DBRS Morningstar Confirms Ratings of Canadian Utilities Limited at “A,” R-1 (low), and Pfd-2 with Stable Trends

DBRS Limited (DBRS Morningstar) confirmed both the Issuer Rating and the Unsecured Debentures rating of Canadian Utilities Limited (CU or the Holdco) at “A” as well its Commercial Paper rating at R-1 (low) and Cumulative Preferred Shares rating at Pfd-2 (high). All trends are Stable. The rating of the Cumulative Preferred Shares is a notch higher than the standard mapping with the Issuer Rating, which reflects very low debt and strong liquidity at the Holdco level.

The confirmations reflect (1) the Holdco’s solid consolidated and nonconsolidated financial profile, strong liquidity, and low Holdco leverage; (2) the strong and stable credit profile at its sizable and diversified regulated subsidiaries, particularly at CU Inc. (CUI; rated A (high) with a Stable trend by DBRS Morningstar); and (3) a substantial reduction in its higher-risk nonregulated generation business through the sale of its fossil fuel generation assets in Alberta in Q3 2019 and its 80% interest in Alberta Power Line (APL) in Q4 2019. The Holdco’s ratings incorporate the subordination of its debt to the debt issued by CUI as well as its regulated natural gas distribution operations in Australia.

CU’s ratings are largely based on CUI ratings, taking into account structural subordination and low leverage at the Holdco level. CUI is 100% owned by the Holdco. CUI accounted for approximately 92% of CU’s segment adjusted earnings in H1 2020. CUI is one of the largest and most diversified regulated utilities in Canada, with a rate base of approximately $12.8 billion as at mid-year 2019. On July 20, 2020, DBRS Morningstar confirmed the A (high) rating of CUI. Please see DBRS Morningstar’s report on CUI dated July 22, 2020.

CU’s other operations are not material to its overall cash flow. They largely include (1) regulated natural gas distribution in Australia (5% earnings in H1 2020) and (2) non-regulated generations in Alberta, Australia, and Mexico (3% of earnings in H1 2020). In addition, CU owns a 50% interest in LUMA Energy, LLC (LUMA Energy), which, in June 2020, was selected by the Puerto Rico P3A to transform, modernize, and operate Puerto Rico’s electricity transmission and distribution system over a term of 15 years. DBRS Morningstar considers LUMA Energy as a quasi-regulated operation and is of the view that this is a credit positive for CU as the LUMA Energy operation will provide CU with stable cash flow without additional debt at the Holdco or subsidiary levels .

CU’s nonregulated business was significantly reduced following the sale of its Canadian fossil fuel generation assets for $821 million and its 80% interest in the APL project for approximately $222 million plus the assumption of approximately $1.4 billion of APL debt.

CU’s consolidated financial risk profile remained strong and relatively stable in H1 2020 despite the ongoing Coronavirus Disease (COVID-19) pandemic. The impact of the pandemic on CU’s regulated operations has been modest as CU continues to provide an essential service and operate critical infrastructure. A substantial portion of CU’s operations, such as electricity transmission, natural gas distribution, and natural gas transmission, are exposed to very limited volume risk. Although the Canadian electricity distribution operation does face volume risk, the decline in industrial consumption is partially offset by an increase in residential consumption. Further, CU’s current rate structure uses a variety of mechanisms (rate minimum, contract minimum, fixed cost recovery) to limit its exposure to demand reductions from industrial and commercial customers. The natural gas distribution operation in Australia is subject to volume risk but this is significantly mitigated by the new five-year Access Arrangement effective January 2020, which includes rebasing of revenues for recovery of operating costs, approved capex, and forecast demand for volume. As a result, DBRS Morningstar expects CU’s consolidated financial profile to remain stable over the near to medium term.

CU’s consolidated liquidity was strong, with approximately $940 million in cash and equivalents on the balance sheet and over $2.2 billion in available credit facilities as at June 30, 2020. In addition, the $200 million in long-term bonds at the Holdco level is not due until 2022. CU’s nonconsolidated financial profile remained strong in 2019 and is expected to stay strong in 2020, supported by low nonconsolidated leverage (under 10% adjusted for the debt portion of preferred shares) and a strong cash flow-to-nonconsolidated debt ratio (approximately 260% in 2019). DBRS Morningstar expects CU’s cash flow-to-nonconsolidated debt to stay in the 100% to 200% range on a long-term basis.

DBRS Morningstar does not expect to take positive rating action on CU’s ratings because these are largely constrained by CUI’s ratings. However, the following factors, should they occur, could place pressure on CU’s ratings: (1) a material increase in consolidated and nonconsolidated leverage, (2) a substantial increase in nonregulated operations (which DBRS Morningstar deems unlikely, given the current business strategy), or (3) adverse changes in regulation in Alberta that negatively affect CUI’s ratings.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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 (September 16, 2019); DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 25, 2019); DBRS Morningstar Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (November 1, 2019); and DBRS Morningstar Criteria: Commercial Paper Liquidity Support for Nonbank Issuers (March 10, 2020), which can be found dbrsmorningstar.com under Methodologies & Criteria.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

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 [email protected].

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

DBRS Morningstar will publish a full report shortly that will provide addi¬tional analytical detail on this rating action. If you are interested in receiving this report, contact us at [email protected].

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

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