DBRS Confirms TransAlta Corporation at BBB (low) and Pfd-3 (low) with Stable Trends

DBRS Limited (DBRS) confirmed the Issuer Rating and Unsecured Debt/Medium-Term Notes rating of TransAlta Corporation (TAC or the Company) at BBB (low) and TAC’s Preferred Shares rating at Pfd-3 (low). The trends are Stable. DBRS’s rating actions follow a review of TAC’s 2017 financial results, as well as its business strategy and refinancing plan for corporate debt over the medium term. DBRS is of the view that TAC’s current business risk and financial metrics (consolidated and modified consolidated) remain supportive of the current ratings.

TAC’s business risk profile will be negatively affected by the early termination of the Sundance B and Sundance C Alberta power purchase agreements (PPAs), effective March 31, 2018, more than two years earlier than the expiry date at the end of 2020. This termination, previously expected by DBRS, will significantly reduce a portion of Alberta PPAs (approximately 700 megawatts (MW) for the Sundance B PPA and 710 MW for the Sundance C PPA). However, the termination is partially mitigated by the achievement of the commercial operation of the 150 MW, 25-year contracted South Hedland Power project (South Hedland) in July 2017. DBRS notes that approximately 25% of the South Hedland PPA was terminated by Fortescue Metals Group Limited (FMG) because of the dispute regarding whether the South Hedland Power Station has met all the conditions for achieving commercial operations under the PPA. Following the termination of Sundance B and C, DBRS expects the long-term contractual arrangements to reduce to approximately 66% of total operational capacity from approximately 75%. Despite the reduction, DBRS views that this remaining contracted capacity is reasonable to support cash flow stability. TAC will receive the termination payment from Balancing Pool (BP) for approximately $157 million, which is expected to be used to reduce the Company’s corporate debt.

DBRS recognizes that TAC’s 2017 financial results were solid and its current consolidated and modified consolidated metrics are supportive of the current ratings. DBRS does not expect any further material shift in TAC’s 2018 financial metrics, which will benefit from the lower dividends, and lower sustained capital expenditure levels. With the power market in Alberta improving due to tighter demand/supply balance, DBRS expects cash flow in 2018 to improve modestly from 2017. DBRS notes that in March 2018, TAC reduced USD 500 million in corporate debt with its cash on hand, free cash flow and payments from BP, as well as from the credit facilities. Corporate debt is expected to be reduced further with funds from monetization of the Off-Coal Agreement (OCA) and asset drop-downs to TransAlta Renewables Inc. (RNW; 64% owned by TAC). However, due to its exposure to the merchant generation, a significant drop of power prices in Alberta and the Northwest Pacific could pressure TAC’s credit metrics since a large portion of capacity is on a merchant basis in these two markets. Should the Company’s credit metrics weaken materially from the current level and/or experience a significant increase in structural subordination without improving the modified consolidated credit metrics, a negative rating action could be taken.

The rating confirmations factor DBRS’s following expectations: (1) the post-2020 Alberta capacity market auction would not materially weaken the Company’s currently business risk profile beyond the level anticipated by DBRS in its previous April 2017 report and (2) TAC’s hydro and wind assets are expected to benefit from capacity payments and green credits post 2020. DBRS notes that TAC plans to convert Sundance Units 3 to 6 and Keephills 1 and 2 to gas-fired generation by 2022 (a year earlier than previously planned) at an expected cost of approximately $300 million. DBRS expects TAC to manage the conversion costs prudently. Significant cost overruns and/or lengthy delays would have a negative impact on cash flow and earnings and could result in a negative rating action.

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

The principal methodologies are Rating Companies in the Independent Power Producer Industry (May 2017), DBRS Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (December 2017) and DBRS Criteria: Rating Corporate Holding Companies and Their Subsidiaries (December 2017), which can be found on www.dbrs.com under Methodologies.

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.