DBRS Confirms Toronto Hydro Corporation at “A,” Commercial Paper Rating at R-1 (low) with Stable Trends

DBRS Limited (DBRS) has today confirmed Toronto Hydro Corporation’s (THC or the Company) Issuer Rating and Senior Unsecured Debentures & MTNs rating at “A” and the Commercial Paper rating at R-1 (low). All trends are Stable. The ratings reflect THC’s low risk electricity distribution business, which operates under a reasonable regulatory regime and serves an economically stable franchise area that provides relatively predictable earnings. However, DBRS expects THC’s financial metrics to be pressured in the near to medium term as the Company incurs significant capital expenditure (capex) to serve a growing customer base and replace aging infrastructure. The Stable trend reflects DBRS’s expectation that THC will manage its balance sheet prudently by exploring equity financing options with its sole shareholder, the City of Toronto (the City; rated AA, Stable trend by DBRS) or by potentially curtailing capex and dividends. DBRS could take a negative rating action should THC’s leverage and cash flow-to-debt metrics continue to deteriorate to a level that is no longer commensurate with the “A” rating.

DBRS expects the regulatory regime in Ontario to remain transparent and supportive, allowing the Company to recover prudently incurred costs on a timely basis and to earn an adequate return on equity (9.30% for 2015 to 2019). In December 2015, the Ontario Energy Board approved THC’s Custom Incentive Rate-Setting (CIR) application, which will provide the Company with funding certainty during the five-year term of the CIR (2015 to 2019) for its $2.2 billion capex program. THC’s capex program is geared to meet growing customer demand and maintain the reliability of the distribution grid.

THC’s capex has consistently exceeded depreciation, providing for rate base growth and incremental cash flows. The Company’s rate base is expected to reach approximately $4.3 billion by the beginning of 2020 from $3.2 billion at December 2015. THC’s key credit metrics at December 2015 -- cash flow-to-total debt 15.2%; total debt-to-capital 62.8%; and EBIT-to-interest 2.37 times (x) -- are reasonable for the current rating; however, DBRS expects credit metrics to weaken in the near to medium term, as THC’s capex is likely to remain elevated. THC’s capex is front-end loaded, whereas the cash flow recovery through rates by way of depreciation usually lags by a year. Although THC’s operating cash flow is expected to grow modestly, the significant capital program and dividends are expected to result in sizable free cash flow deficits that are likely to be funded with debt, causing leverage to remain above the regulatory capital structure (60% debt: 40% equity) in the medium term. DBRS expects THC to access permanent sources of capital by exploring equity financing options with the City or by potentially moderating its capital spending and dividend program in order to maintain credit metrics consistent with the “A” rating. THC’s ratings could be downgraded should the Company fail to maintain cash flow-to-debt and debt-to-capital at or near 15% and 60%, respectively, in the medium term.

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 and DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers, which can be found on our website under Methodologies.

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.

DBRS will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrs.com.