2013, which is well above historical spending and similar to the peak levels in 2011 and 2010. This would likely result in a greater free cash flow deficit of around $150 million to $200 million. In previous years, THC prudently funded free cash flow deficits with a combination of proceeds from the sale of Toronto Hydro Telecom Inc. (approximately $200 million) and debt, maintaining leverage close to the regulatory deemed capital structure. However, proceeds from the asset sale have depleted over the years ($33.5 million cash on hand as at June 30, 2013, versus cash balances of over $100 million prior to late 2012). DBRS expects the Company to manage its balance sheet prudently so that it continues to maintain its leverage in line with the LDC’s deemed capital structure. If leverage rises above the deemed capital structure (over 60%) or if key credit metrics weaken significantly, THC’s financial profile could deteriorate to a level that is no longer commensurate with the current A (high) rating.

The regulatory framework for distribution utilities in Ontario is expected to shift from the current third generation incentive regulatory mechanism (IRM) to the renewed regulatory framework. Under the renewed regulatory framework, the LDC is expected to file under custom incentive regulation (IR) in 2014 for rates effective from 2015 to 2019. Given that custom IR is new and the forecasting period is five years, THC’s rating could be affected if the OEB does not provide reasonable or timely recovery of costs and capex or if the LDC is unable to recover large discrepancies between forecasts and actuals. The current rating is based on DBRS’s expectation that the implementation of the renewed regulatory framework in Ontario will not have a material impact on the credit profile of THC.

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.