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

DBRS Limited (DBRS) has today confirmed the Issuer Rating and the Unsecured Debt rating of Ontario Power Generation Inc. (OPG or the Company) at A (low) as well as its Commercial Paper rating at R-1 (low). All trends are Stable. OPG’s ratings continue to be supported by (1) the reasonable regulatory regime in place for the Company’s generation facilities, (2) continuing financial support from its shareholder, the Province of Ontario (rated AA (low), Stable, by DBRS) and (3) strong cash flow-to-debt and debt-to-capital ratios.

In May 2016, OPG filed its application with the Ontario Energy Board (OEB) for rates effective January 1, 2017. As the OEB had indicated, the Company applied to transition to five-year incentive rate-setting (IR) regimes, proposing Price Cap IR for its hydroelectric facilities and Custom IR for its nuclear facilities. Under Price Cap IR, payment amounts will increase annually under a formula based on inflation less productivity and a utility-specific stretch factor. Under Custom IR, payment amounts will be determined by a five-year forecast cost-of-service approach, but with IR features. As noted, DBRS believes that, following the transition to IR frameworks, the Company’s profitability may continue to be challenged as the introduction of productivity and efficiency targets could further depress earnings. This is partly mitigated by OPG having demonstrated its ability to contain costs through its cost-reduction and efficiency improvement initiative ($1.0 billion in cumulative cost savings since 2011). Additionally, under both Price Cap IR and Custom IR, the Company could initiate a regulatory review of its application if actual return on equity (ROE) falls 300 basis points below the approved ROE, providing some downside protection. OPG has also requested a mid-term review of its nuclear production forecast which, if approved, could reduce some of the forecasting risk associated with the longer IR term.

Profitability for OPG remained challenged in 2016 as the Company earned a corporate ROE of 4.2%, significantly below the allowed regulatory ROE of 9.19%. DBRS notes that this can be partly attributed to OPG’s capitalization at around 35% debt versus the regulatory capital structure of 55% debt. While earnings increased in 2016, net income before non-recurring items remained negative, resulting in a negative EBIT-interest coverage ratio of -0.17 times for the year. While the Company’s financial risk profile remains supported by its strong cash flow-to-debt and debt-to-capital ratios (36.4% and 34.4%, respectively, for 2016), OPG will continue to experience higher-than-normal capital expenditures (capex; $1.7 billion in 2016 and $1.8 billion planned for 2017) as it executes on the Darlington Refurbishment project (final budget of $12.8 billion). DBRS expects the Company’s debt ratios to weaken during this period of high capex with leverage increasing to approximately 40%. This is partly mitigated by the continued financial support provided by the Province through its agent, the Ontario Electricity Financial Corporation (OEFC; rated AA (low), Stable, by DBRS), which provides most of OPG’s financing (approximately 60% of total debt). The Company’s remaining debt is in the form of non-recourse project finance debt. Additionally, DBRS notes that under the Province’s Fair Hydro Plan, OPG will be working with the IESO to manage the financing for the Global Adjustment costs to be deferred. DBRS will continue to monitor as more information becomes available.

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: Guarantees and Other Forms of Support (February 2017) and DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers (March 2017), which can be found on dbrs.com under Methodologies.

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