DBRS Confirms Ratings of Union Gas Limited

DBRS Limited (DBRS) has today confirmed the Issuer Rating and Unsecured Debentures/Medium-Term Note Debentures rating of Union Gas Limited (Union or the Company) at “A,” the Company’s Commercial Paper rating at R-1 (low) and its Cumulative Redeemable Preferred Shares rating at Pfd-2. All trends are Stable. The ratings confirmation reflects Union’s relatively low risk gas distribution business, which operates under a reasonable regulatory framework in an economically stable service territory with a large customer base that is growing at a steady rate. The Company’s financial risk profile also remains reasonable with key credits metrics that are supportive of the current ratings.

Union’s business risk profile is supported by a reasonable regulatory environment in Ontario and predictable earnings from the Company’s regulated business, which account for nearly 90% of earnings (approximately 88% of EBIT in 2014). Union operates under a five-year incentive regulation framework (IR; 2014–2018), which provides predictable cash flows and annual rate escalation at 40% of inflation. The IR also affords the Company an opportunity to earn up to 150 basis points above the allowed return on equity (ROE) of 8.93% through operational efficiency after adjusting for an earnings sharing mechanism with its customers. Natural gas supply costs are passed through to customers, mitigating commodity price risk for Union. The Company’s distribution business serves 1.4 million customers, largely in residential and commercial markets in more than 400 communities across Ontario, and provides Union the ability to better weather economic downturns. Although the Company’s regulated distribution and storage business accounts for the bulk of the Company’s earnings, earnings generated from its unregulated storage business (12% of EBIT in 2014) could expose the Company to some earnings volatility. DBRS views this segment as higher risk than the regulated distribution and storage business because of the impact of seasonality on storage demand and rates.

Union’s capital spending program on transmission and storage expansions is expected to remain relatively high (approximately $750 million in 2015 and $1.0 billion in 2016), resulting in the Company generating negative free cash flows over the medium term. DBRS expects Union’s credit metrics to come under pressure, with cash flow-to-debt and debt to capital ratios moving into the “BBB” category, as major capital projects are executed; however, the impact is expected to be mitigated by incremental earnings as projects are completed and placed into service, forming part of the Company’s regulatory rate base. In addition to supply diversity, these new infrastructure projects are needed to bring competitively priced Marcellus/Utica natural gas supplies to Eastern Canada. DBRS also expects the Company to maintain a flexible dividend policy in order to maintain its regulatory capital structure (64% debt/36% equity). While DBRS does not expect Union’s ratings to be upgraded in the medium term, ratings could be negatively affected should leverage exceed the regulatory capital structure and remain elevated for a sustained period.

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.

The applicable methodologies are Rating Companies in the Regulated Electric, Natural Gas and Water Utilities Industry (October 2015), DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers (April 2015), and DBRS Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (Jan 2016), which can be found on our website under Methodologies.

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