DBRS Updates Its Report on Enersource Corporation

DBRS has today updated its report on Enersource Corporation (Enersource or the Company). The regulatory framework for distribution utilities in Ontario is shifting from the current 3rd Generation Incentive Regulation (IR) to the renewed regulatory framework. DBRS does not expect this shift to have a material impact on the ratings of Enersource Corporation (Enersource or the Company), as the 4th Generation IR, which Enersource Hydro Mississauga Inc. (EHM; the regulated utility) is using to set rates effective January 1, 2014, is similar to the 3rd Generation IR. The major difference is that the 4th Generation IR has a longer period (four years, versus three years), which increases regulatory risk. However, EHM, like its peers in Ontario, has the option to initiate a regulatory review of the IR application if actual return on equity (ROE) is less than 300 basis points, providing downside protection.

For the 2014 rate year, EHM’s rates will increase by 1.7%, which incorporates a price escalator of 1.7%, productivity factor of 0% and stretch factor of 0%, as set out by the Ontario Energy Board (OEB) in its November 21, 2013 Report of the Board: Rate Setting Parameters and Benchmarking under the Renewed Regulatory Framework for Ontario’s Electricity Distributors. DBRS does not expect this to have any rating implications. During the IR period, EHM will be able to earn a reasonable ROE of 8.93% on deemed equity thickness of 40%, the same as during 2013.

For the nine months ended September 30, 2013 (9M 2013), Enersource generated a positive free cash flow as capital expenditures (capex) were lower compared to 9M 2012. Capex was mainly used for the maintenance of existing infrastructure and, given that Enersource’s infrastructure is relatively modern and does not require extensive repairs and upgrades, capex has generally been lower than comparable peers. For 2013, the Company anticipates spending approximately $49 million on capex and $12 million on dividends, which DBRS estimates will likely result in a free cash flow deficit of approximately $8 million to $10 million. DBRS expects Enersource to fund free cash flow deficits with debt, without any material implications on key credit metrics. The Company continued to maintain good financial flexibility in 9M 2013, as its leverage ratio (52.5% for the 12 months ended September 30, 2013 (LTM 2013)) was well within DBRS’s rating parameter.

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.