DBRS Confirms CU Inc. at A (high)/R-1 (low)/Pfd-2 (high), Stable Trends

DBRS Limited (DBRS) confirmed the Issuer Rating and Unsecured Debentures & Medium-Term Notes rating of CU Inc. (CUI or the Company) at A (high), the Commercial Paper (CP) 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 stable business risk profile and solid financial performance for the last 12 months ended March 31, 2018 (LTM 2018). The confirmations factor in DBRS’s expectation that the second-generation Performance Based Regulation (PBR) plan and the regulatory decision on the 2018–2020 Generic Cost of Capital (GCOC) proceeding, expected by the end of 2018, will not have any material impact on the Company’s business risk profile and its credit metrics.

In February 2018, the Alberta Utilities Commission (AUC) issued a decision that provides determination for the going-in rates and incremental capital funding for second-generation PBR (from 2018 through 2022). Based on its review of key aspects of the second-generation PBR, DBRS expects CUI’s current business risk profile to remain relatively stable through 2022. Under second-generation PBR, which is applicable only to the regulated distribution business, revenues will continue to be based on a formula, with the going-in rates to be adjusted for inflation (X) minus productivity (I). Compared with first-generation PBR, DBRS notes that under second-generation PBR, the adjustment for (1) inflation is the same; (2) productivity is much lower (0.30% versus 1.16%, which is positive to CUI); (3) the operating and maintenance (O&M) expense level, based the lowest actual annual O&M during 2013–2016, is unfavourable to CUI, but the impact on key credit metrics should not be material; (4) capital cost recovery should be less uncertain and subject to a shorter regulatory lag since the costs will be recovered through going-in rates (same as first-generation PBR) and a K-bar, which is different from Capital Tracker in first-generation PBR as it is more transparent since it is calculated annually and adjusted for the actual weighted average cost of capital; and (5) there is a mechanism to recover capital expenditures (capex) that are extraordinary, not previously incurred and required by a third-party.

CUI’s credit metrics remained solid and stable in 2017 but were slightly weaker in the first quarter of 2018 as the result of lower going-in rates under second-generation PBR. As the rate base grows, DBRS expects that incremental earnings and cash flows will partially offset the negative impact of the lower going-in rates. Given the current business risk profile, DBRS expects the Company’s credit metrics to continue to support the current ratings through the term of the second-generation PBR. Further, DBRS does not expect the regulatory decision on the GCOC proceeding to have a material impact on CUI’s credit metrics, given that the allowed return on equity (ROE) and equity thickness are already relatively low at 8.50% and 37%, respectively.

DBRS estimates that capex, including maintenance capex, will be approximately in the $1.0 billion range over the next few years, significantly lower than during the 2012–2014 Big Build period. Capex is expected to be financed with internally-generated cash flow as well as new debt issuances with minimal or no equity required from the parent. 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. Based on the current regulatory environment in Alberta, CUI’s ratings are not expected to move up in the medium term. If the following factors occur, however, CUI’s ratings could face negative pressure from (1) an adverse change in regulation that significantly weakens CUI’s business risk profile and/or (2) a material weakening of key credit metrics 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.

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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