DBRS Comments on TransAlta Corporation’s Agreement to Receive a $750 Million Investment from Brookfield Renewable Partners, L.P. and its Institutional Partners

DBRS Limited (DBRS) notes that TransAlta Corporation (TAC; rated BBB (low), Stable, by DBRS) announced today that TAC and Brookfield Renewable Partners, L.P. (rated BBB (high), Stable, by DBRS) and its institutional partners (collectively, Brookfield) have entered into an agreement whereby Brookfield will invest $750 million in TAC through the purchase of exchangeable securities as described below (the Investment). Brookfield has also committed to increasing its ownership in TAC to 9% through the open market. The Investment agreement is expected to close three business days after TAC’s 2019 Annual and Special Meeting of Shareholders, scheduled for April 26, 2019.

The Investment will occur in two tranches: The first tranche will be $350 million at closing, expected in May 2019, in the form of subordinated exchangeable debentures; the second tranche will be $400 million at the second closing in October 2020 in the form of redeemable preferred shares (together, Exchangeable Securities). The Exchangeable Securities will have an annual coupon rate of 7.0%. Beginning January 1, 2025, Brookfield has the right to convert the Exchangeable Securities into an equity ownership interest in an entity to be formed that will hold TAC’s Alberta Hydro Assets (the Hydro Assets) as follows: The value of Hydro Assets will be based on 13 times the average annual EBITDA of the three most recent fiscal years prior to conversion generated by the Hydro Assets less annually sustained capital expenditures (capex) of approximately $10 million. Brookfield can own a maximum of 49% equity interest in the entity that holds the Hydro Assets, and TAC will remain a controlling owner. If Brookfield’s ownership interest is less than 49% at conversion, Brookfield has one-time option payable in cash to increase its interest in the Hydro Assets to 49%, exercisable up until December 31, 2028, and provided that Brookfield holds at least 8.5% of TAC’s common shares and that the 20-day volume-weighted average price of TAC’s common shares is at least $17 per share. Under the Investment agreement, TAC has the right to redeem for cash all or any portion of the Exchangeable Securities for the original subscription price plus any accrued but unpaid interest or dividends payable, subject to certain conditions (please see TAC’s press release dated March 25, 2019, for details).

With respect to the use of the proceeds from the Investment, TAC intends to direct $350 million for its coal-to-gas conversion strategy and renewable generation developments. TAC also intends to repurchase up to $250 million of common shares over the next three years. The remainder will be for general corporate purposes. This Investment, combined with free cash flow from generations, allows TAC to advance its coal-to-gas conversion plan and to meet its target of repaying the $400 million medium-term notes due in November 2020. DBRS notes that TAC remains committed to reducing its corporate debt to $1.2 billion by the end of 2020. The corporate debt was approximately $1.9 billion at the end of 2018.

DBRS does not expect the Investment to have any material impact on TAC’s business risk profile. However, DBRS notes that the Investment will provide TAC with the opportunity to benefit from Brookfield’s hydro asset management expertise and its financial strength. With the Investment, DBRS believe that TAC will have sufficient liquidity to advance its coal-to-gas conversion of the units at its Sundance and Keephills generating stations faster than originally planned.

DBRS views that the potential impact of the use of the proceeds from the Investment on TAC’s credit metrics is modestly negative, reflecting the following:

-- The return to shareholders of up to $250 million in capital over a period of three years will have a negative impact on TAC’s consolidated and non-consolidated capital structure. DBRS believes that this impact will be modest.
-- The issuance of Exchangeable Securities will increase the portion of the non-senior debt treatment of the preferred shares by DBRS and will have a slightly negative impact on the cash flow-to-adjusted debt and EBITDA-to-interest debt coverage.
-- However, DBRS notes that the Exchangeable Securities will rank inferior to TAC’s senior debt and that TAC remains committed to reducing the corporate debt to $1.2 billion in 2020 (from $1.9 billion at the end of 2018 and approximately $2.6 billion at the end of 2017).

DBRS notes that TAC’s 2018 consolidated and non-consolidated financial ratios improved notably from 2017 levels, reflecting a significant reduction of debt and relatively stable cash flow. Although the Investment will raise the debt and equivalents modestly, the pro forma level of corporate debt and equivalents would still remain below the 2017 level. As a result, DBRS does not expect the Investment and the use of proceeds as currently proposed by TAC to have a material impact on TAC’s credit profile.

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

The principal methodologies are Rating Companies in the Independent Power Producer Industry and DBRS Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers, which can be found on dbrs.com under Methodologies & Criteria.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada