DBRS Confirms Hydro One Inc. at A (high), R-1 (middle), Stable Trends

DBRS Limited (DBRS) has today confirmed the Issuer Rating and the Senior Unsecured Debentures rating of Hydro One Inc. (Hydro One or the Company) at A (high), and the Commercial Paper rating at R-1 (middle). All trends are Stable. The ratings confirmation reflects the Company’s low business risk profile, supported by a reasonable regulatory framework in Ontario and a strong financial profile sustained by predictable earnings and cash flows. The Stable trend assumes that the regulatory regime will continue to remain reasonable and supportive, allowing the Company to earn adequate returns and recover prudently incurred costs on a timely basis.

Hydro One operates in an extensive franchise area with a steady growth in customers. The Company’s regulated transmission and distribution businesses in Ontario account for substantially all its earnings. Hydro One’s transmission business (67%: 2014 EBIT) operates under a cost of service framework. In December 2014, the Ontario Energy Board (OEB) approved Hydro One’s transmission rates for two years (2015–2016), largely in line with the Company’s rate application. In December 2013, Hydro One’s distribution business (33% of EBIT) filed a five-year custom rate application (2015–2019) with the OEB under the Renewed Regulatory Framework for Electricity Distributors (RRFE). In March 2015, the OEB in its decision, noted that Hydro One’s application was not sufficiently aligned with the performance-based measures mandated in the RRFE and directed Hydro One to develop and integrate appropriate operating efficiency targets and performance benchmarks into its cost forecasts for its next rate application. In the interim, the OEB approved distribution rates for a shorter three-year period (2015–2017) based on the cost of service and capital cost estimates in Hydro One’s rate filing. While recognizing OEB’s objective to align electricity distribution rate applications with incentive rate-setting, DBRS views the decision as favourable for Hydro One, as distribution rates based on the cost of service method provide more certainty for recovery of operating and capital costs compared with a five-year incentive rate period, as it reduces regulatory lag and forecasting risk.

The Premier’s Advisory Council on Government Assets (the Council) released its initial recommendations in November 2014 on ways to maximize the value of provincially owned assets. For Hydro One, the Council has recommended that the Company’s transmission and distribution businesses be separated, and that the Company’s distribution assets be partially privatized and used to stimulate consolidation of Ontario’s fragmented electricity distribution system. There have also been numerous unconfirmed media reports on the Province of Ontario’s (the Province) plans to privatize Hydro One through an initial public offering, or a sale of Hydro One Brampton. Phase two of the Council’s recommendations is expected by spring 2015. DBRS will monitor these developments and review the economic details of the recommendations to assess the impact, if any, on Hydro One’s credit profile.

Hydro One’s key credit metrics; total debt-to-capital (2014: 52.9%), cash flow-to-total debt (15.5%) and EBIT interest coverage (2.92x) have all remained in the upper range of the “A” rating category. DBRS rates Hydro One on a stand-alone basis, and the ratings are constrained by the rating of the Province (rated AA (low)), which acts as a ceiling. DBRS assumes that Hydro One’s rate base will continue to grow and provide incremental cash flow to fund the majority of capex and maintain debt-to-capital at around 55%, with minimal regulatory lag and no significant cost overruns.

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 methodology is Rating Companies in the Regulated Electric, Natural Gas and Water Utilities Industry (October 2014) and DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers, which can be found on the DBRS website under Methodologies.