DBRS Morningstar Confirms TransAlta Corporation at BBB (low) and Pfd-3 (low) with Stable Trends

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and Unsecured Debt/Medium-Term Notes rating of TransAlta Corporation (TAC or the Company) at BBB (low) and TAC’s Preferred Shares rating at Pfd-3 (low). The trends are Stable.

DBRS Morningstar’s rating confirmations reflect the following factors: (1) more than 90% of consolidated free EBITDA (after maintenance capital expenditures) is generated either from long-term contracts with weighted-average life of more than nine years or from strong cash flows from hydro generation plants in the Province of Alberta (Alberta or the Province; rated AA (low) with a Negative trend by DBRS Morningstar); (2) TAC's coal-to-gas conversion plan is on schedule and within budget, as Sundance Unit 6 is already converted and Keephills Units 2 and 3 and Sheerness Unit 1 are expected to be completed in 2021; and (3) the Coronavirus Disease (COVID-19) had a modest impact on the operational and financial performances in 2020 and to date in 2021. TAC’s 2020 financial profile remained solid with relatively stable modified credit metrics compared with 2019, strong liquidity, and low corporate debt. The Company’s rating also incorporates structural subordination of its debt to the nonrecourse debt at its 100%-owned projects and debt at TransAlta Renewables Inc. (60% owned by TAC). However, the structural subordination issue is significantly mitigated by cash flow from no or minimal debt assets, which account for approximately 70% of TAC’s modified cash flow.

Following the expiry of the contracts for hydro assets in Alberta at the end of 2020, TAC’s hydro plants, accounting for approximately 90% of the Province’s hydro assets, benefit from a strong power market and low operating costs. In addition, hydro assets also benefit from being used for system stability and reliability, which is important as Alberta’s system is experiencing an increase in wind power generation. Furthermore, hydro generation always gets dispatched because of the zero marginal cost, and can consistently generate positive cash flow even in the low power price environment. TAC expects to generate between $170 million and $250 million EBITDA (or $200 million per year on average, which would account for approximately 20% of free EBITDA in 2021) from its hydro assets per year. Even at the low end of this expected range, EBITDA would be significantly higher than the amount generated under contracts prior to 2021 because the contract price was significantly lower.

The Stable trends reflect DBRS Morningstar's view that (1) the exposure to merchant risk in Alberta for 2021 is well hedged, (2) the coronavirus pandemic would not have material impact on the financial and operational performance in 2021, and (3) TAC’s business risk and 2021 credit metrics (modified consolidated) are expected to remain supportive of the current ratings.

TAC’s main challenge remains in the merchant exposure in Alberta, as all Alberta power purchase agreements, accounting for approximately 25% of 2020 EBITDA, have expired. TAC partially mitigates this risk by actively entering into 12- to 24-month financial hedges.

DBRS Morningstar notes that Brookfield Renewable Partners L.P. (rated BBB (high) with a Stable trend by DBRS Morningstar) along with its institutional partners (collectively, Brookfield) have completed its two-tranche funding in TAC. Brookfield’s investment has supported TAC's effort of reducing corporate debt and provided sufficient liquidity to accelerate the coal-to-gas conversion program. TAC is on track with its plan to convert coal-based generating assets in Alberta to natural gas-based generating assets by 2023, and the conversion costs are significantly lower than greenfield projects. DBRS Morningstar notes that TAC will cease its all of its Alberta coal generation by the end of 2021. Considering the energy-only market in Alberta, DBRS Morningstar expects that TAC's gas-based assets can provide support to system stability and that its hydro assets have significant advantages over other alternatives.

DBRS Morningstar does not expect to take any positive rating action in the near to medium term. However, a negative rating action could be taken if any of the following happens: (1) a material deterioration from the current contractual profile, (2) significant delay or cost outruns in the coal-gas conversion plan, or (3) the modified consolidated cash flow-to-debt ratio falls below 20% and the modified debt-to-capital ratio increases significantly above 50% on a consistent basis.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodologies are Rating Companies in the Independent Power Producer Industry (May 19, 2020, https://www.dbrsmorningstar.com/research/361185) and DBRS Morningstar Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (November 2, 2020, https://www.dbrsmorningstar.com/research/369165), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021, https://www.dbrsmorningstar.com/research/373262).

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 additional 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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