DBRS Confirms Hydro Ottawa Holding Inc. at “A,” Stable Trends

DBRS Limited (DBRS) has today confirmed the Issuer Rating and the Senior Unsecured Debt rating of Hydro Ottawa Holding Inc. (Hydro Ottawa or the Company) at “A,” both with Stable trends. The ratings reflect the Company’s low business risk associated with its regulated electricity distribution business and reasonable financial risk profile. However, DBRS remains concerned over the Company’s exposure to higher-risk non-regulated generation operations. Hydro Ottawa’s business risk profile could be negatively affected should non-regulated earnings exceed the 20% threshold for the current rating (17.0% of 2014 EBIT).

Hydro Ottawa’s business risk profile is supported by the reasonable regulatory framework in Ontario and the relatively stable earnings and cash flows from its regulated operations (approximately 83.0% of 2014 EBIT). In April 2015, the Company filed its Custom Incentive Regulation (CIR) application for the five-year period beginning 2016. In its application, Hydro Ottawa has proposed to recover its capital requirements on a five-year forecasted cost-of-service basis while operations, maintenance and administrative (OM&A) expenses will be recovered pursuant to a price cap adjustment. If approved, the Company will be able to recover its return on investments during the CIR period rather than through periodic rebasing, reducing regulatory risk. This will also provide Hydro Ottawa the annual increases necessary to help fund its ongoing heavy capital expenditures (capex) program. However, as the Company must forecast its capex and OM&A expenses for a five-year period, earnings and cash flows could be negatively impacted by large unforeseen discrepancies between forecast and actual costs. This risk is partially mitigated by the ability of Hydro Ottawa to initiate a regulatory review if actual return on equity (ROE) is 300 basis points below the approved ROE.

Earnings and cash flows from Hydro Ottawa’s non-regulated segment are considered more volatile because of the greater associated volume risk. Following the in-service of the 29-megawatt expansion at Chaudière Falls in late 2017, earnings from the non-regulated segment will approach or even potentially breach the 20% threshold for the current rating category. Although earnings from regulated operations are expected to grow substantially following rebasing in 2016 (rate base of estimated $923 million versus $669 million approved in 2012), this growth may be outpaced by growth in earnings contributed by non-regulated operations. DBRS notes there are factors that could materially impact the earnings split between regulated and non-regulated operations, including the approval of the CIR application, ongoing distribution consolidation in Ontario and generation growth. However, should earnings from non-regulated operations exceed the 20% threshold, Hydro Ottawa’s business risk profile could be negatively affected. Additionally, Hydro Ottawa’s credit profile may be negatively impacted should the Company expand its non-regulated operations beyond its current franchise area, or acquire assets that are exposed to merchant markets. Should these investments have a material impact on Hydro Ottawa’s business and financial risk profiles, a negative rating action may occur.

Hydro Ottawa’s financial risk profile is in the “A” rating range, supported by a reasonable balance sheet and strong credit metrics. The Company’s key ratios continued to be commensurate with the current rating category. DBRS also notes that even without factoring in earnings and cash flow from the non-regulated operations, the Company’s key credit metrics are still in the “A” rating range. Although the Company’s debt ratios may deteriorate during this period of high capex in order to enhance the reliability of the system (applied for an average of approximately $130 million per year for the CIR term) and expand generation capacity at Chaudière Falls, DBRS expects Hydro Ottawa to continue to have reasonable financial flexibility for the current rating category going forward.

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), which can be found on our website under Methodologies.