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 strong performance and improved financial profile in 2016 and Q1 2017, along with the significantly reduced capital project risk following the end of the high-capital expenditures (capex) period. The Stable trends reflect DBRS’s expectation that the Company’s key credit metrics will likely remain stable over the medium term based on the Alberta Utility Commission’s (AUC) October 2016 General Cost of Capital decision on CUI’s allowed return on equity (ROE) and common equity in the capital structure for 2016 and 2017 as well as the lower level of capital investments going forward.

CUI’s financial performance improved in 2016 over the previous year and remained strong for Q1 2017. This improvement was largely a result of the continuing growth in the rate base for all business units in 2016 as well as operating efficiencies in distribution operations under the Performance-Based Regulation (PBR). Combined with only a modest increase in debt, this resulted in improved credit metrics for CUI. The cash flow-to-debt ratio moved to the middle of the “A”-rating range for the first time since 2013 while the debt-to-capital ratio remained stable and the EBIT-interest coverage grew stronger. Over the medium term, DBRS does not expect the Company’s ratios to change materially, reflecting (1) a capex program that is significantly lower than during the big-build period (2012 to 2015) and (2) CUI’s allowed ROE for 2017 increasing to 8.50% compared with 8.30% in 2016 while common equity in the capital structure remains unchanged at 37%. DBRS notes, however, that the allowed ROE for Alberta utilities remains one of the lowest across all Canadian jurisdictions.

CUI’s business risk profile improved as risks associated with large capital projects have been reduced following the completion of the big build in electric transmission in Alberta. DBRS notes that, while major capital projects will continue for the Company’s gas distribution and transmission businesses, capex over the medium term is expected to be significantly lower than in previous years (estimated to be between $1.1 billion and $1.2 billion (before customer contributions) for each of the next two years). DBRS notes that capex going forward will likely be financed with internal cash flow after dividends as well as new debt issuances. DBRS expects CUI to maintain its dividend policy in a manner such that there is sufficient cash flow to finance capex without a material increase of debt in the capital structure.

The regulatory model in Alberta has remained stable in 2017, the last year of the first-generation PBR model. Under the second-generation PBR plan (2018–2022), annual distribution rates will continue to be adjusted by a formula that estimates inflation annually and assumes productivity improvements. There will be modified provisions for supplemental funding of capex that is not covered by the formula. Applications to determine going-in rates were filed in April 2017, with an AUC decision expected in the second half of 2018. The second-generation PBR will only apply to CUI’s distribution businesses as the transmission businesses will remain under cost-of-service regulation. DBRS does not expect changes in the second-generation PBR to have a significant impact on the Company’s earnings since, under the Alberta Electric Utilities Act, the regulator must provide a regulated utility reasonable opportunity to earn a fair return on its investment.

Based on the current regulatory environment in Alberta and the Company’s business and financing strategies, CUI’s ratings are not expected to move up in the medium term. Although unlikely, if the following factors occur, however, the Company’s current ratings could face negative pressure: (1) a material change in regulation that is significantly negative on the Company’s cash flow and (2) two of the three key credit metrics fall below the “A”-rating range for a sustained period of time.

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, 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 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.