DBRS Assigns Provisional Issuer Rating of BBB (high) with a Stable Trend to AltaGas Canada Inc.

DBRS Limited (DBRS) assigned a provisional Issuer Rating of BBB (high) with a Stable trend to AltaGas Canada Inc. (ACI or the Company). The rating is supported by ACI’s stable business risk profile underpinned by its ownership of regulated natural-gas distribution utilities, diversified asset base and support from unlevered cash flow generated at its long-term contracted renewable power assets. Key challenges include the relatively small size and operational risks at the Company’s regulated utilities and the impact of weather on natural-gas consumption and electricity generation.

ACI is currently a wholly owned subsidiary of AltaGas Ltd. (AltaGas; rated BBB, Under Review with Developing Implications, by DBRS) and owns 100% of Pacific Northern Gas Ltd. (PNG), a rate-regulated natural-gas distribution utility in British Columbia. The Company has filed an initial public offering (IPO) and intends to use proceeds of the IPO along with external and intercompany debt to purchase the following assets from AltaGas: (1) 100% of AltaGas Utilities Inc. (AUI), a rate-regulated natural-gas distribution utility in Alberta; (2) 100% of Heritage Gas Ltd. (Heritage Gas), a rate-regulated natural gas distribution utility in Nova Scotia; (3) 100% of Bear Mountain Wind Limited Partnership, a 102-megawatt (MW) wind facility in British Columbia; and (4) a 10% equity stake in Northwest Hydro Limited Partnership, which owns three run-of-river hydroelectric generation facilities in British Columbia with a total generating capacity of 277 MW.

At the IPO’s close, the Company’s asset base will consist of regulated utilities across three different regulatory jurisdictions, which provides some protection against regional economic variability. Regulated utilities accounted for approximately 82% of ACI’s pro-forma 2017 EBITDA and are expected to contribute a higher proportion going forward as regulated utilities account for all projected organic growth over the next five years. Two of the three regulated utilities owned by ACI (PNG and Heritage Gas) operate under a cost-of-service framework while AUI operates under a performance-based regulation (PBR) framework. The regulated utilities all operate in reasonably supportive jurisdictions, allowing them to earn a reasonable return on equity (ROE) and allowing AUI the opportunity to earn a ROE that exceeds regulatory ROE. ACI’s portfolio of renewable power assets are also covered under long-term contracts with British Columbia Hydro and Power Authority (rated AA (high) with a Stable trend by DBRS). The contracts are fixed price and indexed to inflation, mitigating the impact of commodity-price risk, although they retain some generation-volume risk. The renewable power assets are also relatively new and require minimal maintenance capex.

Both Heritage Gas and PNG are small regulated utilities in Canada with approximately 6,900 and 42,000 customers, respectively, at YE2017. AUI, which has approximately 80,000 customers, is relatively small compared with its peers in Alberta. Delivery-charge rates at PNG and Heritage Gas are already high and their small size limits their ability to pass on unexpected increases in operating costs to its customers through rates. Each of ACI’s regulated utilities faces unique operational risks, such as: (1) ROE and deemed common equity at AUI, which are among the lowest in North America. AUI also operates under a five-year PBR framework, which makes operational efficiency a crucial factor in determining earnings; (2) Heritage Gas’s status as a relatively new utility and, given the higher cost of procuring natural gas, competition from other forms of energy; and (3) continued weak economic conditions in PNG’s service area with low natural-gas prices, which affect industrial demand. AUI and Heritage Gas do not have weather normalization mechanisms and seasonality can affect the operating results of both entities. Furthermore, the Company’s contracted power assets also have generation-volume risk. If wind or water flows are lower than expected or if extreme cold conditions increase downtime of the wind turbines, generation volume could be negatively affected.

ACI’s rating benefits from its strong financial risk profile and DBRS expects the key credit metrics to remain supportive of the current rating. In addition to the relatively stable cash flows generated at its regulated utilities, the Company’s financial metrics also receive meaningful support from unlevered cash flows from the contracted renewable power-generating assets. ACI is expected to have approximately $635 million in debt (combination of external debt and intercompany debt from AltaGas) at the IPO’s close. ACI intends to be the primary debt issuer with no material external debt at the operating companies. ACI is expected to lend inter-company debt to the utilities to maintain their regulatory capital structure. DBRS believes the impact of structural subordination at ACI is mitigated due to the absence of material external debt at the operating companies, presence of regulator approved capital structure at the utilities and benefits of diversification from its ownership of multiple assets. ACI’s liquidity profile is also expected to be adequate with the proposed revolving credit facility of $200 million. While a rating change is unlikely over the medium term, given the support for the rating provided by the Company’s financial risk profile, a material negative change in the financial risk profile or adverse change in the regulatory environment could result in a negative rating action.

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 and DBRS Criteria: Rating Corporate Holding Companies and Their Subsidiaries, 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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