DBRS Confirms Ratings of Union Gas Limited, Stable Trends

DBRS Limited (DBRS) 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 largely reflect Union’s relatively low-risk gas distribution business, which operates under a supportive regulatory framework in an economically stable service territory with a large and growing customer base.

DBRS rates Union on a stand-alone basis and does not assume any credit support from its ultimate parent, Enbridge Inc. (Enbridge; rated BBB (high), Stable by DBRS). On November 2, 2017, Union and Enbridge Gas Distribution Inc. (EGD; rated “A,” Stable by DBRS) filed a Mergers, Acquisitions, Amalgamation and Divestitures application with the Ontario Energy Board (OEB) to amalgamate. Enbridge expects the regulatory review to take the better part of 2018. Enbridge will seek approval from its Board of Directors to proceed with the amalgamation based on an assessment of the final regulatory approvals from the OEB, which is anticipated to take place in Q3 2018. Should the amalgamation not proceed, Union will file a new five-year incentive regulation (IR) framework application for 2019, and beyond. DBRS will continue to monitor the progress of the application as more information becomes available.

DBRS’s assessment of the Company’s business risk considers the supportive cost-of-service-based regulatory framework in Ontario, which provides a vast majority of Union’s earnings. The Company has operated under an IR framework from 2014 to 2018, which allowed for a return on equity of 8.93% and provided 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 (capex) are pre-approved by the OEB 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 Union’s earnings, earnings generated from its unregulated storage business (approximately 12% of EBITDA in 2017) 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, primarily on transmission expansions. DBRS expects Union’s capital spending program to be relatively high at approximately $1.0 billion in 2017 ($751 million spent for the nine months ended September 30, 2017). As major projects (including the 2017 Dawn-Parkway Expansion and the Panhandle Reinforcement Project) were placed in service in the second half of 2017, capex for 2018 is expected to be lower. DBRS expects the incremental full-year cash flow from projects placed in service and the lower capex needs to result in a gradual improvement in credit metrics in 2018. 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 “A” rating range on a sustained basis.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The principal methodologies are Rating Companies in the Regulated Electric, Natural Gas and Water Utilities Industry (September 2017); DBRS Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (December 2017); and DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers (March 2017), which can be found on dbrs.com under Methodologies.

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 under Related Documents or by contacting us at info@dbrs.com.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

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