DBRS Confirms Ratings of Union Gas Limited

DBRS Limited (DBRS) has today confirmed the Issuer Rating and Unsecured Debentures/Medium-Term Note Debentures rating of Union Gas Limited (Union or the Company) at “A,” the Company’s Commercial Paper rating at R-1 (low) and its Cumulative Redeemable Preferred Shares rating at Pfd-2. All trends are Stable. The ratings reflect Union’s relatively low risk gas distribution business, which operates under a reasonable regulatory framework, and are supported by the Company’s economically stable service territory with a large customer base that is growing at a steady rate. Union’s financial risk profile has remained reasonable with key credit metrics in the current rating category.

Union’s business risk profile is supported by a reasonable regulatory environment in Ontario and predictable earnings from the Company’s regulated business, which accounts for over 80% of earnings. Union operates under a five-year incentive regulation framework (IR; 2014–2018), which provides predictable cash flows and annual rate escalation at 40% of inflation. The IR also affords the Company an opportunity to earn 150 basis points above the allowed return on equity (ROE) of 8.93% through its operational efficiency and an earnings sharing mechanism with its customers. Natural gas supply costs continue to be passed through to customers, which mitigates commodity price risk for Union. DBRS believes the IR framework is well suited to Union’s large multi-year capital programs that require certainty of funding in advance as capex is pre-approved by the Ontario Energy Board (OEB), reducing regulatory lag. The Company’s distribution business serves 1.4 million customers, largely in residential and commercial markets in more than 400 communities across Ontario, and provides Union the ability to better weather economic downturns. Although the Company’s regulated distribution and storage business accounts for the bulk of the Company’s earnings, a portion of earnings are generated from its unregulated storage business (14% of EBIT in 2013), which could expose the Company to some earnings volatility. DBRS views this segment as higher risk than the regulated distribution and storage business because of the impact of seasonality on storage demand and rates.

DBRS expects capex, largely related to Dawn to Parkway transmission and storage expansions, to remain relatively high (approximately $400 million annually in 2015 and 2016), resulting in the Company’s generating negative free cash flows over the medium term. The new infrastructure is needed to offset the declining supplies from Western Canada and support diverse and competitive gas supply options from Marcellus and Utica. Union’s credit metrics could come under pressure as major capital projects are executed; however, the impact is expected to be moderate, as the assets are placed into service and form part of the Company’s regulatory rate base, enhancing earnings. In addition, DBRS expects the Company to maintain a fairly flexible dividend policy, which helps to maintain its regulated capital structure (64% debt/36% equity).

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 methodologies are Rating Companies in the Regulated Electric, Natural Gas and Water Utilities Industry, DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers, and Preferred Share and Hybrid Criteria for Corporate Issuers, which can be found on our website under Methodologies.

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