DBRS Confirms Ratings of Hydro One Inc., Stable Trends

DBRS Limited (DBRS) confirmed the Issuer Rating and the Senior Unsecured Debentures rating of Hydro One Inc. (HOI or the Company) at A (high) and the Commercial Paper rating at R-1 (low). All trends are Stable. The rating confirmations reflect the Company’s relatively low risk business profile supported by a transparent regulatory framework, a strong franchise of electricity power transmission and distribution services and a reasonable financial profile sustained by predictable earnings and cash flow. The Stable trends assume that the regulatory regime will continue to remain supportive, allowing the Company to earn a fair rate of return while recovering costs on a timely basis. DBRS rates HOI as a stand-alone entity and does not assume any credit support from its owner, Hydro One Limited (HOL; not rated by DBRS), which is approximately 47% owned by the Province of Ontario (the Province; rated AA (low) with a Stable trend by DBRS). The Company’s transmission business (approximately 61% of 2017 EBIT) owns and operates approximately 98% of the transmission network in the Province while the distribution business (approximately 39% of 2017 EBIT) serves nearly 25% of the Province’s customers.

In July 2017, HOL announced that it will acquire Avista Corporation (Avista), a regulated electric and gas utilities holding company operating in the U.S. Pacific Northwest, for an all-cash purchase price of approximately USD 5.3 billion ($6.7 billion), including the assumption of approximately USD 1.9 billion ($2.7 billion) of debt. Avista is expected to continue operating as a stand-alone utility following the closing of the transaction in the second half of 2018. DBRS believes that should the acquisition be financed as contemplated in the announcement, it will have no impact on HOI’s credit profile as no debt is proposed to be issued at HOI. Please refer to DBRS’s press release, “DBRS Comments on Hydro One Limited Acquiring Avista Corporation” dated July 20, 2017, for more details.

HOI’s transmission and distribution businesses currently operate under cost-of-service regulation. HOI’s transmission business is expected to file a four-year rate application under a Custom Incentive Rate-Setting (CIR) approach for 2019-2022 in Q2 2018. In March 2017, Hydro One Networks Inc. filed an application for 2018-2022 distribution rates under CIR and a decision is expected in Q2 2018. DBRS does not expect HOI’s transition to a CIR model to have a material impact on the Company’s credit profile as it provides greater clarity with respect to HOI’s ability to recover high and variable capital expenditure (capex) requirements. Additionally, HOI is appealing a October 2017 Ontario Energy Board decision that the tax savings from the net deferred tax asset recorded by the Company’s transition from the payments in lieu of tax regime under the Electricity Act (Ontario) to the federal and provincial tax regime in 2016, should not accrue entirely to HOI's shareholders and that a portion should be shared with ratepayers. HOI has estimated that should the decision be upheld, there could be a one-time decrease in net income of approximately $885 million and an annual reduction in operating cash flow by around $50 million to $60 million. A decision is expected by Q2 2018, and DBRS will review the outcome of the appeal to assess its impact on the credit profile of the Company.

DBRS notes that HOI’s credit metrics continue to be pressured because of the incremental debt used to fund free cash flow deficits resulting from high capex and dividends. HOI’s capex program is expected to total approximately $10.0 billion for the 2018-2022 term (transmission: $6.4 billion; distribution: $3.6 billion) largely to refurbish and replace aging infrastructure. However, as projects are placed in service and added to the Company’s rate base, incremental cash flows should help ease the pressure on metrics. HOI’s dividend payout ratio is expected to remain high in order to meet HOL’s dividend objectives to pay out approximately 70% to 80% of its consolidated net income. HOI’s ratings could be impacted should its cash flow-to-debt ratio weaken below 13% and its DBRS adjusted debt-to-capital ratio exceed 60% on a sustained basis. HOI expects any potential acquisitions of unregulated businesses to be carried out at the HOL level. DBRS believes that acquisitions by HOI of regulated utility assets in less supportive regulatory regimes or acquisitions of regulated assets with some exposure to unregulated operations could weaken the business profile of the Company and have an impact on the current ratings.

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 Methodology (September 2017) and DBRS Criteria: Commercial Paper Liquidity Support for Non-Bank Issuers (April 2018), 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.

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.

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