DBRS Confirms Ontario Power Generation Inc. at A (low), R-1 (low), Stable Trends

DBRS Limited (DBRS) has today confirmed the Issuer Rating and Unsecured Debt rating of Ontario Power Generation Inc. (OPG or the Company) at A (low), and the Commercial Paper rating at R-1 (low), all with Stable trends. The confirmation is largely based on the continuing financial support from the Company’s shareholder, the Province of Ontario (the Province; rated AA (low) by DBRS). The Province, through its agent the Ontario Electricity Financial Corporation (rated AA (low) by DBRS), provides most of OPG’s financing (approximately 63% of total debt). The Company’s remaining debt is in the form of non-recourse project finance debt.

The Province announced in January 2016 that OPG will be moving forward with the refurbishment of the Darlington Nuclear Generating Station (the Darlington Refurbishment). The project has a final budget of $12.8 billion, and the refurbishment of the first unit is scheduled to begin in October 2016, with the last unit to be in-service by 2026. DBRS believes that given the complexity and scale of the Darlington Refurbishment, there is significant execution risk as well as the potential for cost overruns. The high capital expenditures (capex) required, albeit spread over a ten-year period, in addition to ongoing maintenance capex (total capex forecast of approximately $2 billion for 2016), are expected to pressure OPG’s key credit metrics. Although the Company’s cash flow-to-debt and debt-to-capital ratios have remained strong, DBRS expects leverage to increase to approximately 40% during this period of high capex. Additionally, profitability for OPG continues to be challenged as evidenced by the negative EBIT-interest coverage ratio for the year. DBRS notes that while the in-service of the Lower Mattagami River Project and the prescription of 48 previously unregulated hydroelectric facilities to regulated rates in late 2014 have helped improve OPG’s EBITDA, the Company’s reported corporate return on equity (ROE; 4.1% in 2015) remains far below the approved ROE of 9.3%. This has largely been due to the high cost base of OPG, which has resulted in several disallowances by the Ontario Energy Board (OEB) for the Company to recover forecasted compensation expenses.

OPG plans to submit a five-year application with the OEB later this year for new regulated rates effective 2017. The OEB has expressed that it expects prices for hydroelectric operations to be based on an incentive regulation (IR) ratemaking methodology, and that prices for nuclear operations be based on a multi-year forecast cost-of-service approach with IR features. DBRS believes that profitability for OPG could continue to be challenged following a switch to an IR framework, as the introduction of productivity and efficiency targets could further depress earnings. However, through its Business Transformation initiative, OPG has demonstrated its ability to improve efficiency by reducing regular headcount from continuing operations by approximately 2,700 personnel since 2011. Furthermore, earnings should also benefit from the growth in the rate base as Darlington Refurbishment pre-requisite projects are completed, and new regulated rates in 2017.

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: Guarantees and Other Forms of Support (February 2016), and DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers (April 2015), which can be found on our website under Methodologies.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.