DBRS Places Emera Inc. Under Review – Developing Following TECO Energy Incorporated Acquisition Announcement

DBRS Limited (DBRS) has today placed the BBB (high) Issuer Rating, BBB (high) Medium-Term Notes and Pfd-3 (high) Preferred Shares – Cumulative ratings of Emera Inc. (Emera or the Company) Under Review with Developing Implications. These rating actions follow the announcement that the Company has agreed to acquire TECO Energy Incorporated (TECO) for a total consideration of approximately USD 10.4 billion including assumption of USD 3.9 billion of debt (the Acquisition). The rating actions reflect DBRS’s view that the Acquisition would have a relatively neutral impact on Emera’s business risk assessment (BRA) while the impact on the financial risk assessment (FRA) is uncertain since the financing plan has not been finalized. The purchase price represents a 48% premium on TECO’s unaffected closing price on July 15, 2015, and is 25% above TECO’s unaffected 52-week high. The Acquisition is expected to close by mid-2016, and is subject to TECO shareholder approval, as well as various regulatory approvals, including New Mexico Public Regulation Commission and the Federal Energy Regulatory Commission. The DBRS ratings of Nova Scotia Power Inc. (NSPI; rated A (low) with a Stable) are not affected by today’s announcement. DBRS assesses the credit quality of NSPI on a stand-alone basis.

TECO is a vertically integrated utility services holding company with the following regulated electric and gas utilities in Florida and New Mexico: (1) Tampa Electric serves more than 700,000 customers in West Central Florida. Tampa Electric accounted for 80% of TECO’s consolidated net income from continuing operations before corporate and other expenses (Earnings) for the 12 months ended June 30, 2015 (LTM 2015), and 79% of consolidated rate base in 2014; (2) Peoples Gas System serves more than 350,000 customers across Florida. Peoples Gas accounted for 12% of Earnings in LTM 2015 and 12% of consolidated rate base in 2014; and (3) New Mexico Gas Co. serves more than 510,000 customers across New Mexico. New Mexico Gas Co. accounted for 8% of Earnings in LTM 2015 and 9% of consolidated rate base in 2014. Pro forma for the Acquisition, TECO would account for approximately 50% of Emera’s consolidated earnings. The Acquisition is expected to be accretive to earnings in the first full year after closing, excluding one-time Acquisition-related costs.

CURRENT BRA AND FRA ANALYSIS
Emera’s BRA has remained commensurate with the current BBB (high) rating, underpinned by its relatively stable regulated subsidiaries that account for the majority of the Company’s earnings and cash flow (72% of adjusted net income in 2014), while also reflecting the higher volatility and risk inherent with its non-regulated electricity generation and energy trading business. As noted in the DBRS Emera report dated March 13, 2015, the current ratings reflect our expectation that regulated earnings will account for 75% to 85% of consolidated earnings over the medium term.

Emera’s FRA is based on its deconsolidated credit metrics. The current ratings reflect Emera’s deleveraging efforts, reducing its non-consolidated debt-to-capital to approximately 19% as at June 30, 2015, from 40% in 2013. DBRS expects Emera to fund future growth investments in a prudent manner to maintain deconsolidated leverage within the 30% threshold. If Emera is unable to do so, this could result in negative rating actions. Other key non-consolidated credit metrics have also remained supportive of the current rating category including cash flow-to-interest at 12.3 times (x) in LTM 2015 and cash flow-to-debt at 38.4% in LTM 2015.

BRA and FRA Post-TECO Acquisition
The net effect of the Acquisition on Emera’s BRA is expected to be relatively neutral. One of the primary BRA benefits is that Emera’s earnings mix would improve, with a larger percentage of earnings generated from regulated businesses, since all of TECO’s continuing operations are regulated. In addition, Emera would benefit from greater geographic and regulatory diversification. However, the positive BRA factors would be offset by heightened integration risk given the material size of the Acquisition and uncertainty associated with the timing of the TECO Coal divestiture (which is a non-continuing operation), which could result in potential liability issues.

Pro forma for the Acquisition, regulated earnings contribution would be around 85% of consolidated earnings in 2016, which would be in the upper range of the DBRS’s regulated earnings mix range expectation (75% to 85%). DBRS views the quality of regulatory regime in Florida in terms of cost recovery mechanisms and the ability to achieve the allowed regulatory return on equity (ROE) as being similar to the regime in Nova Scotia. However, the regulatory environment in New Mexico is viewed as being weaker when compared to other jurisdictions in North America where Emera currently conducts its business. DBRS is concerned about the timing of the operating and capital costs recovery in New Mexico. However, earnings contribution from New Mexico Gas Co. was relatively small at 8% of TECO’s Earnings in LTM 2015 and is expected to remain below 10% over the next five years. With its higher allowed ROE and equity thickness on average, TECO’s profitability has generally outperformed that of Emera over the past five years. TECO’s return on capital was 6.5% (average basis for last five years from 2010 to 2014) whereas Emera’s return on capital was lower at 5.6% for the same period.

The primary focus of DBRS’s FRA analysis is on Emera’ non-consolidated capital structure (parent level) and cash flow from the subsidiaries to the parent to service the parent’s debt and corporate expenses. On a non-consolidated basis, the cash flow-to-interest expense ratio was reasonable at 12.3x in LTM 2015, while debt-to-capital was approximately 19%. DBRS notes that the non-consolidated leverage of 19% is well within the 30% threshold.

Currently, it is uncertain as to how Emera plans to ultimately finance the Acquisition. As a result, DBRS has placed the ratings of Emera Under Review with Developing Implications. DBRS will further review the Company’s financing plan when it is finalized. Upon final review, if the Company finances the Acquisition in such a way that its non-consolidated debt-to-capital structure exceeds 30% and its other non-consolidated credit metrics deteriorate significantly without corrective action within a reasonable time frame, then a negative rating action is likely to occur.

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 Regulated Electric, Natural Gas and Water Utilities Industry (October 2014), DBRS Criteria: Preferred Share and Hybrid Criteria for Corporate Issuers (January 2015) and DBRS Criteria: Rating Holding Companies and Their Subsidiaries (January 2015), which can be found on our website under Methodologies.