DBRS Confirms CU Inc. at A (high), R-1 (low), Pfd-2 (high), Stable Trends

DBRS Limited (DBRS) has today confirmed the Issuer Rating and Unsecured Debentures & Medium Term Notes rating of CU Inc. (CUI) at A (high), the Commercial Paper rating at R-1 (low) and the Cumulative Preferred Shares rating at Pfd-2 (high). All trends are Stable. The rating confirmations reflect CUI’s low business risk, supported by a reasonable regulatory environment and strong portfolio of diversified utilities, and improving key credit metrics. With the completion of the “big build” associated with electric transmission infrastructure, capital investment (capex) is expected to further normalize, while earnings and cash flow will benefit from a higher rate base, which will in turn improve credit metrics.

DBRS views the quality of regulatory regimes in Alberta as still being supportive of the current ratings because of the high level of cost recovery certainty and downside protection under normal operating conditions, which mitigate negative effects from lower deemed return on equity (ROE) and equity thickness ratios approved in the Generic Cost of Capital (GCOC) decision in March 2015 and the Utility Asset Disposition. With its robust cost recovery mechanism and operating efficiency, CUI has sustained profitability well above its regulatory return parameter and consistently recorded above-average profitability relative to its Alberta peers over the past five years. DBRS acknowledges that recent regulatory decisions on stranded assets were encouraging, as the decisions provided CUI with a reasonable opportunity to recover prudently incurred costs. In March 2016, the Alberta Utilities Commission (AUC) approved the recovery of certain costs and lost revenue associated with the 2013 flood experienced in Southern Alberta, and in April 2016, the AUC approved full recovery for a large scale retirement of assets resulting from ATCO Pipeline’s urban pipeline replacement program. In both cases, the AUC determined that no extraordinary retirement occurred, as these events were anticipated in CUI’s depreciation practice. A significant upcoming regulatory decision is the GCOC for 2016 and 2017, which is anticipated by the end of 2016. DBRS notes that, excluding Crown corporations, the current approved ROE is the lowest among North American utilities, and equity thickness is one of the lowest compared with the North American peers. DBRS believes that any further weakness in the approved ROE or leverage ratio will put negative pressure on the credit quality of CUI.

With the downshifting of Alberta’s economy and the December 2015 completion of CUI’s largest project in its history, the $1.8 billion Eastern Alberta Transmission Line, capex is expected to further normalize, while earnings and cash flow will benefit from a higher rate base. As a result, DBRS expects free cash flow to become neutral in 2016, and for the cash flow-to-debt ratio to gradually recover to around historical levels (15%), which are more consistent with the current rating category. The ratings assume excess cash, which is not required to maintain the regulatory capital structure, will flow up to its parent company, Canadian Utilities Limited (rated “A” by DBRS).

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