DBRS Maintains Enersource Corporation Under Review with Developing Implications

DBRS Limited (DBRS) has today maintained the status of Under Review with Developing Implications for Enersource Corporation’s (Enersource or the Company) Issuer Rating and Senior Unsecured Debentures. The ratings of Enersource were placed Under Review on November 20, 2015, following the announcement of the merger of Enersource, PowerStream Inc. (PowerStream; rated “A,” Under Review with Developing Implications) and Horizon Utilities Corporation (Horizon) in order to purchase Hydro One Brampton Networks Inc. (rated “A” with a Stable trend) had received approval from all shareholders (the Transaction). DBRS will resolve the Under Review status at the closing of the Transaction expected at the end of 2016.

Enersource’s business risk profile continues to be supported by the Company’s steady regulated electricity distribution business in Ontario. The regulatory regime under the Ontario Energy Board (OEB) remains supportive, with Enersource currently operating under the Price Cap Incentive Rate (IR)-setting method. Under Price Cap IR, rates are adjusted annually based on an inflation escalation factor less a productivity and stretch factor (increase of 1.95% for 2016), and the Company can file an Incremental Capital Module to recover any significant capital expenditures (capex) in between rebasing years. Enersource, PowerStream and Horizon filed their application with the OEB for the Transaction in April 2016, requesting approval (a) for the amalgamation of the utilities, (b) to defer rebasing for ten years after the closing of the Transaction, and (c) for the continuation of each utilities’ rate orders following the Transaction. DBRS notes that the Transaction could have a modestly positive impact on the combined entity’s business risk profile should meaningful efficiencies through operational synergies and avoided capital costs be realized (approximately $426 million of net cash savings anticipated). However, this is partly offset by the integration risk associated with the Transaction.

Enersource’s key credit metrics continue to be in line with the current rating category. The Company’s debt-to-capital and cash flow-to-debt ratios weakened in 2015 as a result of a $60 million increase in debt to fund capex of $119 million (versus $54 million in 2014) for the year. The large increase was mainly due to an approximately $41 million payment to Hydro One Inc. (rated A (high)) related to the construction of the Churchill Meadows Transformer Station. DBRS notes that capex is expected to remain higher for the medium term in order to maintain the reliability of the system (approximately $76 million for 2016). This will likely result in net free cash flow deficits that will be funded through debt, which could add pressure on Enersource’s financial risk profile. Furthermore, in their application for the Transaction, the utilities are targeting cash flow-to-debt above 13% and debt-to-capital to not exceed 65%. DBRS notes that these ratios would be weak for the “A” rating. Should the combined entity’s key financial ratios deteriorate to a level that is not commensurate with the “A” rating category, negative rating action may 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.

The applicable methodology is Rating Companies in the Regulated Electric, Natural Gas and Water Industry, 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.