DBRS Confirms TransAlta Corporation at BBB and Pfd-3 with Stable Trends

DBRS Limited (DBRS) has today confirmed the Issuer Rating and Unsecured Debt/Medium-Term Notes rating of TransAlta Corporation (TAC or the Company) at BBB and the Preferred Shares rating at Pfd-3, all with Stable trends. The confirmations are based on DBRS’s expectation that TAC will further improve its relatively constrained key credit metrics over the near term to be more in line with the current rating category. Moreover, DBRS notes that TAC’s ratings reflect its high level of contracted output, strong position in the Alberta (the Province) market and reasonable level of geographic and fuel diversification, while also factoring in unplanned outage risks, the challenging wholesale market conditions over the next several years and TAC’s merchant exposure (including post-2020 power purchase agreement expiries in Alberta).

In 2014, TAC’s key credit metrics improved modestly following its 38% dividend decrease and debt reduction initiatives, which were primarily funded with non-core asset sales, dividend reinvestment (DRIP) proceeds and a secondary offering of TransAlta Renewables Inc. (TransAlta Renewables) shares. However, key credit metrics remained relatively constrained for the current rating, which provides TAC with very limited financial flexibility. As a result, DBRS expects TAC to further reduce its leverage to be more in line with the current rating category, particularly its adjusted debt-to-capital ratio (52% in 2014). This is expected to be driven primarily by the continuation of DRIP and material asset drop-downs to TransAlta Renewables. In addition, DBRS expects TAC to continue to fund any significant unforeseen costs, cash shortfalls, acquisitions and/or significant growth projects prudently to prevent any deterioration of key credit metrics. TAC’s inability to further improve its leverage over the near term could have negative rating implications.

As TransAlta Renewables continues to be used as a funding source, TAC’s ratings also reflect the expectation of a strong level of integration between TAC and TransAlta Renewables. However, if TAC’s ownership in TransAlta Renewables decreases and as TransAlta Renewables’ asset portfolio grows, the integration between the two could weaken. In addition, if a significant amount of external debt is raised at TransAlta Renewables, structural subordination of debt at TAC could become a greater concern. In this case, DBRS will increasingly weigh on deconsolidated analysis to analyze TAC’s business risk and financial risk profile.

TAC’s business risk profile has remained reasonable for the current rating. Although relatively weak wholesale power prices are expected in Alberta and the Pacific Northwest in 2015, TAC’s strong contractual position (88% in 2015) is expected to partially reduce earnings and cash flow volatility. Over the medium term, TAC’s favourable position in the Alberta electricity market is also expected to remain supportive of the current rating, as the Province has historically benefited from a pricing premium over nearby markets. The pricing premium was primarily supported by a limited and disciplined level of competition and good demand growth. However, DBRS recognizes that there is some uncertainty with the Province’s long-term demand growth, given the oil and gas pricing environment. Moreover, the supply conditions could remain challenging over the next several years, with excess supply created by the return-to-service of Sundance Units 1 and 2 and Keephills Unit 1 in late 2013, as well as the expected completion of the Shepard Energy Centre (800 megawatts) in Q1 2015. If these unfavourable market conditions persist over the long term, with supply far exceeding demand growth, this could have negative implications on TAC’s business risk profile.

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.

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

The applicable methodologies are Rating Companies in the Independent Power Producer Industry and Preferred Share and Hybrid Criteria for Corporate Issuers, which can be found on our website under Methodologies.