DBRS Comments on Hydro One Inc.’s Proposed Ownership Change

DBRS Limited (DBRS) today notes that the government of the Province of Ontario (the Province, rated AA (low) with a Stable Trend by DBRS) has announced its intention to broaden the ownership of Hydro One Inc. (Hydro One or the Company, rated A (high) with a Stable Trend, wholly-owned by the Province) through an initial public offering (IPO) that could see the Province gradually reduce its ownership in the Company to 40% over the next four to five years. DBRS has reviewed the details of the Province’s announcement together with the final recommendation of the Premier’s Advisory Council on Government Assets (the Council) released on April 16, 2015, and has concluded that the proposal as it currently stands has no material impact on Hydro One’s credit profile.

DBRS rates Hydro One on a stand-alone basis, independent of its ownership structure; however, the ratings are constrained by the rating of the Province, which acts as a ceiling. The Province provides indirect support to Hydro One with a flexible dividend policy which, given the Company’s heavy capital expenditure (capex) program, allows Hydro One to maintain its leverage below the 60% set by the Ontario Energy Board. At the same time, Hydro One’s current ownership structure limits its ability to access the equity markets directly and the Company’s additional funding needs are financed largely through a combination of operating cash flow and debt. Significant external funding is required to finance the Company’s capex program (nearly $5 billion over the next three years) to replace Hydro One’s aging electricity infrastructure. Maintaining adequate access to the public debt markets is therefore critical for the Company. DBRS notes that the proposed partial divestiture of ownership by the Province could provide the Company wider access to capital through the equity markets.

In its recent rating report on Hydro One dated April 10, 2015, DBRS noted that the Council’s initial recommendations were to separate the Company’s transmission and distribution businesses and that the distribution assets be partially privatized and used to stimulate consolidation of Ontario’s fragmented electricity distribution system. DBRS observes that the Province’s announcement to sell a majority of Hydro One as an integrated entity (excluding Hydro One Brampton) instead of separating and spinning off the distribution business is a better outcome for creditors as it is easier to execute and keeps the underlying business profile of the Company unchanged. Furthermore, following the IPO, the Province would be the largest shareholder and no shareholder or group of shareholders would be permitted to own more than 10% of the Company, providing the Province with the power to continue to exercise control over corporate governance and Company policies. Going forward, DBRS expects that the regulatory framework in Ontario will continue to remain reasonable and supportive, allowing the Company to earn adequate returns and recover prudently incurred costs on a timely basis, and that the Company’s dividend policy will be conservative in order to maintain credit metrics consistent with the A (high) rating.

The Province has also announced that it intends to proceed with a sale or merger of Hydro One Brampton Networks Inc. (Hydro One Brampton; 100% owned by Hydro One) with Enersource Corporation (rated “A” with a Stable trend), Horizon Utilities Corporation and PowerStream Inc., (rated “A” with a Stable trend). For further detail, please refer to the corresponding DBRS press release dated April 17, 2015. DBRS notes that Hydro One Brampton represents approximately 2% of Hydro One’s consolidated revenues and, as such, the sale or merger is not expected to have a material impact on Hydro One’s credit profile.

DBRS will continue to monitor further developments, including legislative amendments that may be required to implement the proposal, as details become available.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodologies are 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.

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