DBRS Confirms Ratings of Duquesne Light Company with Stable Trend

DBRS has today confirmed the Issuer Rating and First Mortgage Bonds of Duquesne Light Company (DLC or the Company) at A (low) and the Preferred Stock at Pfd-2 (low). All trends are Stable. The rating confirmation reflects DLC’s relatively stable operating environment and no material deviation of its key credit metrics from the initial rating assumptions made in September 2013. The credit quality of DLC benefits from its low business risk profile underpinned by stable regulated distribution/transmission businesses and a supportive regulatory environment in Pennsylvania. All of DLC’s earnings have been contributed by the low-risk distribution/transmission businesses following the approval of DLC’s new default service plan since June 2013 which includes the use of a supplier auction process to procure electricity for the Company’s residential customers, effectively eliminating price and volume risk. The distribution (approximately 75% of DLC’s total rate base) and transmission businesses (25%) are regulated by the Pennsylvania Public Utility Commission and the Federal Energy Regulatory Commission, respectively, under a cost-of-service basis. Under this framework, DLC is allowed to earn a reasonable return on equity (ROE) and recover prudent operating expenses and infrastructure investments on a timely basis, reducing regulatory lag.

The recent rate case settled in April 2014 was reasonable, and is expected to increase EBITDA by approximately 4% in 2014 and 6% in 2015 (higher in 2015 due to a full year effect) after adjusting for a projected increase in operating costs. The revenue increase of $48 million represents approximately 63% of DLC’s requested increase, which is slightly below the regional peer average of 67% based on rate cases settled in Pennsylvania over the past three years. Similar to most rate case decisions (including DLC’s previous rate case settlement) rendered in the state in the last several years, the April 2014 rate case was a black box settlement that was silent with respect to traditional rate case parameters including deemed equity thickness and ROE. Regulatory lag has improved moderately by using a fully projected future test year whereas the previous rate case was based on a historical period. There has been no material change in the regulatory regime affecting DLC’s transmission segment. The allowed ROE and equity thickness for transmission have continued to be supportive with (1) allowed ROE of 11.4% and (2) equity thicknesses of up to 59%.

DLC’s current ratings assume that the Company’s financial metrics will weaken, largely due to zero earnings contribution from the higher-risk electricity supply business (approximately 14% of 2013 earnings) under the new default service plan and rising leverage due to high capital expenditures and dividend payout. Cash flow-to-debt is expected to fall to around 25% in 2014 which is still reasonable for the current rating category. Increased debt to capital of approximately 52% is in line with DLC’s regional peers. A debt-to-capital ratio greater than 50% is viewed as strong for a rating consideration.

The ratings recognize that DLC is the primary source of cash to service the external debt of DLC’s parent, Duquesne Light Holdings, Inc. and has a high level of capital spending on the maintenance of its distribution infrastructure. DBRS expects the Company to fund free cash flow deficits in a prudent manner and maintain its leverage at around 50%.

Notes:
All figures are in U.S. 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 methodologies are Rating Companies in the Regulated Electric, Natural Gas and Water Utilities Industry and Preferred Share and Hybrid Criteria for Corporate Issuers (Excluding Financial Institutions) which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.