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 rating confirmations reflect Union’s relatively low-risk gas distribution business, which operates under a reasonable regulatory framework in an economically stable service territory with a large growing customer base.

DBRS rates Union on a stand-alone basis and does not assume any credit support from its ultimate parent, Spectra Energy Capital, LLC (Spectra, rated BBB, Stable). DBRS has determined that the merger between Enbridge Inc. (rated BBB (high), Under Review with Developing Implications) and Spectra, which was announced in September 2016, does not have an impact on the stand-alone credit quality of Union. (Please refer to the DBRS press release “DBRS Confirms Spectra Energy Capital, LLC and Rated Subsidiaries, Removes UR-Dev. Status,” dated September 8, 2016.)

DBRS’s assessment of Union’s business risk considers the reasonable cost-of-service-based regulatory framework in Ontario, which provides a majority of the Company’s earnings. Union operates under a five-year incentive regulation framework (IR; 2014 to 2018), which allows a return on equity (ROE) of 8.93% and provides predictable cash flows. Natural gas supply costs are passed through to customers, mitigating commodity price risk, with annual rate escalation indexed at 40% of inflation. Major capital expenditures are pre-approved by the Ontario Energy Board for inclusion in rates as projects are completed and placed in service. DBRS notes that, 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 (approximately 13% of EBIT in 2015) 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 credit metrics have been pressured over the past few years because of high capex spending. DBRS expects Union’s capital spending program primarily on transmission expansions to be relatively high for the full year 2016 (approximately $1.0 billion in 2016 compared with approximately $750 million in 2015). As major projects (2016 Dawn-Parkway and the Burlington to Oakville) were placed in service in Q4 2016, capex for 2017 is expected to be slightly lower. DBRS expects the incremental full-year cash flow from projects placed in service and lower capex needs to result in a gradual improvement in credit metrics in 2017. In the medium term, the ratings could come under pressure should the Company fail to maintain its debt-to-capital ratio in line with the regulatory capital structure of 64% debt and 36% equity or should cash flow-to-debt remain below the 15% level on a sustained basis.

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

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.